The Future of Global Financial Markets and the Implications for Pensions

1. The Future of Global Financial Markets and the Implications for Pensions Howard Davies Director - London School of Economics Montreux16 May 2006

2. Three topics: • The global economy: imbalances and all that • Changing asset classes in financial markets • Regulation.

3. Over the last year, global GDP growth has been remarkably synchronized. Global GDP, %

4. And growth is forecast to continue 2007 GDP Forecasts: Economist Poll ? ?

5. Even in Europe, sentiment has been improving Morgan Stanley Index of European Business Conditions 50 = long-run average

6. But in spite of this healthy picture, there is plenty to worry about: • slow growth and high unemployment in parts of continental Europe, putting strains on the Euro, • public sector and consumption-led growth in the UK • and, most importantly • trade imbalances between the US and China which threaten to revive protectionism in Washington

7. On one view, the problem is driven by US trade and fiscal deficits US Twin deficits Source: US Bureau of Economic Analysis, Morgan Stanley Research

8. Which have led to a huge discrepancy in consumption growth Personal Consumption as a % of GDP Source: China National Bureau of Statistics, Bureau of Economic Analysis, Morgan Stanley Research

9. and a massive difference in savings rates between the US and China US and China: Savings rates Source: US Bureau of Economic Analysis, World Bank, Morgan Stanley Research

10. Though it is the trade deficits which have attracted political attention Trade Surplus/ Deficit 2004

11. and the huge accumulated foreign exchange reserves Foreign Reserves $ billion

12. At some point, these balances ought to begin to unwind • The US is now a net debtor of $2.5 trillion • Protectionist pressures in Washington represent the most potent threat to the global economy • But when and how?

13. The Global Asset Management market is changing as a result of these trends Growth rates US 11% Non- US 35% Est c. $ 80 trn.

14. There has been rapid growth in debt and equity issues in Asia Asian equity and debt issues $ billion

15. In developed markets, the trend is away from new equity raising to risk transfer • Equity IPOs broadly flat as a percentage of GDP in recent years • US corporate bonds have doubled as a percentage of GDP in 15 years • Credit derivatives volume had rocketed

16. Private equity has grown dramatically • US deal volume over $200 billion in 2005 • More than 100 $1 billion funds • $ 2.5 trillion purchasing power • Too much money chasing too few deals?

17. Hedge funds have outperformed traditional asset classes over the past five years Risk-adjusted Returns 2001-2005 Annualised Return Standard Deviation

18. As a result, asset allocation is shifting: • towards private equity • towards hedge funds • towards international equities • towards other real investments

19. There is considerable change in prospect in the regulatory environment: • Basel 2 • MiFID • More active enforcement

20. The effects of Basel ought to be: • to align economic and regulatory capital more closely • to benefit diversifies and especially large retail banks • to promote more differential loan-pricing

21. The effects of MiFID ought to be: • increased equity market competition resulting from the removal of exchange concentration rules • greater flexibility of execution by enabling internalisation of trades across Europe • But • significant implementation costs across the industry

22. The Future of Global Financial Markets and the Implications for Pensions Howard Davies Director - London School of Economics Montreux16 May 2006