bellwether europe 2012: how to prosper in a zero-growth decade

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BELLWETHEREUROPE 2012 SUMMARY REPORT

As Europe enters a new and dangerous stage of crisis, the corporate world is battling to make sense of the rapidly changing environment. Electorates are not prepared to accept the pain of the austerity measures being imposed on them, the financial system is still in a state of flux, and with Greece’s woes comes a threat to the future of the eurozone itself, combined with the spectre of contagion on countries that are already struggling to pull themselves out of the quagmire. The emerging markets, meanwhile, may be strong in terms of economic growth, but the outlook is tempered by political volatility.

Bellwether Europe 2012 brought together regulators, investors and key figures from the business world to debate the issues. The rescue measures seen so far in Europe have, at best, only bought time – others see it as having wasted valuable time. Confidence needs to be restored, and quickly. As for investors, they need to accept that there is no ‘safe haven’ and should be examining attitudes to risk given the severity of the problems in the developed world.

The conference, sponsored by BNY Mellon (Founding Sponsor) and London Business School (Silver Sponsor), could not have come at a more pertinent time.

BELLWETHEREUROPE 2012HOW TO PROSPER in A zERO-gROWTH dECAdE

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The conference opened with a keynote from Axel Weber, chairman of UBS, and formerly president of the Deutsche Bundesbank. He started on a note of optimism, albeit with significant caveats. “We are not in a zero growth decade but it is a challenge” he said, adding that there would be winners and losers as the story unfolds. While emerging economies may be growing, he noted that this won’t be of benefit to every country in Europe. Core European countries will do better than those on the periphery. Indeed, the policy tightening now evident in emerging markets adds to global slowing, and while there may be a cautious revival in the US, the country still has its own share of woes and cannot expect to be decoupled from events in Europe. Meanwhile, simultaneous deleveraging of the public sector, private households and the financial sector will weigh on the global outlook for years to come.

The rescue measures we have seen so far in Europe have not addressed the root problems. Delegates heard that the same policy discussions we had a twelve months ago are back on the table, and if anything the situation has got worse.

Ambitious and courageous structural reforms need to take place, and while they may be unpopular in the short-term, they will bring long-term gains. And we need to act fast, he warned. Works-in-progress in terms of financial regulation and reform need to be completed quickly to reduce uncertainty and enable financial institutions to plan how

they will make the transition to the new environment. With much debate over austerity measures verses deficit spending, Weber made the point that austerity resulted from a loss of market access and lack of fiscal room to manoeuvre. “When the good times are here nothing is done in terms of reform. We are now limited to deficit-funded adjustment processes. Fiscal budgets have been stretched and that has to change.”

What is needed is decisive intervention from the European Central Bank. LTRO versions 1 and 2 (long-term refinancing operations) and the agreement on Greek debt restructuring have given the impression that we are making progress but they have only bought time, Weber argued. They now need to be exploited by the policymakers and financial institutions.

We also need to worry about the Spanish economy, and its banking troubles. There is the danger of contagion to the rest of the eurozone. Italy, for example, can reform if it is put under no additional pressures from elsewhere in Europe. Meanwhile, Germany should not forget that its banking system may not be as robust as it seems.

The UK government is taking the right steps, delegates heard. “The growth picture is not rosy but it should still outpace the eurozone by embarking on strict austerity programmes to reign in public spending,” Weber added.

Weber also called for a level playing field for banks. While financial reforms are forcing structural changes, and rightly so, it is tough for banks to make the changes. Banks need to move towards new regulatory standards quickly – the markets demand it. But it has to be fair. “The whole logic of having the regulatory process at the G20 level was that at least for these countries you would have the same set of rules and same ballpark parameters on capital liquidity and other issues. But unfortunately I see some of the enthusiasm in the regulatory world waning,” Weber warned.

KEYnOTE AddRESS: Are we facing a zero-growth decade?

Axel Weber, Chairman, UBS


Weber addressed the options available to alleviate some of the pressures in Europe.

• Banks face difficulties in raising the necessary amount of capital. In order to meet their targets, deleveraging will likely be the only meaningful option. This is unavoidable.

