HARNESSING AND REGULATING THE MONEY. Investment laws and customs differ from country to country. Governments and financial exchanges are trying to harmonize them.
London, New York, Tokyo
IT is 1995. Rumor of an Army coup in South America shakes world financial markets. Institutional investors in Tokyo and Hong Kong -- then later in Europe -- dump Argentine stocks for 12 hours before the business day begins in the Western Hemisphere. The Buenos Aires stock market dives. Later in the day, the rumor proves unfounded. But by then billions have been shaved off stock values around the world.
The 1995 story, of course, is fiction, but it does point out a key problem with global finance: There is no central authority to regulate that world system, suspend trading in all time zones in an emergency, or enforce ethics and standards that promote financial stability. Global finance is high stakes, high risk, high hopes. A bump somewhere can make the entire system shudder.
In 1984, a rumor on the commercial paper market in Tokyo caused a run on Chicago's Continental Illinois Bank. That resulted in a massive bailout by the Federal Deposit Insurance Corporation, the Federal Reserve, and a consortium of United States banks. The FDIC broke its $100,000 guarantee and bailed out all depositors. The US government essentially nationalized Continental Illinois Bank for a time.
Late last year, a Singapore-based company collapsed, so shaking the Singapore stock market that the stock exchange (third largest in Asia after Tokyo and Hong Kong) had to be temporarily shut down. The nearby Kuala Lumpur market also closed. Shares of Asian corporations on London and Hong Kong exchanges plunged. Hong Kong gold shares fell. Banks in Hong Kong suffered big losses.
If such transactions are conducted on margin (that is, with a large proportion of borrowed money) there is ``great risk,'' says Takashi Kiuchi, an economist with Japan's Long-Term Credit Bank. If one investment fails, he says, many other parties to the investment could fail -- ``a very big problem.'' BEYOND CONTROL?
In an attempt to counteract volatile interest rates and economic cycles, investors have gone global. Some volatility may indeed have been taken out of the system, but financial or political news in one market can echo in markets around the world. International financial concerns affect all.
In some ways, that helps stabilize things. Third-world debtor countries are not defaulting on loans because they don't want to burn bridges with world capital markets. Governments are eager for big banks to be paid by debtor nations, wishing to avoid a bank bailout. And banks themselves continue negotiating with nations heavily in debt so as to maintain the accounting value of their loans.
Nevertheless, the growing influence of international finance has nations concerned about maintaining control over their own financial systems and key corporations. With financial markets open to all, what would happen, for example, if Japanese institutional investors bought so many shares of one of the Big Three US automakers that they won at least nominal corporate control?
Similarly, what would happen if Japanese investors were to lose faith in the US bond market and dump their holdings of Treasury bonds? US bond prices could plummet and interest rates might soar. Washington might be forced into quick and severe budget cuts or tax increases.
Economists and government regulators are also concerned about what this financial race is doing to banks. In recent years, Japanese and American banks have been packaging more and more of their loans in forms that look very much like securities. But if banks become involved in other forms of securities -- such as underwriting stock -- this could mean more risk for depositors.
Governments and investors are having to come to grips with these and a host of other nitty details that impinge upon the global trading of stocks, bonds, and other financial instruments such as futures and options.
This is not just in the interest of financial houses such as Citicorp, Merrill Lynch, or Nomura Securities. First-world nations want to see liberalized capital flows -- both as a free-market principle and as a practical way of financing global trade, industry, and investment. And with bank lending at an ebb because of the international debt crisis, third-world nations need foreign investment in plants, equipment, and local stocks to help develop their economies.
``A small shift in [global] investment toward emerging markets could increase the volume of capital flowing to developing countries,'' a 1985 World Bank report says; it points out that ``countries with stable economic and political environments are the most successful in this regard.''
If all goes well, this means more jobs and higher standards of living. But as their private sectors participate more and more in the global financial market, governments lose a measure of control over their own economies.
That is a cost that may prove difficult for third-world nations, which increasingly find themselves being forced to conform to the economic systems of the major financial powers. Even first-world nations may not be inclined to alter fundamental financial laws of their lands -- or see ownership of key industries spread around the globe. INVESTOR BEWARE
If ``insider trading'' is strictly prohibited in New York, but not so strictly in Hong Kong or Tokyo, a foreign investor may be at a fundamental disadvantage in those markets. And how can an investor be sure that a foreign company's accounting books haven't been cooked?
Foreign laws and customs can be tricky. In newly developing markets, investor protection may be haphazard or absent. There are also special political problems that arise when one is investing in developing countries -- problems such as overnight changes of government and subsequent decisions to nationalize industries, devalue currency, enact exchange controls, or alter laws that deal with investments and banking.
Those best equipped to trade globally are the powerful institutional investors such as mutual funds, pension funds, and professional money-management firms. They can afford to hire consultants and specialists in the economies of nations and in industries and individual companies. For this reason, the biggest concerns of institutions tend to be not political but technical.
