Capital markets to 2030 - Global Re-alignment


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What will capital markets look like in 2030?

Our new report ‘Capital markets to 2030: Global re-alignment’ explores how the world’s capital markets might evolve by 2030.

Capital markets link savings and investment making them uniquely vital to economic growth. The coming decades will see a major realignment of global markets but some surprising continuity as well. As emerging markets become more important, developed markets will show unexpected resilience with global investors cautious in the face of uncertainty.

What is most likely to pose the biggest risks for those investing in international capital markets between now and 2030?

What proportion of assets currently invested – as equity or debt instruments – in countries presently considered emerging markets is expected to be invested in 2030?

How will regulation of international equity and debt markets evolve over the long term?

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Capital markets to 2030 - Global Re-alignment

  1. 1. Deutsche Asset & Wealth Management S1 SPECIAL ISSUE Global Financial Institute Your entry to in-depth knowledge in finance Capital markets to 2030: Global re-alignment November 2013 Dr. Paul Kielstra
  2. 2. 2 Capital markets to 2030: Global re-alignment Global Financial Institute Message from Asoka Wöhrmann Dear Investor, Since it’s launch in February 2012, Deutsche Asset & Africa? And, particularly of interest for the wealth manage- Wealth Management’s Global Financial Institute (GFI) ment sector, what implications do the next two decades has brought professional investors a wealth of insights hold for wealth succession? into some of the deep economic, financial, and social themes of our world today and beyond. Its inclusive With the financial crisis now behind us, it is time to look research partnerships with some of the world’s most past the current haze of economic uncertainty to make renowned professional and academic subject-matter- informed, strategic, long-term plans for our companies experts gives its publications unique breadth of per- and our portfolios. “Capital Markets 2030” helps you do so spective, depth of analysis and, as a forward-thinking by providing you with the coordinated research of experts institution, length of horizon. in both Deutsche Asset & Wealth Management and EIU, based in no small measure upon global interviews and sur- Today, I am proud to introduce you to the “Capital veys of hundreds of C-level executives such as Jim O’Neill, Markets 2030” series, a collaboration between GFI and academics such as Prof. Barry Eichengreen (who also hap- the Economist Intelligence Unit (EIU), aimed at offer- pens to be on the board of Global Financial Institute), regu- ing readers an educated look into the global invest- lators, and others who will influence the future of capital ment landscape of tomorrow. This series of publica- markets. All signs point to a major realignment of global tions seeks to answer some of the big questions that markets in the coming decades. Where will you be, and all investors probably ask themselves about the road where will your money be, when that happens? ahead. How will demographic shifts impact the capital markets of developed economies? What is the like- With these thoughts in mind, I invite you to take full advan- lihood of our generation experiencing another finan- tage of the rich and relevant content this series has to offer. cial crisis during its lifetime? What are the biggest 2030 may not be right around the corner, but it is close risks and opportunities to be highlighted in emerging enough to affect our financial decisions today. capital markets? How about frontier markets such as Happy reading, Yours truly, Dr. Asoka Wöhrmann Co-Chief Investment Officer Deutsche Asset & Wealth Management
  3. 3. 3 Table of contents Global Financial Institute Table of contents Executive Summary............................................................. 05 About the Research.............................................................. 07 1. Introduction: Facing the future positively but 1.1. Hopeful but guarded .......................................................... 09 1.2. Exploring uncertainties rather than making warily......................................................................................... 09 predictions ............................................................................. 11 2. Uncertainty I: The future of globalisation.................... 13 3. Uncertainty II: The impact of changing eco- 3.1. More money in emerging markets................................. 15 3.2. The implications.................................................................... 15 nomic geography................................................................. 15 4. Uncertainty III: Whither regulation?............................... 19 4.1. The prospects for regulatory convergence................. 19 4.2. Getting regulation right..................................................... 20 5. Uncertainty IV: The shape of the market...................... 21 5.1. Evolving marketplaces........................................................ 21 5.2. Technological surprises in store?.................................... 22 5.3. A different mix of securities.............................................. 23 5.4. A changing mix of strategies............................................ 24 5.5. Why sustainability is important for investors............. 26 6. Uncertainty V: From where will the next crisis 6.1. Government debt................................................................. 27 come? ....................................................................................... 27 6.2. Inflation.................................................................................... 28 7. Conclusion............................................................................... 30
  4. 4. 4 Capital markets to 2030: Global re-alignment Global Financial Institute Introduction to Global Financial Institute Global Financial Institute was launched in Novem- institutions are hundreds of years old, the per- ber 2011. It is a new-concept think tank that seeks fect place to go to for long-term insight into the to foster a unique category of thought leadership global economy. Furthermore, in order to present for professional and individual investors by effec- a well-balanced perspective, the publications span tively and tastefully combining the perspectives of a wide variety of academic fields from macroeco- two worlds: the world of investing and the world nomics and finance to sociology. Deutsche Asset of academia. While primarily targeting an audi- & Wealth Management invites you to check the ence within the international fund investor com- Global munity, publications white papers, interviews, videos, podcasts, and are nonetheless highly relevant to anyone who is more from Deutsche Asset & Wealth Manage- interested long-term ment’s Co-Chief Investment Officer of Asset Man- views on the economic, political, financial, and agement Dr. Asoka Wöhrmann, CIO Office Chief social issues facing the world. To accomplish this Economist mission, Global in Financial Institute’s independent, Global Financial educated, Institute’s Financial Institute Johannes website Müller, and regularly for distinguished publications professors from institutions like the University of combine the views of Deutsche Asset & Wealth Cambridge, the University of California Berkeley, Management’s those the University of Zurich and many more, all made of leading academic institutions in Europe, the investment experts with relevant and reader-friendly for investment profes- United States, and Asia. Many of these academic sionals like you. About the Economist Intelligence Unit The the a variety of pieces covering the financial services world’s leading resource for economic and busi- Economist Intelligence industry including the changing role relationship ness research, forecasting and analysis. It provides between the risk and finance function in banks, accurate and impartial intelligence for companies, preparing for the future bank customer, sanctions government agencies, Unit financial (EIU) is and compliance in the financial services industry, and academic organisations around the globe, inspir- institutions the future of insurance. A published historian, Dr. ing business leaders to act with confidence since Kielstra has degrees in history from the Universi- 1946. EIU products include its flagship Country ties of Toronto and Oxford, and a graduate diploma Reports service, providing political and economic in Economics from the London School of Econom- analysis for 195 countries, and a portfolio of sub- ics. scription-based data and forecasting services. The the charitable sector. He has worked in business, academia, and company also undertakes bespoke research and analysis projects on individual markets and busi- Brian Gardner is a Senior Editor with the EIU’s ness sectors. The EIU is headquartered in London, Thought Leadership Team. His work has covered a UK, with offices in more than 40 cities and a net- breadth of business strategy issues across indus- work of some 650 country experts and analysts tries ranging from energy and information tech- worldwide. It operates independently as the busi- nology to manufacturing and financial services. In ness-to-business Group, this role, he provides analysis as well as editing, the leading source of analysis on international project management and the occasional speaking business and world affairs. role. Prior work included leading investigations arm of The Economist into energy systems, governance and regulatory This article was written by Dr. Paul Kielstra and regimes. Before that he consulted for the Commit- edited by Brian Gardner. tee on Global Thought and the Joint US-China Collaboration on Clean Energy. He holds a master’s Dr. Paul Kielstra is a Contributing Editor at the degree from Columbia University in New York City Economist Intelligence Unit. He has written on and a bachelor’s degree from American University a wide range of topics, from the implications of in Washington, DC. He also contributes to The political violence for business, through the eco- Economist Group’s management thinking portal. nomic costs of diabetes. HIs work has included
