Super funds can be part of the solution to a financial industry which has become divorced from its underlying purpose, according to a leading British economist.

The current financial system has become an industry that mostly trades with itself, talks to itself and judges itself by reference to standards which it has itself generated, according to John Kay, visiting Professor of Economics at the London School of Economics, and a Fellow of St John’s College, Oxford.

Lending to business is less than 3 per cent of the total balance sheets of banks, while trading in foreign exchange markets amounts to 100 times the volume of trade in goods and services, Kay said in a presentation to CFA Societies Australia, hosted at First State Super’s offices.

“According to the Bank for International Settlements the total value of exposures under derivatives is something like $700 trillion. That’s a mind-blowing figure, and it should be mind-blowing because it’s about three times the value of all the assets in the world,” Kay said.

Kay is convinced that the latest round of regulation in the wake of the global financial crisis will not work out the way it was intended, leading to more regulation to try to compensate, which in turn will not work out, leading to more regulation.

“There’s been a shift in the regulatory philosophy where we have moved away from regulation which changes the structure of the industry and the incentives, to regulation that relies on financial conglomerates or large fund managers to merge, and which then attempted to govern such organisations by more detailed and prescriptive rules,” Kay said.

The central development in the past couple of decades in the equity markets has been the increasing power of the large asset managers, such as Blackrock and Vanguard, whereas 20 years ago it would have been pension funds and insurance companies.

However, the superannuation system in Australia means that the super funds are of a sufficient scale to influence the financial sector and bring the market back to meet the needs of the economy and people – the original purpose of the financial sector.

“I’m a passionate believer in the market economy. There is no other story in town that’s generated prosperous societies. But there is a mistake in confusing the market economy with promoting the volume of activity in the financial markets,” Kay said.

Kay is also a Fellow of the British Academy and of the Royal Society of Edinburgh. He is a director of several public companies and contributes a weekly column to the Financial Times. He recently chaired the review of UK equity markets and long-term decision-making which reported to the Secretary of State for Business, Innovation and Skills in July 2012.

His latest book, Other People’s Money, asks what a financial system would look like if it was designed to meet the needs of the non-financial economy rather than the interests of financial market participants.

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