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World Lottery Association
Credit Crisis
The next day for exchanges
Spyros Capralos
Chairman – Athens Exchange S.A.
Chief Executive Officer – Hellenic Exchanges S.A.
Ladies and Gentlemen,
I would like to thank the World Lottery Association and the 2008 Convention Committee
Chairman, Mr. Christos Hadjiemmanuil for inviting me to the beautiful island of Rhodes to
speak about the credit crisis, the Athens Exchange and the Greek capital market, and how
we have responded to the challenges that we faced in the recent past.
Allow me to begin by denying the rumors that have been circulating that Athens Exchange is
planning to join the World Lottery Association. Buying and selling stock has not yet been
reclassified as a form of betting, despite the recent market performance which seems to be
indicating otherwise!
Even though the title of my presentation suggests that I should be speaking about how
Greece managed to become a developed market, given the current market turbulence and
uncertainty, I would like to use my allotted time to present you our thoughts on the crisis
and what it means for exchanges and the world economy.
It seems that this year, capital markets and the financial sector have been in the news, for
mostly the wrong reasons.
The financial turbulence that began in the US a year ago continues, and it looks like it is
reaching a violent crescendo. It is fair to say that just about no-one could foresee the
Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
magnitude of this crisis 15 months ago when it started with the meltdown of the US housing
market.
Initially the crisis was simmering in the USA, first with the subprime loans, then with the fall
of housing prices and the increase in mortgage defaults; yet it looked like the world economy
would weather it out. However, this summer and autumn we are witnessing a financial
upheaval, unprecedented both in scope and in the speed with which events unfolded, and
continue to unfold.
The Fed injected massive doses of liquidity into the system through various new and existing
lending facilities. Nevertheless, several major financial firms with both massive systemic ties
and large exposures to US subprime mortgage debt began to falter. The Fed and Treasury
then stepped in to finance private takeovers or effective nationalizations of several of these
firms.
So far we have seen the US government’s taking control of Freddie Mac and Fannie Mae
and their $5 trillion combined mortgage portfolios; Bear Stearns collapsing and being taken
over by JPMorgan at $2 per share, valuing the once venerable company at $236m.
ΑΙG, the insurance giant, received a $85bn cash infusion from the Fed, in an effort to stave
off bankruptcy, and has asked for $38bn more, as the initial amount provided is proving to
be insufficient.
Merrill Lynch avoided trouble by being swallowed up by Bank of America in a $50bn deal;
Lehman Brothers, the 158-year-old investment bank, went bankrupt and was broken up
and sold to various buyers including Barclays and Nomura. The US Congress finally approved
a $700 billion bailout plan, whereby the government will buy illiquid mortgage assets from
banks and other financial institutions, thus providing liquidity to banks. And this is what is
happening just in the USA.
In Europe, we are seeing similar things happen. In the UK, the government took control of
Northern Rock, the mortgage bank. The Dutch, Belgian and Luxemburg governments with
the participation of BNP Paribas paid €17bn to rescue Fortis, providing an additional €34bn
in short term credit. Just over a week ago, the UK government unveiled a £400 billion bank
rescue plan to take equity stakes in UK banks; the US will follow suit, as will a number of
European governments, including Greece, which has unveiled its own €28bn bank support
package.
And, perhaps overlooked, but certainly not unimportant in its implications is the fact that
Iceland, after seizing its top banks, is on the brink of bankruptcy, and market watchers are
looking at Hungary in Europe and Dubai in the Middle East which are experiencing similar
difficulties.
About ten days ago, for the first time ever, we saw central banks across the world, in a
coordinated effort, reduce interest rates by 50 basis points. A number of countries, including
Greece, are guaranteeing the bank deposits of individual depositors, all in an effort to shore
up confidence.
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Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
I have given you a brief listing of recent events, in order to impress on you the fact that this
is not an “ordinary” crisis.
The size and number of victims of this crisis, all point to a turbulence that is extraordinary in
nature. However, despite the continuing bailout, the banking sector still faces challenges on
several fronts:
1)
Banks still need to de-leverage and re-capitalize
2)
Loαn growth is expected to be weak or negative short and mid-term
3)
Bad debt charges will continue rising and
4)
In all likelihood there will be more bank failures.
