Year: 2009

New dawn fades

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For many, many years central bankers felt a sort of moral obligation to rescue financial institutions, (particularly banks) when they were going under. This situation drastically changed during Barings plc’s turmoil. Barings plc was the most prestigious merchant bank in England at the time. Back in 1873 when Jules Verne wrote his famous Around the world in 80 days, he chose the Barings Bank as the bank where Phileas Fogg had his £20,000 deposited. When Nick Leeson broke the bank down to pieces from the Singapore office, Eddie George had a very tough call to make. Rescue Barings, or let it drown on its own. Certainly, Leeson had put the bank in a very difficult situation. Back in the 19th century the Bank of England had already helped Barings out of trouble from a bad loan in Argentina; why would this situation be any different? This time a billon plus situation would not jeopardise the central bank’s stability. Why would they not help them out this time? Then the governor of the prestigious BOE came with an unusual statement stating that this time the bank would have to fight on its own. Finally Barings’ customers did not have to pay for this ordeal.

The BOE sold that same weekend the bank chosen by Phileas Fogg to the International Netherlands Group, for as little as £1. This became the milestone for a new way to deal with financial institutions disasters. “Let someone else pay for the problem,” were the sentiments emanating from the central bank. The same situation took place when LTCM ended up losing all their marbles and an extra $3.5 billion during the Russia crisis of 1998. At that time the US Federal Reserve pretty much made the top 10 Wall Street investment banks pay for the broken dishes, sending each one a $350 million bill; which they paid. So it was that financial regulators finally had found the key to solving financial disasters. It was, in a way, a new school of systemic financial risk management. For many years, and to this day, having to pay for financial disasters by financial authorities or governments has had but two sources of funding, namely, by spending created money, thus creating inflation, or by taking the money out of other budgets, such as education of social programmes with the correspondent consequences. So this new way of solving the problems seemed to be the right path. Unfortunately the financial crisis of the new millennium that we are now living came with a hefty package of lessons for us all.

Changing times 
Following the new way of dealing with these “uncomfortable situations”, the US authorities at the beginning refused to pay for Lehman’s mistakes in light of new buyers interested in taking charge of them. Unfortunately regulators were not yet aware of the nature of the problem to come. Some say that if Lehman had not been left alone the crisis would have not been as severe. The truth is that with or without the rescue of Lehman at an early stage of the crisis would have not really have made a significant difference.

The real problem lies in the fact that authorities went back to the old way of doing this. This time it appears to be, at least in the case of the US government, that it will take its tow of inflation. Basel II has not been fully implemented yet, and new rules and regulations are breaking into the financial sector. 

The truth is that a real solution for dealing with catastrophes in financial institutions hasn’t been found yet. There is a new wave calling for state intervention into the financial systems, but that is not the solution either. FDIC type institutions have been created across the globe but these types of institutions have not solved the entire problem and appear not to be the ultimate solution as well.

The challenge is not an easy one. Finding the right balance between government interventions and preserving the principle of a free market economy is not an easy task; but quite the opposite. 

What is true is that a new era in systemic financial risk management is being now born, and that we stand before the beginning of a new era in systemic financial risk management. Let’s hope it will all be for the best.

Enrique Núñez-Escudero is chairman at Shirebrook Commodities studies in Economics

The joblessness threat

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Recent data suggest that job market conditions are not improving in the US and other advanced economies. In the US, the unemployment rate, currently at 9.5 percent, is poised to rise above 10 percent by the fall. It should peak at 11 percent some time in 2010 and remain well above 10 percent for a long time. The unemployment rate will peak above 10 percent in most other advanced economies, too.

These raw figures on job losses, bad as they are, actually understate the weakness in world labour markets. If you include partially employed workers and discouraged workers who left the US labour force, for example, the unemployment rate is already 16.5 percent. Monetary and fiscal stimulus in most countries has done little to slow down the rate of job losses. As a result, total labour income – the product of jobs times hours worked times average hourly wages – has fallen dramatically.

Moreover, many employers, seeking to share the pain of recession and slow down layoffs, are now asking workers to accept cuts in both hours and hourly wages. British Airways, for example, has asked workers to work for an entire month without pay. Thus, the total effect of the recession on labour income of jobs, hours and wage reductions is much larger.

A sharp contraction in jobs and labour income has many negative consequences on both the economy and financial markets. First, falling labour income implies falling consumption for households, which have already been hard hit by a massive loss of wealth (as the value of equities and homes has fallen) and a sharp rise in their debt ratios. With consumption accounting for 70 percent of US GDP in the US, and a similarly high percent in other advanced economies, this implies that the recession will last longer, and that economic recovery next year will be anaemic (less than one percent growth in the US and even lower growth rates in Europe and Japan).

