GARY L. PERLIN
Senior Vice President and
Chief Financial Officer
The World Bank
FIFTH ANNUAL INTERNATIONAL CONFERENCE
ALTERNATIVE STRUCTURES OF SECURITIES
MARKETS
OPENING
David A. Walker
Director, Capital Markets Research
Center
We are celebrating our
fifth annual conference on Alternative Structures of Securities Markets.
We have at this conference 62 international delegates from 47 countries.
From the Washington area, we have representatives of international institutions,
including the World Bank, the IMF, the Inter?American Development Bank,
and USAID, as well as business people who are sponsors of the Capital Markets
Research Center. We are able to do this only because of the
generosity of The Nasdaq Stock Market.
We are honored
tonight to be joined by Mary Schapiro, the President of NASD Regulation.
Just recently, I learned that, at one point, about twelve years ago, I
worked for Mary’s husband. I had heard that Chas Caldwell was married
to a brilliant attorney, but I did not know her name.
Mary Schapiro
is one of America’s most important financial regulators and is tackling
the difficult tasks of resolving broker-dealer-market conflicts and enhancing
the nation’s confidence in the potential for electronic markets.
Mary’s impeccable reputation immediately gave the new regulatory agency
an outstanding reputation. She has been appointed to important financial
regulatory positions requiring Congressional confirmation following nomination
by three different American presidents--Presidents Reagan, Bush, and Clinton.
Being appointed by all three demonstrates the great respect that everybody
has for her.
NASD Regulation regulates
5,500 member brokerage firms, almost 600,000 registered representatives,
and has oversight responsibilities for The Nasdaq Stock Market. Previously
Mary served as Chair of the Commodities Futures Trading Commission, following
appointment by President Clinton in 1994. She has been a Commissioner
of the U.S. Securities and Exchange Commission and served as the SEC’s
acting chair. She is a graduate of Franklin and Marshall College
in Lancaster, Pennsylvania. Later, she earned her juris doctorate
with honors at the National Law Center of The George Washington University.
It is a privilege to introduce her.
WELCOME Mary Schapiro
President, NASD Regulation,
Inc.
It is my great
pleasure to welcome this group of international market executives and regulators
on behalf of the NASD and The Nasdaq-Amex Market Group. On behalf
of my colleagues, and particularly Frank Zarb, who is our CEO, we are pleased
to have such a distinguished group of people here. Frank and many
of the senior members of the NASDAQ team are ironically out of the country
right now. Since I lead NASD Regulation, which is the market’s primary
regulator, I cannot brag shamelessly about Nasdaq, as I am sure Frank would.
I am very pleased to join you and to see so many regulatory colleagues
this evening. I expected people from markets and others from the
industry directly, but I did not expect to see so many governmental regulators
and self?regulators. You come from many different markets and levels
of technological sophistication. I know that you share our belief
in the importance of regulation to protect investors and to assure the
integrity of the market place.
We are delighted
to share our experiences with you in market development, operations and
regulation, and this is the right place for all of us to share best practices
and information that will be beneficial to oversee and manage our markets.
Attracting so many senior market officials from around the world to interact
makes this conference successful each year.
What does change,
of course, are the issues. Five years ago, the first year of this
conference, there was no on?line investing. Few of us even knew much
about the Internet. There was no after hours trading, at least not
retail trading, after established business hours. Few of us knew
much about Electronic Communications Networks, or ECNs, which are now a
prominent part of our financial landscape. There was no emerging
trend in privatization of stock markets, and no capital markets in some
of the countries that are represented here tonight. It is a different
world of investing, trading, market operations and market regulation.
The ways we regulate
have evolved, including market surveillance, licensing of industry professionals,
and examination of a firm’s financial and operational capability.
Sound regulation remains essential to global competitiveness. This
forum has helped to build alliances and partnerships and lays the foundation
for opportunities we have not yet even envisioned.
I hope that every one of you will
seize the opportunity to network, to debate, and share your perspectives
with each other and with all of us. We are absolutely delighted that
you are here and we wish you a very rewarding week in Washington and New
York. We at NASD Regulation, Nasdaq?Amex and the NASD all look forward
to working with you for investor access and market confidence, but most
of all, to generate trust and confidence in securities markets around the
world. I would like to thank David Walker and his distinguished colleagues
at the Business School, Reena Aggarwal, in particular, and Jim Angel who
is the NASD academic in residence this year, for the wonderful job that
you all have done with this conference. Thank you.
INTRODUCTION - David A. Walker
Our keynote speaker
this evening is Gary L. Perlin, Senior Vice President and Chief Financial
Officer of the World Bank. Gary’s address highlights our conference.
I have been privileged to know Gary Perlin for approximately fifteen years,
and the focus of the conference is related to how I met Gary. The
primary theme at The McDonough School of Business at Georgetown is international
business. Years ago when I was beginning to introduce international
issues into my courses, a colleague encouraged me to add lectures on international
institutions. I sought a guest lecturer from the World Bank.