This crisis has spread beyond the financial sector and has affected the “real economy” as
well as capital markets, which are sharply down this year; Exchanges globally, from Japan
and Hong Kong in the East to UK and the US in the West are experiencing unprecedented
levels of volatility, with record one day gains being followed by equally impressive one day
losses. Some countries, such as Russia, either shut their exchanges down, or imposed limits
on trading activity, with most targeting short sales.
If this sounds almost surreal, well it isn’t. These are not ordinary events, and we are not
living in ordinary times. We are experiencing, beyond any doubt, one of the most violent
financial crises of all times, a crisis that is in no small part due to the greed for quick and
easy profits by a large number of traders in banks, hedge funds and other financial
intermediaries. This greed led to highly leveraged investments of doubtful quality and we are
all witnessing the violent outcome being played out.
Ladies and gentlemen,
The result is that markets worldwide, including Athens Exchange, have seen share prices
drop significantly with extreme volatility being the characteristic of most Exchanges, even in
the most developed markets. At the Athens Exchange, the General Index, has lost about
60% of its value. In addition, the unfavourable market conditions have kept investors away,
and as a result market activity has also been reduced.
In particular, the average daily value of transactions is down by 28%, (from €481m in 2007
to €349m) so far this year.
The adverse economic conditions have affected business activity in terms of IPOs and rights
issues. Over the past couple of years capital raised by listed companies had been significant
in our market, as exemplified by the €3bn rights issue by the National Bank of Greece in
2006 and the record €5.2bn rights issue by MIG in 2007. By comparison, this year rights
issue activity has been almost non-existent.
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Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
So where does this crisis lead to? What will the financial landscape look like when the crisis
is over? I think a few things can be said about the post-crisis world:
One,
unlike in 1929, which some are comparing this crisis with, today the world
economy has more defences; the central banks will in the end make the
necessary interest rate cuts (something they did not do in 1929) in order to
provide liquidity to the system.
Two,
governments will also, in the end, provide the liquidity and the guarantees
that are necessary in order to restore confidence to and re-capitalize the
banking system, and for entities to once again start lending to one another. If
necessary, the banking sector will be partially nationalized. We have already
seen the first such measures being announced.
Three,
we have seen commodity prices drop significantly from the peaks they
achieved earlier this year; amidst the crisis, we forget for example that today
oil is at approx. $70 per barrel, slightly lower than what it was a year ago.
The commodity price reductions have eliminated one serious cause of concern
regarding inflation.
Four,
we are seeing that companies are quietly using their cash reserves to buy
back stock; in Athens Exchange for example, of the 60 component stocks in
our large and mid-cap indices, 21 are buying back shares (i.e. 35% of those
companies). In addition, insiders are also active buyers. These are powerful
signals that share prices are low.
Five,
in speaking with experienced market watchers, the general consensus seems
to be that while major shocks such as the one that we are experiencing
require about 3 years to be absorbed (meaning that we have 1.5 to 2 years
left, with sustained growth not returning before 2010), what we are
experiencing is, in all likelihood, a “front-loaded” bear market, meaning that
we are going to see share prices drop significantly in the beginning of the
crisis (this has already happened), and that the worst (at least in terms of
share prices) is behind us.
Finally,
there will be losers (we have already seen some of them), but there will also
be winners – we will probably see those emerge in the next 2 to 3 years, and
they will be those with the liquidity and the nerve to take risks today.
Looking at Athens Exchange, what are the implications of this severe, worldwide market
crisis in terms of the activity and participation of international investors in our market?
Despite the unfavourable climate, we are seeing that international investors as a whole are
more or less maintaining their position in our market. In particular, in the first nine months
of 2008, while we have seen a small net outflow by international investors of the order of
€2bn, at the same time their overall participation in our market capitalization has remained
above 50% – 51.8% at the end of 2007 compared to 51.1% at the end of September 2008.
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Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
The figures that I just mentioned should be kept into perspective; one should for example
keep in mind that over the past seven years, international investors have significantly
increased their position in our market from 23.9% of total market capitalization at the end of
2001 to 51.4% today. In terms of capital inflows, international investors were net buyers to
the tune of almost €16bn in the 2005-2007 period, so the outflows that we have seen so far
in 2008 are modest in size by comparison.