  5. 5. 5 Capital markets to 2030: Global re-alignment Global Financial Institute Capital markets to 2030: Global re-alignment Written by A Global Financial Institute research paper written by the Economist Intelligence Unit November 2013 Executive Summary Capital markets link savings and investment, making them McKinsey Global Institute show that foreign direct invest- uniquely vital to economic growth. The coming decades ment and broader international capital flows remain sig- will see a major realignment of global markets but some nificantly down from pre-2008 levels – in the latter case by surprising continuity as well. As emerging markets become 61% in 2012. Most experts eventually expect a resumption more important, developed markets will show unexpected of financial integration, albeit at a slower pace than before. resilience with global investors cautious in the face of Similarly, survey respondents predict greater integration uncertainty. This Economist Intelligence Unit study spon- of capital market institutions, although typically at the sored by Deutsche Asset and Wealth Management takes a regional rather than global level. longer view, considering how the world’s capital markets might evolve to 2030. In so doing, it aims to shed light Contrary to popular expectations, the United States will both on how the industry expects a range of today’s issues remain the world’s leading financial power. This is despite to play out, as well as – crucially – some of the potential a major shift towards the capital markets of emerging implications of such developments for tomorrow. It draws economies. Respondents expect that having substantial on a detailed survey of 353 senior executives from compa- investments in emerging markets will become the norm: nies active in capital markets; in-depth interviews with 16 the proportion with under a quarter of assets invested in experts, corporate leaders, and senior executives; as well as these economies is expected to plummet from 60% today substantial desk research. Its key findings include: to 24% by 2030. At the same time, those surveyed say that by then the United States, China, and India will have the Those involved in capital markets are guardedly optimis- foremost equity markets, and the US, China, and Japan tic despite the global financial system’s unresolved risks. the most important debt ones. A slim majority (54%) also Between 60% and 70% of survey respondents expect that expect the American dollar to remain the global reserve by 2030 global capital markets will have each of greater currency through the coming decades. depth, efficiency, and liquidity. In every case, only 10% or fewer foresee deterioration. Investors remain justifiably As the challenge for regulators moves toward implemen- concerned, with 65% of survey respondents stating that tation of the large and complex new rules devised since increased regulation to capital markets since 2008 has not 2008, survey respondents expect informal, regional con- addressed underlying risks to the system. Magnus Böcker, vergence: Informed observers speak about both the sub- CEO of the Singapore Exchange, reflects the general mood: stantial progress made in devising new regulation since “I am very optimistic about what I can see happening and the Global Financial Crisis and the extensive work that about what capital markets could do. When I say that, remains unfinished. Many agree, however, that implemen- though, [I am aware that] it will be a bumpy road with its tation is now a major priority. Most survey respondents fair share of up and downturns.” believe that the process will lead to regulatory convergence at a regional level rather than a global one and that The stalled globalisation of capital markets is likely to this will happen through cooperation or extraterritorial resume at a slower pace than pre-crisis, but downside risks legislation instead of formal agreements. One perhaps sur- remain: Data from the Economist Intelligence Unit and prising driver of convergence should be the competitive
  6. 6. 6 Capital markets to 2030: global re-alignment Global Financial Institute advantage for markets that strong regulation is seen to transactions, compared to only 23% who disagree. Experts bring. As Isabelle Vaillaint, director of regulation at the interviewed for the study, though, are split. Some point to European Banking Authority, puts it, “Before the crisis, innovations such as peer-to-peer lending as being poten- competition in regulation was toward laxer rules. Now it tially very disruptive. Others stress that predictions of is going the other way.” On a darker note, several experts technological disintermediation of financial markets have expressed concern that the current political environment been around for years and never come to pass because of might lead to irrational regulation harmful to the industry. the value intermediaries can bring. Respondents predict that exchanges will be dominated by Survey respondents have substantial concerns about gov- regional and global players trading a wider range of securi- ernment debt and the potential for renewed inflation in ties than today: As a fixed cost industry, bigger is cheaper the coming year: Over half believe that government debt for exchanges, but most respondents foresee the market is “very likely to have a debilitating effect” on national being shaped by a mix of regional and global exchanges capital markets in all of Germany, France, the United King- for both equity and debt in 2030. This reflects demand: dom, China, India, Brazil and Japan before 2030; more than small and medium sized companies tend to tap local three-quarters say the same of the United States. Majori- capital markets and many investors have a home coun- ties also expect American and Chinese debts to have such try bias. Meanwhile, while respondents see off exchange an impact on international markets. Most experts acknowl- equity investments becoming more attractive faster than edge the potential danger of elevated national debt levels publicly traded shares, they also foresee growth in inter- but a number point out that uncertainty over its precise est in exchange traded government and corporate debt. economic impact means it might prove not to be such a Robert Greifeld, CEO of NASDAQ-OMX calls this part of a major problem. Meanwhile, more than four in 10 respon- broader shift. “We see exchanges evolving to include more dents say that each of US dollar, the Chinese renminbi, and and more asset classes,” because of growing regulation on the euro will see inflation levels which will have a substan- transparency and the liquidity benefits such markets bring. tial negative effect on international markets by 2030. EIU projections are much more benign, but any rise in inflation Technological surprises are likely according to those sur- as economies recover, if not carefully watched, carries the veyed: Sixty-six percent of respondents believe that IT will potential to grow uncontrolled. create new business models for aggregating capital or linking up counter-parties. Moreover 41% agree that new technology will make it harder to regulate international capital
  7. 7. 7 Capital markets to 2030: global re-alignment Global Financial Institute About the Research The report is based on a survey of 353 senior executives Magnus Böcker, CEO, Sinagpore Exchange from companies active in capital markets. Of these, 47% Julian Callow, Chief International Economist, Barclays are asset managers or institutional investors. (These are Stephen Cecchetti, Head of Monetary and Economic roughly evenly divided by size, with 32% managing under Department, Bank for International Settlements $10 bn in assets, 36% managing between $10 bn and $50 Ranu Dayal, Senior Partner, Boston Consulting Group, Delhi bn, and the rest managing over $50 bn). The remaining Romain Devai, Research Manager, World Federation of respondents are from companies that provide non-finan- Exchanges cial goods and services (32% of the total) and banks or Richard Dobbs, Director, McKinsey Global Institute on Cap- licensed deposit takers (22%). These latter types of compa- ital Markets nies also include a range of sizes, with 57% having annual Bernard Dumas, Professor of Finance, INSEAD incomes of over $500 m, and 26% over $5 bn. The survey Barry Eichengreen, Professor of Economics and Political sample is senior, with 57% C-level or above. Respondents Science, University of California, Berkeley are also distributed globally, with 32% based in the Asia- Thomas Finke, CEO, Babson Capital Pacific region, 30% in Europe, and 22% in North America, Robert Greifeld, CEO, NASDAQ-OMX with the remaining 16% from the rest of the world. In addi- Ian Linnell, Global Analytical Head, Fitch Ratings tion, the EIU conducted 16 in depth interviews with leaders Jim O’Neill, Retired Chairman, Goldman Sachs Asset from stakeholder companies and organisations – including Management investment firms, banks, regulatory agencies, exchanges, James Poterba, Professor of Economics, Massachusetts and international associations – as well as academic and Institute of Technology other experts as well as substantial desk research. Isabelle Vaillant, Director of Regulation, European Banking Authority The Economist Intelligence Unit would like to thank the fol- Nigel Vooght, Global Leader, lowing participants in the interview programme for their PricewaterhouseCoopers time and expertise: David Wright, Secretary-General, International Organisation of Securities Commissions Financial Services,
