Financial Ecosystem Diagram: Originally created by me for CFA Institute
The entirety of the investing ecosystem is built on a fundamental transaction: those with a surplus of capital, but a deficit of ideas, provide their capital to those with a deficit of capital, but a surplus of ideas. When those ideas are good then both the providers of, and users of, capital benefit through a return on capital.
The fundamental transaction provides a framework for evaluating financial ecosystem choices. If a choice serves the furtherance or improvement of the fundamental transaction then it is encouraged. Transactions not in the furtherance or improvement of the fundamental transaction are discouraged (e.g. subprime mortgages to first time buyers with no down payment and shaky credit history).
Among the major actors in the financial ecosystem are:
- Providers of capital: These are the actors with the surplus of capital and deficit of ideas described above in the fundamental transaction. Examples include: investors, savers, and proprietary traders at intermediaries. These folks eventually end up as asset owners after electing to transact with users of capital.
- Users of capital: These are the actors with the deficit of capital and surplus of good ideas described above in the fundamental transaction. These folks end up as asset issuers after they transact with capital providers. Examples include: Entrepreneurs and businesses.
- Intermediaries: These actors operate between providers of, and users of, capital providing services that facilitate the fundamental transaction. Examples include: Investment banks, commercial banks, investment companies, ETFs, pension funds, insurance companies, asset exchanges, and boards of directors. This category also includes shadow banking system actors, like venture capitalists (VCs), private equity, hedge funds, special investment vehicles (SIVs), and money funds.
- Groundskeepers: These actors occupy the entirety of the ground of the ecosystem and influence the nature of the fundamental transaction and all other actors. Examples include: Governments, central banks, regulators, securities regulators, quasi-regulators, legal systems, tax authorities, transfer agents, IMF/World Bank/OECD, activists, and business schools. Note: in the diagram below they are occupy the entirety of the gray space on which all of the other actors’ institutions are built.
- Opiners: These actors primarily are paid for their opinion about the nature of the users of capital as well as other aspects of the fundamental transaction, such as security specific issues. Many work for the other actors. Examples include: Buy side analysts, sell side analysts, independent analysts, data providers, investment managers, private wealth managers, Nationally Recognized Statistical Ratings Organizations, economists, think tanks, investment newsletters, and journalists.
- Traders of capital: These actors predominately operate in the secondary market. They serve the ecosystem by aiding price discovery and providing liquidity to those participants whose opinions about assets have changed. These actors are included in the ecosystem to capture the differing interests of speculators and investors, as well as to highlight agency issues – that is, these actors are not party to the initial fundamental transaction. Examples include: Investors, investment companies, ETFs, pension funds, insurance companies, private equity, hedge funds, venture capitalists, and proprietary traders at intermediaries.
NOTE: Ideas and concepts float around the financial ecosystem and also inform the functioning of the ecosystem.