History has taught us that financial crises can be associated with significant declines in
output. Until recently, this lesson had been viewed as a significant downside risk to forecasts
of growth in industrial countries. However, it is now evident that the impact of the current
financial crisis is more than just a downside risk.
The credit crunch, along with other shocks, is now hitting consumer and business spending
more severely than had been anticipated, and the full effects of that crunch are yet to be
felt. Analysts now expect that recession is under way in the US, Europe and Japan. Growth
in emerging market countries is likely to be affected by this. Overall, they expect global
growth to slow to just 2.3% in the year ahead, less than half its 2007 pace. This would make
it the slowest growth rate since 2001 but, owing to the resilience of Emerging Markets,
would leave global growth still above the levels attained in previous recessions.
Where are we now?
Today, the global financial system is essentially on “life support” from the central banks.
Term money markets are frozen. Banks and money funds are not willing to risk lending to
one another for terms longer than overnight, and most such lending is being intermediated
through the central banks. Money market spreads that stood in the US at 10 basis points
during the 1999-2000 market euphoria years and that in more normal times would be 20 to
40 basis points have increased to more than 400 basis points. This is a huge increase in the
cost of funding, if funding can be obtained at all.
Treasury yields have plunged as investors have flown to safety. US conventional mortgage
rates have eased thanks to the bailout of Fannie Mae and Freddie Mac, but other rates paid
on households and business credit are higher than they were before the Fed began its 375
bps rate cut a year ago. The availability of credit has dropped sharply. Private securitization
of mortgages is dead for now and that of auto loans and other consumer loans rapidly dying.
Banks, having been beset by losses on mortgage securities and by demands from investors
for higher capital adequacy ratios, have to cut back on new and existing lending. Potential
borrowers are finding it much more difficult to qualify for loans. In brief, a full-blown credit
crunch is now under way.
To ease the credit crunch, capital will have to be injected into the banks. This is important
because the banking system is capital deficient in the eyes of investors, and it will become
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Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
increasingly so as banks that have not done so mark their bad debt down to fair market
values. But re-capitalisation of the banking system, in part with public funds, is necessary as
a next step in order to encourage banks to begin lending again. A key lesson from past
banking and financial crises is that the cleanup is typically far more expensive in terms of
fiscal commitment as a percent of GDP than is currently being contemplated.
Europe, despite being late to respond, perhaps because the effects of the crisis were felt
later than in the United States, under the leadership of Great Britain, has responded with a
plan that is widely seen as the best response by governments to the crisis and is being
copied by the US itself. Even the ECB, which usually considers its fight against inflation as its
primary task, has responded with a 50 basis points rate cut ten days ago, and a reexamination of its policy going forward.
The main aspects of the European response are an expanded guarantee on the bank
deposits and a recapitalization of European banks through state funds. However, the use of
excessive leverage by banks has been an important element in the development of the
financial crisis also in Europe, and as a result, full restoration of trust in the banking system
will require, besides the injection of state funds, a move to much more conservative levels of
leverage than seen in recent years on a global scale. This will take time, and for this reason,
trust in the system will return only gradually.
What about Exchanges?
Prior to the last twelve months, the past several years were exceptional for most exchanges,
which have seen their margins, profits and other performance metrics rise spectacularly.
Across the globe, they increased their EBIT margins to 39%, from 18%, in the years from
2001 to 2006. During that period, we at Hellenic Exchanges, managed to increase our EBIT
margin from 1.5% to 70% thus becoming one of the most profitable exchanges (in terms of
margins) globally!
The gains of incumbent exchanges were all the more impressive for coming at a time of
great uncertainty: a wave of regulatory change has peaked at that time in US and European
equities markets. Regulators have opened the trading, clearing, and settlement markets to
competition.
At some point, the merry-go-round of ever-expanding trading volumes in exchanges had to
stop. Hedge funds, some of the best clients of exchanges, have been hammered - some of
them going out of business. The global economic downturn is dampening retail volumes.