  8. 8. Global Financial Institute 8 Capital markets to 2030: global re-alignment 34% Yen $ 2030 Don’t know and beyond 1% 5% 2001 Source: World federation of exchanges US 66% China 53% India 35% Japan 24% UK 22% Most important equity markets 2030 62% 9% 30 25 20 15 10 5 68% US 45% China 30% Japan 28% UK 26% Germany Most important debt markets 2030 concerned that US government debt will harm international markets by 2030 21% 2012 Latin America and Asia (excl Japan) have already grown to 26% of global market capitalisation Evolution not revolution market change to 2030 Lack of knowledge of foreign market Euro $ € ¥ Dollar 2025 2030 ~40% expect inflation in these currencies to have a substantial negative effect on global capital markets 2020 Most respondents expect the US dollar to remain the global reserve currency beyond 2030 2015 % of respondents The Future of Capital Markets 34% What’s holding back financial globalisation 39% Concerns about rule of law in some large foreign markets of respondents from the developed world hold this concern Home or regional markets sufficient for capital needs 41% 21% 46% agree disagree Greater demand for capital 10 20 30 40 50 60 Inflation is a concern across major currencies from emerging market companies and governments will drive up the cost of capital % of respondents 10 30 2030 40 50 Emerging markets cannot be ignored Current 20 60 79% 77% 73% % of assets invested in countries currently considered emerging markets now and projected to 2030 46% 62% Majorities see improvements across a range of issues to 2030 Greater market depth Top financial performers The rest Top financial performers Deeper liquidity of capital markets The rest Top financial performers 54% Increased efficiency of capital markets The rest 53% Closer integration of global capital markets 65% Top financial performers The rest 70 A slim majority expect market regulation to be more effective by 2030 YES 38% but barely a third of respondents think that the underlying issues have been addressed by the increased regulation since 2008 UNSURE 29% NO 33% 69% (has) 65% 48% 52% 5% (unsure) 35% (has not) Respondents are split on whether current metrics and models are sufficient to address systemic risks of respondents believe that IT will create new business models for aggregating capital or linking up counter-parties. Respondent percentages drawn from a global survey of 353 senior executives active in capital markets 47% asset managers or institutional investors 22% banks 32% other industries written by
  9. 9. 9 Capital markets to 2030: global re-alignment Global Financial Institute 1. Introduction: Facing the future positively but warily If money is the lifeblood of the economy, then capital mar- important market institutions; as well as substantial desk kets are its essential circulatory system. Their primary role research – considers how these essential markets are likely is simple: “channelling savings to investment” to use the to develop. Rather than focussing on immediate chal- words of Ranu Dayal, a senior partner in Boston Consult- lenges, however, it seeks to take a longer view, considering ing Group’s Delhi office. The search for ways to do this has, ways in which they might evolve between now and 2030. however, created a complex web of stakeholders, institutions, regulators, and even personal relationships. These 1.1 Hopeful but guarded in turn interact on a vast array of financial instruments The good news is that, despite the difficult period through ranging from straight-forward equities, through arcane which the financial system has recently passed – and the derivatives, to online negotiated peer-to-peer contracts. issues it continues to navigate – survey respondents are The collective assets within this system are huge. The Inter- positive about the long term. Sixty-two percent expect that national Monetary Fund’s most recent estimates, for late by 2030 global capital markets will be deeper, 63% say they 2011, put total global equity, debt, and bank assets at just will be more efficient, and 70% predict increased liquidity. under $260 trillion, or 369% of world GDP. McKinsey, a con- Only small minorities foresee deterioration in these areas. sultancy, relying on different data, puts the figure for 2012 at a somewhat lower but still substantial $225 trillion. None of these developments is given. Although depth and liquidity are difficult to measure at the global level, IMF data When all goes well these capital markets undergird eco- on global assets as a percentage of GDP – a proxy for the nomic growth and development. The recent Global Finan- former – have gone up and down with developed world cial Crisis is a stark reminder, however, of the damage that economies over the last decade rather than heading in any occurs when this circulatory system seizes up. As Bernard particular direction (see chart). Similarly, a European Cen- Dumas, professor of finance at INSEAD, puts it, “Capital tral Bank analysis which considered different ways to look markets are largely the advance reflection of the economy.” at financial market liquidity found that one measure – the This study – relying on a survey of 353 senior executives illiquidity ratio – showed a positive shift in leading devel- from companies active in them; in-depth interviews with oped and emerging economies between the late 1990s 16 experts, corporate leaders, and senior officials from and 2005. Thereafter, though, it revealed an underlying How do you expect global capital markets overall to change in the following areas by 2030? 1% Market depth 22 % 41 % 30 % 6% 1% Liquidity 18 % 51 % 20 % 8% 2% 0% Efficiency 20 % 43 % 28 % 8% 1% 0% Increase greatly 1 2 No change 3 4 Decrease greatly 5 Don't know
  10. 10. 10 Capital markets to 2030: global re-alignment Global Financial Institute Global capital assets as a percentage of GDP 600 500 400 300 200 100 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Source IMF stasis punctuated by negative reactions to crises.1 will be increasing depth, liquidity, and efficiency because Nevertheless, many are confident that economic growth in of those issues. The pessimism is about the timing.” Thomas emerging markets and the recovery of developed ones will Finke, CEO of Babson Capital, an investment firm, is also eventually improve capital markets. Nigel Vooght – global hopeful thanks to greater openness in emerging markets, leader for Financial Services at the PwC – holds that “There technological advances and even the impact of recent Financial market illiquidity indicator for advanced economies and emerging markets Notes: The vertical lines correspond to the terrorist attacks on 11. September 2001, the Lehman collapse in September 2008, and the itensification of the EMU sovereign debt crisis in August 2011. Advanced economies: Australie, Canada, France, Germany, Italy, Japan, Spain, United Kingdom, United States. Emerging market economies: China, India, Indonesia, South Africa, South Korea. Latest observations: July 2012 Source: Datastream and ECB calculations 1 “Global Liquidity: Concepts, measurements and implications from a monetary policy perspective” ECB Monthly Bulletin, October 2012.
  11. 11. 11 Capital markets to 2030: global re-alignment Global Financial Institute financial turmoil. “Coming out of this crisis, the lessons of this optimism may arise from the long time horizon from learned will make financial institutions and investors more now to 2030. Romain Devai, who leads the research team aware of risks and more transparent,” he says. at the World Federation of Exchanges, says “We certainly hope for greater depth, efficiency, liquidity and transpar- However upbeat, survey respondents also remain guarded. ency, but have serious concerns about the extent that is They see significant potential current dangers: 65% say really happening at the moment.” that increased regulation to capital markets since 2008 has not addressed underlying risks to the system, and 1.2 Exploring uncertainties rather than making predictions those surveyed are almost evenly split on whether current Such uncertainty highlights a requirement of any exami- metrics and models are sufficient to address systemic risks nation of how global markets might evolve over time: effectively. the need to avoid hubris. The 17 years between now and 2030 is a long period for markets. If we were looking to Looking at the period between now and 2030, the leading today from the same distance in the past, in 1996, only a risk they most frequently mention for those tapping into rare analyst could have foreseen any of the Asian financial global markets is a renewed global economic or financial crisis, the dot com bubble, and the Global Financial Cri- crisis (cited by 45%). For investors, the bigger worries are sis, let alone all three. For instance, IMF’s key policy issues asset bubbles (45%) as well as financial crises (36%). Some report on capital markets that year dwelt on the dangers of Do you agree or disagree with the following? Please select one for each row 0% 20% Increased regulation of capital markets in many countries after the 2008 financial crisis has not addressed the underlying risks in the system, such as substantial global current account imbalances Current metrics and models are sufficient to effectively address systemic risks (eg, Value at Risk) Agree 40% 60% 65 % 38 % Neither agree nor disagree 30 % 29 % Disagree 80% 33 % 100% 5%
  12. 12. 12 Capital markets to 2030: global re-alignment Global Financial Institute foreign exchange risk to systematically important interna- focuses on the growth of emerging markets, the evolution tional banks. of regulation, and the way the marketplace – especially 2 exchanges – will likely develop. This analysis, in turn, will Instead of attempting to predict the next asset bubble, this indicate the likely contours of development of capital mar- study will examine key uncertainties confronting capital kets over the long term, as well shedding light on the cur- markets in the coming decades as they are identified by the rent challenges facing capital market stakeholders. survey respondents and expert interviewees. The analysis Which of the following events or circumstances are most likely to be the biggest risks for those investing in international capital markets between now and 2030? Please select the top three. 44 % Global economic/financial crises Currency volatility 35 % Asset bubbles 34 % Sovereign debt crisis 33 % Political risk/protectionism/capital controls 32 % Regional economic/financial crises 28 % Deflation 19 % Natural disasters 17 % Legal/regulatory risk 16 % Armed conflict Other, please specify 14 % 0% Which of the following events or circumstances are likely to be the biggest risks for those companies accessing capital from international capital markets between now and 2030? Please select up to three. 45 % Asset bubbles Global economic/financial crises 36 % Political risk/protectionism/capital controls 36 % 35 % Sovereign debt crisis 31 % Inflation Regional economic/financial crises 27 % Currency volatility 27 % 25 % Armed conflict 20 % Natural disasters 10 % Legal/regulatory risk Other, please specify 2 1% International Capital Markets: Developments, Prospects, and Key Policy Issues, 1996.