Somebody recommended Gary Perlin, who had become the Treasurer of Fannie
Mae.
Gary Perlin did
his undergraduate work at Georgetown in the Foreign Service School and
then he completed graduate degrees at two other premier universities--
the London School of Economics and Princeton University. He spent
a number of years on Wall Street and at Fannie Mae, and has returned to
The World Bank and has become its Chief Financial Officer and Senior
Vice President.
KEYNOTE ADDRESS - Gary
L. Perlin
Senior Vice President
and Chief Financial Officer
The World Bank
Georgetown awakened my passion for international finance, international economics, and international development, even though I was not a student in the business school. The message I want to deliver is the need for courage, energy, and enthusiasm for what you are doing to develop emerging markets.
Opportunity
I would like
to discuss the trends that will lead us into the next century and will
provide the context within which so many stock market executives and international
regulators are going to develop their markets; the work of market executives
and regulators is extremely important. There is a critical lesson
that we have learned over the course of the last couple of years, marked
by what we still call the Asian Crisis. The lesson is that we need
to encourage both broader and deeper markets.
This is the way to
protect one’s own market and to deter trade imbalances or public deficit
imbalances. At the same time, we do need to look at how global markets
are evolving, to understand the context in which emerging economies must
operate. In the end, the only way to protect your economy is to make
sure that you use capital efficiently. This is what markets should
do; they should allocate resources efficiently. The challenge that
you undertake cannot be overstated.
You are facing
an exceptionally challenging environment in the years ahead. I am
not a pessimist, but I believe that the period ahead is one embedded with
substantial risk. Along with the risk, of course, comes opportunity.
If there is a crisis, those who are better prepared will handle it more
effectively — and are more likely to come out ahead.
This is the operative
course in a rapidly changing world. This serves as the foundation
for your own markets and the issues you are discussing this week.
Why is this market
environment changing so quickly? First, the information and the communications
engineers offer us immediate access to one another. The financial
engineers have provided the instruments with which to transact business
through these new channels. Most importantly, the policy engineers
began to develop, often on a national basis, the basis for a global financial
system. The changes by policy makers and regulators are not necessarily
synchronized. In fact, this can often introduce friction. In
turn, regulators tend to respond to crises. They respond to crises.
They respond to competition, and sometimes to fashion. We should
welcome the push.
Financial Flows
International
finance combines three elements ?? global, regional, and national environments.
At the global level the key element is capital. Capital flows are
global. Markets are primarily regional. Financial institutions,
by and large, are national. The challenge we face is to combine and
coordinate these three levels, not necessarily assuming that we will have
global institutions, or necessarily national capital markets that are protected
from the international forces. From a global perspective we observe
capacity for capital to flow from one market to another. The markets
themselves, however, are typically regional.
Asian, Latin American, or Central
European debt or equity securities increasingly constitute a recognized
asset class. This makes them a market. Investors, either within
or outside of these markets, are making strategic or tactical allocations
to a particular region. Fund managers oblige by offering dedicated
funds, often on a regional basis. Deeper regional markets encourage
knowledgeable buyers to seek value, especially in market downturns.
On the other hand, reasonable valuation can be left behind when major regional
asset allocations are changed. We need to interpret and understand
what these regional flows mean.
Financial intermediaries,
as well, have begun to operate on a regional basis. International
institutions often desire a regional presence, even if this is accompanied
by consolidating formerly independent local firms. Market support
institutions, like clearing systems and rating agencies, help define arenas
for regional market action. However, underlying the global capital
within the regional markets are what are still largely national institutions.
Important as
they are, regulators are not the key to developing deep markets.
Regulators maintain integrity, but investors, especially institutional
investors, are the most critical component for developing deep markets.
Institutional investors have the economies of scale to generate savings,
offer professional skills, provide risk management capacities, and develop
contractual liabilities that create an abiding demand for long?term investments.
The state of
investment institutions reflects the regulatory and legal framework of
individual countries. This is true for investors, as well as those
who raise capital-- sovereigns and municipalities, project developers,
and public?sector enterprises. These issuers represent particular
national circumstances, as do policies and regulations affecting potential
issuers from overseas. When country risk or project risk is high,
the demand for capital ?? especially the long?term capital needed to promote
development projects -- is unlikely to be satisfied within the market itself.
Thus, markets
are often pursuing external capital.
Structural and Systemic Changes
What is the future
for the emerging markets? Increasing global opportunities and international
risks will shape market development. This is true for countries that
are locked in boom and bust economic cycles, as well as those that seem
to defy cycles. This will affect all of us because the changes are
both systemic and structural.
The first systemic
change is the increasing volume of investable flows within and between
countries. The nature of capital flows has also changed. Today
they are much less linked to trade and not even so linked as they once
were to direct foreign investment. The quantity of these portfolios’
flows is rising and with it, unfortunately, comes volatility.
Within the emerging
markets, the flows are not from public sector to public sector, as they
once were, but from private sector to private sector, and often between
countries with substantially different rates of growth. The flows
shift rapidly from those countries experiencing growth in one year to those
experiencing growth the following year.