Conditions seem to deteriorate, and it will be necessary to explore new sources of growth,
beginning with a fresh look at potential M&A opportunities. Despite the recent industry
consolidation, many interesting combinations of geographies and products remain. NYSE
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Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
Euronext, Deutsche Boerse ISE and Nasdaq OMX have all bridged the Atlantic, but major
Asian exchanges have yet to participate in these global tie-ups.
There are two other possibilities: many exchanges can do much more with their offering to
customers and other can tap new sources of growth beyond their core business, as they still
capture only a relatively small part of the value associated with securities and derivatives
trading. Exchanges with diverse and independent revenue streams and strong value
propositions will fare best in the years to come.
By most measures, exchanges have been world-beaters for the past decade. In terms of
capital productivity, they have performed better than the rest of the financial sector and
much better than other traditional industries. Their profitability has proved extraordinarily
attractive to investors; total returns to shareholders have outpaced even those of red-hot
sectors, such as commodities and energy.
Incumbent exchanges have also boosted their income in other ways (fees for listings, data
vending and IT services among others) but most of the growth has come from higher
trading volumes – despite price competition, and the resultant fee reductions. Because
exchanges have held the line on costs – a noteworthy accomplishment given continual
pressures to expand processing capacity and enhance execution functionality – growth in
revenues of all kinds, however derived, produced dramatic growth in the bottom line.
All this has happened even as four forces – a reduction in the barriers to entry, a centralized
post-trading infrastructure, advanced technologies, and competition by new entrants – have
combined to challenge the position of exchanges.
The origins of the crisis had nothing to do with exchanges, but in the end both exchanges
and their listed companies have been severely affected. The irony is that the crisis emerged
from products and markets that have little to do with regulated exchanges. These were
complex structured products issued in non-transparent markets. As liquidity evaporated,
some of these assets became impossible to value. Some of the participants that hold such
products and refinance themselves in these markets are not supervised, are not listed and
therefore are not subject to mandatory disclosure rules. Their level of leverage is not
precisely known. We have seen, in a word, the absence of the main ingredient of any wellfunctioning market: Information. Market participants and rating agencies have not been
disclosing the potential risks involved adequately and on a timely basis.
From the start of the crisis onwards, exchanges helped mitigate the crisis by providing what
they have been offering for years: liquidity, disclosure, transparency and price formation.
During this period of high volatility and uncertainty, exchanges performed extremely well.
Many regulators have welcomed the resilience of post-trading infrastructures throughout the
most difficult moments.
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Credit Crisis – The next Day for Exchanges, October 20th 2008
Spyros I. Capralos, Chairman – Athens Exchange, CEO – Hellenic Exchanges S.A.
What are the lessons that the exchange community has drawn from the crisis?
And now permit me to make my sales speech for the industry I work. I think the most
important lesson from our perspective is that the structure of a market is extremely critical to
its long-term sustainability and to the potential risks it poses for the rest of the sector and
most important for the world economy. The crisis has shown not only the systemic
importance of liquidity, but the need for transparent and reliable price-formation
mechanisms; it has served as a reminder to market participants of the intrinsic positive
qualities of trading in regulated and transparent market environments. And since regulated
exchanges represent the most transparent public market structure, we began to realize that
we should take more pride in our model. To see how important this is, just remember that
only a few years ago, the European Regulated Market model seemed almost “out of
fashion”. At the height of the last economic cycle, industry experts lamented the
unnecessary regulatory burden of accessing regulated markets for listed companies. Private
equity seemed a more attractive route to raising capital. Some commentators started to talk
of private market models – such as issuance off-exchange, trading off-exchange, or
reporting off-exchange – not as means to a goal, but as a goal in itself.
Well, today, after the devastating events of the last few months, the time has come to look
more closely at the risks posed by different market structures. Counter-party risk is a term
that a year ago did not seem to exist in financial vocabularies. Who after all could foresee
that companies like Lehman Brothers would go bankrupt?
The economy needs all sorts of market structures, for all sorts of users, but we need to
regulate these markets effectively, and efficiently manage the different risks they pose.
Otherwise, short term gains and profits for one business activity may lead to disastrous longterm losses for the rest of the economy.
Thank you.
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