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Global Capital Markets

Introduction

After years of robust growth, the world economy plunged into a downward trajectory, which was characterised by financial crises at its epicentre. According to IMF’s figures, world GDP in 2008 grew at 3.4% compared to 5.2% in 2007, and is further expected to fall to 0.5% in 2009. Prolonged period of excessive liquidity, irrational rise in asset prices and inability of the regulators to asses the risk involved in complex financial products were termed as some of the fundamental causes for imbalance in the global economy. The situation further deteriorated when the subprime housing loan crisis surfaced in the US in the beginning of 2007 and escalated to a global financial crisis in 2008. Economies all over the world were affected by credit crunch, crash in financial markets and fears of coercive bankruptcies and insolvencies with the global economy pushed to the edge of a major economic slowdown.

The financial crisis made its worst impact when Lehman Brothers, one of the largest investment banks in the US filed for bankruptcy. The fall-out left a deep scar on the financial system as one of the most vital financial intermediaries, US-based Lehman Brothers Holdings Inc, was lost causing widespread counter party risk and illiquidity in derivative markets. Even the interbank market, which is considered to be buoyant from the liquidity perspective, became illiquid, to an extent. The rippling effects of the turmoil orchestrated a near collapse of giant multinationals and a massive crash of capital markets all over the world. Banks and financial institutions experienced erosion globally in their funding and capital base, owing to accumulating mark-to-market losses. Hedge funds and mutual funds, in particular, faced huge redemptions as investors shifted to safer asset classes like government securities and bullions or even preferred to convert their investments into liquid holdings. Losses booked by hedge funds triggered concerns for those markets in which hedge funds provided a considerable share of trading liquidity. Also, speculations were rife that insurance companies and pension funds were turning incapable of meeting their future obligations as their investments were shrinking rapidly.

Spill over effect of financial crisis: a loss of around US$ 1 trillion

Emerging markets, which were modestly affected in relative terms at initial stages of the crisis, started feeling the spill over effect. Capital flow to emerging capital markets started drying up as foreign investors started pulling out lucrative funds to compensate for the losses and redemption pressures in their domestic markets. Major emerging economies such as Brazil, China, India, and Russia, which had attracted considerable amount of foreign portfolio investments, witnessed steep corrections in their respective stock markets. Carry trades, where traders try to gain from the arbitrage opportunity created by different interest rates in different countries, also saw quick unwinding as these trades turned unviable due to fluctuations in currency rates, interest rates, and sell-offs in assets across all classes. Moreover, investor confidence was brutally damaged across asset classes at all levels.

Eventually, both emerging and developed economies, had suffered tremendous losses. According to the Institute of International Finance, write-downs and credit losses booked by financial institutions such as banks, investment bankers, brokers, and insurance companies since the beginning of 2007 till the end of 2008 was around US$ 1 trillion.

This prompted governments and central banks all over the world to respond with robust fiscal, monetary, and market policies and initiatives. Ban on short selling, guarantee on money market securities, bailout packages, tax cuts, and government buying of distressed assets and partial nationalisation were some of the crucial steps taken to combat slowdown and infuse confidence into the financial system. In the beginning, the condition remained mixed though the monetary measures taken by the central banks to infuse liquidity into the system did help in reducing overnight borrowing costs, but markets witnessed extreme volatility. Subsequently, announcements of stimulus policies mitigated the turmoil to bring rationality and stability across financial markets. In totality, countries around the world have provided stimulus packages worth US$ 2.9 trillion.

Global Equity Markets

Performance of equity markets in the midst of financial crises

Total market capitalisation of the World Federation of Exchanges (WFE), an association of 51 regulated exchanges, stood at US$ 32.6 trillion for Dec 2008; displaying a negative CAGR of 7.3% for the three year period of Dec 2005-08. During the same period, exchanges of Europe-Middle East-Africa displayed a similar trend in line with the overall global exchanges and registered a negative CAGR of 7.9%. However, stock exchanges of Americas and Asia-Pacific regions proved to be at the extreme ends of the spectrum with a negative CAGR of 10.6% and 0.4%, respectively. Of the total global market capitalisation for WFE, Americas’ share decreased consistently from 47.6% in Dec 2005 to 42.7% in Dec 2008. On the other hand, overall share of Asia-Pacific stock exchanges during the same period increased from 22.8% to 28.3%.