• Central banks stepping in to help could be counter-productive in the long term as it incentivises some banks not to address the root cause of the problem.

• Fiscal expansion won’t work. While it may help to stimulate demand during bad times, it could make the whole system in Europe even more unstable if you add to the current amount of debt in the market.

• Reintroducing bond guarantees and ring fencing assets in banks’ balance sheets – this was done in the first round of the financial crisis and should be embarked upon swiftly now.

• ‘Bad’ bank solutions: The German and Swiss approach of taking tainted assets out of the balance sheet. Once you have the bank freed of the tainted assets you can write down these assets. Not just assets but also capital could be transferred into a bad bank, and since that bank has no new business it does not need to hold regulatory capital because it is not a banking institution but a wind-down vehicle. This has helped insulate both tax payers and banks for a long period from losses.

Greece, and the possibility of it leaving the euro, was very much on delegates’ minds. Weber is of the view that it is only the strong country that could leave such an arrangement without being washed away by its legacy debt and depreciating currency after leaving – and there is zero probability of Germany leaving given it is at the core of the eurozone. But what of Greece? Also unlikely given the kudos it gives the country in the region, with countries such as Romania and Albania desperate to be part of the prime club of Europe. Other delegates countered that internal pressures from the electorate may force Greece’s hand – all the average Greek sees is job losses and a reduction in living standards – there may be no option but to leave if they won’t agree to the EU deal.

“The whole logic of having the regulatory process at the G20 level was that at least for these countries you would have the same set of rules and same ballpark parameters on capital liquidity and other issues. But unfortunately I see some of the enthusiasm in the regulatory world waning.”

Axel Weber, Chairman, UBS

To restore confidence in the markets, we need to restore confidence in the financial system but that won’t happen while governments are still propping it up. What we need is a self-sustaining financial system, argued Bill Winters. Government support distorts the function of capital markets. One only need look to the example of the US housing market, which became so fundamentally distorted by such support that it ultimately contributed to the financial crisis.

BASEL OR BUST: How do we achieve financial stability and economic prosperity?

Moderator: Philip Coggan, Capital Markets Editor and Buttonwood Columnist, The Economist

Adair Turner, Chairman, Financial Services Authority

Mario Nava, Head of Unit, Banks and Financial Conglomerates, European Commission

Bill Winters, Founder, Renshaw Bay and Member of the Independent Commission on Banking


But how do we achieve self-sustainability? More capital together with structural reform is the answer, in Winters’ view. While the Basel process initiated the capital debate, it has to be complemented by structural reform, with the ring-fencing of retail and non-retail operations at the core. Winters does not believe this step would have any significantly negative impacts on the economy but the speed of the transition is important and we need to mitigate against any fall-out from a transition happening faster than policy makers are intending because the market is forcing it.

Adair Turner argued that to bring about stability, we need a less leveraged system. “We had too much leverage in some areas of the real economy, we had far too much leverage in banks, and in particular we created a proliferation of leverage contracts within the financial system. We as regulators today are inheritors of a 50 year mistake where we allowed the banking system to become massively overleveraged,” he said.

We also did not have adequate macroprudential focus. “We wrongly convinced ourselves that monetary stability, low and stable inflation, plus a micro approach to regulation were adequate to achieve financial stability. That was wrong as it failed to remember the fundamentally volatile and pro-cyclical nature of bank credit and money creation.”

The challenge now is how to make the necessary progress without slowing the real economy, and the inherent problem with deleveraging is that it is a deflationary process.

We also need to get Basel III right and to be able to present it as final in order to bring certainty. We also have to ensure that macroprudential levers have a stimulatory role. Turner believes that sometimes it is necessary to operate these levers at a national level. He gave the example of Ireland in 2004 to 2006, where it would have been beneficial to have such levers to increase capital requirements on the banks or to decrease loan-to-income within mortgages in order to slow down the credit boom in Ireland, but not in other countries such as Germany. But if that national power exists, there needs to be a central resolution capability if a country is failing to take the measures it needs to. Shadow banking should also come in for further scrutiny.

