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INTRODUCTION

The explosive growth of international financial transactions and capital flows is one of the most
far-reaching economic developments of the late 20th century. Net private capital flows to
developing countries tripled – to more than US$150 billion a year during 1995 to 1997 from
roughly US$50 billion a year during 1987 to 1989. At the same time, the ratio of private capital
flows to domestic investment in developing countries increased to 20% in 1996 from only 3% in
1990. Hence, this has effected a shift from the national economy to global economies in which
production and consumption is internationalised and capital flow freely and instantly across
borders.

Powerful forces have driven the rapid growth of international capital flows, including the trend in
both industrial and developing countries towards economic liberalization and the globalisation of
trade. Revolutionary changes in information and communications technologies have transformed
the financial services industry worldwide. Computer links enable investors to access information
on asset prices at minimal cost on a real time basis, while increased computing power enables
them to rapidly circulate correlations among asset prices and between asset prices and other
variables. At the same time, new technologies make it increasingly difficult for governments to
control either inward or outward international capital flows when they wish to do so.

In this context, perhaps financial markets are best understood as networks and global markets as
networks of different markets linked through hubs or financial centres.

All this means that the liberalisation of capital markets and with it, likely increases in the volume
and volatility of international capital flows is an ongoing, and to some extent, irreversible process.

It has contributed to higher investment, faster growth and rising living standards. But this can also
give rise to shocks and stresses resulting in financial crisis as we have all witnessed in 1997 and
1998.

Testimonies to the risks of open capital markets are the several waves of instability in the financial
markets in early 1998 and again in the wake of the Russian crisis in August/September 1998. To
illustrate, net private capital outflows from the five countries most affected by the crisis, namely,
Indonesia, Korea, Malaysia, Thailand and the Philippines rose to US $28.3 billion in 1998,
reflecting mainly the decline in net bank and non-bank lending. Meanwhile, foreign direct
investment which had been one of the main sources of growth during the pre-crisis period in
these countries remained sluggish in 1998, amounting to US$8.5 billion as compared to an
average amount of US$17.8 billion during the period 1995 to 1995.

Global trade has experienced a slowdown over the past two years due to trade contraction of
East Asian economies. Generally, world GDP and trade growth slowed in the past 1997/1998 as
the East Asian crisis deepened and its repercussion were felt increasingly outside the region. Asia
recorded the strongest import and export contraction in volume and value terms of all regions of
the world. The dollar value of Asia’s imports registered an unprecedented decline of 17.5%. The
five Asian countries most affected by the financial crisis that broke in mid-1997, that is, Malaysia,
Indonesia, Philippines, the Republic of Korea and Thailand experienced import contraction by
one-third.

In the context of these powerful trends, I like to discuss a few significant the issues relating to
them, particularly from a capital market regulator’s perspective. Given the breadth of the topic at
hand, and in the interest of keeping to time, please allow me to focus particularly on current
trends and difficulties faced in the capital markets.

DEVELOPMENTS IN ELECTRONIC COMMERCE AND CAPITAL MARKET REGULATION


Developments in computer and information technology have made dramatic changes to the way
the financial services industry operates. These changes are affecting and will affect every aspect
of the financial services industry and offer the possibility of reduced costs in raising capital,
greater efficiencies in the mobilisation of domestic and international savings and the provision of
better, cheaper investment products more closely tailored to the needs of different investor
segments. The convergence of computer and communications technology is promoting the
development of computer mediated networks, allowing for users to communicate and transmit
data and other information regardless of boundaries and distance. As communication costs
continue to fall, the potential of outsourcing grows.

These changes will affect –

 The way investment products are offered, distributed and marketed and the way in which
investors access information about the products and entities involved;
 The activities of financial services intermediaries, especially advisers, and the way they
deal with investors;
 The continued blurring of product and institutional boundaries, and even the scope of
financial services sector itself as non-traditional entities take on some of the functions of
financial intermediaries;
 The methods of distribution and marketing of investment products which will increasingly
draw upon the techniques of mass marketed consumer products; and
 The way secondary trading in investment products takes place as greater scope for direct
investor transactions and low cost competitors to established securities and futures
markets becomes more of a reality.