For instance, once a stock is bought or sold in the US, it takes five days for the transaction to be settled. In Britain, it takes 14 days. An American investor must remember that he does not have possession of a British stock as soon as he would an American one. This could be a problem if the investor intended to turn around and sell the stock quickly or borrow against it.
US and British authorities are working on harmonizing such details. By September, the National Security Clearing Corporation (NSCC) and the London Stock Exchange's clearing arm plan to allow their members access to each other's settlement systems.
The best tack, says John Kinnaman, president of the NSCC's International Security Clearing Corporation, is to use ``U.K. procedure with the U.K., and US for US securities.'' Still, many analysts expect most Americans to continue to buy and sell British stocks via more common American depository receipts (which represent shares of an alien corporation held at a bank) until the system works smoothly.
``In London, we're satisfied that our members are going to get nearly equal protection in the settlement process'' as they would in the US, Mr. Kinnaman says. ``But the London market doesn't have the same guarantees that we have in the States. We can't provide any better protection than exists there.''
And this is only the US-U.K. link -- and only as it pertains to clearance and settlement.
In Britain, corporate takeovers don't have the same disclosure rules as in the US; a company doesn't know when a raider is buying up big blocks of its stock.
Some foreign mergers have been blocked because of US regulations involving solicitations of US shareholders, and foreign firms with US shareholders have found they cannot do ``rights offerings'' -- raise additional capital from existing shareholders -- because of US law governing registration of these offers.
Points that affect market stability differ greatly from the US. Example: British traders may sell stocks short on a downtick in price. In the US, such sales are allowed only on an uptick, since rampant short selling is believed to have played a part in the 1929 stock market crash.
Most countries do not require corporations to report quarterly on profits and losses -- or with great detail on an annual basis. In the US, well-trained financial analysts can crack apart the accounting details of these reports and determine if corporate finances are sound and the investment a good one.
But German, British, and Japanese executives complain that such detailed reports provide vital information to competitors. Fritz Rau, financial analyst with the giant Commerzbank in Frankfurt, West Germany, cites this as one reason German businessmen are reluctant to go public with stock offerings and prefer to deal with bank loans instead.
There is at least one other variable that investors must weigh when dealing with foreign stock: exchange rates. A stock on the Geneva exchange may have enjoyed phenomenal growth. In fact, the exchange as a whole may have doubled in value. But an American selling the stock will want to be paid in dollars. A big change in the US-dollar, Swiss-franc exchange rate can wipe out a gain on the Swiss stock market (or could enhance that gain, if exchange rates went in the investor's favor).
``Too many people have oversimplified this,'' says Sam Hunter, director of securities trading at Merrill Lynch. ``Americans are not trained to take both market and dollar risk.''
With money at stake, however, the educational process is sure to speed along. SELF-DISCIPLINE
The US generally has the strictest laws involving finance, but it is unrealistic to think that all other countries are going to come up to US standards. Compromise may be necessary.
Tsueno Fujita of Japan's Ministry of Finance says his government ``is now studying taxes, registration, and other ways we have to amend and harmonize the [international financial] system.'' But that does not simply mean adjusting Japanese laws to conform to US standards, he says. ``We have to require the US and Britain to approach our system, too.''
In the US, Japan, West Germany, Britain, and Hong Kong, government officials have told the Monitor they are attempting to resolve these problems. Some suggest a multilateral approach not unlike the General Agreement on Tariffs and Trade. Most, however, think bilateral arrangements are the most practical.
But virtually everyone agrees that the global financial system should approach a kind of ``steady state'' before attempts are made to enact global regulations. Even then, the consensus seems to be that the market and the private sector have the biggest policing role to play.
London Stock Exchange chairman Nicholas Goodison cites a ``growing need for the regulators of markets to form a united front as markets become more international.'' This is necessary, he says, to prevent ``abuses in one country from being exported, as regulations are tightened, to another where they are looser.''
His American counterpart, New York Stock Exchange chairman John Phelan Jr., says regulators worldwide must ``examine what's going on already [and] look ahead 5, 10, or 20 years.'' He calls this practicing ``financial statesmanship.''
The idea behind self-regulation is that individual stock exchanges and financial associations (example: the National Association of Securities Dealers, which regulates the US over-the-counter market) find it in their interest to maintain high standards. A good reputation draws business. A bad one repels it.
The London Stock Exchange, for instance, tells investors that ``whatever protection may be given by the law, it is not enough. Markets must also regulate themselves effectively in order to create the confidence that is needed.''
Case in point: Bankers and brokers in Hong Kong say that by cleaning up the Hong Kong market, they expect to attract some of the business that has migrated from Singapore since that stock market crashed last year. Officials in Tokyo report much the same thing.
Self-regulation can enhance and protect financial institutions -- although undoubtedly financial markets will still be prey to rumormongers and assorted frauds and cons.
National law enforcement agencies will, of course, have to crack down on such abuses.
And it will still be in the interests of national governments to monitor developments in the world of finance, for governments and taxpayers would ultimately have to come to the rescue if the system itself ever crashed.