Will supervision solve the crisis?

Yesterday's problem: Banks that are too big to fail..
Today's worry: Institutions that are too "interconnected" to fail..

The last 2 decades of financial imagery and innovation, combined with globalisation has created a financial system with entities that are connected in unimaginable ways. This interconnectivity has been raised by Trichet that there is an impending need to extend regulatory and supervision oversight to "systematically important" financial institutions.

In the last century, supervisors and central bankers have conveniently and neatly grouped financial institutions into Banks and Non-banks, but the over-simplistic approach to non-bank financial institutions is now deemed to be obsolete. Hedge funds, credit rating agencies, credit default swaps, structured investment vehicles and offshore centres are areas highlighted by Trichet as requiring more regulation and supervision. The role required is likely to include more monitoring, and analysis of financial stability, developing early warning systems for risks to the financial system, conducting stress testing exercises and advising on financial regulation to improve stability.

Whether how Trichet's proposals will tie in with what the Obama administration has in mind is likely to take months to thresh out. It may ultimately lead to a super agency and the list of headline-screaming reforms will definitely have an impact on both financial markets and investor confidence. But whoever's in charge should keep in mind that the one size fit all approach from policy makers across both sides of the atlantic needs to manage the increased supervision without stifling innovation.

Eric Tan, London

A Eurozone Growth Decline. Markets for the week ending 13-Feb-09

Markets:

- Global equity markets suffered sell-offs as optimism turned to scepticism. Evidence of a deepening recession and doubts on the US stimulus package were the key drivers.

- Government bonds benefited from the shift away from equites this week

- Sterling was among the major losers in the currency markets. Bank of England unveiled a stark assessment of economic outlook and signalled that it would embark on quantitative easing policies. The pound fell 2.6% against the dollar and 1.9% against the euro.

- Commodites-wise, oil (US light crude) tumbled 12% after the International Energy Agency forecasted bleak demand, while gold rose to test the $950/ounce level on investor flight to safety.

Eurozone's dilemma

-Eurozone's gross domestic product (GDP) fell 1.5% in the fourth quarter of 2008, led by a sharp deterioration of the German economy. The data show the challenging economic circumstances across the whole of Europe
- German GDP contracted 2.1% which was significantly faster than the UK although Germany had no housing bubble.
- The European Central Bank (ECB) is widely anticipated to cut its rate by another 0.5% next month to 1.5%, - its lowest rate ever.


Eric Tan, London

Markets for the week ending 6-Feb-09

Markets

- US markets rallied despite news that the US economy shed almost 600,000 jobs in January. Market assumed that the job losses would strengthen the president's hand and ensure that the stimulus would go through.

- US financial stocks enjoyed spectacular gains on the close of the week as investors looked beyond the bleak economic data and focused on Obama's plan to shore up the strickened sector.

- In Asia, Shanghai composite share index rose almost 10% this week on hopes that China's economy could see an early recovery

- The sterling pound continued recovering against the euro after the markets welcomed Bank of England's interest rates cut of 50bps to 1%, and the ECB left Euro Area interest rates unchanged at 2%.

Comments

European Central Bank made clear on Thursday, (as the Bank of England slashed UK interest rates by another half a percentage point) that zero per cent rate policy would be inappropriate “at the moment”, but his remarks did not rule out the ECB eventually following the US Federal Reserve, which has moved rates close to that level.

Sterling has climbed to a 2 month high against Euro after weeks after coming close to a whisker of being parity with the Euro.

This week, we also witnessed Unilever and GSK announcing that they will not be providing financial guidance for this year. CEO of Unilever is of the opinion that setting a target and subsequently revising them would lead to a decrease in credibility in the company.

Defensive companies had outperformed the market significantly in the last quarter of the 2008, but with them off their recent highs this week, it has given investors a wake up call that there aren't many more places to hide.

As investors continued to flock to the safe haven asset class of gold, Goldman Sachs, Merrill Lynch and UBS have dramatically altered their earlier forecasts and are all now predicting that the gold price will hit at least $1,000 an ounce this year, up from previous estimates of $700.

Interests in dividend swaps have been stirred up recently and it might be interesting to look at my article posted on 22-Jan-09.

Eric, London