2014.11.28 - NAEC Group Meeting_Adrian Blundell-Wignall
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Transcript of 2014.11.28 - NAEC Group Meeting_Adrian Blundell-Wignall
SESSION 2
BETTER UNDERSTANDING
AND INTEGRATING FINANCE
New Approaches to Economic Challenges
NAEC Group Meeting, 28 November 2014
Adrian Blundell-WignallSpecial Advisor on Financial Markets to the OECD Secretary General,
& Acting Director Financial & Enterprise Affairs Directorate.
The Rolling Bubble in Finance versus
the Need for Sustainable Demand
2
• The past decades has been characterised by rolling financial bubbles, the complex causes of which are rooted a misunderstanding of structural forces: technology, the rapid growth of emerging markets, financial deregulation and innovation.
• Financial deregulation and innovation created a mountain of derivatives and complex counterparty relationships that exploded into a severe liquidity crisis in 2008. These still remain, but are shifting to non-banks.
• The bubble has likely rolled towards illiquid higher yielding assets (especially EME’s), and matching the need for yield in a zero rates world.
• There is no painless path to prosperity. There is instead a need for finance for sustainable demand.
Derivatives Shifting From Banks to
Shadow Banks
3
0
5,000
10,000
15,000
20,000
25,000
30,000
35,000
40,000M
ar-
04
Se
p-0
4
Ma
r-0
5
Se
p-0
5
Ma
r-0
6
Se
p-0
6
Ma
r-0
7
Se
p-0
7
Ma
r-0
8
Se
p-0
8
Ma
r-0
9
Se
p-0
9
Ma
r-1
0
Se
p-1
0
Ma
r-1
1
Se
p-1
1
Ma
r-1
2
Se
p-1
2
Ma
r-1
3
Se
p-1
3
Ma
r-1
4
Se
p-1
4
$US, bn Aggregate Banks Devivatives
Amounts Outstanding of OTC Derivatives
The Emerging Market Bubble in
Corporate Credit
4
50
100
150
200
250
300
No
v-0
8
Feb
-09
May
-09
Au
g-0
9
No
v-0
9
Feb
-10
May
-10
Au
g-1
0
No
v-1
0
Feb
-11
May
-11
Au
g-1
1
No
v-1
1
Feb
-12
May
-12
Au
g-1
2
No
v-1
2
Feb
-13
May
-13
Au
g-1
3
No
v-1
3
Feb
-14
May
-14
Au
g-1
4
No
v-1
4
Feb
-15
May
-15
Index US Tsy Tot Ret 1-3y
US Tsy Tot Ret +10y
Merill Tot Ret EM Credit $
Merill Tot Ret EM Credit EUR
Merill Tot Ret EM Credit JPY
Investment as a per cent of Company Net Sales
5
Debt-to-Enterprise-Value: Japan,
EME’s, USA & Europe
6
0
5
10
15
20
25
30
35
40
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
% Debt / (Debt + Equity) Non-Infrastructure
Expect Banks to be More Constrained
7
• The OECD has been at the forefront of the reform of banks—it proposed a higher leverage ratio and bank separation long before Volcker/Vickers/Liikanen. Now the USA have moved to a leverage ratio of 5% and 6% (GAAP; & 3.9% and 4.6% IFRS). And with its new buffer in the 4.05% to 4.95% range for the UK, well above 3%.
• But the game has moved on now: the next crisis will not be like the last one. Banking will play a reduced role, and non-banks need to play a bigger role. Asset prices will have to play a larger role in investment decisions & the transmission of monetary policy.
• If there is to be another crisis, expect it to look more like 1987—a liquidity crisis in securities markets if monetary policy normalisation is not handled well.
Distance to Default Looking Better: New
NAEC Tool
8
-2
0
2
4
6
8
10
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35 37 39 41 43 45 47 49 51 53 55 57 59 61 63 65 67
DTD DTD End of 2013
DTD End of 2008US Banks European Banks
At 30 June 2014
From Banks to Non-banks in Financing
& the Transmission of Monetary Policy
9
• As banks play a reduced role as liquidity providers, and tend not to have the right business model for very long-term investment, the non-banks will have to step up to the plate in both respects.
