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In the concluding remarks of ‘Why Globalization Works’ (2004), Martin Wolf writes “The view that states and markets are in opposition to one another is the obverse of the truth.” This statement encapsulates the principal division in liberal politics. All of us may only work with the information we have at any one time. Often, manipulated statistics dominate the debate and the issues at hand are discarded as being, frankly, too mathsy. With this in mind, it was a relief to speak to somebody with a fundamental understanding of financial markets who was not trying to blind us with science. Paul Taylor studied at LUMS from 1980-3, majoring in Management and Marketing. “The reason I ended up coming here was primarily because my girlfriend’s father at the time had a really cool car, and he was a Marketing Director. He’s actually my father-in-law now! Lancaster had the best reputation in marketing.” When a job in Marketing did not materialise, Taylor accepted a position with Lloyds. As of 2012, he has served as the CEO of Fitch Group, which generated revenues in excess of $1,118.4 million in 2014. Fitch Ratings, the largest subsidiary of Fitch Group, is one of the Big Three credit rating agencies, based out of New York and London.
Most students don’t know what credit rating agencies are. Would you give us a brief introduction about what credit rating agencies do and their role in the capital markets?
Credit ratings serve a fundamental purpose. There is a symmetry of information in financial markets. What that means is, if you’re an institutional investor, so if you’re investing money, say, in London, you’re a pension fund in London and you want to invest money in China… You’ve got options in China. There will be companies issuing securities, bonds. That might be an electricity company or a food company. You, as the pension fund in London, don’t necessarily have the time or the expertise to assess the quality of the risk of that investment. You essentially outsource that service, and you out source it to credit rating agencies. We have the expertise and presence to opine on the quality of that Chinese bond. You can see if it’s something that you are interested in buying. We rank, on an audible basis, the companies who are issuing fixed income securities. That makes markets more liquid. That means that you, the pension fund in London, are therefore more likely to put your money to use around the world, and hopefully get a better return, whilst the Chinese company raises money. You can apply that globally. It is a huge market, trillions of dollars of debt are being issued all the time.
So investor confidence is built on ratings?
We’re helping provide information that helps them make a decision. Credit rating is only one aspect they have to look at. There’s also interest risk, pricing risk… Does it fit their portfolio? There are a lot of other things they have to think about, but ratings are part of what they need to look at.
To you, what are the main lessons of the financial crisis?
That’s a big question!
[Laughs] I watched a talk that you gave about a year ago, where you said that you felt the financial crisis would continue for five more years. We wondered, how do you feel about that now?
There’s lots of lessons from the crisis. The reason I say it will keep going on, which it is actually, is because the underlying issues are pretty fundamental and haven’t really been fixed. People talk about there being too much debt in the world. If you go into an economic recession, you will normally see the deleveraging effect. So, people will borrow less. Interestingly, this time around, we have seen no deleveraging, in fact it has gone the other way, driven in large part by quantitative easing. Governments have been churning out cash, but also because interest rates are so low, companies in particular have been borrowing more. So there’s been an increase in leverage, at a time when we expected leverage to come down. Now, there are some reasons why this isn’t a bad thing: deepening of emerging markets, capital markets, that’s good, disintermediation of the banks, so banks can’t lend as much as they used to because of their capital controls coming into place. That is not a bad reason for leverage to be going up in the capital markets, but really nothing has been fixed, so everything is bumping along, kicking the can down the road. We’re not in crisis mode, but we are in challenging times. Like you said, look at what is going on with Greece, the Eurozone. There’s lots of arguments about ‘have they fixed their problems? Are they putting structural reforms in place?’ There’s massive unemployment in Spain. There are challenges around.
What is your stance on quantitative easing? I think it was a trillion euros of QE put in by the ECB.
