The World’s Liquidity Pool

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From the Summer Issue “Change Matters

A Conversation with Xavier Rolet

Five years ago, with the world still mired in the depths of the financial crisis, Xavier Rolet became the CEO of the London Stock Exchange Group. This was an apparently unorthodox choice. French by birth and educated in Algeria, then in France, Rolet spent much of his early professional years in a succession of American and European investment banks, from Goldman Sachs to Credit Suisse, First Boston, Dresdner Kleinwort Benson, and finally Lehman Brothers. It was only in 2009, just before his 50th birthday, that Rolet joined that quintessentially British institution, the London Stock Exchange Group, which he has run ever since. Today, as its CEO, Rolet talks about the role of money, currency, and stocks—and their effectiveness as financial, political, and social forces for change—with World Policy Journal editor David A. Andelman and managing editor Yaffa Fredrick.

WORLD POLICY JOURNAL: Let’s begin with the 2008 economic crisis. It shook the global markets, stocks, bonds, commodities, and currencies. Talk to us about the steps the London Stock Exchange is taking in the years since then to stabilize the British markets and, by extension, the global markets.

XAVIER ROLET: Well, global markets is of course a big liquidity pool, but we’ve taken a number of micro measures, and this is really in Europe, a little less so in the United States, where until 2013 we did not have large operations. But we have lobbied the authorities—seeking to convince them that the financial crisis of 2008 was yet again the cookie-cutter replica of all the major financial crises that preceded 2008. It was induced by the same factors, the same causes with, of course, the same effects.

We can adjust technology and changing political positions, but we seem unable to control leverage in the banking industry, as we have seen in every crisis, whether it’s 1929 or all the preceding couple of hundred years of financial crises. We see this in Latin American debt, in the American market, leverage in Russia, and I go through the sequence of ten years between 1987 and the crash of 1997. The only exception, perhaps, is the Internet boom and crash on excessive valuation in 2000-01, from which the world economy recovered extremely quickly for the simple reason that it wasn’t based on excessive leverage. And the point I am making is this: unless we find a way to properly monitor and then control, i.e. limit leverage in the banking system, we will continue to have the same crisis over and over again.

WPJ: So you’re essentially saying we’re talking about a currency and debt rather than equity crisis?

ROLET: Right. There is excessive debt in the banking system, and to a certain extent on national balance sheets as well, for example in the eurozone.

WPJ: The new pan-European currency was supposed to have a stabilizing effect on markets. But you seem to suggest that it’s been somewhat counterproductive?

ROLET: In 1929, in the U.S. and across the globe, the banking system was so highly leveraged that it failed, and at a time the gold standard restricted certain governments from the ability to grow money supply. We don’t have the gold standard any more, but you see the same thing in the eurozone. The banking sector failed and, as it turned out, governments were also equally highly indebted. We had excessive leverage on the balance sheets of banks; many banks in the United States and Europe were leveraged 30, 40, 50, I know some cases of banks leveraged 60 times. Sixty times means a slight move of a percent and a half on your balance sheet wipes out your equity. We say the probability of this happening is exceedingly high.

The LSE was created to finance the real economy. We made the point to governments here, “Look at the way you’re financing growth. You’re leveraging the balance sheets of banks 20, 30, 40 times, and that is subsidized by tax payers.” So that undermines the stability of interest rates. A sustainable, non-leveraged form of financing, which directly benefits innovative start-ups, which are job-creating machines, is being clobbered to death by taxation. And then you look at the regulatory picture, and you see that debt is likely not regulated and that equity, on the contrary, has been regulated to death. In fact, so much today that even the micro structure of equity markets has become utterly confusing. People are questioning whether they’re rigged or not.

So the point we’ve taken to regulators is, number one, they need to recalibrate the fiscal system in favor of long-term refinancing. Number two, we think as a stock exchange we can do a lot to help with their balance sheets. To help finance companies, in the last four or five years we have made a number of proposals, some of which have been adopted by governments and policymakers to help stimulate financing and access to capital for the 23 million small- and medium-sized enterprises in the European Union that could easily help at least 26 million workers.