The role of regulators was examined. It was put forward that with the growth in the number of bodies, there has been a reduction in quality. In some quarters, more needs to be done to attract genuinely experienced people to the roles. The challenge is to hire those that haven’t blown up their own banks, was how one delegate put it.

There are trade-offs in terms of policy verses number of people, it was argued. The higher we can take capital requirements the less we have to be double checking each detail of the capital requirements. Because we had ludicrously low capital requirements it is as if we had designed a road without crash barriers. “As a result we had to crowd the cab full of people looking over the driver’s shoulder because we have a fundamentally dangerous system,” comments Turner.

The UK is moving in the right direction and advice from the Financial Policy Committee (FPC) to the government on the directive powers needed in terms of the macroprudential space will go in to the Financial Services Bill. This includes a counter cyclical capital requirement, a leverage requirement and an ability to vary sector-specific risk weights so you could, for example, slow down a commercial real estate boom without imposing a credit restriction on the rest of the economy.

Debate moved on to that of bankers’ bonuses. It has been argued that they should be limited to no more than annual salary. The reaction of most banks is one of horror as they would have to raise levels of salary higher. This smacks of micro-management to some. But it is an issue that has come increasingly into focus. It was argued that the banks that came through the crisis well were those where bonuses were related to long-term profitability.

“We as regulators today are inheritors of a 50 year mistake where we allowed the banking system to become massively overleveraged.”

Adair Turner, Chairman, Financial Services Authority


Historic changes are afoot. If you looked at trade partners in the emerging markets five or ten years ago, nine out of ten would have been in the developed markets. Now, probably around five or six are between the emerging markets, pointed out Cynthia Steer, who opened up the session by looking at the challenges for today’s investor. Where will they get that seven or eight percent? Steer now finds it easier to get a better sense of the “emerging to emerging” opportunities, compared with the complexities of the developed markets. “This south-south trade, whether you are looking at it from financial flows or trade flows, it is the number one area you have to look at through a multi-class asset allocation to get to the holy grail of investing today for institutional investors of seven to eight percent,” she observed.

So, where does this leave Europe? Rajat M Nag believes that south-to-south cooperation offers more opportunities than threat for Europe, and that is creating new drivers for global aggregate demand. While Europe’s share of trade in the global arena has been declining, its trade with the south has been increasing. Europe has other advantages, too. It is, for example, doing a better job of negotiating Free Trade Agreements than the Asians are doing between themselves. Europe also has first-mover advantage in high-tech areas such as aircrafts and pharmaceuticals, so it needs to exploit these niches. Europe as a time zone has the benefit over America or Asia in terms of emerging markets. It also has deep historic ties.

Some countries are doing well in terms of their export efforts to the emerging world. Germany’s cars are in great demand in Asia. Portugal is making progress – five percent of its exports go to Angola alone, an economy predicted to grow 12 percent this year. But others, such as Spain, are failing to capitalise on trade opportunities with the emerging world. Around five percent of Spain’s exports go to the whole of Latin America, which has been one of the boom stories of the last five to ten years.

There are other opportunities for Europe – for example, in the rate in which emerging markets are borrowing. Latin America corporate borrowing 20 years ago was $20b, four years ago, $60b, today $140bn. “That is your pension fund money going to lend to emerging markets. It will give you a better return and will help support them. Through financial portfolio flows we are going to get the best benefit because we have a lot of savings that need that yield,” was Charles Robertson’s view.

The panel considered the opportunities for investment in the emerging markets. There may be appetite for Asian debt, for example, but is there enough to go around? Not as much as we would like, was the opinion. Investing in specific infrastructure projects offers an alternative.

The conversation turned to equities. A study by the London Business School showed no relationship between GDP growth and emerging markets and investor returns. That is to say that if you chose the country with the highest growth rate in the previous year you ended up with lower returns than countries with lower growth. Why was that? “Emerging markets are a debt culture first then an equity culture second,” said Steer. “I’ve always been pretty agnostic about emerging market equity in terms of the fact that you should be benchmark aware not benchmark sensitive.”

HOW CAn EUROPE BEnEFiT FROM SOUTH-SOUTH TRAdE FLOWS?