Second, job losses will lead to a more protracted and severe housing recession, as joblessness and falling income are key factors in determining delinquencies on mortgages and foreclosure.

By the end of this year about 8.4 million US individuals with mortgages will be unemployed and unable to service their mortgages.

Third, if you plug an unemployment rate of 10 percent to 11 percent into any model of loan defaults, you get ugly figures not just for residential mortgages (both prime and subprime), but also for commercial real estate, credit cards, student loans, auto loans, etc. Thus, banks losses on their toxic assets and their capital needs will be much larger than recently estimated, which will worsen the credit crunch.

Fourth, rising job losses lead to greater demands for protectionist measures, as governments are pressured to save domestic jobs. This threatens to aggravate the damaging contraction of global trade.

Fifth, the higher the unemployment rate goes, the wider budget deficits will become, as automatic stabilisers reduce revenue and increase spending (for example, on unemployment benefits). Thus, an already unsustainable US fiscal path, with budget deficits above 10 percent of GDP and public debt expected to double as a share of GDP by 2014, becomes even worse.

This leads to a policy dilemma: rising unemployment rates are forcing politicians in the US and other countries to consider additional fiscal stimulus programs to boost sagging demand and falling employment. But, despite persistent deflationary pressure through 2010, rising budget deficits, high financial-sector bailout costs, continued monetisation of deficits, and eventually unsustainable levels of public debt will ultimately lead to higher expected inflation – and thus to higher interest rates, which would stifle the recovery of private demand.

So, while further fiscal stimulus seems necessary to avoid a more protracted recession, governments around the world can ill afford it: they are damned if they do and damned if they don’t. If, like Japan in the late 1990’s and the US in 1937, they take the threat of large deficits seriously and raise taxes and cut spending too much too soon, their economies could fall back into recession.

But recession could also result if deficits are allowed to fester, or are increased with additional stimulus to boost jobs and growth, because bond-market vigilantes might push borrowing costs higher.

Thus, even as mounting job losses undermine consumption, housing prices, banks’ balance sheets, support for free trade, and public finances, the room for further policy stimulus is becoming narrower. Indeed, not only are governments running out of fiscal bullets as debt surges, but monetary policy is having little short-run traction in economies suffering insolvency – not just liquidity – problems. Worse still, in the medium term the monetary overhang may lead to significant inflationary risks.

Little wonder, then, that we are now witnessing a significant correction in equity, credit, and commodities markets. The irrational exuberance that drove a three-month bear-market rally in the spring is now giving way to a sober realisation among investors that the global recession will not be over until year end, that the recovery will be weak and well below trend, and that the risks of a double-dip W-shaped recession are rising.

Nouriel Roubini is Professor of Economics at the Stern School of Business, New York University, and Chairman of RGE Monitor (www.rgemonitor.com)

Stamping out corruption

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After much criticism and a diabolical prosecution record, the UK looks set to finally crack down on corruption committed by UK companies both at home and abroad. The country’s outmoded bribery laws – some of which date as far back as 1889 – are to be replaced by the new bribery bill which will make it a criminal offence to give or offer a bribe in the UK or abroad and will increase the maximum prison term from seven to ten years. The bill also introduces a corporate offence of negligent failure to prevent bribery on behalf of a business, and for the first time, MPs and peers can be prosecuted in bribery cases.

The planned legislation comes six months after the UK was criticised by the OECD for failing to modernise its anti-corruption protocols and its publication comes as 20 investigations are under way at the City of London police’s foreign bribery unit. During Labour’s 12 years in power, only two UK companies have been prosecuted for foreign bribery. One case – that of BAE Systems – spectacularly collapsed: the other was brought to the Serious Fraud Office by the company itself.

However, lawyers believe that the UK’s poor record in bringing prosecutions for overseas bribery may be about to end. Rebecca Robinson, solicitor at Wake Smith & Tofields, says that “the impact on companies and businesses is that the combination of the extra-territorial effect and the introduction of a new corporate offence may make it easier for bribery prosecutions to be brought against UK companies.”

She also says that while the new bill does not define what would constitute “adequate procedures”, she warns that “in light of the proposed new legislation, companies should be reviewing their bribery law compliance programmes to ensure that it has responsible and effective risk management systems in place.”

Under the bill it will be a criminal offence for someone – directly or through a third party – to offer, promise or give a bribe (whether or not financial), and it will also be a criminal offence for someone to request, agree to receive, or accept a bribe. The bill will also make it a “discrete offence” to offer, promise or give a bribe to a foreign public official, including those working for international organisations that have as their members, governments or countries. 

