1. FINANCIAL INTEGRATION Paula GarridoMirat

2. Background • High levels of financial integrationa hundred years ago. • British investment in Argentina, Australia, Canada and US between 1865 and 1890 went mostly into railroads and government bonds.

3. Obstacles for investing abroad then • INFORMATION PROBLEMS • Communications technology of the day • Asymmetric information • CONTRACTING PROBLEMS • US laws VS. Britain laws • MACROECONOMIC RISKS • Exchange rate risk • Unstable and uncertain monetary and fiscal policies • ACCOUNTING PROBLEMS

4. Information problems • Communications technology of the day: • Transatlantic cable (1860) • Time for cable transmission less than a minute by 1914 • Equalization in prices in different places of the world

5. Information problems • Information asymmetry: • Adverse selection • Disproportionate share of railway bonds in foreign investment portfolios • Family groups and merchant and investment banks • Freestanding companies for FDI

6. Contracting problems • Uncertainty of legal security of the claims of foreign investors in the US was an issue for British investors • The US prohibited foreigners from serving as directors of the corporations chartered there • Freestanding companies were very trusted then because they were subject to British law.

7. Macroeconomic Risks • British investors viewed securities issued by countries not on the gold standard riskier than those of the countries that were. • Loans to countries with a fluctuating standard value commanded significantly higher interest rates

8. Absence of adequate accounting standards • Suggestion to create generally accepted accounting principles • British investors insisted on the transfer to the US of accounting practices accepted in Britain • Need for regulatory intervention: Interstate Commerce Commission for the railroads until the Securities Exchange Commission • British accountants set up practice in the US from the mid-19th century

9. Financial integration now • Deeper and broader economic integration • More complexity of financial markets • More regulation • More financial innovations • Improvements in communication • Bankruptcies, scandals and fraud still there

10. Problems. The Enron scandal • INFORMATION PROBLEMS • Still asymmetry information • Hidden information • DEREGULATED MARKETS • California deregulated the energy market • RISKS • Credit rating agencies • Enron´s sophisticated financial risk management tools • ACCOUNTING AND AUDITING • Arthur Andersen downfall with the scandal

11. Information problems • Failed investments • ENRON formed partnerships to hide $500 Million in company losses • People continued buying ENRON stocks and the price didn’t go down • NO INFORMATION OF THE REAL STATUS OF THE COMPANY

12. Deregulated markets • 1996: California deregulated the energy market in order to increase competition • Market manipulations and illegal shutdowns • State of emergency in January 2001 • ENRON saw opportunity to make money to cover their huge losses: TAKE ADVANTAGE OF THE DEREGULATED MARKET IN CRISIS • Government regulated the market: no more opportunity to make money for ENRON • ENRON announced its first losses in more than four years

13. Macroeconomic risks • Credit agencies: • They were giving Enron the highest qualifications, when Enron was facing huge losses, which prevented their stock price from falling. • They downgraded Enron´s credit rate too late, when it was already bankrupt. • ENRON´s sophisticated financial risk management tools • Enron's bankruptcy downfall was attributed to its reckless use of derivatives and special purpose entities

14. Accounting and auditing • ENRON succeeded in hiding some important facts, such as off-book liabilities, from banks and shareholders • ENRON's auditor´s firm, Arthur Andersen, was accused of applying reckless standards in its audits because of a conflict of interest over the significant consulting fees generated by ENRON • Arthur Andersen fell with the Enron´s fall • ENRON was attributed as the biggest audit failure in history

15. COMPARISSONS After more than a century, similar problems to those that faced British investors still exist but in a more complex and integrated financial system: • Asymmetry information: the investors (now and then) didn’t have all the real information of the economic status of the company, despite the improvements in communication technologies • British investors and ENRON company also took into account the laws in different places in order to choose the best apparent investment opportunity • Even though there have been many improvements in risk management, sometimes it is very hard to measure it • Distinction between the auditor´s inspective function and the accountant´sanalytical function emerged in the 20th centurybut it doesn´t prevent conflict of interests

16. Conclusion • INFORMATION IS THE KEY ELEMENT IN AN INVESTMENT • THERE WILL ALWAYS BE COMPANIES AND PEOPLE THAT WILL HAVE OTHER INTERESTS • MORE REGULATION CAN HELP BUT WON´T SOLVE THE PROBLEM COMPLETELY