How to Generate a New Wave of Prosperity. The formula of mixed government and private investments to reform the world, Part II

This article is the continuation of: How to Generate a New Wave of Prosperity. The formula of mixed government and private investments to reform the world.  RGE Monitor, 26 Nov 08

Never in the Dark Again.  Central Banks face the challenge of recovering global financial stability. Their opportunity is to gain a higher information level, establishing proactive targeted exchanges with a comprehensive pool of players, starting from Sovereign Wealth Funds. *   *   *

New thinking and action by Central Banks are need and opportunity

This crisis has shown the information failure of existing regulatory and supervisory framework nationally and internationally. It is now clear that new thinking and action by Central Banks are needed, thus opening up a powerful opportunity.

It is now commonly agreed that the global financial system and its architecture require major improvements in the designing of regulation, in the assessment of systemic risk, and in the global coordination of action before and during crisis. The “Perimeter of Regulation”, as it was called by the IMF, proved to be misleading and highly inadequate at national and international level. Central Banks information level must highly improve, their action must change to be more targeted and effective, with no boundaries and without the risk of suffocating or impeding financial innovation. The latter was not the cause of the current problems, which were instead created by a serious lack of information, a misuse of financial instruments and by a total loss of common sense.

For achieving the necessary improvements, Financial Authorities need to make substantial changes in three main areas.

The first area is the creation of western Sovereign Wealth Funds. That is the evolution of Central Banks’ and governments function in their more direct support to bolster national economies in addition to a much needed fiscal stimulus. By taking over, or by being ready to take over, ailing financial institutions (namely banks, insurance companies and soon key industrial players), leading western governments are adjusting “de facto” the function of central banks reserve managers in that of national wealth managers. This is quite similar to the model of the existing Sovereign Wealth Funds. The link between markets and financial authorities needs to evolve quickly. Central governments are seeking to generate stability and growth for their national economies and they also need business partners to help them to deliver on this categorical necessity (Pls. see: Development of Central Banks and Governments policy for the Creation of a New Breed of Sovereign Funds with strategic function to rescue and rebuild: The Economic Reconstruction Institutions; 10 Nov 08).

Each nation will have to take its share to support its economy. Some western countries like France have announced the creation or their own Sovereign Fund established with the purpose of grouping the forced recapitalizations, supporting the financial system and restarting the economic growth in their own country. The UK has already the opportunity of the existing ‘Shareholders Executive’ and it recently set up the UK Financial Investments. The Irish government just announced the creation of its fund with a substantial investment in the country’s banks in partnership with private investors.

A second and related area will be the evolution of the reserves portfolio management, asset allocation and investment strategies employed directly by Central Banks. Changes in this area are due to the fundamental shift that this unprecedented crisis brought and that radically changed the meaning of asset allocation and the dynamics of market intervention. This will be the subject of further and separate analysis.

“Enlightened” communication and cooperation in scope and space

I focus here on a third and possibly most important area that requires improvement. The information factor area which strongly affects the previous two mentioned. This is the opportunity for Financial Authorities to gain a higher level of information and exchange. To develop an active level of awareness and “enlightened” communication and cooperation in scope and space between Authorities and all major market world players.

This new dynamic of targeted relationships will be a primary key to gain precious information and market intelligence, the main base to achieve the key function and objective of Central Banks: to recover the health and stability of the financial system. The latter can be reached only through a real global exchange that Central Banks and authorities will have to achieve with a largest pool of major market participants. Global consensus on international cooperation it is an opportunity and it must now be productively used. The scope of that cooperation will have to be broader in terms of policies, countries and most of all type of financial players to include SWFs, Hedge Funds, Endowments, and all major investors. This will allow Financial Authorities to develop a higher and much needed information gathering and awareness level.

Shortly the USA will materialize its plans, but what done already from their authorities and what announced by their next President, confirms the strong need to elaborate a better and comprehensive information and action plan on financial markets, their variables, and main players.

The world may have gone too fast and beyond its limits but it is now time to catch up. Not just more information but of superior quality will help Central Banks and financial authorities to improve evaluation and awareness of systemic risks. This undoubtedly requires the active coverage of the most comprehensive pool of market participants among which the very important category of the SWFs. It does not mean stringent and/or impossible regulation or excessive transparency and burden, but control through effective relationship, targeted participation, thus achieving true global knowledge.