The Bribery Bill makes it clear that it does not matter whether the bribery was committed in the UK or abroad – if abroad, it will apply to all British nationals, UK companies and anyone ordinarily resident in the UK. If an offence is committed by a company, then any senior manager of the business will be similarly guilty if they consented to or connived in the bribery.

The maximum penalty for individuals is increased from seven to ten years’ imprisonment, as well as the possibility of getting an unlimited fine. For corporate offences only there will be an unlimited fine. Furthermore, it should be easier for government agencies to bring a case as the Attorney General’s consent is no longer required to prosecute a bribery offence.

The bill also creates a new offence for companies. Under the proposed legislation, it will be an offence where a “relevant commercial organisation” – essentially, any company established, or carrying on business, in England, Wales or Northern Ireland, and so extends to foreign businesses operating here – negligently fails to prevent bribery in connection with its business. 

This offence focuses on the failure to prevent an “active” bribe only. The offence is committed where “a person performing services for a commercial organisation (including its employees, agents and subsidiaries) bribes someone anywhere in the world in connection with the commercial organisation’s business”, and “those in the organisation with responsibility for preventing bribery negligently fail to do so”. 

The draft legislation says that if there is no person (or persons) with specific responsibility for preventing bribery, the responsibility is deemed to be that of any senior officer in the organisation, including any director, secretary or manager of a company or a partner in a partnership. 

The finger of blame
However, lawyers point out that there is an incentive in ensuring that someone other than a senior office in the organisation is given such responsibility; and that adequate systems are adopted to prevent bribery.

This is because a defence is available where the person deemed responsible for preventing bribery is not a senior officer and the commercial organisation can show that it had adequate procedures in place to prevent bribery. This means that the onus is on the organisation to prove its defence on the balance of probabilities. As a result, Keith Allen, an associate in the business, crime and regulatory department at law firm Clarion Solicitors, says that “all companies should consider appointing a person with the responsibility of ensuring compliance and that person should not be a senior officer, as defined in the bill, to attempt to ensure that the potential defence remains available to the company.”
 
Generally, experts agree that the draft legislation will make it easier to prosecute companies and individuals for bribery, whether committed in the UK or abroad. Will Kenyon, forensics services partner at accountants PwC, says that the real implications for companies come in the form of a new offence of negligently failing to prevent bribery, which puts directors and senior managers firmly on the hook for corrupt practices at home or abroad.

“The fact that the offence carries both corporate and personal criminal liability for corruption within a company should make directors sit up and listen,” says Kenyon. “Companies of all sizes will need to look carefully at their own anti-bribery programme and controls as well as those of their agents and subsidiaries as they may potentially be liable for breaches in other significant parts of their supply chain and sales channels.”

The UK has had a poor reputation for its lacklustre attempts to stamp out bribery overseas, and the only real stick that has been wielded against UK firms for corrupt practices has been a US law, which until recently, had also not been used a great deal.

The Foreign and Corrupt Practices Act (FCPA) was created in 1977 after a 1970s investigation by the SEC found that over 400 US companies had made questionable or illegal payments in excess of $300m to foreign government officials, politicians, and political parties. During the 32 years since the Act was enacted, its scope has been extended with US prosecutors using it in a tenacious pursuit of corporate wrongdoing – in the US and abroad. Due to the extra-territorial nature of the legislation – as well as its highly punitive measures – business advisers now warn that many UK companies and individuals could be in the firing line, and that many of them fail to appreciate the risk.

Zach Harmon, a partner in US law firm King & Spalding’s Washington, DC office and a member of the firm’s special matters and government investigations practice group, says that “the extra territorial scope of the Act does seem to be expanding”, which he says is in part “due to a feeling that if the US does not move to change poor business practice, then no one else will.”

Harmon says that “US companies have complained that foreign companies are at an advantage in terms of taking part in corrupt business practices. Not only do these practices win them contracts, but they are also unlikely to face any kind of serious penalty for carrying them out. The threat of action under the FCPA will help reduce that and this is partly the reason why the FCPA has become more extra-territorial over the past decade.”

Jim Hough, head of the litigation group in the New York office of law firm Morrison & Foerster, says that “enforcement priorities are not really aligned between the US and Europe. As a result, the US is now much more prepared to push both foreign companies and individuals to follow its set of governance standards and regulations on corruption than rely on European regulators to clamp down on corrupt business practices.”

Practising corruption
Over the past few years US regulators such as the Department of Justice (DOJ) and the SEC have increasingly turned their attention towards the “more questionable” activities of foreign companies. Those firms that conduct business in the US are subject to scrutiny, along with those that use the services of firms and individuals based there. The FCPA allows prosecutors to take action against such companies for corrupt practices, even though the corruption may be taking place in another country.