  13. 13. 13 Capital markets to 2030: global re-alignment Global Financial Institute Global FDI as percentage of GDP 5.0 4.5 4.0 3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source EIU 2. Uncertainty I: The future of globalisation For years conventional wisdom considered ever greater the sure bets they once seemed. globalisation the inevitable direction of travel for capital markets. Now, though, notes David Wright, Secretary- Economic data also point to a slowing – and in Europe a General of the International Organisation of Security reversal – of financial integration in recent years. Global Commissions, “One thing which is becoming less sure is foreign direct investment (FDI) fell by 43% between 2007 how global will we be. Is there a retrenchment from what and 2009, according to EIU figures. Although there has we were seeing?” DHL’s annual Global Connectedness been some recovery in absolute terms, as a proportion of Index – which measures the depth and breadth of glo- GDP, FDI remains well below the pre-crisis peak [see chart]. balisation – in December 2012 reported ongoing “capital McKinsey Global Institute data on broader cross-border market fragmentation” which had grown worse since 2008 capital flows – including lending, FDI, and foreign portfolio rather than improving. One heartening aspect of the cri- investment – tells an even more striking story. These flows sis has been the degree to which countries have resisted – a useful proxy for financial integration – dropped 86% protectionist impulses however, new capital regulations during the crisis and by 2012 remained 61% below their which the US Federal Reserve are looking to implement on 2007 peak. foreign banks operating in the country may, in the words of the Economist, have a “chilling effect…on cross-border The potential for worse to come certainly exists. Mr O’Neill banking almost everywhere.” Jim O’Neill – who recently notes that globalisation is a function of policy decisions retired as chairman of Goldman Sachs Asset Management and the current fashionable hostility to financial institu- and coined the term “BRICs” – is less than sanguine. “I think tions could lead to poor policy choices. He adds, “If the probably the biggest uncertainty about the future of capi- US economy goes into semi-Japanese coma for a long tal markets is whether globalisation itself will survive the time,” that country’s government might act in ways which challenges since 2008. Frankly it is very hard to tell.” He impede global integration. Another danger, says Richard notes that, while emerging markets still view the phenom- Dobbs, director of the McKinsey Global Institute, is that enon positively, “Since 2008 many western countries are governments with large debts “may worry about an exit of full of self-doubt and self-pity. Globalisation is in retreat capital and bring in closet protection, dressed up as con- and taxpayers resent bailing out their own banks, never sumer protection, in order to force capital to build up close mind ones in other countries.” Financial globalisation and to home.” integration are likely to continue slowly but are no longer
  14. 14. 14 Capital markets to 2030: global re-alignment Global Financial Institute Overall, though, few see the world ready to abandon finan- globalisation rather than a reversal. They expect some cial globalisation wholesale. Mr Dobbs thinks that a more internationalisation of various aspects of capital markets likely explanation of the data is that “we are back in line by 2030 including, where people will invest, the nature with the long term trend line [of increasing financial inte- of regulation, and the level at which exchanges operate. gration] and have blown off the froth” that developed in These views give a collective impression that respondents the heady days before 2008. In parallel, Julian Callow, chief see steady coalescing of markets at a regional – and to international economist, Barclays states, “You could argue some extent world level – rather than a resumption of the that just before the crisis there was insufficient awareness speedier financial globalisation of the past. of risk, so some of the flows went too far.” The resultant losses, he adds, have led to some domestication of capital, A closer look at the McKinsey data supports this view. Most but over time, with a better understanding of risk, the pro- of the global drop in capital flows comes from European cess should revert. banks and other investors there re-domesticating assets in the face of perceived higher risks within the continent. Just as important is continuing investor interest in foreign By contrast, capital flows to and from emerging markets markets. Robert Greifeld, CEO of the NASDAQ-OMX mar- have largely recovered their pre-crisis levels. Any apparent ket, calls it “important to recognise that first and foremost reversal of financial globalisation, then, likely results from investors have become global and can access markets very specific causes limited to a particular geographic area. globally.” Moreover, Mr Finke believes, “investors in the Stephen Cecchetti, head of the monetary and economic last five years have been looking to be more international department at the Bank for International Settlements says in their portfolios. That is a process.” In the short term, he that “Europe has been a special case where people have adds, European issues or low returns in some countries been concerned with matching books within European might constrain such activity, but “the desire to diversify countries. Even there, the risks of re-denomination have is there. Relative value across different markets will dictate receded substantially.” timing, but the trend isn’t ending.” Globalisation may be limping, but it is far from dead. Survey data also indicates that respondents see slower Global cross-border capital flows(1) ($ trillion, constant 2011 exchange rates) 1 Includes foreign direct investment, purchase of foreign bonds and equities, and cross-border loans and deposits. 2 Estimated based on data through the latest available quarter (Q3 for major developed economies, Q2 for other advanced and emerging economies). For countries without quarterly data, we use trends from the Institute of Intgernatinal Finance. Source: International Monetary Fund (IMF) Balance of Payments; Institute of International Finance (IIF); McKinsey Global Institute analysis
  15. 15. 15 Capital markets to 2030: global re-alignment Global Financial Institute What proportion of the assets you manage are currently invested – as equity or debt instruments – in countries presently considered emerging markets and what proportiondo you expect in these countries in 2030? 1%1% Current 15 % 19 % 26 % 22 % 5% 3% 2% 4% 1% 6% 2030 6% 13 % 20 % 27 % 12 % 4% 5% 3% 5% 1% 0% 10% 20% 0% 30% 10% 20% 40% 30% 40% 50% 50% 60% 60% 70% 70% 80% 90% 80% 90% 100% 100% 3. Uncertainty II: The impact of changing economic geography 3.1 More money in emerging markets Mr Finke is already seeing such a shift. Since the economic The dramatic growth of developing economies, nota- crisis began, risk-reward calculations are different, he says. bly those of the Asian giants China and India, have “The mind-set has changed. Now people worry about bank- been reshaping much of the world economy for several ruptcies in Spain, not Brazil.” In his own company, he adds, decades. Capital markets are no exception. Mr Vooght “Before the crisis, we made investments in the Asia Pacific calls today’s “biggest shift in capital markets the one region on an opportunistic basis. Since then we have focused to emerging markets, particularly the SAAAME (South on growing our investment operations in Australia and Asia America, Africa, Asia and the Middle East) countries.” To to complement our long time presence in the US and Europe. take just one measure, according to the World Federation We are intent on being a truly global firm.” Looking ahead, of Exchanges (WFE), between 2002 and 2011 the level of Magnus Böcker, CEO of the Singapore Exchange, sees sub- domestic market capitalisation held by Asian exchanges stantial drivers of future growth for capital markets in the outside of Japan rose from 9% to 21% of the global total. developing world, particularly in Asia. On that continent, “in The equivalent numbers for Latin America are 1% and 5%. under 20 years, 2.5 bn people are coming into the middle class. We can cater to their needs only if we get resources Increased investment in emerging markets will drive this to the right places [for economic growth and infrastructure trend further. Survey respondents expect their average building]. This is what financial markets are all about. It is an assets under management in these countries to rise from underestimated challenge.” 26% currently to 39% by 2030, growth which will come from investors in all global regions. Even more important 3.2 The implications than the average increase will be a shift in what is normal. “The unanswered question,” arising from the growth of these Today 60% of respondents say that under a quarter of the markets, says Mr Vooght, “is what it means in terms of their assets they manage are invested in emerging markets. power.” Ian Linnell, global analytical head at Fitch Ratings, By 2030, that proportion is expected to decrease to 24%. expects “a shift in dynamics and a slow erosion in the impor- Those with a small stake will become the exception. tance of traditional capital markets at expense of new ones.” WFE figures show that this change too has already begun.
