The Making of Finance

Perspectives from the Social Sciences

Isabelle Chambost, Marc Lenglet, Yamina Tadjeddine, Isabelle Chambost, Marc Lenglet, Yamina Tadjeddine

• Publisher: Routledge
• Year: 2018
• Print ISBN: 9781138498563
• eBook ISBN: 9781351016094
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Using a variety of theoretical frameworks drawn from the social sciences, the contributions in this edited collection offer a critical perspective on the dominant paradigms used in contemporary financial activities. Through a detailed study of the organisation and functioning of financial intermediaries and institutions, the contributors to this volume analyse 'finance in the making', by shedding light on the structuring of banking and financial systems, on their capacity to prescribe action and control, on their modes of regulation and, more generally, on the process of financialisation.

Contributions presented in this volume have been written by authors working within the 'social studies of finance' tradition, a research programme that emerged twenty years ago, with the aim of addressing a diversity of financial fieldworks and related theoretical questions. This book, therefore, sheds light on different areas that are representative of contemporary financial realities. Specifically, it first studies the work of financial employees: traders, salespeople, investment managers, financial analysts, investment consultants, etc. but also provides an analysis of a range of financial instruments: financial schemes and contracts, financial derivatives, socially responsible investment funds, as well as market rules and regulations. Finally, it puts into perspective the organisations contributing to this financial reality: those developing and selling financial services (retail banks, brokerage houses, asset management firms, private equity firms, etc.), and also those contributing to the regulation of such activities (banking regulators, financial market authorities, credit rating agencies, the State, to name a few).

Each text can be read without any specific knowledge of finance; the book is thus addressed to anyone willing to better understand the intricacies of contemporary financial realities.

Part I

Critical analysis of mainstream financial theory and its uses

Introduction

Founded on an assumption of rational decision-making in a context of known risks, and the principle of perfect competition, mainstream financial theories are based on the idea that financial markets exist in a state of general equilibrium. The informational and allocative efficiency of these markets is secured by the modelling of financial asset prices, based on the random walk hypothesis (Fama, 1965), and optimal investment decisions made possible by effective models for valuing financial assets (Markowitz, 1959; Sharpe, 1964). Market prices therefore reflect the ‘true’ value of financial assets, whether they are issued by companies or governments, and ensure the optimal allocation of resources. The research cited in this first section questions the practical implications of these concepts, in terms of the way in which prices are formed in the market and the oft-overlooked importance of the process of commensuration of financial derivatives (Rainelli-Weiss and Huault), the statistical choices made when it comes to modelling market values (Walter) and the fact that financial services are inevitably dependent on various non-market parameters which shape exchanges (Tadjeddine).

The researchers cited here have also questioned the way in which these theories are embodied in the tools, rules and organisations which influence financial, economic and legal practices, and are used to legitimate certain professions, reinforce roles and delimit spheres of influence. Hence Ortiz explores the role played by the political and moral positions which tacitly underpin the selection and deployment of mathematical formulae in finance. Close analysis of the manner in which financial actors comprehend risk also reveals, at best, a patchwork system which overrides the supposed division of labour in this domain (Larminat) or, in the worst cases, the existence of baseless assumptions underpinning supervisory systems which are themselves a source of considerable risk (van der Graaf ). The role played by financial analysts, supposed to provide the whole financial community with analysis based on information drawn from outside the financial markets, is also called into question, not least in light of the importance of ‘road shows’ held to bring together company directors and investors (Chambost). Close scrutiny has also been applied to the financial structuring of public—private partnerships, with their capacity to shelter their creators from the risks involved (Deffontaines). Finally, Jovanovic has examined the way in which the hypothesis of market efficiency gives rise to fictional constructs with real consequences for judgements, contextualising these judgements with reference to the phenomenon of hyperreality.

TABLE I.1 Critical analysis of classic financial theory – classification based on scale of observation

Techniques	Organisations	Institutions
(c.6) van der Graaf Sociology of quantification (Risk models)	(c.1) Tadjeddine Convention economics (Asset management)	(c.9) Jovanovic Economic sociology (Financial law)
(c. 7) Rainelli-Weiss & Huault Organization studies (Pricing models)	(c.2) Larminat Economic sociology (Asset management)
(c. 8) Walter History of financial theory (Theory of risk)	(c.3) Ortiz Anthropology of finance (Asset management)
	(c.4) Chambost Neo-institutionalist sociology (Financial analysis)
	(c.5) Deffontaines Economic sociology (Public financing)

