Ethical Issues In Financial Markets Flashcards
Why are ethics important in financial markets?
For them to operate efficiently, participants need to have confidence that markets are fair and transparent
Regulators such as ASIC and ASX play a role in ensuring that markets are policed with respect to laws and rules governing appropriate behaviour by market participants
Professional bodies such as the CFA instutite also have a role to play in ensuring that members behave in a highly ethical manner
What are the areas of ethical behaviour?
Professionalism Integrity of Capital Markets Duties to Clients Duties to Employers Investment Analysis; Recommendations and Actions Conflicts of Interest
What is a financial crises?
Behavioural finance - tendency for policymakers and managers to forget the lessons of part crises
Underlying the failure of Barings Bank, the Asian financial crisis and global financial crisis is the failure of risk management policy and pratice
The failure can be at government legislative level, prudential supervision level or executive management level within a financial institution
In many financial crises the failure of risk management policy and practice has lead to a culture of excessive risk fundamentally motivated by a desire to increase profits or performance bonus payments
What is a nation-state’s financial system?
An integral part of the global financial system. There is an important relationship between an efficient financial system and growth in the real economy within a nation-state
What is globalisation?
The process whereby financial markets are interconnected, interdependent and integrated
Globalisation of financial markets and the standardisation of financial instruments used in global markets has been facilitated by rapid development and adoption of technology-based information, communication and product delivery systems
New markets in risk management products, particularly those using derivatives products, have also evolved
What other factors and relationships have had an impact on globalisation?
- Unrestricted movement of capital around the world. Theoretically, the global market will encourage savings and allocate those savings efficiently to the most productive purpose
- Deregulation of nation-state financial systems
- Financial innovation to develop new systems, products and services
- The need for corporations to diversify their funding sources on a global scale
- Increased competition between financial markets and financial institutions
- Volatility in market prices and associated demand for risk management products
- Changing demographics and savings patterns
- Development of emerging markets in particular parts of Asia, South America and Eastern Europe
What was the Asian financial crises?
Occurred in countries experiencing rapid economic growth and prosperity but fragile domestic financial systems
Excessive bank credit was available and there was a reliance on short-term funding from overseas. However, the level of economic growth did not keep pace with the increasing debt so overseas investors withdrew their funds, putting downward pressure on the asian currencies
What was the GFC?
In Oct 2008, the Aus share market fell 16% in a month and 40% in a year. The value of the $AUD fell in relation to the $USD from $0.96 to $0.69 in 6 months.
Similar scenarios occurred in the major financial markets around the world.
This phenomenon originated in the US where a significant problem was embedded in the US financial system
What is a sub-prime loan?
For years, the US federal reserve maintained low interest rates to stimulate economic activity. This low-cost finance increased demand for housing and generated a property price boom.
US Govt policies also encouraged banks to provide housing loans to lower socioeconomic groups which saw a lowering of credit standards and loans being made to borrowers who would find it difficult to repay the loans over the long-term (sub-prime loans)
When large numbers of borrowers began to default on their loan repayments, the number of bank foreclosures increased. The resulting property sales decreased property prices making it difficult for banks to recover the full amount of the loans
What is liquidity crunch?
It developed as investors became very hesitant when investing and financial institutions began to cutback on their lending in the inter-bank market and also normal lending to individuals and corporations. Consequently, the sub-prime crisis became a global credit crisis.
Central banks tried to relieve the crisis by pumping massive amounts of funds into the financial system.
Turmoil in the financial markets saw global economic activity slowed considerably. An important response by most countries to the evolving crisis was to implement massive economic stimulus packages.
Examples of derivative and other financial market losses
Barings
- Nick Leeson
- Futures and Option on Equities and Bonds
- Originally an arbitrage strategy between different futures exchanges became a speculative strategy as losses mounted
- US $1.4b
Sumitomo
- Yasui Hamanaka
- Copper Trading
- Losses accumulated over a 10y period of trading
- US $2.6b
Orange County
- Robert Citron
- Leveraged Bond Investments
- Took out highly leveraged positions to boost the returns to the country in a low interest rate environment. When interest rates rose, massive losses resulted due to the leveraged nature of his positions
- US $1.7b
What are the reasons for derivative losses?
- Fraud
- Organisational Reasons
- Lack of education of senior management
- Internal controls
- Remuneration of employees
- Counterparty risk - Systematic Reasons
- Size of market
- OTC market invisibility
- Ease of trading
- Complex securities