  16. 16. 16 Capital markets to 2030: global re-alignment Global Financial Institute While exchanges in the developed world continue to of exchanges for initial public offerings by value, and in dominate in terms of market capitalisation, the organisa- 2012 remained in the top 10. Mr Devai says of the Chinese tion reports that in 2012 the National Stock Exchange of exchanges in particular “Because of the size of the country, India had the greatest number of electronic order book they are already huge. If they become international, they share trades worldwide and the Shanghai and Shenzhen will immediately become regional, if not global, actors.” exchanges saw the fourth and fifth highest levels of trad- Those surveyed expect that emerging market exchanges ing by value globally. Between 2009 and 2011, accord- will solidify their places among the world’s leaders. The ing to Dealogic, the latter two were also in the top five most common choices among respondents for which Which of the following economies do you think will have the most important public equity markets for the global economy by 2030? Please select up to three. United States 65 % China 53 % 35 % India 24 % Japan 22 % United Kingdom 21 % Brazil 19 % Germany France 8% Italy 8% Other, please specify Capital will be so international that location will have little relevance 3% 5% Which of the following countries do you think will have the most important bond markets for the global economy by 2030? Please select up to three. United States 68 % China 45 % 30 % Japan 28 % United Kingdom 26 % Germany 24 % India 12 % Brazil 10 % France 9% Italy Other, please specify Capital will be so international that location will have little relevance 3% 4%
  17. 17. 17 Capital markets to 2030: global re-alignment Global Financial Institute countries will have the foremost equity markets by 2030 Less clear than the gain in the relative importance of are the United States, China, and India, with roughly the emerging capital markets is the influence that economic same number expecting Brazil (21%) and the UK (22%) to development in these countries will have on the global be among the leaders. For debt markets, the most frequent cost of capital. Here 46% of respondents expect that selections are the United States, China, and Japan (30%). greater demand for capital from emerging market companies and governments will drive up the price (just 21% Rapid institution building will need to undergird this disagree). Mr Callow describes a growing risk for those who change. The largest barrier to greater use of global capi- access capital in developed countries. So far, public sector tal markets by respondents from developed countries is investors from every region, and even sovereign wealth concern about the rule of law in some markets (41%). More funds, he notes, have often been conservative. They will generally, Mr Dayal sees capacity, especially in the area likely soon look for better returns in different countries. of fixed income, as lacking in the capital markets of some “If you think about countries that have tended to focus on major emerging states, including China. “Markets are still US markets, we must reckon with those diversifying which immature and clearly small relative to GDP,” he says, but may lead to higher interest rates.” adds that “a lot of institutional changes are in train that should lead to dramatic improvements.” Pressing demand Predicting the extent of any change, though, is compli- will help drive these developments. Survey respondents cated because emerging markets will also be sources of in emerging markets are particular likely to see a greater capital. Before 2008, says Mr Cecchetti, “There was some- use of corporate bonds: 37% see them as being among the thing confusing for a long time – capital flowing from poor most likely investments to grow in attractiveness by 2030. to rich countries. That was odd because return on capital is Mr Böcker explains that the infrastructure requirements of higher in low capitalization countries.” He adds that, since emerging Asia will require huge capital resources in the the crisis, the extent of this flow has diminished, but not coming decades. “One of the key ways to make it happen is disappeared. with well-structured bond markets.” Nevertheless, China, the world’s largest developing country Developed Market Respondents Emerging Market Total Respondents Total Concerns about rule of law or political interference in some large, foreign markets 41% 23% 34% Home/regional markets sufficient for needs 39% 39% 39% Lack of knowledge of foreign markets 33% 29% 31% Stricter regulations in your own country 31% 34% 32% Stricter regulations in the receiving country 29% 29% 29% Home/regional markets provide funds at lower cost 29% 28% 29% Lack of resources/personnel to operate effectively in foreign capital markets 28% 29% 28% Home/regional markets have superior legal/regulatory structures 23% 26% 24%
  18. 18. 18 Capital markets to 2030: global re-alignment Global Financial Institute and one seeing substantial growth, remains a net exporter happier with poor legal structures than those in developed of capital –something Mr Dobbs calls “a bizarre paradox.” countries. “Asian households have a very high savings rate,” He expects Chinese savings rates to drop in future, thereby he says. “As household wealth in more and more countries likely driving up the cost of capital. On the other hand, the rises, the proportion of the world population active in willingness of households in that country to shift from con- financial markets will increase. But, for that, the quality of servative bank accounts to equities – another open ques- legal and regulatory institutions has to be improved. If not, tion – might in turn dampen this for some securities. A capital will be pulled back.” bigger question mark for that country, though, will be government policy. The state’s pervasive role in the financial A final noteworthy aspect of survey respondents’ views services sector means that the allocation of capital remains about the future geography of capital markets is the ongo- a largely political choice. Meanwhile, the easy credit the ing importance they expect for the United States. Whatever country has enjoyed as a result of state policies may have the growth of emerging economies, American capital mar- a downside. Both Fitch and Nomura have expressed con- kets are still more likely to be seen as among the leaders of cerns that rapid credit expansion and an increasingly 2030 than those of any other country. Similarly, although a active shadow banking system may be precursors to a significant minority (39%) foresee the dollar losing its sta- financial crisis there. tus as the global reserve currency by 2030, most (54%) see it retaining its place. This partly arises from a lack of obvi- This illustrates how the capacity of emerging market ous successor. The Euro certainly is not ready for the role capital to help meet increasing global demand will also and the renminbi is not a freely traded currency. depend on institutional developments in these countries, such as the development of investment or pension funds. As with globalisation overall, then, the shifting geography Mr Dayal, says that “The mobilization of savings and find- of capital markets should bring a combination of stability ing ways to bring them onto capital markets is no small and change rather than a wholesale transformation. challenge. The creation of large, fungible pools of savings is as important as the gross amount of generated,” in determining how much capital will cost. Moreover, as Professor Dumas points out, emerging market investors will be no
  19. 19. 19 Capital markets to 2030: global re-alignment Global Financial Institute 4. Uncertainty III: Whither regulation? “The biggest [current uncertainty facing capital markets] Looking ahead, Ms Vaillant and Mr Wright agree with many has got to be regulation. The market doesn’t know where other interviewees that a priority now needs to be effective that is going to end up,” says Mr Vooght. implementation – both domestically and internationally – of the substantial body of newly devised rules. This will be His view is understandable. Regulation has long been a no mean feat for in many cases highly complex regulation defining element of capital markets but, in response to the – the latest edition of Basel III contains 509 pages and 78 crisis, the world has seen a wave of changes with the Basel III calculus equations. The way this occurs will do much to framework, America’s Dodd-Frank legislation, and Europe’s shape capital markets over the coming decade. Capital Requirements Regulation and Directive (CRR and CRD IV) only the most prominent examples. Despite the 4.1 The prospects for regulatory convergence extensive work done, progress can be described in dif- A key issue in this implementation will be the degree ferent ways. Isabelle Vaillant, director of regulation at the to which investors and companies will be dealing with European Banking Authority, stresses that “the [regula- broadly similar regulatory regimes worldwide or highly tory reform] programme of the G20 since 2008 has been fragmented ones. The importance of this issue will only more or less covered.” Mr Wright, on the other hand, points grow as the number of countries hosting major markets to the “long way to go” in areas such as shadow banking, increases. Mr Devai explains that “as capital markets have derivatives regulation, and even removing ambiguity from become global, there is a need for co-ordinated global resolution mechanisms. Both are correct. As Mr Cecchetti effort but regulations are national. There is a danger of reg- puts it, “quite a bit has been accomplished, but we are not ulatory arbitrage.” At the moment, says Mr Wright, “there yet in a position where we believe the current structure is is no enforcement at the global level of the standards we the final answer.” For survey participants, the glass is half purport to agree to. We have only the soft tool box, which empty rather than half full. As noted fully, 65% say that is transparency, monitoring, peer pressure, and prayer.” increased regulation has left the underlying issues of 2008 unaddressed. Survey respondents are split on the prospects for Which of the following statements best describes how you see regulation of international equity and debt markets evolving over the long term? There will be regional convergence through cooperation between regulatory authorities 18 % Extraterritorial regulation by different authorities will lead A mix o and to de facto convergence around best practicef reg io n al an d g lo bally co n so lid ated exch an g es d o min ate the market difficulties where regulations contradict Reg io n ally-co n so lid ated exch anges dominate the There will be global convergenceothroughme h ave g lo bal asp irations market, alth ug h so cooperation between major regulatory authorities 31% A variety o f reg io n ally o r g lo bally co n so lidated markets wh ich fo cus o n d ifferen t in d ustrial o r sectoral niches 12 % 30% so me h ave multi-n atio n al o r reg io n al aspirations There will be formal global convergence governed by a A h an d analogous to the common international organisation, ful o f exch an g es co n so lidated at th e World Trade Organisation g lo trade for bal level d o min ate th e market A variety o f reg io n ally o r g lo bally co n so lid ated markets which 0 11 % 24% d ifferen tiate by formal There will be regional convergence governedth emselves by p roviding d regional organisations ifferen t levels o f reg ulatio n/risk 1% 15 % 30% Regulatory regimes will differ even more as countries use them stly n atio n alinternational d o min ate th e market, although Mo to influence exch an g es capital flows Other, please specify 18 % 46% 13% 10 20 11 % 30 40 50 60 70 80 90 100
