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2009 Global megatrends 2
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
globalised and interdependent, with the world’s foreign direct
investment (FDI) flows running at over US$1.8 trillion in 2007-17
(over three times the level in 2003) and foreign investors owning
over 25% of global equities. As a result of their spectacular
economic growth, emerging markets are now net providers of capital flows,
financing the large current account deficits of the developed
countries, and in particular that of the US. However, high levels of
interdependency bring higher levels of risk; as the global reach of
the US sub-prime crisis demonstrated, challenges in one market no
longer stop at the national boundaries.
The new power brokers …
As well as being more interconnected, the financial landscape has
been redrawn by the emergence of four new power brokers. Asian
sovereign investors and petro-dollar investors (often using
sovereign wealth funds (SWFs) as investment vehicles) have moved the
power base further to the East, while private equity (PE) and hedge
funds have re-defined financing and leverage. The scale of these
power brokers cannot be underestimated; their combined assets
quadrupled between 2000 and 2007 to reach US$ 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.
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,
institutionalised 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 2015-22), these funds are well positioned to
continue to make some very sizeable and strategic investments,
capitalising 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 capitalisation 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 nationalise
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 Ukraine have taken this even
further. As governments take centre stage and nations take on
responsibility for commercial failings, one certainty is that
greater regulation of the financial sector will not be far behind.
(Source: Ernst & Young)
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.
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