Guest editorial

Citation

Keasey, K. and Cai, C. (2009), "Guest editorial", Journal of Financial Regulation and Compliance, Vol. 17 No. 1. https://doi.org/10.1108/jfrc.2009.31117aaa.001

Guest editorial

Article Type: Guest editorial From: Journal of Financial Regulation and Compliance, Volume 17, Issue 1

The editorial for this issue of JFRC comes at a very interesting time and is split into two parts. The first part examines the credit crunch and considers the impact on regulation and compliance. The second part introduces this special issue on Asian Financial Markets.

The credit crunch – more to come!

In January 2003, I wrote an article titled “Bah humbug” (University of Leeds, IIBFS Focus Report) which highlighted my concerns with the growing debt burden in the UK. I concluded the article with the following question:

The question is will our new borrowing habits bring the whole economy down or just the unlucky few?

We, of course, now know the answer – the “age of financial irresponsibility” has almost brought the whole system down and it will have a lasting and painful legacy. The basic cause of the crisis has been the uncontrolled provision of debt on the back of a “wall of cash” from the Far East. Money has been provided in such quantities that individuals, companies and countries have eventually struggled to meet repayments – this issue was heightened when money markets froze but we should not forget that any entity has a sustainable level of debt and these were exceeded a long time ago. The debt overhang problem has been exacerbated at the system level because debt has been repackaged to such a degree that nobody knows who is bearing what and thus the fundamental plank of the financial system, trust, has been removed and will take a long time to recover. The $55 trillion credit default swap market, which few people understand or know where the risks truly lie, is just one example of the financial insanity we are now facing.

To get a handle on the consequences of the crisis, let me look at the major players – individuals, companies, banks, and governments.

Individuals

They have borrowed to buy over priced properties, holiday homes, cars, flat screen TVs, etc. They have lived the “dream” on borrowed funds. House prices are now declining, borrowing is more expensive and difficult to access, living costs have risen significantly and not surprisingly, spending is being reined in! And this is all before the significant rises in unemployment that will occur in 2009 and 2010. In short, many will have to significantly tighten their belts and for some this is going to be a very painful adjustment process. One imponderable is how far this financial stress will feed through to pay demands given the increases in unemployment.

Companies

We have already seen significant distress in the property, construction, car and retail sectors but this is just the start of the mounting pressures. All indicators point to a significant tightening of the corporate sector, with increased numbers of insolvencies and redundancies. Many companies have been postponing their cutbacks, hoping for glimmers of light, but it now looks likely that many will action cost reduction processes this winter.

Banks and other financial service organisations

Over the past couple of months, we have seen a lot of distress in the banking sectors around the world, with huge government bail-outs in many countries. Over the coming months, we will see more distress in hedge funds as they struggle to sell assets at realistic values and raise further funds. Equally, we have not seen the last of the distress in the insurance sector as the de-leveraging continues to unwind. Finally, the banks will need further capital as they are forced, quite rightly, to strengthen their balance sheets. The consequence of this is that the availability of funds will continue to be limited with an obvious impact on individuals and companies.

The Government

If the above are not concerning enough, we have the past, present and future actions of the government to consider. In all kinds of ways, we have ended up with a very unbalanced economy and society. First, there is the over reliance on the financial sector that has been promoted for far too long to the detriment of many across the UK. Second, there has been the burgeoning public sector which has not given us the improvements which should have been achieved given the spending. Third, we have the high taxation and borrowing levels which have paid for the ineffective spending with obvious consequences for the balance between the individual and the state, private and public.

