Bank Negara, the central bank of Malaysia, has just announced it is relaxing its foreign exchange administration rules to allow domestic institutions and mutual fund portfolios to allocate up to 10% of their assets internationally.

Technically, institutions such as the $56 billion Employee Provident Fund have been allowed to invest offshore, but Bank Negara declined to approve such measures, lest it disrupt the ringgit's fixed rate of MR3.8 to the dollar imposed by former prime minister Mahathir Mohammed in the wake of the Asian financial crisis in 1998.

The central bank's latest annual report indicates it has no intention of ending this pegged exchange rate, but notes the ringgit has been allowed to fluctuate within a narrow band around that level, indicating the peg is becoming flexible. As a result it is possible to allow a limited degree of offshore allocations by institutions.

The central bank has probably timed this liberalization with an expected upswing in the domestic equities market, which would blunt a rush to diversify abroad, says Danny Quant, managing director at Watson Wyatt's Kuala Lumpur office. "So this may not result in a lot of activity right away, although we argue that institutions will benefit from diversification."

Among those institutions expected to be the first to invest overseas are insurance companies and the EPF. Insurers such as Great Eastern Life (its Malaysian arm has nearly $5 billion of assets) and Malaysia National Insurance ($1 billion) as well as foreign insurers such as AIG have the size and capability to invest overseas themselves. According to the new rules, insurers may invest up to 5% of their total assets or 10% of their investment-linked assets internationally.

The EPF is likely to use external managers if it invests abroad. In 1996 it had already decided to mandate four managers for its international debut but was unable to go forward when capital controls came down. (The four managers were Capital International, Lazard Asia, Salomon Smith Barney Asset Management and Schroder Investment Management.) It currently outsources up to 5% of its assets to domestic managers, and has kept in touch with foreign fund houses.

Other institutions such as Socso (the Social Security Organization, $2.6 billion) and Pramodan Nasional (PNB, a financial institution for ethnic Malays, $10.5 billion) would need to first change their internal bylaws or improve their level of sophistication before they're ready to invest overseas.

The liberalisation also covers domestic fund managers. The Securities Commission has always allowed a portfolio to invest 10% of its NAV overseas, and the funds industry badly needs to expand its product range if it is to enjoy sustainable growth. Bank Negara let a few houses such as Hwang-DBS Asset Management to invest overseas, but with only a handful of foreign-invested fund houses in Malaysia (DBS, Allianz Dresdner, Macquarie and Principal are the only ones), there hasn't been any real offshore option for fund investors.

Whether investing 10% abroad will make enough impact on a portfolio to warrant the trouble remains to be seen, but Karen Kaur, an associate at Deacons in KL, says since the Bank Negara announcement this week, she has already seen a number of the bigger fund houses start to change their documentation to allow them to invest overseas.

Bank Negara has also relaxed reporting requirements for exporters, loosened rules on residents' foreign currency accounts - which should offer a fillip to the new but rapidly growing private banking industry, made it easier for non-residents to borrow in ringgit, and allowed forward foreign exchange contracts.