There have been some very high profile foreign prosecutions under the FCPA in recent months. In June 2007 the US Department of Justice announced that it is investigating defence contractor BAE Systems for its possible non-compliance with anti-corruption laws regarding securing contracts with the government of Saudi Arabia – an investigation that the UK Serious Fraud Office decided not to continue. The US investigation is still ongoing.

In November 2006 the DOJ announced that it was investigating German electronics and engineering giant Siemens over suspicious payments to win business contracts. It was also looking into possible violations with regards to its conduct concerning the UN Oil-For-Food humanitarian assistance programme in Iraq. The case was settled in December 2008 when Siemens pleaded guilty to a host of charges ranging from falsifying its books and records to paying over $1.7 million in kickbacks to the Iraqi government in exchange for 42 contracts from which the company earned profits of more than $38 million. The company was fined a total of $1.6 billion by the Department of Justice, the SEC, and German prosecutors.

Tony Parton, partner in the forensic practice at accountants PwC’s, says that “in recent years the emphasis upon ensuring businesses are ‘whiter than white’ has led to the FCPA being interpreted broadly. When the Act initially came into force, an amnesty produced over 500 companies admitting violations, but few prosecutions. But 1995 proved a milestone as advanced technology firm Lockheed paid a $25 million fine for improper payments relating to contracts in Egypt and, for the first time, a businessman was sentenced to jail for violating the Act.”

Experts agree that sanctions under the FCPA are potentially the toughest in the world. Under criminal prosecution, corporations and other business entities are subject to a fine of up to $2 million while officers, directors, stockholders, employees, and agents are subject to a fine of up to $100,000 and imprisonment for up to five years.

Moreover, under the Alternative Fines Act, these fines may be up to twice the benefit that the defendant sought to obtain by making the corrupt payment. So, for example, if a company paid an official $10,000 to secure a $30 million contract, then the SEC and DOJ can attempt to fine the company $60m. Furthermore, fines imposed on individuals may not be paid by their employer or principal.
 
The Act also affords a threat of civil action. The Attorney General – the government’s principal legal adviser – or the SEC may bring a civil action for a fine of up to $10,000 against any firm as well as any officer, director, employee, agent of a firm, or stockholder acting on behalf of the firm who violates the anti-bribery provisions.

Compare that level of enforcement and punishment to the UK. According to the OECD, 108 allegations of corruption have been recorded against UK citizens or companies since February 2002. Yet of these, 24 were closed due to insufficient evidence, one was discontinued and in 32 cases no action was taken because the allegation was not substantiated.

In fact, the first UK company to be successfully prosecuted for overseas bribery only took place in July this year. British engineering company Mabey & Johnson admitted it was involved in overseas corruption after it tried to influence officials in Jamaica and Ghana when bidding for public contracts. It also paid more than $200,000 to Saddam Hussein’s Iraq regime, violating the terms of the UN oil for food programme.

The Reading-based firm, which builds temporary bridges, said it regretted its past conduct.

It pleaded guilty to ten charges of corruption and sanctions violation at Westminster Magistrates Court. The company had brought the matter to the attention of the Serious Fraud Office itself, following an internal investigation and five of its eight directors have resigned since the allegations came to light.

Blurred boundaries
Evidence suggests that UK companies are unaware of the US legislation and the risks it presents. According to a report issued last year from KPMG Forensic, the fraud investigations arm of professional services firm KPMG, almost half (46 percent) of respondents that conducted business in the US either wrongly believed they were not subject to the FCPA or did not know whether they were subject to it. In addition, 56 percent of respondents who said they were subject to the FCPA did not have, or did not know whether they had, an FCPA compliance programme.

However, despite criticism of the UK’s failure to investigate or prosecute bribery cases, the US Act is not as wide-reaching as anti-bribery legislation in the UK. Bribery of public officials has been an offence since 1889. This was extended in 1906 when a new Act was introduced which makes it a crime to bribe any “agent” – defined as anybody employed by or acting for another, whether in the public or private sector.

In 1916 the law was changed again and the “presumption” of corruption was introduced. Under this provision, if a contractor gives a gift to a public official, that gift shall be presumed to be corrupt unless the accused person can prove otherwise. This can be said to represent a “reversal of the burden of proof”, meaning the accused person is in effect denied the presumption of innocence, though the Law Commission has recommended the abolition of this presumption and the government has said it will repeal this law soon.