We believe that is the fundamental contribution an exchange like us can make—help recalibrate the economy away from debt to long-term risk capital which powers innovation, and as we know innovation yields pricing power. Pricing power yields new jobs and a capital-market-based economy.

WPJ: So effectively you’re saying that the more governments can be kept out of regulating currency and trading, the better the broader economy is, and we should move increasingly to self-regulation?

ROLET: Not really. Self-regulation means different things from one country to the next. We are suggesting that governments have imposed an enormous burden on certain classes of financial assets and no burdens in other cases, even obligating citizens to subsidize other forms of financing mechanisms which tend to be unstable, mainly debts. We are arguing not for de-regulation or self-regulation, rather for re-calibration—better equilibrium so that sustainable, non-leveraged forms of finance aren’t clobbered to death by taxes and regulations. But that doesn’t mean necessarily self-regulation. We do think that the reduction of the fiscal burden on equities would be extremely helpful to job creation.

WPJ:  Let’s go back to the euro for a minute. You are sitting in the one part of Europe that opted out of the euro currency. Do you think the UK was correct, in retrospect, in doing that, and how has that affected your ability to trade freely and fairly on the LSE?

ROLET: The LSE offers multicurrency trading. It is the most, not the largest by capitalization, but the most international of stock exchanges in the world, offering trading in securities around the world, from Vietnam to Canada. And it offers it in currencies in every major denomination, including now in Chinese renminbi owing to the recent signature of an offshore RMB facility between the UK and the Republic of China via the Hong Kong Monetary Authority. So for the exchange, currencies have never been an issue. Membership in the euro is obviously a highly political question, and you will find answers on either side of the argument.

ROLET: There’s no doubt that not being a member of the eurozone in the last few years has enabled the United Kingdom to pursue its own independent monetary and therefore currency policies. There is nothing fundamentally wrong with seeking a currency union if you are prepared to abandon some sovereignty, pull your markets together, and create joint banking supervision. That is ultimately a sovereignty question. But what went wrong with the euro is that for several decades European governments have been funding through debt. And most of it of the hidden kind. The welfare system and the rate of public spending were unsustainable. Ultimately, some nations that joined the eurozone were highly industrial; others were highly leveraged; others highly dependent on real estate speculation or investment; some highly export oriented; and others not. You had entire economic cycles when monetary policy became centralized. The euro was a great success when introduced with a switch to the single system of notes—technically, very well executed.

But many of these nations, when the euro was started, enjoyed pretty much the same yield on their government debt. Eventually, the markets and investors realized that some countries had been deeply uncompetitive for several decades, with the lack of ability now to competitively devalue their currency by ramping up their public debts. Then they started effectively differentiating between the quality of the government debts of these different countries. So, in my opinion, the issue of the eurozone crisis is really an issue of competitiveness. If you hitch your wagon to the German economy, it better be competitive. In that sense, the UK, it looks now, was wise not to join in. It is clear now that for many of the European economies, economic cycles are becoming harmonized.

Everybody has been brought down, and now recovery is starting slowly to gain ground. However, there is still a very large disparity between growth rates in Germany and growth rates in France, even the growth rates in Holland and some of the Nordic countries. So it is important that further banking supervision and economic integration continue if you want the eurozone to operate effectively. And for the UK going forward, not just membership in the euro, but membership in the EU is an open question.

WPJ: We’d like to go back to the renminbi. There is some talk that it could eventually become a global reserve currency. How do you think the arrival of other reserve currencies or other pan-national currencies, even Bitcoin, could affect the stability of markets or profitability?