In essence, we have a very highly leveraged and unbalanced economy and society, and the nature of the response by the government will determine how long we have to pay for the mess. The appropriate response will be to have a judicious amount of government spending and tax cuts but to let the consumer and companies rebalance their activities in the face of a “normal” lending environment. Quite simply, we have to learn to live within our means and this will not be a bad thing given issues with food and the environment. More likely, however, is that the government will try to spend its way out of the crisis by further borrowing. This will have a number of serious and lasting consequences. First, the public sector may well crowd out the private sector to the long-term detriment of the UK as a global trading nation. Second, we will be merely delaying the eventual adjustment of individuals and organizations to a sustainable borrowing environment and the cost will be even higher the longer it is avoided – we will have learnt nothing from the costly Greenspan punts over the past decade. In summary, I suspect the government will borrow and spend, and we will be in the current recession until the autumn of 2010 but the actions of the government will have consequences for many decades as we all struggle to pay for the mountains of debt and an increasingly, uncompetitive and unbalanced economy/society.

Given all of the above, the interesting question is what this all means for regulation and compliance? It is quite clear that there are going to be demands from government and society for better regulation and compliance, and this raises a number of issues. First, how do we organize regulation for a global economy when it is presently driven at the national level? Second, how do we regulate complex financial products when even the experts struggle to comprehend them? Third, how should we tackle “off balance” sheet entities which have been such a feature of the present crisis? Fourth, how do track risk when the financial system is a complex web of companies, products, sectors and countries? Fifth, where do the skills and experience come from given that regulation and compliance has played such a second fiddle for so long? Finally, what role should academics play in forming the regulation and compliance agenda going forward? To my mind, we have to be a lot more vocal in our concerns and be open to different research methodologies. For example, there is little doubt that the slice and dice model of shoveling risk around the globe and complex derivative products both played their role in the present crisis and both suffer (along with a lot of academic finance) from the assumption that risk is largely exgonous to the parties directly involved – which is clearly incorrect given recent events.

As an editor, I welcome explorative and agenda creating articles on regulation and compliance.

Kevin Keasey

Asian special issue

I have had the pleasure of assembling a special issue on Asian Banking and Financial Markets. Given the rise of Far Eastern economies as significant global players and the changing landscape of global economic and financial markets, the timing of this issue could not have been better. As the world economy continues to adjust to the credit crisis, with consequences for all countries across the globe (witness manufacturing companies in China laying off thousands of workers as the rest of the world reins in its spending), understanding different aspects of the Asian financial system is ever more important.

To this end, and at the request of Kevin Keasey, the first article, by Iain Clacher and myself, reviews the behavior and actions of the Sovereign Wealth Fund (SWF) – the Chinese Investment Corporation (CIC). SWFs are an increasing feature of the global financial system and their influence is likely to increase as global institutions (and countries) have to recapitalize; a good and recent example if this is Barclays turning to the Royal Family of Abu Dhabi for significant funds. The article on CIC describes the size and strength of SWFs and highlights the increasing freedoms of CIC to play a significant role on the global stage.

The second and third articles are concerned with Japanese and Chinese banking markets. We all know that Japan has suffered from its own banking and financial crises for quite some time but there has been a suggestion that it is now out of the woods. Maximillian Hall’s article suggests, however, a note of caution on low levels of core profitability and asset quality. None the less, he ends on an upbeat note stating that Japanese banks are back on track. The next article by Chen Meng analyses how multinational banks have accessed China post-WTO accession. From a base of a number of interviews, Chen Meng, concludes that multinational banks need to be clear about their strategic objectives and to be aware of the efforts needed to establish networks, client resources and human assets. However, this task has become more difficult as a result of the credit crunch because regulators and market participants are both more cautious of the “western banking models.”

The final two papers in this issue are concerned with the financial markets of China and Malaysia. Paul McGuinness examines the reform of the non-tradable shares of Chinese state-owned enterprises (SOEs) and shows there is little evidence of significant stock disposals by the SOEs and notes that given the recent significant falls in the Chinese stock markets, the authorities have every incentive to dampen large-scale share sell-offs. However, as a number of share restrictions are not relaxed until 2009-2011, the full impact of the share reform in China will take some time to be evidenced. The final paper in this issue investigates the market risk disclosure practices of Malaysian listed firms. The findings indicated that Malaysian firms do not report credit risk and there is, therefore, in these difficult financial times, a need to improve risk reporting and achieve greater financial transparency.

Charlie Cai