Just as electronic commerce affects investors and providers of financial products and services, it
will affect the role of corporations and capital market regulators. Just as electronic commerce
facilitates activities across jurisdictional borders, it poses in clear terms questions about the
practical enforceability of national laws. As well as practical enforcement questions, electronic
commerce also raises issues about the role that capital market regulators should play and the
effectiveness of many of the traditional regulatory approaches and mechanisms that have been
employed by them. An example might be an offering of securities made without a prospectus or
registration statement on the Internet by a person in a jurisdiction with which the capital market
regulator has no regular contact or mutual enforcement arrangements. There are also concerns
about illegal and fraudulent activity on the Internet.

In this regard, the Malaysian position is that it is committed towards a structured development of
electronic commerce. Towards this end, Malaysia has proposed to introduce a National E-
Commerce Masterplan. This Masterplan should focus on key initiatives which will create
momentum in trading via e-commerce. Besides looking at developing the technological
infrastructure such as telecommunications infrastructure and systems providing for electronic
delivery of goods as well as payment, the Government is also aware that there are legal and
regulatory issues which will arise with regard to e-commerce. Malaysia has introduced several
sets of laws catered towards proper regulation of e-commerce known as ‘Cyberlaws’. The
Cyberlaws which have been introduced include, among others :

(i) Computer Crimes Act 1997

This Act provides for a framework to counter computer offences such as unauthorised access
to computer material, crimes of fraud and dishonesty through the computer, unauthorised
modification of contents of a computer and so on. The Act is not limited by jurisdiction. It has
effect outside as well as inside Malaysia. Where a computer crime is committed outside
Malaysia in respect of computers or data in Malaysia or that which may be connected to or
used in Malaysia, the crime may be treated as a crime within Malaysia and the perpetrator
may be dealt with under the provisions of this Act; and
(ii) Digital Signatures Act 1997

This Act addresses issues of security and authenticity of electronic transactions and it allows for
greater confidentiality and integrity of messages. It allows for businesses to use electronic
signatures instead of hand-written counterparts in legal and business transactions. The Act
provides for the treatment of document signed with a digital signature created in accordance with
this Act to be treated as legally binding as if the document was signed with a handwritten
signature.

The development of an effective regulatory framework is essential in attracting and maintaining


confidence for the world in trading with Malaysian counterparts via electronic means. The
regulatory framework as it stands is currently incomplete as many other areas such as electronic
banking and broking are still in the process of development.

To instil confidence, Malaysia must be able to provide for regulatory certainty and coherence as
well as prevent regulatory capriciousness. In relation to financial services, a major consideration
is cross-border implications. The Securities Commission, as an example, is currently looking at
issues relating to Internet offering of securities and fund management and broking services over
the Internet. A re-examination of current laws would need to be conducted to ensure that they
have not been overtaken by technology and to restructure the laws so that they are technology
neutral.

As far as the capital market is concerned, the Securities Commission recognises that electronic
commerce is an area where it is important that the regulatory infrastructure responds in a positive
and timely way to facilitate market developments and not hinder innovation in market products
and processes. We believe that there are important benefits to be gained through the
Commission’s facilitation of market developments in this area for the competitiveness of the
Malaysian capital market, efficiencies in the operation of our capital markets and the better
making of investors at lower cost. At the same time, the Securities Commission considers that it is
important for the successful implementation of electronic commerce that investors retain
confidence in the integrity of the market for investment products.

LIBERALISATION VS. PROTECTIONISM

On the issue of liberalisation vis-à-vis protectionism, there has been a proliferation of multi-lateral
trade agreements since the middle of the century. Such agreements provide for a framework of
rules within which nations are ‘obligated’ to assure other nations signatory to the agreement of a
sovereign’s approach towards international trade. For example, Malaysia is a member of, among
others, the World Trade Organisation through which it is a signatory to the GATS (General
Agreement on Trade in Services) and GATT (General Agreement on Tariffs in Trade), APEC as
well as ASEAN, all of which have the objective of achieving liberalised trading of goods and
services within specified, albeit not immediate, time frames. Through these trade blocs, Malaysia
has committed itself to progressive liberalisation which essentially entails a gradual opening of
the economy to foreign participants.