ROLET: The remarkable phenomenon we’ve seen in the last ten years, but which has accelerated after the crisis of 2008, was about correcting the need for adjustment in the trade balance and the current account balance between developed economies and growing economies. Emerging markets were creating capital and creating wealth, and mature markets were sinking deeper into debt. We’ve seen an adjustment with the eurozone crisis, bank bailouts in the United States, and deep skepticism about the fairness of the capitalist economy, not just in Europe where we don’t need to push people to think that way, but also in the United States where this is a bit of a new component. But we are still talking about 2.8 billion people who live on $2 a day or less, which is the new accepted extreme poverty threshold. Still, over a billion and half people in the last ten years have gained access to housing, to a decent lifestyle, to effectively the opportunity to become part of the middle class. So, the two-thirds of humanity that has been watching the top third enjoy a comfortable lifestyle while they live in poverty, have had an opportunity in the last ten years to grow. The overreliance on a single currency or a single model, or a single form of nationally driven governance, symbolizes the fact that humanity is becoming more harmonized, and the vast majority of humanity today considers capitalism and an open market economy as the way to go.

The flip side of the American victory in terms of establishing a free economy, a capital-market-based economy in the rest of the world, which in the long run will lead to the establishment not only of a financial but a global political governance, is that you have to share power. By next year, China’s GDP could be equivalent to that of the United States. Sharing power means you need more than one reserve currency. We might go back to the archive system, where effectively a basket of currencies conceivably could get to become the new global reserve.

As for Bitcoin, that points to the need and demand for a single world currency and exchange. That’s an important point, to preserve a single currency. If we could create a sort of monetary basket, including euros, dollars, renminbis, and maybe a few other currencies as a sort of United Nations of currencies, that could become the standard global currency. And I think we will end up getting there. Then, ultimately, the possibility  for currency wars, and perhaps even wars period, would likely be much reduced.

WPJ: OPEC had been trying to create some sort of basket for denominating oil back to the 1970s. But they could never figure out a way of actually getting all the component currencies lined up appropriately. Are you not concerned that the vastly disparate levels of growth and liquidity in countries all over the world would militate against some single currency? Or, might those inequities be smoothed out by one currency?

ROLET: I agree with you. This is the short-term impact exactly along the lines you described in the case of the eurozone. First and foremost, there is something that was not well understood in America. The decisions are not economic. They are first and foremost political. Which is why we have been saying for years that the euro would not collapse despite all imbalances, that no nations will be likely to leave; at least certainly not while the euro is in a state of crisis. And I think that to get to a single currency, you are right. Countries don’t have the same economic cycles. They don’t have the same makeup. But ultimately, they will want to share a single currency. We are already seeing it in finance despite the reluctance of national authorities. I insist that this is a highly reluctant process, and a slow process, but it is an obligatory and inevitable process. Finance is actually coming out of the crisis of 2008, the first step in my humble opinion toward establishing a global political governance system. Currencies will come with it. It will be first and foremost development emerging from the political desire of key countries to facilitate exchange, to facilitate wealth, to reduce the opportunity for frictions. And a single currency will follow. But I don’t think a currency union can be established unless there is an ultimately dominant political desire to get there. So we may be many decades away from that.

WPJ: Obviously your focus at the LSE is on trading and stocks. But which do you think can or should be the driving daily agenda—is it stocks, is it currencies, which have a truly global reach. Or, is it bonds? Commodities? What should be the driving force setting the economic agenda?

ROLET: It should be job creation—i.e. the funding of innovation and economic growth.

WPJ: But which of those four entities: stocks, bonds, commodities, currencies, are most effective in driving this job creation and economic growth?

