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21.10.2008 Business & Finance

Global Financial Crisis (2)

By Nii Kwaku Sowah -

The first lesson relates to regulation.  It is not unusual to hear market-players bashing regulators, “who don't understand the market”, for their high-handedness.

Part of the blame for this financial crisis stemmed from the fact that regulators washed their hands off regulating certain instruments because they actually do not understand how it works! 

John McFall, the Chairman of the British Commons Treasury Select Committee, noted that “best and brightest at our top investment banks have expended great energy designing ludicrously complex financial instruments, which you need a Nobel Prize in physics to understand”. 

The British Treasury Committee therefore recommended that if banks do not make their products less opaque, then they should be even more heavily regulated.

More regulation does not kill genuine operators. 

Those engaged in shady operations usually worry about regulation. Regulation in this case must endeavour to keep the playing field as fair as possible, ensuring that the investor takes genuine risks and not just become prey to traps only the initiate can see and understand. 

In our part of the world, where illiteracy heightens information asymmetry, the burden is on the regulator to ensure that the investor is not ensnared by exotic products for which the obvious sale advert is that “they yield high profits”. 

How many investors in Ghana are aware that higher return often trades-off with higher risk? In other words, for “frontier economies” like Ghana, regulation must not only rely on “full” disclosure, it must also be on merit!

 Oftentimes, market players are carried away by over-exuberance to meet certain high targets.  In the process, basic regulatory precautions are side-stepped. 

As we learnt in Physics, “short-cuts can be dangerous”!  It is for instance very important for brokers to ensure that trades are covered by appropriate titles before they are executed.

Again investment bankers sometimes want to move faster than the rest of society. 

 Ours is a developing market and thus in introducing products one should be mindful of that fact.  One often hears suggestions of the introduction of short-selling, hedge funds, derivatives and other “exotic” strategies and products. 

While under normal circumstances such strategies and products can lead to improved liquidity on the secondary market and hence improve stock market activity they are arguably very risky. The least crack can lead to a major crisis. 

Consider the fact that, although currency is declared by fiat as a legal tender it is still backed by all sorts of assets – gold, Special Drawing Rights, etc.  This gives strength to the currency. 

Thus, it is important for securities to be backed by some form of asset base.  In this sense the Securities and Exchange Commission will in the very near future introduce higher base capital and stringent capital adequacy requirements for various categories of capital market operators in Ghana.

It is also important for the investing public to be well-informed about various investment options and their associated risks.  This means that the market operator himself or herself must be well-informed.  The absence of formal examination and certification for the various classes of market players in Ghana needs to change. 

The Securities and Exchange Commission has initiated discussions with various stakeholders for the introduction of various levels of certification for the different market players.  

Above all, it is important for all market players to be guided by a high sense of professional integrity and ethical standards. 

As players in the financial market, we should guard carefully the TRUST the public has vested in us. TRUST is the basic foundation on which rests all financial transactions. 

It is the reason we accept a mere paper from each other as currency and willing to do business with it.  Paper money as we know it has no intrinsic value.  In other words, it is a mere piece of paper which has no value for its sake, unlike items such as gold or cow or commodities for which we easily find alternate uses. 

One may be tempted to argue that the State has sanctioned it by fiat to be money and hence our use of it as such.  But it is not the fiat which makes it money.  It is because it is generally acceptable as a medium of exchange. 

The principle of general acceptability rests on the notion of TRUST. 

However, TRUST in finance has become so commonplace that we forget that it is indeed the very foundation of financial dealings. Any crack in this essential foundation leads to the tumbling of the financial superstructure.

We have been entrusted with the hard-earned assets of the public. We must be mindful of the risks we take even as we seek to maximise returns for the investing public.

The writer is the Director-General of Securities and Exchange Commission