  20. 20. 20 Capital markets to 2030: global re-alignment Global Financial Institute international convergence. Most believe it will occur at a Looking at the situation from Europe, Ms Vaillant has a sim- regional level rather than a global one and that it will hap- ilar view: “In emerging markets we see that they are willing pen through cooperation or extraterritorial legislation and can pay the price of being very demanding on their rather than formal agreements. Twenty-six percent, on the banks. Convergence in the regulatory framework is tak- other hand, believe that the future holds little change in ing place.” Mr Böcker believes that competition will drive this area, or even fragmentation. progress further: “If you are a newer market, you need to be even tougher when it comes to openness, transparency, They have reason to be unsure. Major regulatory bodies and building trust.” engage in substantial dialogue, but important theoretical differences can impede progress. Mr Wright notes that the 4.2 Getting regulation right United States focuses on the details of legislation when The benefits of convergence depend on having good regu- deciding if other countries’ regulation is equivalent, while lation in the first place. Here, the environment of the last Europe looks at outcomes. Politics are also never far away. few years has left many uneasy. Mr Dobbs says that “the Ms Vaillant explains, for example, that coming to an agree- biggest risk that we have is misregulation that gets dressed ment on a resolution regime “is easy when you are not a up as a reaction to the crisis.” Mr Linnell adds, “While clearly government in charge of public finances and when you needing reform, the financial services industry is an easy don’t have responsibility for financing a backstop regime,” target [of blame] for the financial crisis and a lot of the but that issues of who will pay when things go wrong inev- noise that you hear in the regulatory debate is often driven itably bring complications. not by regulators but by politicians. That doesn’t necessarily make the best regulation long-term.” Mr Vooght agrees One possible driver of convergence in the post-crisis world, that politics, rather than dispassionate analysis, seems to on the other hand, will be a growing sense that strong have the upper hand. “There are no votes in reducing regu- regulation, rather than being a hindrance, provides a com- lation at the moment,” he says. “I would love to be able to petitive advantage for markets operating in a given juris- tell you that somebody is going to say ‘let’s work out what diction. Ms Vaillant notes that, “During the decade before we need,’ but I don’t see that happening.” Instead, layers of the crisis, competition in regulation was toward laxer rules. excessive regulation are a real threat. Now it is going the other way: if you are claiming that you are a stronger regulator, now your banks will attract more Despite clear difficulties, over half (52%) the respondents capital.” Mr Böcker adds “There will always be a flight to believe that market regulation will be more effective by [regulatory] quality. Over time there always is.” 2030 and only 15% think it will be less so. This may be because, as Mr Callow puts it, “the issue of regulation is Survey respondents see the value of strong regulation, but one where the same topics get revisited every decade or are less sure that it will drive change everywhere. Fifty-four so.” Should things go wrong, adds Mr Linnell, “in 10 years’ percent agree that the strictness of regulatory regimes will time we may be looking at whether the pendulum swung remain a substantial competitive advantage for capital too far and resulted in serious unintended consequences.” markets in developed countries for many years to come. Regulations tend to move cyclically, trying to prevent the Only 10% dissent. Several interviewees, though, think this last crisis but struggling to get ahead of the next crisis as inaccurately reflects developing market conditions. Mr yet unforeseen. This should be the heart of financial ser- Dayal takes the finding “with a huge dose of salt. In sev- vices and compliance is no substitute for effective risk eral emerging markets, the regulators are quite studious management. and very focussed on getting the best regulation in place.”
  21. 21. 21 Capital markets to 2030: global re-alignment Global Financial Institute 5. Uncertainty IV: The shape of the market 5.1 Evolving marketplaces The institutions which support capital markets have changed dramatically in the last two decades: in the mid1990s exchanges were wrestling with the implications of electronic trading, while international mergers were some years in the future. Looking to 2030, globalisation, evolving market demands, and new technology will, in Mr Finke’s words, “continually cause markets and [investment] firms like ours to innovate and result in new markets emerging.” Inevitably, the specific direction of evolution is less clear. Survey respondents see the trend toward internationalisation continuing: 60% expect markets to become more integrated. These institutions, however, will not be Which of the following statements describes the most likely trend for debt exchanges by 2030? Please select all that apply. A mix of regional and globally consolidated exchanges dominate the market 54 % Regionally-consolidated exchanges dominate the market, although some have global aspirations 35 % Mostly national exchanges dominate the market, although some have multi-national or regional aspirations 29 % A variety of regionally or globally consolidated markets which focus on different industrial or sectoral niches 27 % A variety of regionally or globally consolidated markets which differentiate themselves by providing different levels of regulation/risk 22 % A handful of exchanges consolidated at the global level dominate the market 19 % Which of the following statements describes the most likely trend for equity exchanges by 2030? Please select all that apply. A mix of regional and globally consolidated exchanges dominate the market 46 % Regionally-consolidated exchanges dominate the market, although some have global aspirations 31 % A variety of regionally or globally consolidated markets which focus on different industrial or sectoral niches 30 % Mostly national exchanges dominate the market, although some have multi-national or regional aspirations 30 % A handful of exchanges consolidated at the global level dominate the market A variety of regionally or globally consolidated markets which differentiate themselves by providing different levels of regulation/risk 24 % 13 %
  22. 22. 22 Capital markets to 2030: global re-alignment Global Financial Institute predominantly global. Only 4%-5% of respondents believe been “redoubling their efforts. We are seeing increased that markets will be so international that their location transparency [across the industry], more effort going into will not matter. Instead, most expect a mix of regional and explaining rating actions, criteria and models – including global exchanges for both equity and debt. greater opportunity to critique them – strengthened internal procedures and controls, and more investment in staff Certain factors favour the creation of global market insti- and better systems.” He also notes a greater willingness of tutions. Mr Devai notes that exchanges are “a fixed cost agencies to critique each other’s work. “It is refreshing,” he industry where a lot is based on IT platforms. At least on concludes, “and gives investors different viewpoints.” paper, there is a clear rationale for regional or global mergers and already you have a few global players.” Moreover, 5.2 Technological surprises in store? existing information technology is more than capable of Although market demand, rather than technological supporting highly global markets. Mr Greifeld explains that determinism, will dictate the shape of markets, technol- “In NASDAQ-OMX’s data centre for US equities, we have ogy has a way of bringing disruptive change by meeting the ability to process every equity trade on the planet, unserved or as yet unrecognized market needs. If anything, probably two times over. The capacity is built, but we respondents expect some surprises along these lines: 66% don’t believe this will be a consolidation point.” Instead, he believe that IT will create new business models for aggre- adds, despite recent sometimes prominent mergers, more gating capital or linking up counter-parties. places to trade exist now than did five years ago. “There is an expanding universe of competitors.” Interviewees, on the other hand, disagree on what the impact might be. Mr Vooght notes that currently technol- One reason for the lack of concentration, notes Mr Greif- ogy is changing markets in a variety of ways, with disinter- eld, is that accounting rules and national regulations dif- mediated peer-to-peer lending being a leading example. ferentiate markets. “A second, dominant factor is that both “Technology allows these things to happen but in a way companies and trading members tend to relate to markets the market doesn’t understand. The consequences will be on local basis.” Mr Böcker agrees. Some global and interna- huge and are cross border. In five years, financial services tional markets will arise, but small enterprises and investors will not look like today as a result.” The big question, he will never disappear. The former “use local capital markets adds, then becomes how to regulate such developments for growth and expansion and [the latter] have a tendency to protect market stakeholders but not stifle innovation. to invest locally. That will continue to be the case.” Survey Respondents expect authorities to struggle with this issue. data supports this view. The most cited barrier to greater Forty one percent agree that new technology will make it globalisation of capital markets is that home and regional harder to regulate international capital transactions, nearly ones are sufficient for their requirements (39%). twice as many as disagree (23%). Even this degree of internationalisation will have knock Mr Devai, in contrast, sees less likelihood of rapid technol- on effects on other capital market institutions. Regulation ogy-driven change disrupting existing institutions. “Disin- is discussed above. Mr Linnell notes that the more inter- termediation has been talked about for years, but hasn’t national markets develop, the more investors will need happened yet. The technology might allow it, but there to understand the risks involved with securities issued are still huge issues in terms of market surveillance, mar- by potentially unfamiliar companies and institutions. He ket resilience, market integrity,” and market liquidity. Mr therefore expects demand for rating agency services to Böcker adds that disintermediation has never occurred on increase. To perform this task effectively, the major agen- the scale predicted because middlemen provide signifi- cies will need to continue with efforts regain the confi- cant value that is especially important in international mar- dence which was damaged as a result of the financial cri- kets. “The ones who benefit most [from these conditions] sis. Mr Linnell believes that, driven by both regulation and are those who deliver trust, transparency and openness.” the need to improve their standing, ratings agencies have Mr Greifeld agrees: exchanges offer “not just technology
