Network for Sustainable Financial Markets

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					3  Annual Forum on
  rd

Responsible Investing
        Learning From the Financial Market Crisis
 Keith Johnson, Chair, Reinhart Institutional Investor Services
                             New York City, January 12, 2009




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« We’re still dancing »
                        2
                    2
             The Morning After

•   Lehman Brothers
•   AIG
•   Fannie Mae/Freddie Mac
•   Bear Stearns
•   Merrill Lynch
•   Wachovia
•   Northern Rock
•   General Motors
•   Chrysler
•   Bernard Madoff
                                 3
 The wasted decade….
S&P 500 from 1998-2008




                         4
     Increasing Velocity of Financial Crises
                          1987 Crash
                                             2001
                                            Dot com
•   1987 Market Crash
•   1989 S&L Debacle
•   1994 Mexican Peso Crisis
•   1997 Asian Financial Meltdown 2007
                                 Subprime
•   2001 Dot Com Bust
•   2007 Subprime Disaster


                                                      5
             Sunday 21 September 2008


  “ … once we stabilize the markets, we
  then have to take actions to make sure
        this doesn't happen again.
  … we have a regulatory system that is
broken. It's outdated. It's outmoded. It
    doesn't fit the world we live in.”

 Hank Paulson, US Treasury Secretary
   Former CEO of Goldman Sachs             6
    Network for Sustainable Financial
     Markets – A Different Approach
• International, non-partisan network of individuals
• Currently participants from ten different markets
• Finance professionals, academics & others
• Interest in long-term health and sustainability of
  markets
• Foster inter-disciplinary collaboration on
  research, solutions and advocacy
• Focused on systemic and fundamental issues

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                                                   7
 Robert Adamson       Jonathan Hayward              Amin Rajan
Keith Ambachtsheer     Keith L. Johnson       Benjamin Richardson
     Rob Bauer           Sean Kidney                Nick Robins
  Adrian Berendt          Eric Knight         William Russell-Smith
     Ann Byrne       Janelle Knox-Hayes              Janis Sarra
 Mark Campanale      Floris Lambrechtsen         Howard Sherman
  Greg Chipman             Jinyan Li              Penny Sheperd
                       Steve Lydenberg
   Cecile Churet                                     Dan Siddy
                       Michael Mainelli
   Gordon Clark                                 Michael Siebecker
                        Franz Maritsch
 Ronald B. Davis         Heleen Mees
                                                    Ken Sewart
  Stephen Davis           Paul Moxey             Nicholas Taylor
  Paul Dickinson        Mike Musuraca           Raj Thamotheram
   Hans Dijkstra     Robert A. G. Monks           Jeroen Tielman
    Ralf Frank        Louise O’Halloran          Mark van Clieaf
    Murray Gold       James O’Loughlin              Ed Waitzer
     Jack Gray         Matthew Orsagh              Robert Walker
  Danyelle Guyatt     Vasudec Palladam            Steve Waygood
Frank Jan de Graaf      Frank Partnoy            Helen Wildsmith
 Stirling Habbitts     Avinash Persaud           Cynthia Williams
  Mathew Haigh          Poonman Puri       Peer Zumbansen … and more


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                                                                 8
            Some Key Lessons from the
                  Market Crisis
•   Excessive leverage/debt
•   Inadequate risk management
•   Flawed and excessive incentive structures
•   Conflicts of interest endemic to financial system
•   Vicious circles of short-termism at all levels
•   Separation of risk from product creation and distribution
•   Segmented regulators with inadequate resources and lack of will
•   Politics and ideology trump knowledge and policy
          System is as prone to periodic crises and
          misallocation of capital as it was before sub-prime.




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                                                                      9
The NSFM Principles Lead to Solutions
1. Purpose of markets is to efficiently create sustainable value

2. Identify and value hidden risks and opportunities

3. Balance short-term and long-term interests

4. Improve market participants accountability for their actions

5. Improve governance at financial institutions

6. Reduce conflicts of interest through smarter alignment of rewards

7. Promote a coordinated global approach

                 This is what NSFM participants have signed up to…



                                                                   1010
Efficient resource allocation




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       Beyond economic measures
 “Gross national [or domestic] product measures
neither the health of our children, the quality of
  their education, nor the joy of their play […]
 It is indifferent to the decency of our factories
          and the safety of our streets […]
It measures everything in short, except that which
           makes life worth living […]”
                Robert Kennedy 1968



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Currently, the active NSFM working groups…
 • Fiduciary duty and long term investing
    – Comments to OECD on Pension Fund Governance
      Best Practices
    – Modernizing Pension Fund Legal Standards
      Consultation Paper
 • Regulatory reform white papers
    – Survey of financial professionals on who is to blame
      for the crisis
    – Credit Derivatives Market Design Consultation Paper
 • Executive remuneration reform
 • Climate change and long-term investors


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                                                         13
Climate change is the greatest and widest-
       ranging market failure ever
                      Stern Report, 2007




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                                           14
Identify, value & recognize costs offloaded to
                    society
                                 Solution?
  $4.7 trillion of carbon damage to real economy per year

                   95%




                                           5%

             carbon externalised     carbon internalised

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                                     Source: Nick Robins, NSFM
Fiduciary duty & long-term investing
                          problems




                                       16
“The obsession with short-term results by investors, asset
management firms, and corporate managers collectively leads to the
unintended consequences of destroying long-term value, decreasing
market efficiency, reducing investment returns and impeding efforts
to strengthen corporate governance.”
CFA Centre for Market Integrity & Business Roundtable Institute for Corporate Ethics,
July 2006




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                                                                                    17
   Short-Termism is a Systemic Cause of
            Value Destruction
“. . . It is shocking that the majority of firms are
   willing to sacrifice long-run economic value in
   order to deliver short-run earnings. Companies
   do this in response to intense pressure from the
   market to meet expectations. . . . we assert that
   the amount of value destroyed by firms striving
   to hit earnings targets exceeds the value lost in
   these high profile fraud cases. . . . What is
   worse is that these actions are not even
   considered to be a „problem‟ by many CFOs.”
Value Destruction and Financial Reporting Decisions, John Graham et al., Duke
   University, September 2006




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                                                                                18
So, do we need more regulations?




                                   19
       NSFM/AQ Research Survey of
        Investment Professionals
Who was to blame for the financial crisis?
• Bank leaders and their boards: 21%
• Shareholders/fund managers: 19%
• Politicians and regulators: 14%
• Central bankers: 10%
• Asset owners: 9%
• Investment analysts: 9%
• Hedge fund investors: 7%
• Accountants: 6%
• End customers: 6%
Only 7% think solutions should only come from government

Source: http://www.aqresearch.com




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       For financial markets to change,
         we need to change together
• Mainstream investment and responsible investment professionals
  both need to think creatively!
• Both face same challenges – going beyond their current products,
  competencies & business models
• Both face organisational/group think constraints
• Projects like NSFM could help introduce new approaches

  A challenge to you! Find an important issue you know the
  responsible investment community doesn't really have a good
  enough answer to, which you are really concerned about, and
  join/start a working group!

  www.sustainablefinancialmarkets.net


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posted:9/13/2011
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