New Challenges in a Rapidly Changing Environment
Speeches
22 Feb 2000
New Challenges in a Rapidly Changing Environment
Tony Latter, Deputy Chief Executive, Hong Kong Monetary Authority
(Speech at the Asian Treasury Forum 2000, 22 – 23 February 2000, Hong Kong)
- There was a time, many years - or more likely decades - ago,
when it seemed that the main role of the company treasurer, if
indeed there was any such identifiable position in the company, was
to make sure that enough money had been transferred from time
deposits to current account before each month's pay day; and it
seemed that the main, possibly the only, function of a company's
finance director was to make sure that the accounts were compiled,
audited and filed on time.
- How times have changed. Not only has there been a ceaseless
escalation in the range and complexity of financial instruments
available to us all, and in the sophistication of accounting, but
there has also been an inexorable rise in the expectations which
others, such as shareholders or executive boards, have as to what
can be delivered from the financial side of a business. As a
central banker I feel some empathy with those who find themselves
sandwiched between pressure on one side from their masters to
achieve ever lower funding costs or ever better returns from
financial investments, and persistent enticements on the other side
from bankers claiming that you could be freed of all that pressure
if you simply subcontracted everything into their capable
hands.
- Treasury has come to be regarded in many instances as a
separate profit centre. The treasurers of some major corporates are
nowadays acknowledged as being at least as significant players in
the financial markets as are the banks themselves. There are some
well known examples where the profitability of an enterprise in the
manufacturing or services sector has been sustained by deft
treasury and financial management for considerable periods when the
mainstream business has itself been floundering. And there are also
examples, alas, where reputable companies have been brought to
their knees by flawed financial management. You probably don't have
an easy life, but you won't need me to tell you that.
- I find myself wondering whether or for how long the financial
scene will continue to be one of such rapid change as we have been
witnessing in recent years; and what the implications are, for any
or all of us here, of recent and prospective developments in
financial products and infrastructure.
- It is difficult to put a starting date on the financial
revolution which I am attempting to describe - I mean the era of
sophisticated asset and liability management techniques, of ever
more exotic derivative and hedging products, and so on. But I guess
it got going during the 1970s. Why not before? It seems that for
most of the preceding post-war years banking and finance enjoyed a
rather cosy and protected existence around the world. Capital
controls and domestic regulation tended to constrain the scope for
competition or diversification; many domestic banking sectors were
cartelised to a significant degree, or in some cases state
controlled; cross-border migration was, for one reason or another,
rather rare. All in all, the incentive and scope to innovate were
weak by today's standards.
- The environment changed quite quickly when national
administrations began to deregulate their financial sectors at the
micro level and to free up movements of capital at the macro
level.
- Just as importantly, the electronic data processing revolution
began to open up avenues for financial engineering that could never
have been dreamt of before. In the dealing rooms of London - then
as now the world's leading international financial centre -
professional mathematicians moved in alongside, or even displaced,
the "barrow boys". Perhaps I should explain that the barrow boy
stereotype was a Cockney young man from the east end of London with
probably no very accomplished formal education but with strong
mental arithmetic and trading skills, acquired from working on
market stalls. Such people were until then regarded by many as
possessing the best qualifications to become dealers or floor
traders in the City of London.
- The IT revolution has not of course been a static one. Since
the introduction of the first computers into financial product
development and trading, computing power has grown exponentially.
New vistas and previously unimaginable complexities for trading
strategies have thus continually opened up; and the ever-increasing
speed of processing and communication has progressively rewritten
the definition of "time critical".
- The stream of innovation requires us not only to master the
mathematics but also to assimilate a whole new vocabulary of jargon
- designed, no doubt, to make the underlying mathematics more
easily digestible. For example, I received a document from a
leading international bank the other day explaining to me that the
butterfly involved three tenors where the middle was the bullet and
the wing was the barbell; moreover I could long a two-five-ten by
being long the two and the ten, each for a PV01 of half the sum for
which I should short the five; in so doing I could profit from a
bow at five but would be indifferent to any directional move
provided it was parallel. Meanwhile, our universities today
probably devote more teaching time to gamma trades than to gamma
rays; I'm not sure whether we, as citizens of the world at large,
should be elated or depressed by this.