Charles Robertson, Global Chief Economist, Renaissance Capital

Rajat M Nag, Managing Director General, Asian Development Bank (ADB)

Cynthia Steer, Head of Manager Research and Investment Solutions, BNY Mellon


Around 12 percent of China’s trade with the world is in renminbi, and over the last three years central authorities in Beijing have encouraged every importer and exporter in China to move from dollar invoicing to the renminbi. Most are keen to do so, delegates heard. Once the renminbi is moving across borders, pools of liquidity are created offshore and financial market products can be developed on the basis of that liquidity. There is increasing interest from foreign multinationals to issue bonds, and Chinese corporates are coming out into Hong Kong, issuing debt offshore and then bringing the funds back.

Over the next five years Hong Kong will be operating as the offshore hub to the CNH markets. The renminbi in London will feed through to Hong Kong, which will provide the bridge back into China. The same goes for Singapore, New York and Sao Paulo: Hong Kong will be the hub to the spokes of the renminbi offshore market.

Why do we need that hub offshore? Trade has been liberalised, everything on the capital account remains controlled. The key for China over the next five to ten years is how to open up the capital account carefully. Holes are being punched through in China’s capital account and these holes will be expanded with the renminbi allowed to flow back and forth through them.

Stephen Green discussed how this offshore experiment can get to a stage where the currency is held by central banks and long-term institutional investors and there is global trading of that currency. We need a more independent central bank in China, we need deeper more liquid capital markets, and we need interest rate reform, was the view.

An independent central bank is unlikely to happen under the present government so there are challenges. While the expansion of the Fed’s and the European Central Bank’s balance sheets expand, China’s balance sheet is bigger and getting bigger more quickly. Of all the M2 money created from the largest 30 economies in the world, 52 percent of it was created in China. This year it will be around 40 to 45 percent. But the monetary growth in China has to be controlled to control the value of the currency. While everyone offshore thinks renminbi is a great bet that will get stronger, onshore this view is challenged by M2 growth and the inflation that creates means that people have a lack of faith in their currency, Green pointed out.

In Asia, capital markets are not as developed on the equities side, and the equity is much more restricted, especially given the significant number of large family-controlled businesses.

The role of Europe’s financial centres was debated. Popular opinion in Europe is against the finance sector – could it be driven elsewhere? London has had the advantage of a cluster effect, bringing the biggest names in the world to the city. But increasingly we are seeing the rise of strong financial centres around the world. Hong Kong, Singapore, and Tokyo will become more prominent. Pools of capital are creating opportunities elsewhere, and the likes of Moscow, Dubai and Istanbul are fighting it out to be the EMEA time zone financial centre.

Whether or not Europe can benefit from the emerging markets remains to be seen – but worrying some delegates is the impact their demand will have on the world. With the growth of China, India and Africa, we don’t have the resources to meet demand.

MARKET SignAL: THE REnMinBi iSSUE

Stephen Green, Head of Greater China Research, Standard Chartered Bank


In terms of interest rate reform, rates are still regulated, and while the central bank would ultimately like to move to a modern central bank system where it sets the overnight rate and banks price their own credit and deposits, this is controversial. But only when you have that system can you start pricing debt off a yield curve and developing a real bond market. We are not there yet.

In terms of opening up the capital account, we have seen a big push to encourage other Asian central banks to come in and invest in onshore debt. Several Asian central banks have bought renminbi debt. China’s renminbi in that respect is already a ‘micro reserve’ currency. What China wants is long-term institutional money and it is paving the way for big institutional money managers to come in and invest in local debt and local equity markets. The State Administration of Foreign Exchange would also like to allow Chinese households, which have assets in renminbi, to take their money offshore.

There is debate in Beijing about whether to reform interest rates first, open up the capital account as priority, or do a bit of both. The new orthodoxy among the International Monetary Fund and all the top economists is that we got it wrong 20 years ago. They argue that in China’s case we should start with interest rate reform and sort out the banks, and when all that is okay move on to capital account reform and internationalisation of the renminbi. China’s central bank has a different idea – it wants to do a little bit of everything at the same time. All this makes policy hard to predict.