Perhaps the most
important systemic changes are the developing regional markets and among
international investment flows. These flows have less information
content about the underlying economic fundamentals than did trade flows
and direct foreign investment. The changing structure of markets
will create continued volatility.
The nature of
investors has also changed. Much of our investment has been professionalized
in response to the volatility of the 1980's and the 1990's. The demand
for performance and high returns comes from both institutions and individuals.
Institutional investors,
many of whom have a very short-term performance perspective, tend to dominate
market expectations. Individual investors, who are now participating
in savings plans and defined contribution plans, are having an increasing
impact. Individuals do not necessarily have the short-term view of
the institutional investors, who are accepting risk because they believe
they can outperform their competitors. But as individuals are being
advised to ignore short-term risks while pursuing long-term returns, they
can reinforce the one-way outlook of institutional investors.
This demand for
performance and high returns comes from both institutions and individuals.
This is true in the United States and elsewhere.
Risk and Performance
These changes
in investors’ behavior accompany real changes in their risk appetite.
Investors perception of the risk and their pursuit of high yields influence
their willingness to accept the risks of leverage. Risk premiums
are the smallest just before a crisis, as caution which should be increasing
in fact gives way to recklessness on the part of those who fear they have
missed opportunities.
Investors desperate
over poor relative performance often ignore the fundamentals and try to
achieve high returns either through leverage or accepting excessive risk.
In retrospect, we wonder: How could those spreads have declined so much?
Was excessive optimism the source of the crisis? Could the market
be that wrong or inefficient? Is our information that erroneous?
If the market
clearing price had indicated that risk was declining, then the market was
wrong. It indicated that risk appetite was increasing!
Credit Risks and Premiums
The risk premium
is the most important element in tracking how markets are evolving and
volatility is increasing. Increasing credit risks have become acceptable.
Investors are avoiding interest rate risk because commodity-like hedging
markets have driven down returns. Currency risk is not easy to capture
because of one-sided markets. Investors are therefore seeking higher
yields by accepting credit risk. The market structure allows investors
to accept these risks and offers a sense of comfort, liquidity, and occasional
euphoria.
The structural
changes in the markets are largely beneficial. They encourage the
accumulation of savings for investment, and transfer risk to those institutions
and those savers who are best able to manage the risks. When they
seek abnormal returns in poorly developed and unregulated markets, however,
opportunity shows its other side--volatility. This challenges not
only investors but also the newer markets they are intended to nurture.
Managing Risk and Transparency
For those of
us involved in the international financial arena, risks and volatility
can overwhelm the capacity of regulators and supervisors to respond.
Even if it were possible, capital control is not the best way to stimulate
growth and development. The challenge that faces regulators and stock
market officials is how to manage what we cannot control.
At the firm level,
rational behavior is likely to compound the challenge that the markets
are presenting. It is reasonable for firms to lever and de-lever
themselves quickly in response to changing risk premiums. Firms require
liquidity, whether it is real or created by central banks.
Investors and
other firms will seek returns in non-transparent markets. Although
the international financial community claims that transparency is the answer
to economic problems and that transparency would have prevented the recent
crises, I question how many investors would have entered new markets if
they were not so transparent that everybody appreciated their real
value. The challenge for the public sector, whether at the international
level or the national level, is to deal with the issue of transparency
for the public benefit. It is not just a matter of fairness, but
also one of avoiding excess optimism at a systemic level.
Recommendations
You, as regulators
and leaders of developing markets, are the ones who have to deal with the
liquidity and related crises. You help by giving time necessary for
over?leveraged borrowers to restructure and for over-leveraged investors
to unwind. You share the burden of systemic credit experience, both
at the national and corporate levels. You have to reconcile long?term
economic health with short-term political and corporate agendas, and many
of you help other authorities and regulators within your countries.
I encourage you
to deal with the exchange authorities to develop resistance to economic
stress, to improve the quality of financial management, and to improve
the quality of supervision of financial institutions. Risks are easier
to manage before they materialize. Success in this highly volatile
world will depend on the success of early warning systems and your prompt
response to them.
In this environment,
it seems to me, that the future growth for many countries will depend on
the development of both securities markets and capital markets. Capital
markets, unlike banks, can accommodate unleveraged investments. They
can offer a long-term investment horizon. They tolerate risks,
but sometimes they accept too much. Capital markets can be much more
efficient than other kinds of financial intermediation when it comes to
supplying risk capital for large-scale and non-tradable investments.
But it cannot be taken for granted that securities markets will consistently
reward the effective deployment of scarce risk capital.
We must work
to maintain and enhance the confidence in all the actors who comprise financial
markets. This includes: the underwriters and others who originate
and place securities; traders and brokers, who provide liquidity in secondary
markets; rating agencies, that offer credit transparency; back offices,
that offer settlement and delivery systems; regulators and supervisors,
who assure the integrity of information and participants in markets; and
finally individual and institutional investors. In other words, the
promise of markets is within our grasp if we will only reach.