Lehman Brothers
A decade has passed since the collapse of Lehman Brothers – the emblematic event of the Global Financial Crisis (GFC).
How has the financial world changed since then? In several important ways, the world of 2018 is reminiscent of the pre-financial crisis world: valuation levels and leverage levels are high, and the world’s ever-increasing complexity and interconnectedness gives scope for the effects of a crisis to be felt across the world, no matter where it starts.
But in many other ways, the world today is a very different place: financial regulation is more abundant and stringent, alternative finance providers and Asian banks have risen, fintech is creating new ways of doing business, and rising political populism is changing society’s relationship with business and finance.
Here, we illustrate the key ways the world has changed and how the world is similar to how it was before the GFC. History may not repeat, but it may well rhyme.
In the aftermath of the financial crisis, policymakers responded with a raft of new regulation. Thomson Reuters tracked around 9,000 regulatory alerts of interest to financial services companies in 2008. By 2017, this had risen to more than 56,000: a more than six-fold increase.
Stricter regulation has obliged banks to hold more equity, thereby increasing the buffer against major losses. The much higher regulatory burden banks are bearing has also arguably contributed to the rise in alternative credit providers.
Peter Bevan, Global Head of Financial Regulation, Linklaters:
“The regulatory response around the world was significant. Regulators moved from a light touch model to a far more rigorous system of capital and liquidity requirements.”
With new regulations affecting banks in particular, and banks reorganising their activities in the aftermath of the GFC, alternative providers of finance such as hedge funds, insurance companies and pension funds have joined them as significant players in the financial landscape.
At a global level, bank assets as a proportion of the total financial landscape have returned to pre-crisis levels.
Andreas Steck, Financial Regulation Partner, Linklaters:
“There’s definitely been a rise in alternative credit providers in recent years. They will increasingly come under the spotlight as regulators try to understand if they pose systemic risks and whether they are sufficiently addressed by the current rules.”
In the aftermath of the crisis, central banks across the globe slashed interest rates, easing pressure on borrowers.
In emerging markets, the result has been to bring relatively high rates down to more manageable levels. For advanced economies, however, interest rates have been close to zero since 2008-09. Lower interest rates have had the knock-on effect of driving higher leverage across the world, increasing risk levels. Low interest rates have also made it harder for banks to make money from margin, incentivising them to find new business models such as through fintech.
Fionnghuala Griggs, Corporate Partner, Linklaters:
“In today’s ultra-low interest rate environment, banks are having to increasingly focus on how and where they can create margin. We’re seeing innovative solutions emerge as they look at new business models, new technologies and new partnerships to drive revenue.”
While dissatisfaction with the status quo had been bubbling for some years, the GFC was the first of several global crises that catalysed change.
In Europe, the events of 2008 were followed in quick succession by the Euro crisis and the refugee crisis, all of which have driven political populism.
Despite the crises in Europe and the US, global poverty levels have halved since 2008 as emerging markets have developed their economies - with the perceived resulting shift in global patterns in industry and jobs also driving populism in the West.
Populist parties on both the right and left have transformed the political landscape, promising radical change. The percentage of populist votes across developed countries has risen significantly since 2008.
In 2007, British and European banks dominated the ranking of the largest 20 banks by assets. Just a handful remain on the list today, and their total assets have fallen from $28 trillion to $13 trillion. The big American banks have fared much better, with their total assets rising across the same period.
The most dramatic change to the banking landscape has been the spectacular rise of Asian banks, particularly those in China and Japan. Chinese banks comprise the top four places in today’s rankings. Assets of Asian banks have grown almost six-fold over the past decade from $4 trillion to over $23 trillion.
Michael Kent, Global Head of Finance & Projects, Linklaters:
“Ten years on from the administration of Lehman’s, the global banking industry is unrecognisable. Banks across the world have seen an unprecedented wave of regulation hit them and some markets have fared better than others.”