Market capitalisation of majority of the global stock exchanges fell by more than 40%

The repercussions of the global financial crises on world capital markets were tremendous during Dec 2007-2008. The Americas’ market capitalisation was recorded at US$ 13.9 trillion by the end of 2008, a drop of around 42.9% compared to the previous year’s US$ 24.3 trillion. The market capitalisation of Asia-Pacific exchanges, which stood at US$ 17.9 trillion, fell to US$ 9.2 trillion, displaying a fall of 48.6%. Similarly, exchanges of Europe-Middle East-Africa registered market capitalisation of US$ 9.5 trillion, a fall of 49% compared to US$ 18.6 trillion in 2007.

No significant changes in total share trading value globally in 2007 & 2008

The total share trading value globally was recorded at US$ 113 trillion, which was quite stagnant as compared to the previous two year’s figures; however, the region-wise share trading values witnessed mixed movements. For instance, the exchanges in Americas registered a share trading value of US$ 73 trillion, a surge of 21% versus 2007’s US$ 60 trillion. The Asia-Pacific exchanges recorded a decrease of 19.05% at US$ 17 trillion in 2008 against 21 trillion in 2007. Exchanges in the Europe-Middle East-Africa region also registered a drop in share trading value of 25% at US$ 23 trillion as compared with the previous year’s US$ 31 trillion. This surge can largely be attributed to the fluctuation in the US dollar exchange rates witnessed during 2008. In 2008 the US currency surged by 37% against the British pound and by 5% against the Euro, and lost 19% against the Yen. The Nasdaq Stock Market recorded the highest share trading value globally at US$ 36.5 trillion, a growth of 29.6% compared to 2007. The London Stock Exchange among European stock exchanges and Tokyo Stock Exchange Group in Asia were the exchanges to have recorded the highest share trading value in their respective regions.

MSCI BRIC Index succumbed to global fall out

The sell-off in the emerging equity markets was deeper than developed markets; MSCI All Emerging Market Index gave up all its gains of previous years to give a negative return of 50.42%. The most promising of emerging markets, the BRIC markets, also performed disappointingly; the MSCI BRIC Index gave an y-o-y negative return of around 55.4%.

Among the global emerging market, the European emerging markets recorded the worst negative returns of 66.53% where as emerging markets in Latin America relatively gave a negative return of 43.64%. In terms of local currency valuation Iceland Stock Exchange was the worst performing stock exchange in the world losing 94% of its value, where as Tunis Stock Exchange, the stock exchange of Tunisia, was the only stock exchange to give a positive return of 10% in 2008.

IPOs and Mutual Funds

IPOs preferred to adopt a wait and watch attitude in 2008

In 2008 the IPO market globally saw a major slump; the number of companies that got listed through IPOs was 1,115, a staggering 66% lower than 3,366 IPOs recorded in 2007. The Asia-Pacific region accounted for 43% of the new equity issues globally. Americas and Europe - Africa - Middle East accounted for 31% and 26%, respectively. The capital raised globally through IPO’s was recorded at US$ 124.3 billion. Two out of the top three IPOs were from BRIC nations. Euronext, NYSE group, and London Stock Exchange were the top three exchanges to raise capital through IPOs and secondary market issues.

Shift from equity to money market funds in Q3 2007 to Q3 2008

According to The Investment Company Institute, assets worth US$ 21.6 trillion were managed by mutual funds worldwide in the third quarter-ended 2008, which translated to a decrease of 12.1% as compared with the second quarter-ended 2008 figures and a fall of 16% when compared with the third quarter-ended 2007. Globally, the number of mutual funds was 69,477 at the end of the third quarter of 2008. At the end of the third quarter of 2008, around 40% of worldwide mutual fund assets were held in equity funds. The asset share of bond funds was 18% whereas balanced/mixed funds accounted for 10%. The money market fund assets represented 25% of the total worldwide assets. In terms of regional distribution, 55% of worldwide assets were managed in the Americas, 34% were in Europe and 11% in Africa and Asia-Pacific.

The assets managed under equity funds in the third quarter 2008 fell by 31.3% to US$ 8.6 trillion as compared with US$ 12.5 trillion recorded during the third quarter ended 2007. Bond fund assets declined by 10.1% and balanced/mixed funds assets declined by 16.8% as compared with their third quarter 2007 results of US$ 4.2 trillion and US$ 2.6 trillion, respectively. However, assets of money market funds increased by 16.8% to US$ 5.4 trillion as compared with US$ 4.7 trillion, which showed a gradual shift from amount of assets managed under equity funds to money market funds.