Sharing informally this thoughts and analysis with Central banks and supranational institutions, we find confirmation of the need to create a new communication function of link, knowledge and information sharing with the relevant market participants beginning with SWFs. The latter are an “extension” of their own Central Banks and through these institutions as well, we perceive interest in a new information exchange with mutual added value. The stability of global markets it is also something that affects them closely. Not only that. The action of SWFs is often misunderstood, while the positive way in which their role could be guided seems not perceived. In this respect, an active exchange between Central Banks and SWFs would be of great assistance. This is what it is necessary and not just strict and forced transparency. As Andrew Rozanov, leading expert in this field and creator of the word ‘Sovereign Wealth Funds’, observed at a recent forum on the subject of SWFs: “Increased transparency is a highly delicate matter. If imposed too quickly or without proper consideration for portfolio and market issues, it can actually be detrimental to both SWFs and broader market”.

The same applies to Central Banks in their internal portfolio management of reserves. Is it really necessary that they tell the rest of the world how in strict detail and real time they manage their reserves?

The SWFs are in reality a precious resource and a potential blessing especially in the current and in the post crisis world. Having a long term investment horizon, providing liquidity and capital to global financial markets, SWFs enhance the optimization of markets operations, lowering the cost of capital and supporting equity valuations. Generating wealth as “Sovereign Alpha”, their pool of free capital seems to be a crucial element in a much needed national and international reconstruction and economic bolstering process. I define ‘Sovereign Alpha’ as the part of the company’s extra value generated simply by the organization and positive presence of the State among the shareholders. (How to Generate a New Wave of Prosperity. The formula of mixed government and private investments to reform the world; 26 Nov 08). Central Banks and SWFs are united in many ways but foremost for the goal of achieving global financial Stability and growth. New Central Banks Coverage of SWFs and Important Institutions

Thus, Central Banks need to achieve a comprehensive and higher level of information, and in each respective country need to create a function responsible for the relationship and exchanges with the mentioned institutions. With the purpose of reaching the goals outlined below, it is necessary the development of an “observatory point”, a center of information integration and of active exchange between Central Banks, SWFs and of all those market players and forces that is today no more possible to ignore.

  • Start research on these global institutions
  • Start a program of regular exchanges and targeted communications
  • Exchange market views, key information and strategic economic data
  • Where proper share asset allocation strategies, co-investment opportunities or cooperation in the case of interest from a SWF in investing in a national firm
  • Global coordination on these functions and findings with other Central Banks

The above is the most effective way to augment the information and knowledge base to support Central Banks decision process. To establish global governance and to create mechanisms for effective international action, to reduce the risk of crisis by preventing them and by addressing the problems when they occur. Enhanced information provision and global coordination will be a key for any systemic risk assessment. Our global world has in fact no more perimeters; financial innovation is based on interconnection and generates multidimensional levels. Major barriers have been knocked down, the speed and extent to which shocks are transmitted across asset classes and countries increased. The design of regulation must be different, as the new role of Financial Authorities.

The mentioned interconnection boundaries are blurred between systemic and non –systemic institutions, between different asset classes.  Central Banks must adopt a more targeted, hands on role that the above mention functions will start to provide. Conclusion

In summary, the current regulatory set up revealed to be inadequate and lacking crucial market intelligence. While action across a range of areas is needed to help the global economy and financial system regain their footing, information enhancement through active targeted relationships with major market world players will be of key importance for Central Banks. The latter can no longer just rely on setting interest rates, monetary policy and setting a “Perimeter of Regulation” to be in their comfort zone.

To perform their fundamental function of establishing financial stability, Central Banks will have to recur to a new kind of active presence. “Perimeter of Regulation” was the past. In the post crisis world, and in the transition period as well, Monetary Authorities will have to be out in the marketplace to properly interpret their role in a new global order. They will engage in new functions, to effectively gain key information with important market players and engaging them in a process of cooperation and exchange, restoring confidence, financial markets soundness and achieving global governance.

The new world will seal a radical change that is taking place in the evolution of the global economy and of the political order. The emerging economies will play a crescent role and a bipolar era will open to a multi-polar one. To properly solve the equation of balance and growth in the future, the variables to be solved will be a multiple to include the growing economies. Central Banks are now challenged in a different way and new targeted exchanges, key information gathering and global coordination are necessary. The first G-20 summit on Financial Markets and the World Economy that took place last month in Washington is a confirmation of the need for a new Central Banks presence. That the world authorities had a sense of fear and they showed up with a strong response is a positive thing. The world has changed and so the role of Monetary Authority. The near and long term challenges are really of difficult and unprecedented nature. Yet, in an ever interconnected world each of us has an interest that the unbalances be resolved.

“As our case is new, we must think and act anew.”  Abraham Lincoln