The collapse of Lehman Brothers led to a raft of new regulation to improve the safety of banks and the wider financial system. These changes have meant that the capital-to-assets ratio for banks in Europe and globally as a whole has risen significantly since 2008.
Safety at banks is also not just about capital levels. New regulations have also catalysed significant changes in governance, compliance and remuneration at banks. Banking culture has become more conservative and prudent with greater safeguards in place.
Benedict James, Banking Partner, Linklaters:
“A vast amount of work has been done by regulators over the past ten years to put in place capital and liquidity standards, and stress test regimes to ensure a much safer and stronger banking system.”
The rise of fintech has caused significant evolution in the financial services sector since the crisis. Financial services have moved from in-person to digital banking. Traditional incumbent banks are collaborating with fintech start-ups and are developing in-house innovation hubs.
Cryptocurrency, digital cash, blockchain technology and smart contracts are just some of the new methods changing the landscape. Over $100 billion has been invested in the global fintech sector since 2010. Deal value grew by almost one fifth in 2017 alone.
However, questions remain on the regulation of fintech, which has often been relatively unencumbered by the restrictions imposed on traditional banks following the crisis.
Alexandra Beidas, Employment & Incentives Partner, Linklaters:
“There is a lot of focus on technology at the moment and that is only going to increase in the coming years. Whilst the remuneration rules are there to address risk-taking behaviour, there’s a concern it could stifle innovation if people feel hampered by the inability to experiment and therefore do the best job possible.”
Lehman Brothers was a major player in over-the-counter (OTC) derivatives, and its collapse made clear the systemic importance of derivatives in the world’s financial system. At the Pittsburgh Summit of 2009, the G20 sought to overhaul the OTC derivatives markets in order to mitigate systemic risk. A major component of this was the objective that standardised OTC derivatives should be centrally cleared: should a counterparty involved in OTC trading go bankrupt under central clearing, it would not create the chain reaction that the default of Lehman Brothers triggered.
Significant progress has been made on this front. For example, the proportion of outstanding OTC interest rate derivatives that are centrally cleared is estimated to have increased from 24% in 2008 to 61% globally in 2016.
Michael Kent, Global Head of Finance & Projects, Linklaters:
“Prior to the administration of Lehman’s, clearing of over-the-counter (OTC) instruments was not mandatory. The crash showed that clearing was an effective safety mechanism when properly undertaken. Accordingly, this was a focus of new regulation, with it becoming mandatory to clear many OTC derivative instruments.”
The global value of mergers and acquisitions (M&A) deals dropped off during the global financial crisis, falling from over $3 trillion in both 2006 and 2007 to less than half that amount in 2009. Between 2010-13, the annual value remained fairly constant at around $2 trillion. Since 2013, the annual value has been north of $3 trillion each year – similar to pre-crisis levels. Deal acquisition multiples are also at pre-crisis levels.
Stock market valuations have also increased since the lows of 2008, with the S&P 500 index even exceeding pre-crisis levels.
Today, the world is loaded with record levels of debt. Global debt reached a historic peak of $177 trillion in 2017 – a 50% increase on debt levels a decade earlier. The fastest growth has been in non-financial corporates, followed by growth in government debt.
Overall debt levels now represents over twice the world’s Gross Domestic Product – 217%. This is well above the level in 2007.
Fionnghuala Griggs, Corporate Partner, Linklaters:
“There is a question of what happens when interest rates return to normal levels. We have learnt lessons from the financial crisis and need to ensure that they remain front of mind. It would be risky to become too accustomed to this low interest rate environment.”
Our work on Lehman Brothers is one of the many landmark cases on which we have worked. It has also been a demonstration of our purpose: to provide legal certainty in a changing world. Lehman’s insolvency has been played out in a very public arena over the last 10 years, with the sheer scale of the collapse and the impact on the global financial markets helping to drive the regulatory changes explored in this infographic.
To find out more, please visit linklaters.com or feel free to contact us directly.