• The crucial issue now, is that with safer more constrained banks, who will finance long-term investment and provide liquidity in markets where asset prices will play a larger role in investment decisions & monetary policy transmission.
• New NAEC issues emerge.
Distance to Default: the AQR Remains the
Big Issue for Europe in 2014
10
0
10
20
30
40
50
60
70
80
0
50
100
150
200
250
300
2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
$US, tn$US, tn Private Banks
Central Banks
Insurance Companies
Pension Funds
Investment Funds
Hedge Funds & Funds of Funds
Others
Total Asset of Financial Institutions
World GDP (RHS)
New Policy Issues for NAEC
11
• The LCR & other rules mean that bank broker dealers are pulling back, while products that promise daily liquidity while investing in underlying illiquid assets are rising (e.g. ETF’s). Market makers focus on core client, and are reluctant to absorb large positions. Dealer inventory is falling.
• Demand for yield exceeds new issues, and liquidity premia are being driven down—they are too low now. What happens if interest rates rise, demand slows and exit from illiquid positions is attempted?
• Is QE undermining the role of long-term investors as liquidity providers? they should buy at troughs and sell at peaks, but central banks are smoothing both sides and undermining this role.
More New Issues for NAEC
12
• There is need for finance for sustainable demand—QEgives rise to demand shifting (exchange rates), low trust in the future as normalisation lies in front of us. Sensible expectations about the wealth effects upon exit from QE imply no now easy transmission mechanism from low interest rates to consumption and investment.
• Longevity is rising while terminal (after normalisation) interest rates will be lower—posing real problems for liability matching.
• What do we need to do to increase the sustainable role of non-banks in financing investment and matching liabilities, i.e. patient capital—buy and hold business models for non-banks?
1920 to Today: Real S&P500 and Real
10-year Bond
13
-20
-15
-10
-5
0
5
10
15
20
25
Jan
-20
Jun
-24
No
v-2
8
Ap
r-3
3
Sep
-37
Feb
-42
Jul-
46
De
c-5
0
May
-55
Oct
-59
Mar
-64
Au
g-6
8
Jan
-73
Jun
-77
No
v-8
1
Ap
r-8
6
Sep
-90
Feb
-95
Jul-
99
De
c-0
3
May
-08
Oct
-12
% int rate
Roosevelt devalues against gold
Real S&P 500
Real 10y bond
1920 to Today: Nominal 10-year
Below 4% Again!!
14
0
2
4
6
8
10
12
14
16
18
Jan
-20
Jun
-24
No
v-2
8
Ap
r-3
3
Sep
-37
Feb
-42
Jul-
46
De
c-5
0
May
-55
Oct
-59
Mar
-64
Au
g-6
8
Jan
-73
Jun
-77
No
v-8
1
Ap
r-8
6
Sep
-90
Feb
-95
Jul-
99
De
c-0
3
May
-08
Oct
-12
% US 10-yr 1920 to Today
New Policy Issues are Upon Us
15
• Policy must improve liquidity in bond and derivative markets.
• Policy must bring SME financing more towards capital markets.
• Policy must encourage (not discourage) direct loans by non-banks, and buying private bonds.
• Policy might encourage sale and leaseback markets.
• What policies will encourage long-term equity holding (listed and unlisted)?
• What policies will encourage the infrastructure debt markets?
• What policy will encourage longevity bonds and longevity swaps?
4 Sets of Issues for Policy Makers
16
• There are at least 4 sets of issues to develop investment for growth, but in a sustainable demand framework.
• First regulatory, legal and governance impediments to long-term investment.
--accounting, solvency II, macro-prudential, local content requirements, ownership restrictions, capital controls; treaty frameworks; etc.
• Second the institutions themselves are not prepared:
--credit assessment capability; underwriting framework; origination; operational services.
• Third, public participation in resolving transparency and trust.
--market rules; longevity table benchmarks; reliability of contracts for public utility private sector participation (legal framework).
• Fourth, corporate governance and RBC (environment, local communities, labour); due diligence on global supply chains, etc..