- But the world of finance is moving forward not only in the
realms of such highly complex or sometimes - dare one say -
gimmicky instruments. Continuous change and innovation are
observable at the more prosaic level too. Looking at Hong Kong
alone, over the past year there has been an impressive list of
innovations, actual or planned, in the financial sector. These are
not necessarily all of specific interest to the corporate treasurer
but are nonetheless significant in a more general context.
- Thus, first, we have established a reciprocal link with South
Korea for access to each other's bond settlement and custody
systems (following earlier links of this sort with Australia and
New Zealand). Next, Hong Kong has launched the Tracker Fund as a
means of disposing of part of the Exchange Fund's Hong Kong dollar
equity portfolio; although this bears many characteristics of a
conventional index-tracking unit trust, it also has some unique
innovative features. In addition, the Hong Kong Mortgage
Corporation has successfully introduced its first mortgage-backed
securities programme. And notes issued by HKMA and HKMC have been
listed on the stock exchange for the first time. Finally, we are
preparing a US dollar clearing system which we hope will offer a
wider range of facilities than any other offshore clearing; I would
not want today to anticipate the more detailed announcements about
the planned timetable for this project, which we expect to make
shortly.
- The foregoing is not necessarily an exhaustive list of changes
which are being implemented here. And, assuming that Hong Kong is
by no means the only place where new ideas are being developed
across the financing spectrum, I am led to the conclusion that
there is little prospect of any immediate let-up in the pace of
global product innovation in finance.
- That is a conclusion reached from merely observing what is at
present happening in the financial world, but it does raise
questions as to where in all of this lies the scope for extra value
added and profit. If one assumes that the overall levels of savings
and of investment demand in the economy are little affected by
micro developments in the financial sector, then it follows that
innovations, in order to be profitable, must be continually
exploiting new arbitrage opportunities, new and more efficient ways
of serving customers, and so on. One can understand how, over the
years, the increased level of competition in finance, both within
and between countries, as well as the communications revolution and
the IT revolution, have provided the basis for extraordinary gains
in efficiency. But will this trend continue? Indeed, can it? Might
the financial sector now be encountering sharply diminishing
returns from innovation, in which case much of the new effort put
into designing new products would prove to be an expensive mistake?
Or would it perhaps be more accurate to describe it as an expensive
necessity, since, if you don't do it, someone else will? In the
intensely competitive environment you can't afford to be left
behind, but will, or can, everyone still make profits?
- I pose these as questions, but I'm afraid I don't have any
conclusive answers. Yet I suspect that we may continue to be
pleasantly surprised by the fruits which this ongoing revolution
can bear. While it is certainly clear that finance is by and large
a hugely competitive business, we observe that many of the
participant institutions are enormously successful and profitable.
At the same time, however, those of us with responsibilities for
regulation, whether for purposes of consumer protection or in order
to ensure systemic stability, are surely justified in imposing
capital and liquidity requirements designed to make the
institutions proof against the sort of setbacks which too intense
competition may eventually bring to some.
- Of course, the scare story of impending diminishing returns and
so on has been told many times before. What, if anything, is new,
as we set off into the new millennium? I believe there are two new
ingredients, both concerning the internet. They are access and
speed. They are of course related.
- We can all now enjoy direct access to almost anyone and
anything, anywhere, without having to go through intermediaries -
other than electronic ones. We are all aware that a degree of
caution is required here. For example, the HKMA supervises the
banks that are located in Hong Kong, and it is unlawful for anyone
to solicit for deposits in Hong Kong without authorisation. But if
you click onto the website of someone in a far-off country and are
seduced into transferring funds into a deposit with them, we may
not be able to help you if things subsequently go wrong. This is a
fairly simplistic example and I'm sure that everyone in this
audience, at least, would be alert to the risks and would act with
the necessary caution. But the proverbial man in the street, who
may nowadays have his own internet access, may be more gullible.
Moreover, there may be products on offer that are more subtle and
beguiling than a straight deposit, and very seductively packaged
too; all of us here today are potential victims to some sort of
dupe; it is a brave person, or perhaps an arrogant one, who would
deny that vulnerability.