So, where is the renminbi heading? In 2002 to 2005 it weakened by about 20 percent and then from 2005 to today it appreciated three percent to four percent a year. There was a big trade surplus back in 2007 and 2008 which has come down but not disappeared, so despite the fact that many funds and people in the markets think that the renminbi is now at fair value, not everyone agrees with this view. Delegates heard that there will be more appreciation but it will be slower – a rise of 1.5 percent against the dollar is a reasonable expectation this year, and about the same for next year. This slowing is deliberate: China’s central bank knows that as they approach the point where the renminbi is in equilibrium more money will come out of the country and they want to manage that process very carefully. If they go too far, people have depreciation expectations and at that point you can see a huge amount of capital coming out through the holes in the capital account they have created (as well as the holes they haven’t which certainly exist). It will be a carefully managed appreciation of the renminbi.

CORPORATE CASHPOinT

Moderator: Scott Moeller, Director of the M&A Research Centre,Cass Business School

Tom Singer, Chief Financial Officer, InterContinental Hotels Group

Simon Henry, Chief Financial Officer, Royal Dutch Shell

Corporates are sitting on huge piles of cash, and given the current economic instability, they seem keen to keep it there rather than invest in the real economy. Various estimates put the figure at between $2.6 trillion and $4.2 trillion worth of cash that is sitting on corporate balance sheets – and at that level it has been argued that 75 percent is excess cash, rather than working capital.

Delegates were asked how they felt the money should be used: give back the cash as a dividend, go out and make an acquisition if there are assets out there, buy back stock, or invest the money. Based on an interactive poll taken at the conference, fully 41 percent think it should be spent on internal growth with stock buy-backs the least popular option.

Tom Singer says it is InterContinental Hotels Group’s priority to invest in future growth – and as an asset-light business model, the business always has surplus cash each year. Its second priority is to have a sustainable dividend policy, especially given the cyclical nature of the industry it is in. Its third call on its cash is to return it to investors through a combination of special dividends and buy-backs.


IHG’s business is focussed on developing its brands, with its hotels typically built by private companies and other hotel owners who have relied historically on the bank credit markets to finance their projects. “In Europe and the US now that is a challenge. The amount of credit available and the terms on which it is available mean it is far harder for people to get their projects off the ground,” he noted. Markets with less dependence on bank credit, such as China, are providing strong growth for IHG. The Chinese government is supportive, recognising the hotel industry is a good source of job creation for the unskilled, helping to pull them out of poverty. Strategy is built on a country by country case – those with high GDP growth are priority as that correlates with future demand for hotels. Turkey and the CIS are high on the list.

Simon Henry argued that the amount that sits on corporate balance sheets is not huge. Shell’s $15 billion may sound a lot but it is 10 days of revenue or 10 weeks of third party purchases of services and goods. “The concept of the corporate ATM being used through the real economy with our customers and suppliers to help replace the banks in terms of providing liquidity and credit it is not going to last very long,” Henry pointed out.

Reflecting the view of the poll, Henry pointed out that of the $40 billion Shell generates each year, three-quarters is reinvested. But he noted that currently less than 15 percent is invested in Europe, despite the company’s European heritage. “What do we look for when we invest? A stable, predictable investment framework, we look for a growing attractive market, and solid human resource capability and technology. Europe currently only scores well on people and technology.”

There is also huge anti-business sentiment in Europe, which corporates in the region are battling against. Sustainable development, responsible behaviour, and transparency will help position corporates as part of the solution not the problem. But they can’t do it alone. It was felt that governments need to make positive statements about the role of business and civil society. While businesses may, or may not, be able to become ‘corporate cashpoints’ what they can do is create jobs, which results in individual wealth and with that the ability of individuals to put that wealth back into the real economy. The most socially responsible thing the business world can do is create good well-paid jobs, and invest in human capability, was the conclusion.

The euro will survive although whether that is in its current format is an open question – but it is in the UK’s interests that it does survive. That is the view put forward by Alistair Darling, who opened the session by arguing that the euro has not lost the confidence of the countries that use it.