  23. 23. 23 Capital markets to 2030: global re-alignment Global Financial Institute but adequate liquidity as well as buying and selling inter- 2030 are equity in privately held companies (38%), and the est across a wide range. Especially as you get into assets third highest is private equity (34%), both of which trade that don’t trade as frequently, you have a stronger require- away from exchanges. Just 25% predict interest in the ment for intermediation.” equity of publicly listed companies to increase. Others are sceptical of such a long term shift toward non-exchange 5.3 A different mix of securities equity. That such a change is likely “is certainly a popular The securities traded within – or outside – capital market- view now,” says Mr O’Neill, “partly due to problems of the places are also likely to evolve in the coming years. Here past and compliance requirements, but I’m not sure it will survey data give contrasting pictures for equities and persist. It will depend on markets: a 10 year rally would other types of assets. The investment classes which survey change it.” respondents say are most likely to grow in popularity by When considering where to invest the assets you manage, what asset classes do you expect will become more attractive between now and 2030? Please select top three. Equity in privately held companies 38 % Real estate 37 % Private equity 34 % Government debt 29 % Specialised investment funds 28 % Corporate debt through bond markets 27 % Hedge funds 27 % Equity in public companies 25 % Commodities 17 % Corporate debt through loan agreements (held either directly or as part of a group) 16 % Options/Futures Other, please specify 7% 0%
  24. 24. 24 Capital markets to 2030: global re-alignment Global Financial Institute Away from equities, things are rather different. Mr Greif- While this activity has raised fears of a bubble in the eld says that “We see exchanges evolving to include more short term, over the longer one conditions point toward and more asset classes. In the post-2008 environment, a greater use of corporate paper to replace of loans. Mr more products will be traded in a transparent, open access Wright explains that “the intellectual writing is toward fashion.” higher capital [requirements for banks than in the past]. Market based financing will therefore take on a hugely new In our survey this is particularly notable on debt securi- and important role.” Mr Callow sees such a development as ties. Government debt (29%) and corporate debt sold a matter of straightforward economics. “Historically banks through bond markets (27%) are the publicly traded secu- have been the main source of financing, but if you are rais- rities which respondents most expect to rise in popular- ing the relative cost of bank loans [through higher capital ity. The latter in particular look set to grow in importance requirements], this will shift the supply of bank credit.” On relative to bank loans as a means of companies financing the other hand, Professor Dumas points out, this practice themselves. Forty-seven percent of those surveyed foresee has limits: “Except for very large firms, bank loans are more alternative lending to corporations dwarfing bank loans by efficient than bonds because someone must do the screen- 2030, compared to just 17% who disagree. ing of borrowers and must monitor their actions. These are the roles of commercial banks. There is no sense in each The trend is not new. In recent years, with banks increas- and every bond investor performing that role.” ingly reluctant to lend, it has accelerated rapidly: as the chart shows non-financial corporate bond liability in the 5.4 A changing mix of strategies United States has been rising exponentially. Corporate The survey data also reveal a shift in how capital market bond issuance has been reaching new heights in much of actors, in particular institutions, will approach investment. the world and, again for non-financial corporations, in 21 The asset allocation strategy which respondents expect of the 38 countries for which the Bank of International Set- to grow most in attractiveness between now and 2030 tlements has data, debt securities are at record levels and is active management (cited by 55%). This comes as no a further seven are within 5% of the highest figure as well. Nonfinancial Corporate Business; Corporate Bonds; Liability (CBLBSNNCB) in the US Billions of Dollars 5,000 4,000 3,000 2,000 1,000 0 -1,000 1940 1950 1960 1970 1980 1990 2000 Shaded areas indicate US recessions. 2013 Source: Board of Govenors of the Federal Reserve System 2010 2020
  25. 25. 25 Capital markets to 2030: global re-alignment Global Financial Institute surprise, given the level of uncertainty expected in the United States are using them. coming years. The expected continued growth in popularity of passive More striking is the extent to which passive investment strategies does not invariably mean an abandonment of strategies also seem set to grow more popular. Twenty- active ones: 26% of all institutional investors expect active nine percent of respondents predict that index tracking and passive strategies to simultaneously be among those will be among those approaches to asset management which grow attractive most quickly. Instead, passive strat- seeing the greatest increase and 21% say the same of pas- egies appear to be filling a specific role. The most recent sive ETF-led strategies by 21%. In total, 41% named at least Greenwich Associates study, for example, found that inves- one of these. Respondents from institutional investors tors tend to use them to provide passive exposure to cer- in particular expect these approaches to become more tain asset classes in their core portfolios and to provide popular: 56% cited at least one passive strategy, nearly as greater liquidity. In other words, active managers are look- many as expected active management to grow more pop- ing at combining both traditional securities and passive ular (60%). This is consistent with other research. Annual tools in the years ahead. surveys over the last four years by Greenwich Associates, a research consultancy, have shown increased interest in ETFs, so that by 2013 18% of institutional investors in the Institutional investors Banks Other Total Actively managed 60% 57% 46% 55% At least one passive strategy 56% 39% 23% 42% Growth focused 29% 34% 57% 39% Balanced 41% 43% 33% 39% Index tracking 41% 28% 13% 29% Absolute return 25% 25% 21% 24% Passive investment (ETF led) 27% 17% 14% 21% Income driven 15% 24% 24% 20% Unconstrained 25% 7% 9% 16% 9% 24% 17% 15% Systematic/Rule-based 10% 17% 13% 12% Momentum based 15% 11% 4% 10% 0% 1% 1% 1% Alternative asset focused Other, please specify
  26. 26. 26 Capital markets to 2030: global re-alignment Global Financial Institute 5.5 Why sustainability is important for investors Over-optimism about the rise of sustainability, however, Financial markets not only allocate capital. They can, can cloud assessments in this field. For example, 60% of through both regulation and collective investor action, respondents, and 77% of those with the best financial transmit ethical and social norms and expectations. results, agree that “Integrated reporting is a strong indi- Accordingly, the last few decades have seen a rise in the cator of a company’s resilience and the ability to deliver profile of advocates of the explicit consideration of moral long term returns.” Only 10% demur. However, integrated choices – most often environmental or social – as part of reporting – the provision of financial and other relevant making investment decisions. data, particularly ESG information in a coherent whole – is still at a very early, conceptual stage. Only in the last year or The highest profile example of this behaviour has been two have pilot programmes been taking place to produce Socially Responsible Investment (SRI), which has devel- such reports, and the International Integrated Reporting oped into an established niche in capital markets. Measur- Council is still drafting a globally acceptable framework for ing its size is difficult, as definitions and SRI strategies vary. the practice. The survey result may represent a statement Some practices, though, have become very widespread: of belief about the future rather than current reality. Eurosif – the European membership organisation for professional investors in this field – reported in 2012 that Ultimately, however, the actual results—not just the per- nearly half of money overseen by European asset manag- ceptions—will prove decisive. Jim O’Neill, recently retired ers formally excluded from potential investment any com- chairman of Goldman Sachs Asset Management, notes panies that produced munitions banned by international that “Investors are trying to give more attention to sustain- treaties. More generally, according to US SIF, between 2007 ability but relative to risk and return, it is tough to have and 2011, the amount held by individuals, institutions, huge influence. When an investor demonstrates that pay- investment companies, or money managers in the United ing attention improves the return and risk profile, then States using SRI strategies rose from $2.7 trillion to $3.7 many will follow.” trillion. The signs are currently that this will eventually happen. Despite such growth, however, explicit SRI investment Although the extent to which good ESG performance cor- remains a minority activity. The rapid rise in the US SIF fig- relates with financial results is an old debate which has ure, for example, mirrored that of the investment industry stubbornly resisted resolution, recent research suggests as a whole: in both years, the numbers represented roughly a link. A 2012 Harvard Business School study found that, 11% of all assets under management. over the long term, companies which adopt strong environmental and policies outperformed those which do not More significant is the attention which the mainstream on share price, return on equity, and return on assets.3 investment community is paying to environmental, social, and corporate governance (ESG) in making its decisions. Just as important is that sustainability is consistent with a In our survey, 53% of respondents say that these issues growing corporate understanding of resources constraints. receive the full oversight of at least one board member, Mr Vooght points to the increasing tendency, especially of and most of the rest are uncertain if they do. More striking emerging market countries, to buy the land which pro- is how far leading companies are ahead on this: 68% of duces resources, be it fuel, food or water. “You are now those who benchmark their companies well above average seeing significant investment in infrastructure and land to at financial performance have at least one board member secure resources for populations.” Companies with appro- focussed on the issue, compared to 47% of those which priate ESG policies will be the ones which can adjust to this are average or below. Nigel Vooght, global leader Finan- reality. cial Services at PwC, explains that addressing this issue has become the norm. “People are far more concerned that Mainstream investors are taking sustainability seriously. If their investments are going into ethical and environmental it continues to deliver good returns, they will stick with it. companies. That is the given. It is what people already do.” Robert G. Eccles et al., “The Impact of a Corporate Culture of Sustainability on Corporate Behavior and Performance”, Harvard Business School Working Paper 12-035, May 2012. 3
