1.  FINANCIAL INTEGRATION Paula Garrido Mirat

2. Background  High levels of financial integration a 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-19 th 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´s analytical function emerged in the 20 th century but 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