The emergence of sovereign funds in Asia and worldwide caps the huge developments in the regionÆs capital markets since the onslaught of the Asian financial crisis of 1997, says the CIO at one of them: Guan Ong of the new Korea Investment Corporation. But governments cannot depend on these massive funds to protect them from another crisis: that requires the development of local capital markets, he says.

Ong spoke last week in Seoul at AsianInvestor magazineÆs conference on Korea offshore investment, addressing institutional investors and fund distributors.

Noting that itÆs important to understand the crisis and its aftermath in order to appreciate what could occur over the subsequent 10 years from today, Ong says trends such as offshore investment are not just Korean but regional.

Among the most important developments since the crisis are the emergence of sovereign funds, of new markets, of new Asian asset classes and new benchmarks.

Sovereign funds modelled after SingaporeÆs Government Investment Corporation are proliferating. The first was KIC, which has been seeded with $20 billion, but now Beijing is founding an investment company that could invest up to $300 billion of foreign reserves, while markets such as Taiwan, Thailand and Indonesia are considering following suit.

These represent a commitment to diversify central banksÆ massive holdings out of traditional assets. These will serve as enablers û ôpillarsö, Ong says û of financial market development in Asia. TheyÆre not just big, but they are being set up to follow best international standards and practices. They are managing assets, measuring performance and using benchmarks according to global norms, and will help introduce these to local markets.

ôWe arenÆt competing with other sovereign funds,ö Ong notes. ôWe welcome other governments to do the same in order to help develop the Asian financial region.ö

But these funds need markets to invest in. That requires more rapid reform in the region, as well as expanding the geography of Asian investment to new markets. This is already happening in places such as Vietnam, Sri Lanka and Pakistan. But Ong believes æAsiaÆ will over the next decade include Central Asia states as well. ôNot long ago, Bric countries [Brazil, Russia, India, China] were the frontier,ö he says. What today are marginal markets should also benefit from the rise of China and India as world economic powers, while Japan remains a ôreserve engineö.

The past decade has already seen the idea of an Asian bond market become accepted by many global investors. In 1995 the US dollar-denominated market for Asian issuers was $20 billion; today it is $300 billion and this is dwarfed by the size of local-currency bond markets by a factor of 10. A decade ago, emerging-market debt generally meant Latin America; today the development of a local investor base means Asia is decoupling from being pigeonholed as part of the emerging-market debt universe, and coming into its own as a region of global interest.

But this huge regional patchwork of local markets remains stymied by local taxes. Ong says the region will struggle to match its potential as long as withholding taxes on capital gains remain in place for cross-border fixed-income investors.

One reason why Asia 10 years ago was regarded as part of a global emerging-market story was because there werenÆt Asia-focused benchmarks. What few indices existed tended to lump Asia ex-Japan together with either Japan or Australia, which in terms of market cap dominated. Moreover these indices were offered by stock exchanges or newspapers and were not run along professional lines; they did not offer analytics. Local markets remained fragmented and illiquid, particularly for fixed income.

Although some of these stock exchange/publisher indices still operate, the region has seen an explosion of benchmarks and sub-indices offered by global index vendors, providing not just performance data but sophisticated analytical tools. They have also developed regional bond indices in both US dollar and local-currency terms, and included these in their global benchmarks.

Today as Asian investors, both retail and institutional, emerge as serious cross-border investors, the region offers more compelling markets to receive those allocations, Ong says. ôAs Asians investor offshore they also need a diversified home market,ö he says. ôAsia is beginning to build an investment character of its own.ö

The biggest risk, he believes, is if the regionÆs markets were hit by a big downturn, particularly one that proved contagious. But Ong is optimistic, noting that events like ThailandÆs coup and capital controls, and the sharp sell-offs in ChinaÆs A-share market, have not spooked investors elsewhere in the region. But Ong hopes that, as investors do go offshore, AsiaÆs enormous savings pools are prudently diversified outside of emerging-market country funds.