However, the austerity policy is failing to deliver. “I don’t think the policy of austerity as currently being practiced in the eurozone is working,” Darling commented. “Any treaty of the sort they have entered into which requires countries at or near recession to keep cutting in order to keep their deficit within three percent of their GDP puts them into a downward spiral,” Darling said.

EURO MARK 2: Looking for signs of life

Moderator: Abhik Sen, Managing Editor, Industry and Management Research, Economist Intelligence Unit

Pierre Olivier Sarkozy, Managing Director and Head of Global Financial Services Group, Carlyle Group

Nikhil Srinivasan, Group Chief Investment Officer, Allianz Investment Management

Right Honourable Alistair Darling, MP


Where do we go from here? Delegates heard that we need a credible plan for survival for Greece – if it doesn’t Europe is at risk of the contagion effect. If the current path is followed, at best there will be no growth, at worse, another crisis. Around Europe, governments need a solid strategy for their countries, and they can make a difference with strong leadership, was the argument.

Pierre Olivier Sarkozy was of the view that a Greek exit would be the easier option for the country. He argued that it would not be catastrophic if it does. “It has become the headline news, it is symbolic, but mathematically it is inconsequential. More focus gets placed on it than rhyme or reason would dictate.”

How do the Greeks themselves see it? “The majority of Greeks know their country’s problems have been building up for years. They can’t collect taxes, people openly don’t pay them, there are a lot of structural problems. My guess is they want to stay in the EU and the euro. The problem arises that if you look at the eurozone settlement, the IMF conditions, it leaves them in eight years time with a debt of 120 percent of their GDP. It is a reasonable conclusion when Greeks say this isn’t going to work,” said Darling.

If Greece leaves, the country will see further turmoil and the EU will have to step in to help a distressed neighbour. Money will have to be spent and Darling argued that it would be far better to try to fix the problems within the framework we have.

The panel debated whether the eurozone had expanded too quickly in the first place in terms of letting in countries that were not ready for that kind of a union. Greece, delegates heard, should not have been allowed in. But once you are in, how do you get out again? You would not have a nice orderly departure. “What would happen if people looked at the value of what they have on a Friday knowing that on the Monday morning it would be very different?” Darling said.

Germany, for its part, wants to keep the eurozone together, and is the biggest believer in the European ideal, but it was pointed out that their frustration with the Greeks for failing to understand they cannot do this in a pain-free way is understandable.

The debate over austerity verses growth continued. It was argued that austerity is always talked about in a pejorative sense but austerity drives are actually reforms – labour, wage, and pension reforms in particular – and action was needed to address these issues. Despite impatience on the part of the markets, and opposition from the electorate, we need to continue along this road and cannot expect to see the results overnight. It was added that we are seeing a failure of the political class to educate the electorate on the seriousness of what is happening. “People do not understand how close we are to a major calamity – with the result that we have a wave of unseating of incumbent governments. Irrespective of whether they are right or left, if they are in or they are out,” said Sarkozy.

It was also discussed whether a Europe-wide bank recapitalisation programme will work. While the system needs to be stabilised, recapitalisation won’t solve the problems, it was argued. What is needed is to get wholesale funding markets refinancing the bonds that are coming due in the banking system. Right now that market is frozen, which is causing banks to sell assets to raise cash to repay liabilities. It is this that is disrupting sovereign debt markets. Banks have been the biggest buyers of that debt and have now been forced to become the biggest sellers.


There is no such thing as risk-free, was Jerome Booth’s opening warning, and our view of what is a ‘safe haven’ is very much askew when it comes to investment. We have to recognise that markets are volatile no matter where they are rather than being swayed by what are often long-held prejudices. We must also challenge the illusion that investing in European sovereign bonds or treasuries is somehow safe.

In Europe we face more risk than the emerging markets, it was argued. Rich countries default by other means – devaluation, or by changing contracts with its pensioners, for example, but they still default and rob you, even if that is over time by not providing the same economic value. There is also more risk in the attitudes of the electorate. In poor countries, people will vote for macro prudence. In Colombia the electorate even voted for the candidate they didn’t like because he had majority in the congress and could pass the measures required. In the developed world, the electorate votes for the version of reality they prefer.