  27. 27. 27 Capital markets to 2030: global re-alignment Global Financial Institute 6. Uncertainty V: From where will the next crisis come? One of the safest predictions about capital markets at any Interviewees, by contrast, are less certain over how gov- time is that another crisis will occur, but anticipating its ernment liabilities will affect capital markets. The risks from cause is often futile. Therefore we assess major underlying this borrowing certainly exist. Mr Linnell says that already concerns rather than trying to pinpoint the next bubble. current “levels of debt are flooding the world with government securities. That has a crowding out effect for some 6.1 Government debt sectors.” Moreover, weakened finances leave them less able As a benchmark for other business risks, government debt to respond to any future crisis. “That is a worrying devel- currently has a high profile. Mr Callow expects that rather opment,” he concludes. Looking ahead, Mr Dobbs points than arising in the private sector, “the next crisis, whenever to demographic change driving greater spending in many it is, will more likely be about public debt and how cen- countries, even before some have to deal with “50% youth tral banks are monetizing it.” Respondents have substantial unemployment and need to do something. Government disquiet about this issue. Over half of respondents believe deficits are going to increase. That will be a big suck of that government debt is very likely to have a debilitating capital out of global markets.” Similarly, Mr Cecchetti says effect on national capital markets in all of Germany, France, that the Bank of International Settlements “is very con- the United Kingdom, China, India, Brazil and Japan before cerned about the sustainability of government debt in the 2030 and 76% say the same of the United States. Majorities advanced world. Governments have made promises to also believe that American (62%) and even Chinese (52%) populations. Where are they going to get the funds to do debts are very likely to have such a negative impact on this? At some point there has got to be some kind of limit.” international markets in the same time period. Other experts, though, point to the difficulty in knowing Is the level of national government debt in any of the following countries very likely to have a debilitating effect capital markets by 2030? – National capital markets 77 % United States 59 % India 57 % United Kingdom China 56 % France 55 % Japan Germany Brazil Russia 54 % 52 % 50 % 49 %
  28. 28. 28 Capital markets to 2030: global re-alignment Global Financial Institute how much debt governments can carry. Mr O’Neill agrees 6.2 Inflation that a sovereign wealth crisis is a plausible scenario but Another long term worry many survey respondents share thinks it far from certain. “The world has gone through is the possible impact of inflation on capital markets: 44% periods where this would seem to be possible so many expect that inflation of America’s and China’s currencies times and it has not happened. The big story could be will have substantial negative effect on international mar- how quickly debt becomes not so big a concern in those kets; 42% say the same about the euro. More generally, countries which manage to grow.” Mr Vooght adds that only 4% believe that no currency will suffer from inflation fortuitous developments might ameliorate the risk. For to such an extent as to substantially harm global capital example, he asks, “Will America be able to pay back debt markets before 2030. because of shale gas revenues?” Even if the current debt trajectory persists, he says “No one knows what a sustain- EIU predictions are more sanguine. Forecasts for Chinese able level of government debt is.” Academic research pro- inflation up to 2030 never top 4.2% in any given year and in vides less clarity here than it once seemed to. In particu- most are between 2% and 3.5%. For the United States the lar, the recent public controversy over the implications of figures are between 1.9% and 2.5% for the entire period. errors in the influential writings of Carmen Reinhart and More generally, in no major economy does the projected Kenneth Rogoff have left little clear except that, while a annual inflation rate ever rise above 10% before 2030. correlation exists between higher levels of government debt and lower growth, no number signals a dangerous The danger is that, even if the risks are low, inflation has point of no return. a strong capacity to become unstable when not kept in Is the level of national government debt in any of the following countries very likely to have a debilitating effect capital markets by 2030? – International capital markets 62 % United States 52 % China 39 % Japan India 37 % United Kingdom 35 % France 30 % Germany 28 % Russia 24 % Brazil 24 %
  29. 29. 29 Capital markets to 2030: global re-alignment Global Financial Institute check. It will be a battle central bankers need to fight. As In retrospect, the causes of the next crisis will seem all Mr Callow points out, “It is very likely we will get more infla- too obvious. Their importance to the evolution of capital tion because central banks desire it. We must also expect markets will be substantial as participants and regulators the current output gap and labour market slack will go at seek to avoid a repeat of what will have occurred. For now, some stage over a five- to 10-year horizon. Inflation is com- though, here in particular we see through a glass, darkly. ing back. Will it be slightly higher or unstable? That is the uncertainty.” For which of the following currencies, if any, do you expect that inflation is likely to have a substantial negative effect on international capital markets between now and 2030? Please select all that apply. United States Dollar 44 % Chinese Renminbi 44 % European Euro 42 % Indian Rupee 35 % Brazilian Real 25 % Japanese Yen 25 % Russian Ruble 23 % British Pound 20 % Swiss Franc Canadian Dollar None 13 % 6% 5%
  30. 30. 30 Capital markets to 2030: global re-alignment Global Financial Institute 7. Conclusion This review of the major uncertainties facing capital mar- be mistaken, such group behaviour could create a huge kets from now until 2030 can be made to point to a com- resource misallocation. If history is any guide almost cer- forting, if not particularly dramatic, picture of change tainly nowhere near all of the broadly expected future will amid continuity rather than complete transformation. occur. Stakeholders need to be prepared for the range of These markets look set to resume a steady level of increas- possibilities to which current uncertainties point: a retreat ing financial integration and internationalisation – if not from globalisation in the face of ongoing economic mal- outright globalisation – even as they accommodate new aise; emerging markets driving up capital costs as they stakeholders and institutions from emerging economies. seek to finance their rapid development; fragmented Regulators will push on with finishing the work begun regulation used as a protectionist tool; disintermediation in the wake of the financial crisis and likely find arrange- disrupting existing markets as new entrants find ways to ments, one way or another, that are broadly similar world- provide the sufficient trust for peer to peer trading securi- wide. Exchanges will become more international but local ties that eBay did for second hand goods; a currency crisis players will continue to have an important role, even as all leaving the credit ratings of select sovereigns in tatters; or of these institutions allow for the more transparent sale of shale gas letting America grow out of its debt. an ever wider array of asset classes. Finally, stakeholders will keep an eye on government debt and inflation which The inability to see the future is not a failure. Rather than lend themselves to greater uncertainty. trying to provide an inevitably flawed prediction this piece seeks to help those involved understand the context in This conventional wisdom has an importance beyond the which they make decisions because ultimately, the world possibility – given the reasonableness of its underlying will have the capital markets that it deserves. Rather than assumptions in current conditions – that it will come to the product of nameless forces, these markets are the end pass. What people believe about expected risk and return result of innumerable stakeholder choices which will map will affect how they invest and in turn shape market reality. out the journey for the next 17 years. Whatever else, it will This could create a self-fulfilling prophecy. be quite a ride. If, though, the most common expectations turn out to
  31. 31. 31 Capital markets to 2030: global re-alignment Global Financial Institute Table Summary 2013 Expected for 2030 Top three most important equity markets* 1st United States 2nd Japan 3rd United Kingdom 1st United States 2nd China 3rd India Top three most important global debt markets 1st United States 2nd Japan 3rd France 1st United States 2nd China 3rd Japan Percent investing >40% of assets in currently emerging markets 18% of survey respondents 56% of survey respondents * Note: This is considering Hong Kong separately from mainland China Respondent expectations To 2030 Sources of capital growing in importance 1st Insurance companies 2nd Hedge funds 3rd Sovereign wealth funds Asset classes increasing in attractiveness 1st Equity in privately held companies 2nd Real estate 3rd Private equity funds Allocation strategies becoming more attractive 1st Actively managed 2nd Growth focused 3rd Balanced Leading risks for investors in capital markets 1st Asset bubbles 2nd Global economic crises 3rd Political risks Leading risks for those accessing capital markets 1st Global economic crises 2nd Currency volatility 3rd Asset bubbles Respondents expect improvement in capital markets across a range of factors By 2030 Market depth 62% Liquidity 70% Efficiency 63% Integration 60% Regulatory effectiveness 52%
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