Copyright G. DUFEY UoM & NTU/NBS 1 GLOBAL FINANCIAL MARKET DYNAMICS Prof. Gunter DUFEY Nanyang...

Copyright G. DUFEY UoM & NTU/NBS 1

GLOBAL FINANCIALMARKET DYNAMICS

Prof. Gunter DUFEY<[email protected]>

Nanyang Business School/ NTU Singapore

& The University of Michigan, Ann Arbor, MI USA at

ISEAS19 January 2005


The ‘BIG’ Picture:Technological Change esp. in Data Processing & Communication

Globalization/Internationalization

Liberalization/Deregulation

Securitization/Financial Innovation

--Engineering

Disintermediation/Reintermediation

Northwestern Public Service Company

U.S. $10,000,000Term Loan

managed and provided by:

Dresdner Bank Aktiengesellschaft Grand Cayman Branch

Merrill Lynch International Bank Limited

Merrill Lynch International Bank Limitedas agent

Framatome S.A.SFr 35,000,000Term Loan

Arranged by

Manufacturers Hanover LimitedProvided by

Banco Central, S.A. Electro BanqueManufacturers Hanover Trust Company London Branch Via Banque

ASLK-CGER Bank Caixa Geral de Depõsitos Paris Branch

Agent Bank

Manufacturers Hanover Limited

April 1989

The Investment Banking Group

This advertisement appears as a matter of record only


Market Jurisdiction

Currency Interest Rates

Institutions


Financial Markets Markets for Payments

Demand Deposits/Cash Markets for Credit

CreditChannel

National International

FinancialIntermediaries

SecuritiesMarkets

“Internal” “External”

Markets for Equity

Domestic “Global”


Conditions for the existence and growth of an external market for intermediated funds

1. Ultimate borrowers and lenders must have freedom to move funds “internationally”.

2. There must be free access to clearing balances (non-resident convertibility).

3. External financial intermediaries (Eurobanks) must have sufficient cost advantages to overcome the risk perceptions of transactors.


Transformation of Jurisdiction

Cost Control Risks

German Interest Rate

EDM Rate

Transaction Cost

Exchange Expectations

Exchange Risk

E $ RateCost Control RisksU.S. Interest Rate

Tra

nsfo

rmat

ion

of C

urre

ncy

Den

omin

atio

n

Source: Adapted from G. Dufey and I.H. Giddy, „The Linkages that Tie Together International Interest Rates“.

Euromoney Nov. 1978, pp. 122-132.

Eurocurrency Interest Rates and Rates in National Markets


CAPITAL CORPORATIONU.S. $1,800,000,000

Zero Coupon Notes due November 15, 2004Unconditionally Guaranteed by

CORPORATION

Merrill Lynch Capital Markets

Daiwa Europe Limited Crédit Lyonnais

Dresdner Bank E.F. Hutton & Company (London) Ltd. Aktiengesellschaft

Nomura International Limited Westdeutsche LandesbankGirozentrale

Julius Baer International Limited Banca del Gottardo

Banque Internationale à Luxembourg S.A. DG BANKDeutsche Genossenshaftsbank

Norddeutsche LandesbankGirozentrale

November 1984

NEW ISSUE These notes having been sold, this announcement appears as a matter of record only


International Credit Markets: A Schematic Presentation

CreditChannel

National International

FinancialIntermediaries

SecuritiesMarkets

“Internal” “External”


The Eurobond Market(The Market for International Issues)

The fundamental reason for its existence is the basic discrepancy between relatively

(A) Tight controls on securities’ issues by foreign borrowers in national markets

and

(B) Fewer (or unenforceable) restrictions on investors to purchase foreign securities


Structure of International Bond Markets in the 2000s

A. National Markets

New York (“Yankee”)

Swiss foreign bond market

German market

Japanese foreign bond market (“Samurai”)

U.K. (Bulldog)

B.Eurobond Market

USD, EURO

CAN, SFR

Sterling

Composite Units(SDR, etc.)

Exotics

C. Global Bonds






--Engineering



Financial Market Liberalization:A Miracle!

