Global megatrends 2009 - The changing financial landscape
The interconnectedness of the global capital markets
The global picture of financial power and centricity has fundamentally changed. Capital markets have become increasingly globalized and interdependent, with the world’s foreign direct investment (FDI) flows running at over US$1.8 trillion in 200717 (over three times the level in 2003) and foreign investors owning over 25% of global equities.18 As a result of their spectacular economic growth, emerging markets are now net providers of capital fl ows, financing the large current account deficits of the developed countries, and in particular that of the US. However, high levels of interdependency bring higher levels of risk; as the global reach of the US sub-prime crisis demonstrated, challenges in one market no longer stop at the national boundaries.
The new power brokers …
As well as being more interconnected, the financial landscape has been redrawn by the emergence of four new power brokers. Asian sovereign investors and petro-dollar investors (often using sovereign wealth funds (SWFs) as investment vehicles) have moved the power base further to the East, while private equity (PE) and hedge funds have re-defined financing and leverage. The scale of these power brokers cannot be underestimated; their combined assets quadrupled between 2000 and 2007 to reach US$11.5 trillion.19 They have transformed the financial landscape.
… and their uncertain future
Hedge funds and PE firms will be under pressure in the short term. While hedge funds have not proven so far to be the systemic threat that many feared, they have not been able to deliver good returns during the crisis. Institutional investors, hit by the fall of the equity and credit markets, are being forced to withdraw their funds from hedge funds in significant ways to maintain asset allocation ratios; other investors are dissatisfied with recent weak returns and high fees charged by the funds. They may also be worried about perceived poor risk controls. Hedge fund industry executives predict assets under management could fall by 30-40%.20
PE firms also face a number of significant challenges: with credit markets likely to remain tight well into 2009, there will be limited debt to finance large acquisitions (only 10 PE deals above US$2 billion were announced between April and October 2008, against 41 deals in the same period in 200721), forcing PE firms to consider new types of deals (such as minority equity investments and all-equity investments). The appetite for a short-term approach to business will continue to be vastly reduced and PE firms will have to focus more on creating value and risk management in portfolio companies.
The lines between different types of financial players were blurring as we headed into the crisis; when we begin to emerge, the lines should look very different.
Many of the smaller hedge funds and PE firms will operate with a much lower profile and may disappear (through acquisition as well as failure) and both industries are likely to be more consolidated, institutionalized and regulated. In the case of PE, we may see a few very large, publicly listed, global players with much more diverse offerings (e.g., Blackstone); perhaps filling the void being left by investment banks. As regulation increases around these previously under-regulated areas, we may also see new types of players emerge — creating niche offerings in the (much smaller) high-risk, high-reward, low-regulation space.
SWFs have become more yield-seeking, with equity, PE and hedge fund investments making up a larger proportion of their investment dollars, and are more actively partnering with corporates. While they may have been disappointed with loss-making investments done early in the crisis (e.g., in US banks and PE firms), this is unlikely to put them off for long. With large reserves (they currently manage funds of US$3 trillion and are expected to grow to US$10 trillion by 201522), these funds are well positioned to continue to make some very sizeable and strategic investments, capitalizing on depressed share prices in the West, and stimulating growth in the East. The financial crisis may lead some nations to retreat to protectionism, potentially hampering the growth of these players. However, with liquidity at a premium, their ready cash is likely to persuade most governments of the benefits of foreign investment.
The fall of big banking …
As the repercussions against financial innovation and complex derivatives continue, for the moment the mood in the financial world is one of simplification and caution. The lines between different types of financial players were blurring as we headed into the crisis; when we begin to emerge, the lines should look very different. Traditional investment banks have suffered heavily. Some household names have collapsed (e.g., Lehman Brothers, Bear Stearns), and others have changed their capitalization models (linking up with commercial banks or establishing themselves as bank holding companies) as their previous business models — and taste for leverage and risk — failed them. Retail banking has also suffered, with the industry seeing numerous failures and consolidations; as the worst seems yet to come for the man on Main Street, this trend is likely to continue.
… and the rise of big government
Governments too are moving back into the spotlight as financial power moves towards the state; state capitalism is no longer only found in emerging countries (where around one-fifth of the largest companies are stateowned23), but also in the previously more hands-off West. The unprecedented step to effectively nationalize banks across Europe and the US has placed government at the heart of finance, and torn up decades worth of free-market thinking. Iceland’s pleas for Russian assistance and International Monetary Fund (IMF) interventions in Hungary and the Ukraine have taken this even further. As governments take center stage and nations take on responsibility for commercial failings, one certainty is that greater regulation of the financial sector will not be far behind.
- 17 UNCTAD (stats.unctad.org/FDI); 2008.
- 18 Long term trends in the global capital markets, McKinsey; Feb 2008.
- 19 The new power brokers 2007, McKinsey; July 2008.
- 20 The incredible shrinking funds, The Economist; Oct 2008.
- 21 Based on Dealogic data, EY analysis; 2008.
- 22 SWFs: Growth Tempered – US$10 Trillion by 2015, Morgan Stanley; Nov 2008.
- 23 The Rise of the Emerging-Market Multinational, Accenture; Jan 2008.
