Big players add liquidity and risks to global market

NEW YORK (Reuters) - The four largest players in global financial markets have grown at a breakneck pace in the last six years, and the assets they manage are expected to double to $20.7 trillion by 2012, according to a report released on Thursday.

Petrodollar investors, Asian central banks, hedge funds and private equity firms -- collectively called "the new power brokers" -- have had the positive effect of adding liquidity to global capital markets, the McKinsey Global Institute said in the report.

But the controllers of such massive amounts of money also pose significant risks to the global financial system, it said.

"One of the most noteworthy things about these new power brokers is that, particularly with the petrodollars and Asian central banks, there has been a big rise in global liquidity," said Diana Farrell, director of the Institute.

"We've seen this tremendous rise in liquidity without an increase in volatility," she said.

In the last few months, keeping financial markets liquid and stable has been a prime objective of central banks around the world as investors grapple with a credit market meltdown.

The report suggests that the four biggest providers of liquidity to the global financial system are expected to grow steadily over the next five years.

Collectively, assets managed by the power brokers have grown from about $3.2 trillion in 2000 to an estimated $8.4 trillion to $8.7 trillion at the end of last year -- 5 percent of total global financial assets, the report said.

Included in these figures is the Chinese central bank's enormous coffer of foreign exchange reserves, valued at more than $1 trillion, as well as the investment derived from recycled oil sales proceeds by oil exporters.

MOUNTAINS OF MONEY

If oil prices pull back from current record highs and hedge fund and private equity returns moderate, McKinsey forecasts those assets could grow to $15.9 trillion by 2012, a slower pace of expansion than that seen in the prior six years.

However, if the rate of growth is sustained over the next five years, assets held by the power brokers could grow to as much as $20.7 trillion.

With such large amounts of money sloshing around, it is no wonder that the power brokers have had a sharp impact on capital markets by diversifying the kinds of investors and spurring financial innovation, the report said.

Yet, the new players have brought risks with them as well.

For example, some economists fear that state-controlled investment funds financed with oil export earnings or central bank reserves may be inclined to make investment decisions driven by non-economic motives.

"The fear is that rather than investing solely for commercial pursuit of returns, their state connections may introduce an element of political or mercantilist considerations in their investments," the report said.

McKinsey Global Institute recommended increasing transparency in all four of the power brokers in part through increased bank oversight and an improvement in governance structures.