The very term emerging market was debated. There is the argument that it is now so heterogeneous that we should get rid of it. If you take the view that all countries are risky, the one thing so-called emerging markets have in common is that the risk is priced in whereas in the developed world, the risk is completely ignored. “Eventually we will get rid of the term emerging markets not because they graduate or become less risky but because the developed world starts to behave in a more efficient way, and bond markets price in risk in a sensible way.” To do that, we have to understand the details of markets, of investor bases, of politics, and of structural change. We also have to look at what political risk really means. As an investor, it should only mean politics or policies that adversely affect the returns to the foreign investor.

In Europe we are seeing financial repression, which Booth describes as any policy that captures institutional savings in order to fund the government and to do so at lower interest rates than would otherwise be possible. The fast implementation of Basel III, for example, is an attempt to corral institutional savers to invest in pretty high risk and not even high returning paper in a way that creates systemic risk. It also creates a greater homogenisation of the investor base over time. “By affecting the price artificially it forces the freer investors who can think for themselves and who aren’t so regulated to go and invest elsewhere,” he says, adding that we have seen this with US treasuries and with European sovereign bonds. “We have got to realise there is no easy way out.”

Delegates wanted to know Booth’s view on valuing stocks in the emerging markets. ‘Don’t try this at home’ was the warning. “The answer is every company is risky and if you go into equity you are going for risky asset classes. If you have less information than someone else you are taking on more risk. Part of the problem of managing in a complex arena such as emerging markets equities is people do it in an unsophisticated way and don’t take the trouble to find information they need. The information is out there.”

MARKET SignAL: Where is it safe to hide? Re-examining the investors’ safe havens

Jerome Booth, Head of Research, Ashmore Investments


John Kay opened the debate by challenging the conventional view of the importance of the equity markets and who they are actually serving. Equity markets are secondary markets, not primary markets, it was argued. Equity is not a significant source of funds for new investment in UK business and British listed companies are predominantly self financing – cash generative not cash demanding: “Anyone who thinks that equity is a major or even significant source of funds for new investment in UK business has not understood how markets today function,” said Kay.

But equity markets are far from being unimportant as they are a mechanism of corporate governance and the mechanism by which the market oversees the internal process of capital allocation within companies. It also allows early stage investors in business to get liquidity from their investment. They are no longer a means of getting money into companies but rather of getting it out.

Who holds these shares has also become more diversified. It is not now the preserve of UK pension funds and UK insurers, which today own less than 20 percent of total UK equities; the major players are asset managers. Foreign ownership is also more significant.

We also have a greater amount of intermediation with a tangle of registrars, custodians, pension fund trustees, and so on, each with their own compliance specialists and auditors. Consequently, costs have risen and the scope within that chain for differences in objectives is substantial, raising questions over whether they really are serving the needs of the customers, whose money it is. While the asset management process may improve the underlying performance of companies, what are the returns to the people at the end of the investment chain? Lower costs and fewer layers of interconnection between the savers and the company making use of the money is needed. It was argued, however, that price competition is ineffective – much like a saying you may not be the best doctor in town but you are relatively cheap.

The conference moved on to address the issue of a lack of funding for small to medium enterprises. How do we get funding to that part of the economy? It is not that the banks won’t lend but the conditions they impose are too onerous. The amount of money lent to SMEs is small and part of the problem is that the expertise in small business lending within the large banks is not being used in the right way.

Should venture capital play a larger part? The nature of venture capital has changed a great deal over the years and we need to get back to the old Silicon Valley-type purpose of providing early stage funding for new businesses. Angels might be a way forward with local affluent individuals better placed to do the necessary micro research.

Pension funds and insurance companies could provide a suitable source to help stimulate that area of the economy, it was felt, and are natural lenders to this area if they have the expertise. There is no major regulatory barrier and so long as pension funds and insurance companies are investing in a way that maximises the return for a given amount of risk they are able to take, there shouldn’t be any real blockage on those assets flowing. If they could feed in to some of the government initiatives, so much the better, such as the UK government’s plan to guarantee loans to the SME sector. One such fund has already been set up – but the problem has been in finding SMEs who wanted to take the money.