In the past ten years the government has ratified the OECD’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions, a voluntary framework aimed at reducing corruption in developing countries by encouraging sanctions against bribery in international business transactions carried out by companies based in the Convention member countries, and has strengthened its laws on international corruption with the Anti-Terrorism, Crime and Security Act 2001. Part 12 of the Act, which came into force in 2002 and amended the scope of the UK law as it relates to bribery, gives UK courts jurisdiction over crimes committed abroad by UK nationals and UK companies.

The UK toughened its stance on foreign-based UK corruption again when it ratified the United Nations Convention Against Corruption (UNCAC) in 2006. UK law became fully compliant with the convention when the Criminal Justice (International Co-operation) Act 1990 (Enforcement of Overseas Forfeiture Orders) and the Proceeds of Crime Act 2002 (External Requests and Orders) Order 2005 both came into effect from 2006.

 “The US definition of ‘corruption’ is about bribing a foreign government official. It is not about bribing individuals, third-parties or other companies, all of which are deemed corrupt practices in UK law,” says Jennifer Hammond, director at KPMG Forensic. Furthermore, she points out that the FCPA contains an explicit exception to the bribery prohibition for “facilitating payments” for “routine governmental action”. For example, a person charged with a violation of the FCPA’s anti-bribery provisions may assert as a defence that the payment was lawful under the written laws of the foreign country or that the money was spent as part of demonstrating a product or performing a contractual obligation.

Moreover, under Federal sentencing guidelines, if a company can safely prove that it has a good system of internal control and has in place procedures to detect, report and stamp out corrupt or unethical practices, it may benefit from up to a 90 percent reduction in any fines awarded. This is because the FCPA actually requires companies to devise and maintain an adequate system of internal accounting controls.

As a result, some feel that the threat of prosecution is overstated. Mark Jones, partner in the internal audit practice at accountants RSM Bentley Jennison, says that – in theory – the law should pose no real problems to UK firms because compliance with UK anti-corruption legislation is tougher than with the US act, which only focuses on bribing foreign officials – not other parties. The real difference, he says, is in enforcement and prosecution. “US regulators are more proactive in tackling such abuses and do not shy away from taking companies to task,” he says.

Simon Bevan, head of the fraud services unit at professional services firm BDO Stoy Hayward largely agrees. “It is little wonder that US firms are becoming increasingly willing to point the finger at non-US firms and prompt regulators to investigate the business practices of rivals working in the same sector,” he says.

1: The US Foreign and Corrupt Practices Act (1977)

  • Brought into statute in response to endemic business corruption

  • Enables US authorities to prosecute US and foreign companies for corrupt practices involving public officials abroad

  • Extended in 1988 to apply to “foreign firms and persons who take any act in furtherance of such a corrupt payment while in the US”

The Act says that if there can be shown to be any connection to the corrupt practice and a US employee, a US operation or any part played by anyone within the US itself, then the SEC and the Department of Justice have a case to prosecute.

2: The Council of Europe’s Criminal Law Convention on Europe (1999)
 

  • Obliges signatories to criminalise a wide range of acts of corruption, which it defines as the “requesting, offering, giving or accepting, directly or indirectly” of a bribe

  • A pioneering aspect of the Convention is that it extends criminal responsibility for bribery to the private sector.

3:  OECD’s Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (1999)

  • Countries that have signed the Convention are required to put in place legislation that criminalises the act of bribing a foreign public official.

4: The United Nations Convention against Corruption (2003)

  • Includes measures on prevention, criminalisation, international co-operation, and asset recovery. The treaty entered into force on December 14, 2005. There are currently 140 signatories.

Indian Ocean unity

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What international association brings together 18 countries straddling three continents thousands of miles apart, united solely by their sharing of a common body of water?

That is a quiz question likely to stump the most devoted aficionado of global politics. It’s the Indian Ocean Rim Countries’ Association for Regional Cooperation, blessed with the unwieldy acronym IOR-ARC, perhaps the most extraordinary international grouping you’ve never heard of.

The association manages to unite Australia and Iran, Singapore and India, Madagascar and the United Arab Emirates, and a dozen other states large and small – unlikely partners brought together by the fact that the Indian Ocean washes their shores. I’ve just come back (as India’s new Minister of State for External Affairs) from attending the association’s ministerial meeting in Sana’a, Yemen. Despite being accustomed to my eyes glazing over at the alphabet soup of international organisations I’ve encountered during a three-decade-long United Nations career, I find myself excited by the potential of IOR-ARC.

Regional associations have been created on a variety of premises: geographical, as with the African Union; geopolitical, as with the Organisation of American States; economic and commercial, as with ASEAN or Mercosur; and security-driven, as with NATO. There are multi-continental ones too, like IBSA, which brings together India, Brazil, and South Africa, or the better-known G-8.