I understand fully why they are doing it. In theory, it should be positive. The whole issue is about getting lending going in the European economy, particularly to the SME sector. I’m not sure how much there is a lack of demand for money, versus the inabilities of supply from the banks. There is a lot of discussion going on at the European level. I was in Brussels a few weeks ago at a lunch, where we were talking about this, to develop more liquidity in European capital markets so we can fund the SME sector, where there is a view that there is not enough credit and it is stifling their growth. QE should help that, and it should continue to help the recovery process, but it’s just one part of the solution. It is not the only solution. There’s a big argument – again I’m out of my area of expertise here – there is a huge argument going on amongst economists about whether it has been successful or not in the US or in the UK. I don’t know the answer. To go back to your previous question about lessons from the crisis, I think that you should never stop asking questions about what might happen. I think we got in too, ‘we’, the entire world of financial markets, got into a bit of complacency, about how nothing could ever go wrong. Why would you assume things would go wrong when things have been so good for so long? The crisis has taught everyone to go back to basics and just question, more than ever before. That’s a good thing, certainly a good thing for our business.
What role did the Big Three (S&P, Moody’s and Fitch) play within the crisis?
Again, that it a very complex question. Our business, and most people don’t really see this, or understand it, even… Since the financial crisis, ’08, ’09, we have had really strong growth in our business, despite what you read in the press. Not just we, but the industry, has had an incredibly strong growth path. Partly that is because, as I said at the start of this discussion, ratings serve a fundamental purpose. If they didn’t exist, you’d have to recreate them, because they are a fundamental part of the markets. The need for ratings is still there. They are fundamental. Capital markets have grown coming out of the crisis and we have grown with it. Most importantly, when you hear about ‘the ratings agencies messed up’, ‘they got it wrong’, all this kind of stuff, [that’s because] in US mortgages, the US housing market, we didn’t do a very good job. We missed a lot of the problems there. When you apply it to most of the other sectors, that’s non-financial companies, banks, insurance companies, sovereigns, ratings were fine. Actually, they did a good job. Our customers know that, because they’re sophisticated institutional investors, so they see on a daily basis what we are doing. They know that a rating still serves a good purpose. For the newspapers, they like stories. You need to make it news worthy. No one ever writes an article that says ‘ratings are mostly right’.
Investors are being accused because they placed their investments in the wrong companies and what not, what do you think?
People talk about securitization. That was the issue, toxic assets. You remember all the headlines we saw? This meeting I was at in Brussels, they were talking about how we get the securitization market going again. This is the same policy makers that four or five years ago were talking about toxic assets being terrible. Actually, they weren’t as toxic as people thought. Between 2001 and 2009, I think it was, there was something like $10 trillion of securitized assets issued. It is a huge amount of money. When the crisis came along, the price of those securities collapsed. Normally, you’d invest $100 and get $100 back at the end of the day. So your price tends to be bumping around $100, depending on interest rates. If you get default risk appearing the price goes down, because you might get less back than you thought. In the financial crisis, if you get mortgage backed bonds at $100, the prices collapsed down to, on average, 30-35 cents in the dollar. So you were assuming a 70% loss on your assets. If you invested $1 million, you would lose 70% of that. Most of that was due to market panic; a lack of liquidity, no one was selling, so the price didn’t reflect the underlying quality of the asset. Now you fast forward five years, six years, with the benefit of hindsight, we were saying this at the time, the actual losses on those assets is probably going to be around 5%. At the moment it is around 2%, because they are long tail assets. At the end of the life of these things, which is going to be twenty years, it’s probably going to be about 5%. All the toxic asset stuff was going on when the price was down to 30, 35 cents in the dollar, but there’s still an underlying asset under that bond, which is houses. First of all, people have to default on their loan and then you have to have no value in the asset if you try and sell it, in the house. There was a huge gap between the liquidity risk which was in the transaction and the actual credit risk. Our job is to do the credit risk. It is not to comment on [whether] the price [is] right. People have now belatedly started to realize that it wasn’t quite as bad as it was made out to be at the time. Of course, that was only one sector. When you look at most of our business as rating companies, there are always one or two exceptions, but nothing went wrong, or banks, where most things didn’t go wrong. My favorite example is [that] a few years ago I did the Treasury Select Committee, which is not a fun experience. There is a lot of political theatre. One of the MP’s asked me about Northern Rock, which obviously famously failed. He said, ‘how did you get Northern Rock so wrong?’ I said ‘well, we didn’t get it wrong’, and he said ‘of course you did! It failed, it defaulted’. I said, ‘but the bonds actually paid out’. The bit that we rated, we asked ‘will you get your money back on those securities?’ Yes, you did actually get your money back. So even though the bank failed, what we were supposed to be doing [concerning whether] if you own that security, will you get you get your money back, well yes, you did. Therefore, our rating didn’t change that much. From a policy maker point of view, the bank failed, so surely our rating was wrong. There was a complete lack of understanding of fundamentally what it is we were doing. A lot of that appears in the media as well. It’s better now. You’ve seen the commentary disappear because they’ve learnt a bit more about this, and we’ve put a lot of work into educating them as well. You see a lot less now about how rating agencies got it wrong and all that kind of stuff. You see much more about what we think about something. So particularly the FT, the Wall Street Journal, the quality financial media, the tone has changed quite a bit. There is this lack of understanding about what really happened. We don’t cover ourselves in glory. There were things we did that weren’t very good, but that was just poor analysis. We didn’t assume that there would be as many defaults in US mortgages as there were. We didn’t get everything right by any stretch of the imagination, but most of what we did was right, which is why we have grown so well coming out of it.
On to some more personal questions. If you could tell your twenty year old self one thing, what would it be? What would you tell yourself, in 1982?
Oh, God! I think you’ve just got to get your head down and get on with it, is the simple answer. I was lucky. I applied and got a job at Lloyds and got on with it. I didn’t assume I was going to change the world on the first day. I had to learn. I think it gets worse as you get older, you think you know a lot more than you actually do. I’ll give you an example. I took on my current job three years ago. For the two years previous to that, I was essentially the number two in the company, and I shadowed the guy who was my boss, who was the then CEO. When they first made me President of the company, essentially number two, I was thinking ‘I know how to do the CEO job, why aren’t I being given the CEO job?’ Over the two years I realized that I didn’t actually know. There were lots of things that I didn’t understand and didn’t know. I needed those two years to be able to do the job properly. I see that now in people in the firm. They think they know more than they do. Sometimes, you just have to be a little bit patient to develop that understanding. Maybe I could apply that to when I was twenty!
Most of us are going through our job interviews at the moment, so what do you think are the ideal characteristics that a company such as Fitch would look for? What would you look for? What is important in the sector and in the industry?
First of all, you’re lucky because you’re at a good institution. Assuming you get a good degree, you will come out with a strong academic qualification and reputation. A lot of it is about being personable. I’ve seen lots of people over the years who are incredibly well academically qualified, but they lack that inter-personal ability, or they lack that ability to stand up to a group of people in a room. Having those kind of soft skill abilities are really important to us. We throw people in at the deep end in some ways. You could be sitting opposite a senior management team of a big firm, and you’re allowed to ask questions. The gravitas of how you do that is important. Just having those soft skills is pretty important. I asked my HR department to tell me what we are looking for in people [laughs]! I can tell you if you want. Here we go! What differentiates the best candidates? A finance orientated or numerate degree. You can always find examples of Arts graduates in the city, but they are increasingly rare. They start their career planning early. CV’s of most graduates we hire already demonstrate a commitment to the sector through previous work experience or internship placements. Interesting. They are persistent. They know why they want the job. You’d be surprised how many candidates fall down on the basic question, ‘why do you want to work here?’ All employers want graduates with a genuine fascination with financial markets and who can communicate this professionally, yet passionately. You can’t fake interest. That’s what my HR department say! You’ve got to know why you are there.
Lastly, just before we round up, what makes a great leader?
Ears. You’ve got to listen. I’ve made it a policy for me not to talk first in meetings internally. If you ask people at Fitch about me, they’d probably say I listen lots. Normally, because people are smarter than me, I like to listen to what they think before I talk.
A special thanks to Steven Young, Libby Packham, Joanna Stephens and the Accounting and Finance department for facilitating this interview and for allowing Divesh and I this opportunity.