The globalisation of economies is intrinsically linked to the internationalisation of the services


industry. It plays a fundamental role in the growing interdependence of markets and production
across nations. Information technology has further expanded the scope of tradability of this
industry. Access to efficient services matters not only because it creates new potential for export
but also it will be an increasingly important determinant of economic productivity and
competitiveness. The main thrusts of the ‘services revolution’ are the rapid expansion of the
knowledge-based services such as professional and technical services, banking and insurance,
healthcare and education. Responding to this phenomenon, regulatory barriers to entry in service
industries are being reduced worldwide, either through unilateral reforms, reciprocal negotiation
or multilateral agreements. Developing countries such as Malaysia are increasingly looking at
foreign direct investment in services as an especially powerful means of transferring technical
and managerial know-how, besides attracting foreign capital and investment to the country.

Malaysia has made a commitment under GATS under legal services covering advisory and
consultancy services relating to home country laws, international law and offshore corporation
laws of Malaysia. Under the GATS commitments, commercial presence of foreign legal firms is
not available except in relation to the Federal Territory of Labuan and in such a case, their
services are limited to legal services given to offshore corporations established in Labuan.
However, there are no limitations placed on the provision of legal service cross-border, that is,
provision of such service from a foreigner without having a legal presence in Malaysia. This may
be done via fax, telephone or the Internet. As stated before, most aspects of legal services does
not need the physical presence of the service provider except perhaps where a court appearance
is necessary. Furthermore, a Malaysian may obtain legal services abroad without any limitation
either.

Malaysia is also signatory to the ASEAN Framework Agreement on Trade in Services (AFAS).
The AFAS is an agreement made within the auspices of the GATS. In very basic terms,
commitments under AFAS are GATS-plus which means that liberalisation of trade is accelerated
within the ASEAN region under the AFAS as compared to the world at large under GATS. Its
ultimate aim is to achieve regional integration and free flow of services within the region. In
achieving integration and free flow of services within the region, many issues would need to be
ironed out. Issues such as harmonisation of professional standards, acceptable levels of
accreditation between member countries, movement of labour in relation to provision of these
services, licensing and certification of service suppliers are still under intense discussion within
the Member Countries. Taking into account the different levels of economic and regulatory
maturity of Member Countries within the ASEAN, it is understandable that it would be a long
process of consultation before a consensus may be achieved.

LIBERALISATION OF CAPITAL ACCOUNT

A most obvious impact of globalisation of trade are pressures exerted on developing nations to
liberalise their financial markets and capital accounts. However, it is important to recognise that
domestic and international financial liberalisation heighten the risk of crises if not supported by
prudential supervision and regulation and appropriate macroeconomic policies. Domestic
liberalisation, by intensifying competition in the financial sector, removes a cushion protecting
intermediaries from the consequences of bad loan and management practices. It can allow
domestic financial institutions to expand risky activities at rates that far exceed their capacity to
manage them. By allowing domestic financial institutions access to complex derivative
instruments it can make evaluating bank balance sheets more difficult and stretch the capacity of
regulators to monitor risks. External financial liberalisation in allowing foreign entry into the
domestic financial markets may facilitate easy access to an abundant supply of offshore funding
and risky foreign investments. A currency crisis or unexpected devaluation (such as in the Asian
crisis) can undermine the solvency of banks and corporations which may have built up large
liabilities denominated in foreign currency and are unprotected against foreign exchange rate
changes.

The ideal free market is one that every one should be free to enter, to participate in and to leave.
However, events in the recent financial crises have led many of us to believe that in the freest of
markets, there is a need to ensure that free flow of capital does not destabilise the market itself.
Indeed, calls for reform have gained increasing support and credence within the international
community with the unfolding of the devastating effects of the crisis beginning mid-1997. The
SC’s work within IOSCO’s Emerging Markets Committee has drawn attention to fundamental
weaknesses in the existing global financial infrastructure that have caused and exacerbated
these effects. These weaknesses include the inordinate power of highly leveraged institutions to
move markets, the destabilising force of volatile short-term capital flows and the failure of existing
credit assessment systems to adequately inform market participants of increasing risk of default.

One example of this mounting consensus was the express recognition by G7 countries at their
recent meeting in Cologne of the need to strengthen the international financial architecture.