The complexity of these theories, of the financial dynamics in action and the financial derivatives involved acts as a barrier to entry and may prove to be off-putting (and understandably so) for researchers who do not consider themselves to be specialists in this field. In our opinion, a more accessible approach to understanding these financial processes is to begin by observing the organisations involved and the professionals who operate within them (cf. Table I.1). This is the approach adopted by Tadjeddine, Larminat and Ortiz, who have conducted research within asset management firms in order to produce studies focusing on managers, and thus address the practical side of investment processes. Similarly, Chambost visited brokers’ offices to meet sell-side financial analysts and traders. The analysis offered by Deffontaines is also rooted in a detailed examination of the organisations and professions involved in the financial structures which underpin public—private partnerships. Focusing on techniques makes such studies easier to conduct, allowing researchers to address subjects such as interest rate coverage (van der Graaf) and how prices are established on the derivatives market (Rainelli-Weiss and Huault). Mastering the theoretical aspects of these techniques allows us to directly analyse their foundations (Walter), or even their origins in legal precedent as seen from an institutional perspective (Jovanovic). While reading this section you may also find it useful to refer to Figures 0.1 and 0.2 provided in the Introduction.

References

Fama, E. (1965). Random walk in stock market price. Financial Analyst Journal, 21(5), 55-59.

Markowitz, H. (1959). Portfolio selection: Efficient diversification of investment. New York: John Wiley & Sons.

Sharpe, W. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19(3), 445-442.

1

Financial services

A collection of arrangements

Yamina Tadjeddine

The role of financial organisations is to act as intermediaries providing a service targeted at either those who hold savings funds and wish to invest in the financial markets, or those who have a need for monetary resources. Thanks to the financialisation of the economy, the intermediation chain has become considerably strengthened. New services, roles, and organisations have appeared, notably in the area of risk hedging and asset management. Examining the hegemony of finance today means questioning the legitimacy of the economic rent received by financial intermediaries and in the same instance questioning the true nature of the financial services provided.

For those with savings, asset management proposes to turn to the expertise of an intermediary – the funds manager – in order to build up a portfolio of financial securities. The funds manager is considered to have a greater understanding of those entities issuing financial securities (governments, corporations) and of how the market works. He/she is also expected to have privileged access to information and rumours, and is therefore better informed as to how best to yield profit from capital. It is this enhanced knowledge concerning opportunities for speculative profit that justifies his/her fees. Appealing to the services of a funds manager means the saver can expect a higher profit than what he/she would have achieved without this mediation.

From the perspective of a canonical economic interpretation, a direct connection should exist between the quality of the service provided by the manager – namely the judicious selection of securities to include in a portfolio – and the capital yields paid out to the saver. The issue of the quality of financial services would therefore be resolved. Yet, the financial reality is marked by the uncertainty of price variations: financial hazard is not Gaussian, it follows more complex processes which render its prediction impossible both in the short and long term. As a result, speculative profit achieved over the short term is above all the result of good luck or of a bad turn. It provides little information regarding the value of the service provided by the manager and furthermore makes it impossible to determine his/her prospective ability to attain the same returns. This informational deficiency both ex ante and ex post creates suspicion and market failures (Akerlof, 1970). Nevertheless, in practice, the trade undoubtedly takes place as certain arrangements like signals or reputation are employed to resolve the market failure. The existence of such arrangements was revealed through socio-economic research examining the quality of services by Eymard-Duvernay (1989), Gadrey (2004) and Karpik (1989). Ortiz (2005) additionally proposed to assimilate these various socio-economic studies, in order to understand the nature of the relationship between funds manager and broker. He shows how the personalisation of the trades leads to the existence of various modes of qualification. We pursue this pathway within this chapter, basing our work upon another type of relationship (between sales personnel and institutional investors).

This chapter therefore proposes to examine the social and political construction of the quality of a particular financial service – asset management. The first section succinctly describes the activity of fund management delegation that takes place between institutional investors and asset management corporations. The second section focuses on the quality of the financial service. The financial relationship cannot singularly be reduced to the returns yielded; rather, it is built through a collection of social and political arrangements which will be presented in the final section of this chapter.