It is easy to identify the forces that resist liberalization:

The politicians and bureaucracy loose power and influence

Established competitors -- once they have adjusted to the regulatory regime -- find that it provides effective protection against competition from new entrants -- both domestic and foreign

So what changes the balance of power? Domestic ‘players’ change their attitude toward

liberalization when their customers go abroad for fin. services and ‘reciprocity’ starts to kick in


EMERGING ISSUES IN REGULATION

Privacy and Consumerism “New” issues: Money laundering, drugs and terrorists -- and

what really matters: TAXES Compliance and intl. power-plays “Value adding” vs. “value destroying” regulation

Principles of consumer/investor protection:- Disclosure vs. legal protection?- What are “appropriate” investments?- Who takes the risks of criminal activity?- Ethics?






--Engineering



Financial Innovation IStripping a Term Loan

(Fixed Rate)

What are its elements? Provisions of Cash Availability Guarantee Interest Rate Guarantee Credit Risk Interest Rate Option Options on the Collateral

This announcement appears as a matter of record only. The Notes are not being registered for offer as sales in the United States. Offers and sales of the Notes in the United States or to the United States nationals and residents will not be made as part of the distribution and might constitute a violation of United States Law if made.

Lead ManagersBanca Commerciale Italiana Banca Nazionale del Lavoro

Banco di Roma Banque Nationale de Paris

Banque Paribas Credit Commercial de France

DG BANK Deutsche Genossenschaftsbank Dresdner Bank AG, Chicago Branch

Girozentrale und Bank der österreichischen Westpac Banking Corporation

ManagerBanca Nazionale dell’Agricoltura Banco di Napoli – New York Branch Banco di Sicilia – New York Branch Banque Internationale à Luxembourg

CIC-Union Européenne International et Cie. Kansallis-Osake-Pankki

Co-ManagersBanca Popolare di Milano Banco di Santo Spirito (Luxembourg) Bank of China, New York Branch Bank of New Zealand

Banque Générale du Luxembourg S.A. Berliner Handels- und Frankfurter Bank

Malayan Banking Berhad Monte dei Paschi di Siena

Sears, Roebuck and Co.and

Sears Roebuck Acceptance Corp.

U.S. $5000,000,000

Revolving Underwriting Facilitywith

Continuous Tender Panel

Chicago Branch

Arranger and CTP Manager

Dean Witter Capital Markets-International

May 1985

Sparkassen Aktiengesellschaft

New York Branch

New York Branch


Financial Innovation II Securitization & Structured Finance

Innovative product trends such as securitization of future export receivables, dollar denominated mortgages, credit card receipts, commodities and similar cash flows from other than emerging markets.

Issuer considerations such as reasons for implementing a securitization program, resources necessary, evaluating risk, servicing options, financial guarantees, credit enhancement, I.e. value creation.

Organizational issues such as choice of a legal structure or where to locate your securitization special purpose vehicle.

Regulatory matters including local legal rules can facilitate or hinder transactions.

Tax and accounting considerations such as sale vs. financial treatment, after tax analysis and valuation, cross-border tax issues


How Swaps Link the International Capital Markets

Cross-C

urrency

Inte

rest R

ate S

wapCross-Currency

Interest Rate Swap

Interest Rate Sw ap

Fixed RateAsset or Liability

Exam ple: Dollar-Denominated

Eurobond

Exam ple: Eurodollar

FRN

Exam ple:Sam urai Bond

Exam ple:Euroyen

Rate Loan

Floating RateAsset or Liability

Cu

rren

cy X

Cu

rren

cy Y

Interest Rate Base:

CurrencyofDenom ination

Fix

ed

-Fix

ed

Cu

rre

ncy

Sw

ap

Flo

atin

g-F

loa

ting

Cu

rrenc

y S

wa

p

Interest Rate Sw ap


A swap is a (conditional) exchange of future cash flows between two parties. Cash flows may be based on periodic interest payments (“coupons”), or principal when relevant.

Swaps will differ in terms of reference rates (e.g., LIBOR, treasuries, etc.) and/or currencies.

While the expected value of the cash flows at the initiation of a swap is the same, the actual value of the respective cash flow obligation will change over time. In line with changes in different bases for rates of interest and relative currency values (exchange rates).