FEEding THE MiCRO ECOnOMY


Alan Rubenstein, Chief Executive Officer, Pension Protection Fund

John Kay, Chair, The Kay Review of UK Equity Markets and Long-Term Decision Making, UK Government


While China’s economic rise continues, so do the huge societal changes within the country. The current enthusiasm for China should be mitigated by its immense volatility and no one knows how that will really play out over the next five to ten years. Corporate executives were warned to stop thinking in the short-term in terms of shareholder return and personal compensation.

The country also needs to restructure its economic system and get away from state capitalism. “China has grown for 34 years at 10 percent a year on average because of the state and the country understands it can’t continue to grow that way,” noted Ian Bremmer. But while the authorities understand the need for change, it doesn’t mean the country can actually implement it. Bremmer is sceptical that China can undertake the reforms needed, given the size of the population, the country’s economy, and the nature of the political system. “I don’t think there is any risk as large as whether the Chinese get this transformation right and the implications of that for their relations with the developed world and most importantly the United States.” America welcomes the ‘peaceful rise of China’ – so long as it behaves as the US wants it to. But what if it doesn’t? Delegates heard that it is rare for a country to become globally economically dominant in a peaceful way.

The problem for China is that it is moving towards being the world’s largest economy and yet it is still a poor country. As such, it will not be interested in anything like the dialogue that the Europeans and the US have on the likes of climate change, on global trade, on nuclear proliferation, etcetera. It will still expect the Americans to do the heavy lifting. Meanwhile, America no longer has the capacity to lead on these issues. Nor will China have the enthusiasm to support US-led global standards in areas such as trade and telecommunications – why would it when the country thinks its own standards are better?

CLOSing KEYnOTE inTERViEW: What if…? The search for growth in a volatile world

Ian Bremmer, President, Eurasia Group interviewed by: Robin Bew, Editorial Director and Chief Economist, Economist Intelligence Unit

“I don’t think there is any risk as large as whether the Chinese get this transformation right and the implications of that for their relations with the developed world and most importantly the United States.”

Ian Bremmer,President, Eurasia Group

China and the US will not work harmoniously going forward and are actually moving towards a more confrontational relationship. “Cyber security, east and south China sea security issues, state capitalism and indigenous innovation are structural trends moving towards more conflict that will be difficult to adjust towards for a United States that is less interested in being a lender of last resort or global policeman,” says Bremmer.


The conversation moved on to the prospects for the Middle East. While a poll among delegates found most thought that an oil price shock is unlikely over the next 12 months, instability in the Middle East generally is of concern. The medium to long-term growth trajectory for both Iraq and Libya are more negative today than they were six to 12 months ago. While Iran is less risky than it was, Bremmer is not optimistic of a deal any time soon. And the situation could escalate on the military side which would increase geopolitical risk around oil.

As to America’s own prospects, are we likely to see a strong recovery in the next 12 months? Delegates in the poll were not optimistic. However, Bremmer argued that if you asked the same question to a similar group in the US, the response would be very different and CEOs there are feeling bullish. While the US is in a state of uncertainty given the November presidential election, CEOs are excited by the possibility of Mitt Romney winning. While President Obama’s policies are not anti-corporate, there are few people around him from the private sector, and he has not effectively maintained relations with the key representatives in the executive community.

The role of congress was discussed. Given it is so partisan, it has been slow to push through some of the legislation needed which might help the economy. In a ‘G-Zero world’, where there is no global leadership, the US is comparatively well positioned. It is viewed as more of a safe haven, Bremmer argued, and so more people invest in US equities and US treasuries. As a consequence, there is less pressure for the US to take the action needed in areas such as the deficit. This gridlock is further compounded by more political polarisation within the country as a whole. Despite this, decisive action is possible, as was the case with the financial crisis in 2008. President Bush and congress were capable of resolute and quick leadership to ensure the US and the world did not fall off a financial cliff.

OTHER EVEnTS in THE BELLWETHER SERiES inCLUdE:

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SYdnEY, AUSTRALiAJuly 12th 2012

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BEiJing, CHinANovember 16th 2012

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