ROLET: Well, equities represent about 6 percent of total global financial assets. The largest financial asset class by a long shot is interest rate swaps. Then you have foreign exchange products, credit products, government debt, corporate debt, then you go down all the way down to equities, which are the smallest asset class. But in the same way you are looking at a reverse pyramid, with equity underpinning everything—ownership of the real economy. So I don’t think economic policy really should focus necessarily on pushing a lever of one at the expense of the other, but fundamentally we want to remain in a capitalist economy. Most important in terms of government action and policy is to insure that the potential for entrepreneurship and innovation that comes out of the youngest part of the population, particularly university graduates and entrepreneurs, gets financed at the start-up level with the right kind of capital. Most definitely that isn’t bank lending. But at the appropriate cost and in relative abundance we can create the economic activity that will power everything else—currency exchange, exports, [and] consumption of commodities. At the end of the day we want to be able to live comfortably, and we need to create that wealth to support a welfare system that is growing everywhere in the world, becoming more expensive. So my suggestion would be policy action rather than necessarily looking at an asset class—to establish what can most quickly power innovation and help create wealth, while supporting small- and mid-size enterprises. Even though it is a small asset class, that seems to put equity in the lead position.

WPJ: Back in the days of Paul Volcker, the number everybody looked at was money supply. Now all of a sudden that’s as antiquated as the horse drawn carriage. Now it’s other issues. It’s quantitative easing; it’s debt; it’s unemployment. Those are the numbers people look at, especially unemployment. So who’s right? And where should institutions like the LSE be trying to move the international agenda?

ROLET: Of course, equity is what our brand is about. But equity trading is 10 percent of our revenues. From a revenue standpoint, our business of interest rate swaps is far larger. But what we are articulating with governments and what we’re doing ourselves is launching new initiatives like ELITE in the UK, which supports young companies and enables them to find access to private sources of finance. We are in training with business schools, facilitating access to government resources, and lobbying for the arts to help recalibrate the fiscal system in their favor. But what we’re telling the authorities is that, at the end of the day, it’s all about creating jobs that are not going to come out of government. The country that has created the most jobs in the EU is the UK. It’s also the country that has destroyed the greatest number of public service jobs. It’s destroyed 500,000 government jobs, while creating 1.7 million private sector jobs. And that’s not blue chip jobs either. Of course, in bad years, companies tend to cut costs quite aggressively, so that really the small- and mid-size enterprise sector is the only source of net new job creation. Whatever the source—whether crowd funding, private equity, venture capital—we’re encouraging governments to customize their regulations. This is really what we are suggesting to governments.

WPJ: We would be remiss if we didn’t ask you one final question which is the topic on everybody’s agenda, at least in the United States, when it comes to exchanges—and that is high frequency trading. How serious a problem is this?  What rules should regulators or exchanges like yourselves play in controlling this type of activity, or should it be controlled at all?

ROLET: High frequency trading is an activity that appeared because of competition introduced in the exchange industry in equities. It was never meant to apply to other activities, but arrived as a result of introducing competition in the exchange industry, competition that resulted in fragmentation. This means that the same securities are traded across a multiplicity of venues. And that requires someone to provide a synchronicity of services to maintain the trading of these identical securities across multiple venues that are consistent.

There are a total of 6.3 billion routing permutations possible for every single U.S. equity order. That is the result of fragmenting the exchange markets to introduce competition. I know the whole conspiracy theory of whether the market is rigged or not. I would say that if you look at the volumes that high-frequency trading represents, it’s something in the vicinity of 60 percent to 70 percent of the market, though in London, since 2009, that figure has been 20 percent or less.

And the reason our markets are so different from those in the United States is because we have ensured, going back to 2009, that we had eliminated or proscribed any fee schedules that benefit high frequency trading. Exchanges don’t decide our regulations; it’s the regulators. The one bond of trust that exchanges cannot breach is their neutrality. And so for us high frequency trading is not a problem, and it’s not going to become a problem here. From the very start, we have maintained utmost neutrality, without privileging anyone. Our older functionalities are much simpler, as they do not favor high frequency trading like flash trading, for example. We have had circuit breakers for years, and our technological proclivities do not permit privileged access to data or execution to anyone. So we’re completely neutral whether it’s buy side, sell side, high frequency, as a result of all the measures we took five years ago, and high frequency trading has never been an important percentage of the flows on the LSE. This is really a U.S. phenomenon and a U.S. question.

WPJ: It’s been a privilege to have spent this time with you.



[Photo courtesy of Jeff Danziger]

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