There are now increasing calls for greater transparency and regulation of hedge funds and
greater awareness of the dangers of volatile short-term capital flows. To rebuild East Asia and the
global economy, we now urgently need to engage in a sincere discussion about what constitutes
sound governance in the contemporary world.

On the domestic front, we would have to ask ourselves this question: has our financial markets
kept pace with change? Whilst markets have become global, applicable rules and regulations
remain predominantly parochial or local. From a regulator’s perspective, the challenge for us in a
global market is to design the regulatory and structural framework which will allow the market to
function efficiently, competitively in a fair and level playing field environment, ensuring at the
same time that the market is not subject to highly concentrated or destabilising forces that would
disrupt its functioning.

The recent crisis also shows up the need for a careful and sequenced approach towards
liberalising a country’s capital account. The experiences of Thailand, Korea and Indonesia clearly
tells us that there is no prescribed formula on sequencing. However, it is important to recognise
that countries vary greatly in their levels of economic and financial development, in their
institutional structures, in their legal systems and business practices, and their capacity to
manage change in a host of areas relevant for financial liberalisation. It is in recognition of this
that the IMF policy-setting committee and subsequently the Finance Ministers and central bank
governors of the G7 industrial nations, in the fall of 1998, stressed that a country opening its
capital account must do so in an orderly, gradual and well sequenced manner.

Issues of liberalisation versus protectionism would need to be considered at great length to


ensure that a country is competitive in a global trading environment. In a developing nation such
as Malaysia, a protectionist policy towards local financial services industry and industry
participants have been adopted to assist the local industry to develop to international standards.
In the area of financial services, for example, the Government’s stance has been that
consolidation of local financial services providers is necessary to ensure the development of a
core group of strong and stable financial institutions to be able to withstand international
competition when the financial services markets are opened to international participants.

Indeed, the Malaysian experience clearly shows that a premature freeing up of the capital
account, which was done in 1988, without the requisite reforms and institutional arrangements in
order to withstand the shocks, can result in debilitating effects as was faced in the Malaysian
financial services industry.

MALAYSIA'S EXPERIENCE

Perhaps the most important lesson learnt from the Asian financial crisis was the interdependence
of financial markets. Even the most developed economies were not spared of the effects of the
financial turmoil which began as a result of Thailand’s default on its eurobond issue in February
1997. By May, 1997, the Malaysian Ringgit was under severe pressure from currency speculators
and interest rates had risen from between 7% to 9%. It was reported that Bank Negara Malaysia
expended about RM1.2 billion of its foreign exchange reserves to try to stave off the attack of
currency speculators. However, this was the first of many repeated attacks on the currency.

The effects of the currency crisis began to take its toll on the country in 1998. Interest rates were
rising to above 11% and the Ringgit had dipped to an unprecedented low of RM4.71 in January,
1998. All sectors of the economy experienced severe contraction as access to liquidity and credit
became more scarce. Bank Negara had made many attempts to quell the effects of the financial
crisis through imposition of tight monetary policies and attempts to ease credit to certain sectors
of the economy to no avail. But the avalanche would not stop.

Malaysia’s sovereign credit rating was downgraded by international rating agencies to just above
so-called junk bond status. Malaysia was facing a serious credit squeeze. Raising international
capital was prohibitively costly. Flight of capital from the country resulted in a sharp decline in the
stock market which fell to levels of 250 before bottoming out in the second half of 1998.

As many of you are aware Malaysia’s response to the crisis was one that was totally unexpected
by the global community. The Government decided that it needed to protect the economy from
increasing global pressures on the Malaysian economy. On 1 September, 1998 the Government
introduced selective exchange controls with the intention of curbing and preventing further
manipulation and speculation on the Ringgit. The Ringgit was pegged at RM3.80. The
Government took further measures to discourage short-term flows of money by requiring that
inflow of funds should remain in the country for at least one year. On 15 February 1999, this was
replaced with an exit levy for repatriation of capital. The selective exchange control measures
imposed by the central bank on 1 September, 1998 were directed towards reducing the
internationalisation of the Ringgit by eliminating access to Ringgit by speculators and reducing
offshore trading of the Ringgit. This involved the introduction of rules relating to the external
account transactions of non-residents and currency of settlement of trade transactions. However,
general payments, including movement of funds relating to long-term investments and
repatriation of profits, interest and dividends remain unaffected. Payment for the import of goods
and services must be made in foreign currency. All export proceeds must be repatriated back to
Malaysia within six months of the date of export and proceeds from exports must be received in
foreign currency.

