The Purpose of Finance

7 November 2011


From October 24th to 26th, the Caribbean Group of Securities Regulators hosted their annual general meeting and conference at the Hyatt Trinidad. 2011’s theme was “Regulatory Challenges in a Time of Financial Turbulence: The Way Forward”.
Firstline’s Chairman & C.E.O. Keith M. King was invited to speak on October 25th and we’ve reproduced his words here. What do you perceive to be the purpose of finance?

Good morning to all.

I am surrounded today by regulators. Given my three decades in the business of finance, you will understand when I say that I find myself amongst strange bedfellows. At a very basic level, market actors chafe at the idea of regulation. We dismiss it as unnecessary paperwork. However, at that same level, we welcome regulation when it refers to the regulation of unsavoury others; when we see our regulators “weeding out” the unprincipled element of the industry, leaving us professionals to do our work.

When a regulator keeps us busy with paperwork yet still leaves the door open for misuse of financial apparatus and abuse of the market’s end participants – the investors – we consider this to be a failed regulator.

As regulators, your objectives are principally to protect the investor, to ensure that the markets are operating fairly and efficiently; and to reduce systemic risk. But what is the larger context of these objectives? Focusing in particular on the objective to ensure fair and efficient markets, the question must first be asked: what are these markets intended to do anyway? What is their purpose?

It is only after we answer this question that we can decide what is fair or not, what is efficient or not, and how and what to regulate.

So my discussion today centres around the question: what is the purpose of finance? I say ‘discussion’ as I look forward to planting the seeds of a free exchange of information amongst yourselves in your private sessions.

You may or may not be aware, but I am a late replacement to the original speaker hailing from Kenya. I am humbled to be speaking to such a knowledgeable audience and it would be presumptuous of me to give prescriptions to such a grouping. Due to the recent request to speak, I am in the fortunate position that I am not expected to bolster any position by quoting authorities or to put forward arguments that have been buoyed by research papers and field analysis.

What I shall do however, is raise these following questions based on my personal experience in the field of finance, in the trenches of investment banking these past three decades.

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So, what is happening in the world today?

We are now operating in the midst of a recent rise in the U.S. stock market which we hope will be followed by increased trading volumes in T&T. Or is this too much to hope for? Perhaps fear of Europe’s toxic overhang of excessive leverage will continue to hold sway over investor sentiment here.

And while investors shut down in the face of Europe’s sad story, will that region have to hang its head and take an IMF-delivered bitter medicine, as Third World countries were forced to do? Or maybe they will gradually provide for losses over the long term and defer the hit.

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It has been thought that the purpose of finance is to channel a nation’s wealth into productive activities that create jobs and make economic growth possible.

However, when we have situations where institutions take their funds out of the host country, take positions against their clients, or collude with one client against another, the purpose seems inconsistent with the practice.

The regulator’s road is not a smooth one in such trying times. Which takes precedence: the law, policy, or practice?

Here are my questions:

Is it appropriate for an institution to bet against its host country?

Or can such an action be defended as simple prudence for an institution to hedge assets on its books so as to protect itself. When these assets are sold on to its clients however, is ‘prudence’ still the defence?

For a financial enterprise to be given a regulatory bill of health, beyond its capital strength, should its moral capital also be weighed? Should it be viewed as equally or more important?

Should regulation be principles or rules based?

Is there a functioning collaboration, in practice and not just on paper, between regulators, the FIU and the tax authorities to ensure that on all fronts, institutions are compliant?

Should such a collaboration be structured with the specific goal to source and then attack insider trading and price manipulation?

And speaking of insider trading: is this crime only a factor in bull markets, to be ignored in a market downturn, on the altar of public policy to promote economic activity?

Can the regulator look past policy supporters?

We shall soon be having some IPOs in T&T to get our collective blood pumping.

How can it be ensured that the IPOs are free of stock manipulation?

What does the regulator think should be the limits to the purpose of underwriting, to secondary market support, to the use of nominees as market makers? Will the regulator be in sync with public policy to promote much-needed investor optimism?

If so, will this acquiescence necessitate turning a blind eye to market manipulation when it takes the market profitably higher?

In this time of increased activity, what will the regulator seek to protect?

Will these newly issued stocks be widely held or will only institutional investors throw their hats into the ring, the body of retail shareholders still too scared to return to the market? Is the regulator on firmer ground if the retail investor stays at home sitting on his wallet and only institutions with the presumed knowledge to protect themselves, turn out?

And with respect to some of these institutional investors:

Will statutory fund limits halt an upward momentum of the market in its tracks should the Central Bank show up to arrest any heavy insurance participation?

Should derivative fixed income assets – mezzanine, convertibles – then be created to mimic stocks and allow the statutory fund space for a free run-up of values and volumes?

Is there a role for the regulator in activating a stagnant market and boosting investor confidence?

Over the years, debt has been T&T’s favoured source of capital. Should we recognise this reality and make fixed income trading the main pillar of the local stock exchange? In a recession, is there real hope for an uptick of broad-based activity from new listings? Can the considerable liquidity in the market be re-directed to the stock market?

In which arena is public policy best served for investor confidence: debt or equity?

As stock prices are low, is there statutory fund head room for acquisitions via stock issues or…

Will debt continue to be the order of the day?

Will shorting stocks be permitted locally…

Or is this practice inimical to the economic interests of a nation, particularly in these recessionary times?

Is the regulator mandated to protect the market from exuberance, rational or irrational?

Should it champion alternative market views so as to temper excesses and narrow the bid/ask spread?

The Securities Dealers Association of T&T of which I am recent Past President and current board member, would have submitted many proposals to the government with respect to the Securities Bill and there has been little to no response.

Is the bill now off the legislative agenda?

With specific respect to this bill, I must ask: should legislation and regulation prohibit online trading with foreign brokerage houses?

Is this market protection or is this overreaching?

If we are to stay within a rules-based system, regulators need to be very clear when they establish guidelines and definitions. Is it too much to ask for common guidelines for operating in different countries in the region? Our nations and our markets are inextricably tied and economic activity in one location immediately affects another.

Can we demand standardisation of the registration and licensing requirements for industry professionals across the region?

We also need more efficient regulatory determinations.

Can the loss of economic activity be quantified that is caused during the time taken by a regulator to make a determination on a matter, and the negative impact on the firm or individual during that period?

Is adequate staffing and training of regulators an absolute imperative for the proper functioning of the financial markets, without reference to national budgetary constraints?

I would like to leave you with this final question, though it is at the risk of repeating myself, as it has been referred to already in various guises:

Is fostering economic activity any part of the regulator’s remit?

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Ladies and gentlemen, I thank you for your kind indulgence in allowing me to muse with your valuable time.

May you have an enlightening and successful conference to the benefit of the financial health of our respective economies and the people within them.  After all, that is the purpose of finance.

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