- A still more significant manifestation of the internet, with
potentially sinister consequences, is the speed which it brings to
all dealings. Generally we marvel at the instant availability of
up-to-date information, and the capability to act upon it, if we so
desire, by a return click of the mouse. If the response is simply
an e-mail message to a friend or colleague, the scope for loss or
damage may be limited, but, even then, how often do we later rue
the impulsive riposte? How many times do we go to bed composing the
most fantastic letters or office memos, only to wake up the next
morning to realise that they were wholly over the top, too effusive
or too offensive, tactless, or whatever. The trouble is that
nowadays we do not have to wait to respond until we can reach the
other person on the phone the next day, or mail him a letter, or
hand him an office memo; by the time we awake the next morning it
may already be too late to censor our folly; we may have clicked
the send button the night before. Worse still, in an increasing
number of instances our counterparty will actually expect a
response almost immediately. The phrase, "Let's sleep on it",
wasn't born for nothing, but now it may not be allowed. If you are
executing major financial decisions by a mouse click, the scope for
subsequent embarrassment may be substantial, to say the least.
- What I find slightly worrying is that the economics of, or
business case for, continuing financial innovation and the quest
for new efficiencies may depend in large part on successful
exploitation of opportunities that can be seized only if you are
able and willing to respond with lightning speed. The ultimate
manifestation of this is programmed trading, where the computer
virtually takes the decision for you. As history bears witness,
such strategies are as good, but only as good, as the assumptions
that are programmed in, be they about economic forecasts,
covariances between various events, or whatever.
- But even if we felt that these particular strategies were
foolproof, there are a myriad of other financial transactions which
can only really be consummated by a conscious human decision. The
home buyer faced with a choice between taking a mortgage from bank
A or bank B is unlikely to have a sophisticated and reliable
mathematical model with which to compare the offers and determine
conclusively his choice. But the culture nowadays, bred at least in
part by the technological feasibilities of the IT era, is one which
is likely to place the home buyer under much greater pressure to
reach a quick decision than his parents would have been a
generation ago, or even his brother five years ago, for fear of
losing the best offer - if only he could assess which was the best.
There is less time to reflect; less time to seek out disinterested
advice.
- There are of course some areas of finance which appear
relatively untouched as yet by this revolution. In the realm of
corporate finance, in every jurisdiction so far as I am aware, the
documents seeking shareholder support for a merger, for example,
are still required to be sent by post, and with a reasonable
minimum notice period for response. I wonder how long it will be
before documents will be deemed to have been delivered to
shareholders so long as they were sent by e-mail or posted to the
person's interactive television; and the response period may be
compressed on the assumption that you can pick up your mail
wherever you are and at any time. All of this may sound fanciful
for the moment, but is not impossible at some stage.
- What we still need, but may be in danger of losing, is the
chance to pause for breath. We need time not only to think things
through for ourselves but also to consult others. If, having
dispensed with your human stockbroker because you resented paying
his level of commission, you buy a company's shares via the
internet at what you think is a bargain price, but in ignorance of
the fact that a couple of minutes previously the company issued a
profits warning, you have only yourself to blame. But you may have
felt forced into dealing in that manner by peer pressure, or for
fear of loss of face if some colleague in the office starts
boasting about what a killing he has been able to make on
such-and-such a "day-trading" deal. If that is indeed a fair
characterisation of the atmosphere which many of us nowadays
breathe, then I have to say that I find it rather distressing. We
ought not to feel embarrassed to confess confusion, to seek advice
or indeed to pay for advice.
- So, we live in a very challenging and pressurised environment.
I am in no doubt in my own mind that the revolution which has swept
through finance in the past quarter century has been beneficial to
institutions and customers alike. We have, I think, now entered a
phase where the basic margins may be narrower, where temptations
may be greater and more varied, where the pressures to move quickly
may be much stronger, and where of course the risks may therefore
be rather greater. We all need to exercise skilful discernment and
judgement, and I am sure this is as true for corporate treasurers
and finance directors as for the rest of us. But it is not my
intention to be a killjoy; as I have suggested, there will continue
to be exciting new opportunities to explore; and I wish you all a
fruitful couple of days here doing just that.