The selective exchange control regime is intended to provide the time and opportunity for the
Government to institute the necessary financial reforms in the Malaysian financial markets. This is
in fact in progress in the work of Danamodal (the equivalent of the Resolution Trust Corporation
of the US) to alleviate non-performing loan from banks’ balance sheets and Danamodal which is
to recapitalise the banks. The Government is also committed to consolidating the domestic
financial services industry in having few but strong and viable financial services providers in order
to be prepared for financial liberalisation.

GIVING CERTAINTY TO INTERNATIONAL FINANCIAL TRANSACTIONS AND PROTECTION


TO FOREIGN INVESTMENTS

International trade and finance, because of its global nature, necessarily involves many areas
which may give rise to uncertainty as to the applicability of the contract under which certain trade
and financing arrangements are made. These areas range from political issues and political
stability to sovereign intervention of the economy, certainty of applicable laws as well as
independence of the judiciary.
The Asian lawyer will be fascinated by the rapid changes which are taking place in foreign
investment law both within this region as well as in the rest of the world. In less than half a
century, the states of Asia have moved through a whole range of stances which could be adopted
towards foreign investment. The immediate post-colonial period was characterised by a period of
hostility towards foreign investment, motivated by the belief that the ending of economic
imperialism alone will bring about true independence. The ensuing period was dominated by a
debate about the regulation of multinational corporations and the fear that they posed a threat to
state sovereignty. In this period, laws were devised to control the entry of foreign investment and
the manner in which such foreign investment operated in the host country after entry. The third
and present period is a period of pragmatism where the dominant view is that foreign investment,
if properly harnessed, can be an instrument which generates rapid economic development.
Competition for the limited investment that is available means that each state country which is
bent on a foreign investment led growth strategy must make its laws as hospitable to the foreign
investor as the other state which is also bent on a similar strategy.

As much as there is competition among countries to attract foreign investment, there is


competition among multinational corporations to enter host countries. Whereas previously the
market was dominated by large multinationals, now, there are small and medium enterprises
which can transfer more appropriate technology and bring sufficient assets for investment.

This “open door” policy towards foreign investment in developing countries is typically achieved
through careful screening of entry by administrative agencies which have been established for the
purpose and regulation of the process of foreign investment after entry has been made. After
entry, there is continued surveillance of the foreign investment to ensure that the foreign
investment keeps to the conditions upon which entry was permitted. In this regard, attitudes to
foreign investment protection and dispute resolution will be affected by the new strategies
adopted towards foreign investment.

In the context of the new strategies which have been developed by controlling entry and the later
surveillance of operations of foreign investment, the foreign investment has ceased to be a
contract based matter and had become a process initiated by a contract no doubt but controlled
at every point through the public law machinery of the state. The old notions of foreign investment
protection which concentrated on the making of the contract and the contract as the basis of all
rights of the foreign investor would inevitably become obsolete. This transformation which has
taken place is crucial to the devising of effective methods of foreign investment protection. The
subject matter of the protection has also changed in that not only physical assets of the foreign
investor but his intangible assets which includes intellectual property rights as well as public law
rights to licences and privileges have become the subject of protection.

The proposition that contractual provisions in an agreement concluded with a host country offer
little protection to foreign investment must be qualified in a situation when a bilateral investment
treaty has been entered between the state of the foreign investor and the host country. The result
will be different, for the contract becomes effectively internationalised as a result of the existence
of such a treaty. It is a basic proposition of international law that any matter that is essentially
within the domestic jurisdiction of any state could be internationalised if it is made the subject of
an international treaty. The existence of a bilateral investment treaty which covers the foreign
investment then internationalises the whole process of foreign investment which would otherwise
have been a process that takes place entirely within the sovereign jurisdiction of the host state.
But, whether this result will follow depends on the terms of the bilateral investment treaty.