The relation between institutional investor and asset management companies

Asset management companies provide the service of portfolio management. In France, conducting fund management activities for third-party accounts is regulated by the AMF – Autorité des marchés financières (Financial Market Authority). According to a report on third-party account management published in 2012 by the AMF, in this same year there existed a total of 604 asset management companies which between them handled 2,867 billion euros. However, this elevated figure obscures a major imbalance: the subsidiary of large insurance and banking groups manage practically 90 per cent of the assets (AMF, 2012). We have monitored the case of one management firm, the subsidiary of a private Belgian bank, which declared in April 2013 that it had under its management 2.6 billion euros worth of assets. This private bank employs around a hundred employees and offers its services to private individuals, though also and more importantly to institutional investors. We were able to observe the work of the person responsible for customer relations with their institutional clients. The observation consisted of regular encounters with this person, within their firm, for over more than a year, in addition to the consultation of numerous commercial documents (prospectus presenting the company’s products, contracts, calls for tender, reports).

The main institutional investors in France are insurance companies, private health insurance firms (mutuelles), pension funds, associations and foundations. The origin of funds could be private savings or regulated capital (insurance reserves or retirement funds), the management of which is controlled by public rules. In France, 69 per cent of managed assets are from institutional investors. Consequently, the relationship between institutional investor and asset management company is at the very core of current financial capitalism (Aglietta and Rigot, 2009). Certain institutional investors own the subsidiaries of fund management firms and hence invest their funds within them. This is the case with several insurance firms (AXA with AXA IM), but also with a number of private health insurance firms (EGAMO is a subsidiary of MGEN) and some pension funds (Pro BTP Finance). Institutional investors can also choose to invest with an external service provider, such as the private Belgian bank that I was able to observe. The service may be carried out in various juridical forms: share subscriptions for UCITS (undertakings for collective investment in transferable securities) or trust. It is common that institutional investors turn at the same time towards various competitor internal and external service providers. Decisions concerning the delegation of fund management involve numerous internal actors (financial directors, executive officers, lawyers, follow-up committees, etc.), but also external consultants who will be tasked with selecting the management firms. The representative for the management firm is generally the salesperson responsible for canvassing new clients and fulfilling their expectations.

The quality of the financial service

Within the collective management market, the client (here the institutional investor) must choose a producer (the manager). The production in this trade is the portfolio yield. This yield is furthermore the only market signal received by the client, yet it is impossible to infer from it the true quality of the manager.

We thus find ourselves confronted with a key debate within the informational economic theory, which concerns the consumer’s knowledge about the quality of the provided service. Three types of services have been identified in economic literature. In the first instance, Nelson (1970) proposes to distinguish between services for which the quality can be discerned ex ante (‘search goods’) and services for which the quality will only be known once consumed (‘experience goods’). Darby and Karni (1973) have added a third category, ‘credence goods’, covering those services for which it is impossible even ex post to discern the quality. Yet none of these three categories are applicable to the circumstances of financial services due to the presence of financial uncertainty. The knowledge of past yields is not reliable enough to distinguish good managers either ex ante or ex post. The financial service therefore cannot be classified as either a search good or an experience good. Neither is it, on the other hand, a credence good in which the agent is able to use the information asymmetry in an opportunistic way to maximise his/her own interest. The existence of financial uncertainty harms equally the client (who may lose their money) and the portfolio manager (whose hard work may go unrecognised).

The financial service thus falls under the definition of a unique good, also known as ‘singularities’ (Karpik, 2010). The challenge of the trade is to overcome this lack of information by establishing a personal relationship based on the co-production of a service. To this end, the protagonists must back-up the commercial relation with measures that they will eventually define over time and which will allow the financial service to be qualified, framed and monitored.

The arrangements required for trading and legitimising financial services

Financial services cannot merely be summarised as a simple market exchange, as they involve a personal relationship which engages the co-exchangers. As such, it is not only the yield that is bought, and which must be taken into consideration by the client and the seller, but also a collection of practices, knowledge, rules, symbols and feelings which will bind together the protagonists (Ortiz, 2005). These non-commercial and co-constructed arrangements are precisely what constitute the essence of the financial trade. In these conditions, the characterisation of the good or bad manager, as well as any impending sanction, is dependent upon the nature of the relationship founded. We propose to illustrate this unique aspect of the financial service through three arrangements thus observed: membership with symbolic social networks (a personal arrangement according to Karpik, 2010), the standardisation of practices involving the use...

Table of contents

• Cover
• Half Title
• Title Page
• Copyright Page
• List of figures
• List of tables
• List of contributors
• Table of Contents
• Acknowledgements
• Introduction: finance as social science
• Part I Critical analysis of mainstream financial theory and its uses
• Part II Structural dynamics in the financial industry
• Part III A new system of accumulation
• Index