Such changes give rise to default risk in a swap transaction. Thus, a swap of whatever nature is simply a technique to change the characteristics of cash flows (outflows on the liability side or inflows on assets).

The technique must be carefully distinguished from the use of swaps, I.e. when is it useful to change the characteristics of cash flows?

Cash flows can be changed not only via a swap but also by the direct method: repay liabilities and borrow one with different cash flow characteristics. Thus: swaps permit the separation of funding (investing) from cash flow characteristics.

Implications: what is good for the investor is not necessarily good for the borrower.

Minimize head-on conflict, e.g. allows for securitization (standardizing liquid claims).


Ranking of the BBA Credit Derivatives Survey

What are the applications for credit derivatives in global markets in 2005?

Management of credit lines Diversification Management of economic capital Investment Management of regulatory capital Balance sheet optimization Product structuring






--Engineering



Trends in Shaping Financial Intermediaries in Asia

The 97 crisis has been a defining moment for financial institutions in Asia. The reaction comprised the following aspects:

1) More professional management, esp. better risk management 2) Improved supervisory environment (rules and enforcement)3) Some improvement of governance and credit environment, enhanced

ability to collect.4) Foreign ownership and competition improves system - not because of

better technology but because of independence from political pressures. However post-colonial hang-ups and loss of political favors impose limits.

5) First time shift from business and gov. lending to consumer services including private banking -- with some ‘teething’ problems.

6) Push for asset management and other non-credit services including capital market activities.


Pensions and Financial Market Developments The confluence of a) rapid increase in standards of living

(GDP/capita), b) lower birth rates and c) longer life spans puts strains on pension arrangements in all countries

Europe: relying on PAYG to replace approx. 60-70 of last years’ income. Modest employer pensions and savings. System under extreme stress due to confluence of a) and b).

USA: modest SS system, middle class relies on pension systems, individual savings tax supported ret. savings (IRA’s). Strong trend from defined benefits to defined contribution. Tendency for co’s to default on pension promises and putting burden on PBGC.

Asia: Individual savings and extended family system gives way to employer funded pension arrangements, modest SS systems if any, with beginnings of segregated pension fund arrangements (Singapore, Malaysia, GPF in Thailand)


Special CG Issues in AsiaIn international comparisons, Asian companies fare worst

Lack of regulatory provision and compliance monitoring

Asian co’s pay a steep price in terms of cost and availability of capital (see McKinsey study). WHY?

Experience of first generation entrepreneurs causes perception of property rights to be precarious: loading up with credit from gov. controlled banks provides insurance against political risk

Disclosure and transparency of information is dangerous.

Disprop. representation of minority groups in business class of most SE Asian countries leads to defensive-aggressive behavior!

Fair business practices -- what is fair price in a small market?

Minority shareholders are viewed as stupid and impudent - give money away and want it back with return!


The Evolving Financial System

Households

Non-financial Enterprises

Banks(DDs and TDs)

NBFIswith

Equity(Insurance/

Finance Companies)

Modified from Allen, Franklin and Douglas, Gale, Comparative Financial Systems: Competition versus Insurance, Unpublished, 1998, by G. Dufey, UofM BS 2001.

Direct


The Evolving Financial System

Households

Non-financial Enterprises

Banks(DDs and TDs)

NBFIswith

Equity(Insurance/

Finance Companies)

NBFIswithoutequity

(Mutual Funds/ Investment Co.)

Modified from Allen, Franklin and Douglas, Gale, Comparative Financial Systems: Competition versus Insurance, by G. Dufey, 2001.


Implications for Singapore

Recognize that competition is not regional but global

Increasing the distance between politics and financial markets

Regulatory environment that balances safety and innovation

Improve corp. gov. framework. Foster an agglomeration of talent --

local and foreign


Implications for all of us

The financial markets of the future will provide ample opportunities for intelligent, ethical people who have acquired a thorough understanding of the techniques, as well as the dynamics that determine (1) the regulatory environment, (2) the innovative products and (3) the institutions of the future.

Copyright G. DUFEY UoM & NTU/NBS 1 GLOBAL FINANCIAL MARKET DYNAMICS Prof. Gunter DUFEY Nanyang...

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