As a matter of general international law, the position seem to be that a contract between a party
and host country must always be subject to a national legal system. Those who seek to prove the
contrary have an onerous task of showing that his accepted proposition has undergone a change.
There are a few usually uncontested arbitral awards which support the view that a foreign
investment contract is subject to international law or some other supranational system.
Bilateral investment treaties are obviously regarded as important by both capital exporting and
capital importing states. But, these treaties are not uniform and they do not have the ability to
create any uniform law on foreign investment protection. But their existence adds to investor
confidence and creates an expectation of investor protection. The importance of these treaties
lies in the several results they achieve. The first is a signaling function about the national policy
towards foreign investment.

Another advantage is that the foreign investment contract in the context of a bilateral investment
treaties could have the effect of forming assets protected by the bilateral investment treaties. This
will also include licences and other advantages obtained from the government during the course
of the foreign investment. Whereas without the bilateral investment treaty these licences and
advantages may have been without protection under general international law, they new receive
protection as a result of the wide definition of property in the bilateral investment treaty. Whether
the host country did intend that its administrative decisions be subjected to international review as
a result of the treaty, will remain a moot point. But, it remains a possible result if the treaty.

In Malaysia, efforts have been made by the Government to ensure a level of certainty between
international trading partners trading with Malaysian counterparts. The Government has expressly
guaranteed that foreign companies acquiring equity participation in local companies would not be
required to restructure its equity at any time[1]. Further to this, the Government has taken many
steps to increase confidence of foreign investors in Malaysia.

INVESTMENT GUARANTEE AGREEMENTS (IGA”)

The Investment Guarantee Agreement protects parties involved in an international transaction


from non-commercial risks such as nationalisation and expropriation. The IGA will provide a
foreign investor with the following :

 protection against nationalisation and expropriation;


 prompt and adequate compensation in the event of nationalisation or expropriation under
a lawful or public purpose;
 free remittance of currency, profits, capital or other fees on investment;
 settlement of investment disputes either through a process of consultation through
diplomatic channels or if such process fails, for referral to the International Court of
Justice. Disputes in connection with investments, under IGAs should first be resolved
through local judicial facilities. In the event of failure to settle, it would be referred to the
Convention on the Settlement of Investment Disputes or the International Adhoc Arbitral
Tribunal established under the Arbitration Rules of the United Nations Commission on
International Trade Law.

Malaysia has concluded IGAs with about 64 trading nations including trading blocs such as
ASEAN and major trading partners such as the United States of America, United Kingdom,
Germany, Taiwan, etc.

TRADE DISPUTE SETTLEMENT

Another aspect of international trade is the availability of acceptable dispute resolution form.
Globalisation of trade obviously involves greater potential for generating international trade
disputes. The international business community looks for prompt, economical and fair conflict-
resolution mechanisms. Negotiation, conciliation, litigation, and arbitration are well-known conflict-
resolution devices. Direct negotiations and conciliation may resolve a conflict. However, when
parties fail to solve the controversy through direct negotiations, they have two choices: litigation
or arbitration.

Within the context of the GATS, there is an express provision for trade settlement dispute where
countries have disputes in relation to commitments made under the agreement. The WTO have
provided for procedures in relation to a dispute settlement process. The dispute settlement
procedure is considered to be the WTO's most individual contribution to the stability of the global
economy. The WTO's procedure underscores the rule of law, and it makes the trading system
more secure and predictable. It is clearly structured, with flexible timetables set for completing a
case. First rulings are made by a panel, appeals based on points of law are possible and all final
rulings or decisions are made by the WTO's full membership. No single country can block a
decision.

Malaysia is also signatory to the Convention on the Settlement of Investment Disputes


established under the auspices of the International Bank for Reconstruction and Development
that establishes facilities for international conciliation or arbitration. Further to this, the Kuala
Lumpur Regional Centre for Arbitration was established in 1978 with the objective of providing a
system for the settlement of disputes for the benefit of parties engaged in trade, commerce and
investments with and within the Asian and Pacific region.

In conclusion, as we draw close to the new millennium, it is indeed a challenge to us all to be able
to grapple with some of the abovementioned issues and adopt appropriate responses.