Even Goldman Sachs can claim to have invented an inter-governmental body, since the “BRIC” concept coined by that Wall Street firm was recently institutionalised by a meeting of the heads of government of Brazil, Russia, India, and China in Yekaterinburg earlier in the year. But it’s fair to say there’s nothing quite like IOR-ARC in the annals of global diplomacy.

For one thing, there isn’t another ocean on the planet that takes in Asia, Africa, and Oceania (and could embrace Europe, too, since the French department of Reunion, in the Indian Ocean, gives France observer status in IOR-ARC, and the French foreign ministry is considering seeking full membership).

For another, every one of Samuel Huntington’s famously clashing civilisations finds a representative among its members, giving a common roof to the widest possible array of worldviews in their smallest imaginable combination (just 18 countries). When IOR-ARC meets, new windows are opened between countries separated by distance as well as politics.

Malaysians talk with Mauritians, Arabs with Australians, South Africans with Sri Lankans, and Iranians with Indonesians. The Indian Ocean serves as both a sea separating them and a bridge linking them together.
The potential of the organisation is huge. There are opportunities to learn from one another, to share experiences, and to pool resources on such issues as blue-water fishing, maritime transport, and piracy (in the Gulf of Aden and the waters off Somalia, as well as in the straits of Malacca).

But IOR-ARC doesn’t have to confine itself to the water: it’s the countries that are members, not just their coastlines. So everything from the development of tourism in the 18 countries to the transfer of science and technology is on the table. The poorer developing countries have new partners from which to receive educational scholarships for their young and training courses for their government officers. There is already talk of new projects in capacity building, agriculture, and the promotion of cultural cooperation.

This is not to imply that IOR-ARC has yet fulfilled its potential in the decade that it has existed. As often happens with brilliant ideas, the creative spark consumes itself in the act of creation, and IOR-ARC has been treading water, not having done enough to get beyond the declaratory phase that marks most new initiatives. The organisation itself is lean to the point of emaciation, with just a half-dozen staff (including the gardener) in its Mauritius secretariat. The formula of pursuing work in an Academic Group, a Business Forum, and a Working Group on Trade and Investment has not yet brought either focus or drive to the parent body.

But such teething pains are inevitable in any new group, and the seeds of future cooperation have already been sown. Making a success of an association that unites large countries and small ones, island states and continental ones, Islamic republics, monarchies, and liberal democracies, and every race known to mankind, represents both a challenge and an opportunity.

This diversity of interests and capabilities can easily impede substantive cooperation, but it can also make such cooperation far more rewarding. In this diversity, we in India see immense possibilities, and in Sana’a we pledged ourselves to energising and reviving this semi-dormant organisation. The brotherhood of man is a tired cliché, but the neighbourhood of an ocean is a refreshing new idea. The world as a whole stands to benefit if 18 littoral states can find common ground in the churning waters of a mighty ocean.

Shashi Tharoor, Minister of State for External Affairs in the Government of India, is a former Under Secretary General of the UN and an award-winning novelist and commentator

Brazil and BRIC’s financial facet

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Sao Paulo, considered the most vibrating financial cluster in Latin America, has all that mega cities should be about – tantalising gastronomy, year-round business and cultural events, and of course 20 million people. “We have never seen more dynamic times for business” says Alvaro Vidigal, (known as Guti), of Socopa, a Sao Paulo based broker dealer.

As the home to 63 percent of foreign, and 38 percent of Brazilian companies – including 17 of the top 20 banks – Sao Paulo’s destiny seems to reflect Brazil’s own as a key destination for Latin American business. Brazil has been a promising Eldorado for a long time, but recently experienced more interest globally. This has been aided by the establishment of the BRIC ideology.

Since Brazil, Russia, India and China have been lumped together under BRIC many have discussed the convenience and importance of the umbrella term. A great deal of rhetoric, diplomacy and politics set aside, one must look at essential differences and similarities the countries offer each other.

Critically speaking, Russia’s dependence on oil; the rivalry across the Indian Ocean involving India and China, and Russia and China competing in Central Asia there may seem to be a few aggresive aspects. China, as a key importer, doesn’t exactly sit at the same table as Brazil and Russia. Brazil cannot be said to share an eastern cultural background with India or China, nor does the South American nation expect India and China to make a joint-venture proposing a new Doha round.

Nevertheless, BRIC does share a growing self-confidence, an increasing role in world markets, and demand for greater say in global policy-making. On top of recent economic performance, the BRIC countries are also trying to take the lead on post-crisis recovery economics. Brazil’s GDP is growing faster than the Latin American average, and will be back to pre-crisis levels by 2010. As BRIC contributes about 20 percent (15 percent in 2000) of world output, it is easy to identify the importance of the nations to world recovery. Of course, a lot of what happen depends on how the BRIC economy might outgrow rich countries, which depends on decoupling.

