This decade has seen a dramatic shift in global economic power, and nowhere is this shift more evident than in the financial markets. In an age where capital can cross borders at the touch of a computer button, it is increasingly flowing to new players, new regions and new investment vehicles. This trend was made clear when Asian and Middle East sovereign wealth funds stepped in to shore up the balance sheets of several large Western banks hit by the recent credit crisis.
The McKinsey Global Institute, McKinsey & Company's economic research arm, has been tracking this trend and recently examined how the four "new power brokers" of global finance - Asian sovereign investors, oil-exporting nations, hedge funds and private equity firms - fared amid the credit squeeze and broader financial crisis that began in mid-2007. MGI found that their clout is steadily increasing despite soaring oil prices and evaporating financial liquidity, a shift in financial power that is destined to continue. And as financial power is diversified away from the traditional Anglo-American world of finance, Canadian investors, financial institutions and stock exchanges - along with their American and British counterparts - will need to adapt to a new market environment with different players, intensified competition and new opportunities.
According to MGI, the combined financial assets of the four power brokers increased by 22 per cent in 2007 to $11.5-trillion (U.S.) - equal to 6 per cent of the world's total financial assets. Even a conservative forecast finds that the new power brokers' assets will increase to $21-trillion by 2013, and if their growth continues at the brisk pace of recent years, their assets could reach $31-trillion, a sum worth more than half of the world's pension or mutual funds.
Rising trade surpluses among Asian nations have allowed their foreign assets to grow rapidly over the past decade. In 2007, Asian sovereign assets rose to $4.6-trillion, with $3.9-trillion held by central banks as foreign-exchange reserves and about $670-billion held by sovereign wealth funds.
Propelled by soaring oil prices, oil exporters' foreign financial assets rose to an estimated $4.6-trillion by the end of 2007, an 18-per-cent increase over the previous year, extending the financial reach of old and new players. Russia, for instance, gained $105-billion in foreign assets in 2007 alone, securing its place as the world's third-largest holder of foreign reserves, after Japan and China. Second-tier oil-exporting countries such as Algeria, Iran, Libya, Nigeria and Venezuela became significant investors in global capital markets, with a combined $610-billion in foreign assets.
The capital flowing from the Asian and petrodollar investors has also fuelled the growth of hedge funds and private equity. The additional liquidity has helped restrain global interest rates and allowed for the leverage that boosted the returns of hedge funds and private equity. Meanwhile, hedge funds and private equity provided the Asian and petrodollar investors with ways to diversify their portfolios and broaden their investment strategies in new ways. Although funding has slowed since mid-2007, private equity firms are weathering the storm by creatively deploying their capital in the public equity and debt markets, in emerging markets, and by providing liquidity to large financial institutions. Hedge funds, despite being adversely affected by the credit crisis during the past year, saw their total assets under management grow to $1.9-trillion at the end of 2007.
The power brokers' actions, MGI finds, have helped contain the current financial crisis. Asian and oil-producing sovereign investors have been an important source of liquidity during this time: From March, 2007, to June, 2008, Asian SWFs invested $36-billion in Western financial institutions, while oil-producing states' SWFs invested $23-billion. Yet their influence requires investors and regulators to also consider the potential risks over the longer term. Asset-price inflation is fostered by increased liquidity, the use of wealth as a political tool by state investors, hedge fund failures that destabilize the financial system and increased credit defaults by private equity firms with heavy leverage. These are all down-side risks that merit careful monitoring.
To date the new power brokers have used their newfound influence conservatively. However, in the future, new regulatory and diplomatic frameworks may be required to ensure the continued success of a realigned financial system. Canadian financial players will need to play an important role in defining these new rules of global finance if they are to adapt and successfully compete in a much more complex and sophisticated global financial market.
Jiri Maly is a principal in the Toronto office of McKinsey & Company