Global Business Perspectives
Durga93
GBE4lecture8.pptxThe Global Business Environment
LeCTURE 8
Challenges and responsibilities
Global finance
How global financial markets impact on the business environment
Summary of contents
Evolution of the international monetary system
International capital flows
Global financial risks and their consequences
When financial crisis strikes nations
The global financial crisis of 2008
Global markets for corporate control
Challenges and responsibilities
Conclusions
The international monetary system
The gold standard system – 1870s to 1914
Currencies were ‘pegged’ to gold – there was a conversion rate for each currency
System depended on central banks adhering to external convertibility
Marked the emergence of a global financial order
No restrictions on international gold flows
System broke down at the outset of the First World War, when governments restricted movements in gold markets
The Bretton Woods system
Dates from the aftermath of the Second World War It lasted from 1944 to 1971
Currencies pegged to the US dollar
But some flexibility for countries in setting the value of their currencies
National capital controls allowed
The IMF and World Bank are Bretton Woods institutions
Bretton Woods system collapsed, largely due to a growing US trade deficit and steep rises in the price of oil
Exchange rate system
Overseen by IMF
Provides guidelines to governments on managing their currency
Currencies can range from fixed rate to free-floating
Pegged exchange rate – currency pegged to another, e.g. US$
The peg is adopted to provide stability, and is favoured by developing and transition economies
Governments can come under pressure to devalue
The IMF warns against the accumulation of vast currency reserves, but many countries in fact hold large reserves, e.g. China
The IMF and World Bank
Both are involved in economic development policies for member countries (numbering over 180)
Both are influential institutions, e.g. attaching conditions to loans, based on principles of the ‘Washington consensus’
The World Bank focuses on development programmes, especially in Africa, Asia and post-communist transition economies
The IMF focuses on broader development issues and financial stability
The IMF is a co-ordinating organization of the G20
The Washington consensus
Post-Bretton Woods
Issues of global financial stability
IMF seeks to maintain exchange rate flexibility
Currency pegs can be more flexible, moving in bands
If the currency is undervalued, benefits flow to the country’s exporters
Free-floating currencies are ‘reserve’ currencies – the US $, Japanese yen, UK £ and the euro
Growing influence of China
China’s currency, the yuan, is no longer pegged, and has become a reserve currency
International capital markets
MNEs raise capital by offering shares to investors (equity funding), and by borrowing (debt financing)
Capital markets – flows of capital, including equity and debt markets
The financial environment has become highly globalized, due largely to improvements in computing and communications; characterized by:
Growing opportunities for cross-border financing and investment in business
Growth of global financial institutions
Growing role played by governments, e.g. sovereign wealth funds
Equity markets
Shares in listed companies are traded on stock exchanges, beginning with the IPO (initial public offering)
China has overtaken New York in new listings of companies
Global companies now often seek listings outside their home countries :
In countries which are growing markets or where new investors are emerging
In countries where costs and regulation are more advantageous
Institutional investors, such as pension funds and investment funds, have become major players in capital markets
Debt financing
A bond is a loan instrument which promises to pay a fixed sum on a fixed date, and to pay interest to the lender
Many organizations issue bonds, from companies to governments
Sovereign debt, or government debt, has grown to huge proportions
Derivatives – financial instruments which have facilitated the securitization of debt
Hedge funds – investment funds active in bond markets
Their speculative behaviour can cause volatility in capital markets
Private equity funds – Investment funds which focus on buy-out activities, often financed by debt
Global financial risk
Globalization has increased risks
Derivatives markets are largely unregulated
Use of ‘asset-backed securities’ or ‘mortgage-backed securities’ - of uncertain value
Hedge funds are active in derivatives markets and in sovereign debt instruments
Some, known as ‘vulture funds’ purchase government bonds in secondary markets, known as ‘junk’ bonds, and pursue legal actions for full payment
Finance is now seen as an activity in its own right, not merely a function
National financial crises
National financial systems can become vulnerable through a banking crisis, especially when banks are exposed to derivatives markets
Some causes of national financial crises:
Openness to global financial flows
Accumulation of too much debt – by governments, businesses and households
Falling currency and dollar-denominated debt
Argentina – sovereign debt default, but the government eventually paid off vulture funds
Russia – currency crisis in 1998, following rapid liberalization under IMF-recommended reforms
The Asian financial crisis
Started in Thailand in 1997, and contagion spread to 3 other Asian countries – South Korea, Indonesia and Malaysia
Investment boom and huge inflows of capital preceded the crisis
Risks of the pegged currency: the government struggles to maintain the peg, risking running out of reserves
The currency crisis caused investors to flee
IMF rescue packages ensued, but one-size-fits-all market solutions were criticized
Global financial crisis 2008
Financial growth in the preceding decade was based on low interest rates and extensive borrowing
Growth in derivatives trading and the re-packaging of debt as securities, especially mortgage-backed securities
Banks became active in derivatives, using debt to fund further lending – a risky strategy
The crash in the US housing market led to uncertainty in financial markets and an abrupt halt to lending
Failure of Lehman Brothers bank in the US – a watershed event
Repercussions around the globe, affecting globalized banks which were exposed in derivatives markets
Aftermath of the financial crisis
UK government rescued two banks (RBS and HBOS) – RBS had become overextended through global acquisitions
Scandals involving rigging of the interbank lending rate (LIBOR)
Banks have also faced fines for mis-selling financial products
Quantitative easing (QE) – in the US and UK – intended to inject money into the financial system
Regulatory issues
It had been widely assumed that financial markets would be self-regulating
The near-collapse of banks and other companies, which had to be bailed out by governments, led to a rethinking of stricter regulation
How can future crises be prevented?
Compel banks to become more conservative in strategy and national in focus
Raise capital adequacy requirements for banks
Bring derivatives trading within regulatory framework
How far will governments co-operate internationally to regulate banking?
Global markets for corporate control
A merger is the coming together of two or more companies to form a new company
An acquisition or takeover involves one company buying out another:
Often paid for by borrowing, in the leveraged buy-out (LBO)
If the board of the target company does not approve the takeover, it becomes ‘hostile’, and is submitted for shareholder approval
Emerging markets are now the source of much merger & acquisition (M&A) activity
Challenges and responsibilities
Assumption has been that the ‘free’ market comprised of self-interested organizations is essentially stable
‘Self-regulation’ does not imply that all players will behave responsibly
How to combine an enterprise culture and a sense of responsibility
The global crisis revealed a banking culture in which illegal and unethical practices occurred – the ‘casino’ mentality
Conclusions
Financial systems are vital to individuals, businesses and governments
Stability is the key feature required in financial markets, but the rise of global finance has brought greater instability
Global markets have seen innovation in finance, but also greater risks
What of regulation at international level?
IMF rescue measures help individual countries to some extent, but they do not constitute a global framework