Decoupling implies a lack of synchrony between BRIC and rich countries’ economic cycles. This lack of synchrony was placed under the spotlight by the 2008 crash. Many market analysts argue that greater globalisation should bring greater synchrony. Whereas in the first weeks of the crash, many nations experienced dramatic meltdown, which was not felt so much across BRIC, allowing for much faster recovery. Greater synchrony was indeed found among rich countries, but not in comparison to BRIC economy. As unforeseeable economic indicators may be, decoupling is making its mark as a risk diversification factor.

Considering this and BRIC internal diversification, a number of global leaders are taking a closer look at the Brazilian financial industry. And they should.

After years of struggling against inflation and recession, Brazil did its homework in terms of orthodox economics and reliable monetary policy. Years of high inflation rates and – still present though not so outrageous – interest rates forced the Brazilian Central Bank into developing a very efficient, real time, gross settlement system that is now one of the most advanced cash transference and settling systems in the world. Acting as full permission custodian, clearing and settling for foreign investors in Brazil, Socopa can take full advantage of the central bank online system when settling FX or clearing for over 20 broker dealers.

But as foreign investors are most welcome to play in very good conditions in Brazil, including incentivated tax treatment, Brazilians face a much more rigid system if they want to go abroad. “Brazil is more open to foreign investors and financial players than for Brazilian capital going abroad. This is about to change, and a big movement is expected when Brazilian capital searches international markets and products,” continues Vidigal, explaining how Socopa is planning the infrastructure and building partnerships with foreign clearings, banks and brokers in order to organise such flow.Strict leverage and capitalisation rules helped Brazilian banks survive the financial turbulance witnessed in late 2008. Socopa, in business for over 40 years, expects to collect recover well, and has already established itself as ready to perform exceptionally. The last six months has raised expectations, as clients expect more efficient ways to execute, clear and act in prime brokerage. Much tougher competition compared to 2008 fair weather requires sharper service for even more aggressive rates.

Covering 47 percent of South America, 180 million consumers in the internal market Brazil still lacks the sophistication of international standards. Far from ‘toxic’ derivatives or oversecuritisation, Brazil is over-collateralised, but keen to try new products and financing methods.

Local institutions have a long tradition of helping foreign investors. Fully electronic, the BM&F Bovespa has shown an increasing market share of non-residents, side by side with electronic order routing. Most of Socopa’s foreign clients and partners rely on the firm as a traditional, experienced advisor for regulation and market practice understanding. This is necessary as foreign capital markets penetrate the Brazilian economy.

Many predict that huge deep sea oil fields will certainly boost economic growth over the next decade, bringing wealth to different sectors of Brazilian society. Unsurprisingly, financial markets are expected to play a determinant role organising such flow. IPOs, M&A, securitisation, hedging, risk management and debt financing are activities that shall be greatly benefited by international expertise and product diversification.

Brazil dependency being lower than 15 percent of GPD, commodities trading is still bound to encourage futures and derivatives trading. Greater liquidity and efficiency within agriculture will allow foreign companies to help Brazil’s natural role as a supplier of goods worldwide.

BM&F Bovespa has just converted futures floor trading into fully electronic market. This is set to boost the volume of trades, as it did in equities’ trading a few years ago. Even then, few brokers such as Socopa took the lead in investing in speed and reliable trading technology. For most brokers linked to international or major Brazilian banks, electronic trading improved proprietary trading activities. For Socopa, an agency only broker, it suited as a medium to service clients who were used to levels of speed and efficiency not found in Brazil a few years ago. Following Vidigal’s dynamic leadership, Socopa offers a complete solution to access Brazilian markets. Including unmatched execution, custody, prime brokerage, investment and private banking. The company may be the one-stop way to be part of Brazil’s promising, interesting and profitable times ahead.

The author of this article, Thomaz Teixeira, is associated broker at Socopa

For further information tel: +55 11 3299 2039.
email: thomazbt@socopa.com.br.
web: www.socopa.com.br

An attractive offshore alternative

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A key to Chile’s success throughout the economic downturn has been disciplined adherence to its regulatory standards and laws that have successfully promoted economic stability since their establishment over the last few decades. This conservative approach is evident in the organisation of fiscal accounts, the integrity of the central bank, a monetary policy with a flexible exchange rate, and well-regulated markets.

