Opening the 2014 European Investment Conference in London, Robert W. Jenkins, FSIP, adjunct professor of finance at London Business School, asked if the investment profession is a source of systemic risk or part of the solution.
“Our global financial system is big, is complex, and is accident prone,” said Professor Jenkins, pointing out that a 10% change in holdings by China’s central bank generates $330 billion of sales. A 3% shift in global asset preferences triggers $4 trillion of securities transactions, and adding leverage to the mix amplifies the vulnerability. He stated that “Regulators have failed to erase the lessons of the bubble; leverage remains excessive.” In fact, Jenkins believes that banks’ asset values need only fall by 3% to wipe out their capital under current Basel rules on bank capital adequacy.
Placing the blame for excessive leverage squarely on investment bankers, Jenkins questioned whether the reticence of the investment profession to comment on the fecklessness of many investment bankers has meant that regulators and the general public fail to distinguish between investment banking and investment management. “We missed a golden opportunity both to secure a seat at the reform table and to differentiate ourselves in the process,” said Jenkins.
With so much at stake, politicians rightly fear the industry, according to Jenkins: “Failure to resolve the issue of ‘too big to fail’ risks starting a regulatory campaign to stop and control any and all threats that just might lead to bank failures.” But regulators already control investment firms, and “neither we nor they can control investment flows,” said Jenkins.
The industry has begun to mobilize, with the CFA Institute Future of Finance initiative seeking to encourage those in the investment industry to play a more active part in financial issues of the day. But as an industry, the reform efforts do not impress Jenkins, who cites the unseemly fight against applying European bank bonus rules to the industry and the fight with US authorities over constant-net-asset-value money market funds.
On another level, the interest of the authorities in the investment industry is a good thing since it encourages knowledge sharing between those with liquidity and those without it. “But the time has arrived to show we are part of the solution not part of the problem,” said Jenkins. “We need to demonstrate that we are different.”
In a robust defense of the investment industry’s corner, Jenkins noted that the clients of the investment industry supply funding and liquidity to the system, most often on the basis of 100% loss absorbing equity. Even the hedge fund industry operates with one-tenth of the leverage authorized for banks by the Basel rules. “We do not deploy excess leverage, we do not act as principals, we are not subsidized by the taxpayer, we are not too big to fail, bail (out), or jail,” argued Jenkins.
“Our industry is far from perfect,” he said, “but we are crucial to finance: We convert streams of savings into rivers of economic capital that fuels economic growth.” The industry gives opportunities for investors to diversify and control risk, he maintained. “We must help regulators understand where the real threats lie.”
Jenkins concluded on a hopeful note, suggesting the latest regulatory onslaught offers the investment industry a second chance to make a major difference to the future of finance.
The full transcript of Robert Jenkins’ session at the European Investment Conference is available here.