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This article is effectively a manifesto for the new think tank I have set up called New Financial. It’s all about making the positive case for capital markets – but also making the case for better markets and encouraging the industry to raise its game and embrace reform.
Investment banks and asset managers need to start making a more constructive and positive case for what they do and the valuable role that capital markets can play – before it’s too late.
A few billion here, a few billion there, and pretty soon you’re talking serious money. If you combine the apparently limitless capacity of the financial markets for misbehaviour with the regulatory appetite for ever tougher sanctions, you quickly get to some very big numbers.
For European banks, the fines could add to up to more than $100bn , according to a recent report by Credit Suisse. The final bill for the big US banks could be closer to double that.
In the context of this relentless scandal and bad press – whether it’s Libor-rigging, the manipulation of FX rates, sanctions busting or tax evasion - it can sometimes be hard to remember the positive case for what goes on in the financial markets.
As a result, there is a real danger that the vital role that healthy capital markets can and should play in driving sustainable economic growth is being overlooked and possibly even undermined – at a time when the European economy needs capital markets more than ever.
‘The purpose of capital markets is not primarily to enrich the people who work in them’
New Financial aims to address these challenges head on, by making the positive case for what capital markets do, and by simultaneously making the case for better markets. In other words, encouraging the industry to rethink the way it does business, to raise its game, to embrace reform where necessary, and to help make markets work better for the poeple they are supposed to serve.
Back to basics
It may have been lost over the past few decades, but the purpose of capital markets is not primarily to enrich the people who work in them or the shareholders of the banks or asset management firms that employ them. Instead, it is to allocate capital as efficiently as possible into productive investment, and to allocate risk to those parties most able to deal with it. In short, capital markets move money from where it is, to where it is needed.
And they move lots of it. Last year in Europe, the capital markets helped connect thousands of companies, institutions, and governments in need of capital with a giant pool of nearly €20 trillion of assets managed by more than 5,000 different asset management firms of different shapes and sizes looking after the savings, insurance policies and future pensions of hundreds of millions of people. In doing so, they helped raise more than $2 trillion in debt, roughly $1tn in syndicated loans, and a few hundred billion dollars in equity.
While there may be question marks over the social or economic utility of some aspects of the business, secondary markets provide liquidity to investors and in doing so help generate economic growth by encouraging competition for capital and investment in both the public and private sector. The trillions of dollars of bonds, currencies and stocks traded every day helps companies, governments and individuals manage their risk and future liabilities, and underpins global trade. In developing economies, this translates into helping to lift billions of people out of poverty.
For good measure, the capital markets industry in Europe employs hundreds of thousands of well paid staff, whose much vilified pay and bonuses translate into high levels of consumer spending and tax receipts (although this has to be offset against the risk of perverse incentives and the distorting effects that this may have on other parts of the economy).
Making the case
Despite this prima facie case, it is hardly surprising that no-one is making the positive case for the capital markets right now. Some sectors of the industry think it best to wait for the anger to simmer down. Others hope that if they keep their heads down, this will all blow over. Where the case is being made, it tends to be from the narrow perspective of one sector defending its own vested interest against a particular piece of legislation, rather than making a collective case for capital markets as a whole.
Unpopular though the capital markets may be – and that unpopularity is largely self-inflicted – this disjointed and half-hearted response is concerning. Not least because the answer to a lot of the long-term economic problems in Europe is probably more capital markets, not less.
Europe’s battered banks are struggling to deleverage and shrink their balance sheets, and are in no position to help companies borrow their way out of trouble. As people get older they will need mechanisms to save for their retirement that do not involve mattresses, and governments need to find ways of funding infrastructure investments and future pensions liabilities that do not rely solely on tomorrow’s tax receipts.
‘Instead of shouting at the waves, the capital markets industry needs to adopt a more enlightened approach’
Capital markets can play an important role in helping address these challenges. They are not going to replace bank lending altogether, but they can supplement it and provide access to alternative pools of capital with a more diverse range of investors. This should help reduce the negative feedback loop between markets, bank balance sheets and the real economy that has dominated the past five years. A shift from bank-led to markets-led financing would also help reduce the political interference and patronage embedded in some European banking systems, particularly at a local level.
Embracing change
Of course, capital markets are not perfect and making the positive case for them is not a one way argument. ‘More capital markets’ is a deeply unpopular message at a time when the word ‘banker’ has become a generic term of abuse for everyone who works in finance.
The industry needs to address and respond to the growing body of research that shows you can have too much of a good thing, that questions the assumed benefits of ‘financialisation’ and that beyond a particular point (long since passed in most Western economies) finance act as a drag on economic growth rather than as a catalyst for it. Markets overshoot in both directions and access to them can be volatile.
Yet too many people working in the industry still don’t get what all the fuss is about and still think that that things will return to normal. They ignore the need to rebuild what Mark Carney recently called the ‘social capital’ on which much of the industry is based.
Instead of shouting at the waves, the capital markets industry needs to adopt a more enlightened approach. In order to regain the trust of its clients and of policymakers, different sectors of the industry must work not only with each other and but also with policymakers to come up with constructive solutions to common problems. Coming up with a renewed sense of purpose for the capital markets would be an excellent start.
Only by making a more compelling and more positive case for what they do – while embracing the need for significant reform of the way they do it – can capital markets hope to break out of the painful and potentially damaging cycle of having that reform done for them.