During the commodities boom in the early part of this decade, Minister of Finance Andrés Velasco anticipated the economic downturn and insisted that the surplus of copper revenues be put into savings rather than immediately recycled. This strategy has minimised the effects of the global recession on the Chilean economy, and has not forced the government to spend any money on bank bailouts. During the high grossing copper production years, Chile settled the majority of its foreign debt and has continued to increase exports, turning its balance of payments positive, which in turn made it a net creditor nation. Because of this financial success, Moody’s Investors Service upgraded the country’s debt rating in March 2009.

Having accumulated over $20 billion in copper savings, Chile has designed an economic stimulus plan to promote growth, create jobs, provide tax breaks and incentives for businesses and invest in public-works projects. In relation to the size of its economy, Chile’s stimulus package is one of the largest in the world, equaling 2.8 percent of the GDP compared with two percent in the US.

The nation’s firm commitment to regulation ensures a stable economic environment for foreign investors. Moreover, investors have unfettered access to major world markets due to favourable foreign trade policies instituted in the 1990s and free trade agreements with countries that constitute 90 percent of the world’s GDP.

Chile has implemented sound economic policies and promoted comprehensive investment strategies across multiple industries, significantly reducing risk through sector diversification. Even though copper remains the primary export, Chile has focused on growing a number of industries, including aquaculture, agribusiness and global services. Additionally, Chile, to support long-term, sustainable economic development, has structured related industries into clusters, in order to better integrate the public and private sectors and enhance growth.

Within Latin America
Chile is the sixth largest economy in Latin America in terms of GDP ($169.5bn EIU 2008). With a population of just 16 million people, Chile’s population is 1/10th the size of Brazil and less than half of Argentina. Despite this, it has the largest GDP per capita in Latin America ($14,493, EIU 2008), easily surpassing giants in the region. Chile also boasts the most advanced and well-developed high tech infrastructure and educational institutions in Latin America. Additionally, 50 percent of the population has access to the Internet and cell phone penetration is in excess of 90 percent.

In terms of regional cost of living, the Economist Intelligence Unit’s 2008 Latin America cost of living index ranked Santiago fifth out of fourteen cities in Latin America behind Rio de Janeiro, São Paulo, Bogotá and Mexico City.

Stability
Chile’s economic behaviour has been consistent for the past twenty years; foreign exchange, inflation, tax and growth rates have all, on average, trended favorably. Furthermore, employment and production rates show the country’s advancement.

Foreign exchange rates are highly correlated to the price of copper and have remained steady because of the central bank’s commitment to keeping the exchange rates sound. The bank maintains a conservative monetary policy based on a fixed inflationary goal.

Over the past two decades, the average inflation rate has been 4.5 percent.

Chile has one of the lowest tax burdens in the region, and has special regulations for financial services, which permit foreign companies to use Chile as a hub to access other regional markets, taking advantage of the free trade agreements that the country has with the key players in the financial services industry.

In order to enhance the stability of the economic system the government and regulatory authorities continue to review and strengthen the standards and implement additional regulations to support the development and expansion of the capital markets.

Chile is attracting financial services corporations like Citibank, JP Morgan and Equifax with its highly capable talent pool. Citibank sold its banking operations in Latin America but kept its Chilean IT shared services office because of its notable efficiency. Despite being hard hit by the crisis in the US, JP Morgan increased the size of its Chilean IT shared services division because of its impressive productivity.

Having found that Chile is home to exceptionally talented programmers and engineers, Equifax opened an R&D facility focusing on credit risk analysis development. Every year, Chilean universities graduate more than 17,000 students with business and economics degrees, who are then placed with leading financial services firms.

Foreign investors
One of the biggest differences between Chile and many other Latin American countries is its mature, stable, free-market economy.

Historically, Chile has sought out FDI to supplement its organic economic growth. As a result, Chile understands the benefits of partnerships with foreign investors and strategically pursue opportunities.

In this regard, the Chilean Economic Development Agency (CORFO), through the InvestChile program, has played a critical role in supporting investment essential to the country’s economic growth. Established nine years ago, InvestChile has been instrumental in providing support to companies establishing a variety of KPO, ITO, and BPO centers of excellence in Chile and is fully equipped to introduce foreign investors to the local market, and will assist with any administrative needs, in addition to providing financial assistance through its generous incentive program.
To further encourage FDI, InvestChile developed the National Registry of Individuals with Advanced English Language Skills, which was the first of its kind in the world, and includes over 37,000 English speakers accredited to international standards (TOEIC-Test of English for International Communication).

This registry is available to foreign companies setting up in Chile who wish to hire workers in various fields with a particular level of English. Additionally, a scholarship program has been established to further improve and promote English skills to increase the capabilities of the highly skilled talent pool.

According to IDC, Chile had over $840 million in global services exports in 2008, a number expected to increase to $1 billion by 2010. With tertiary education a national priority, the labor force is highly capable and is prepared to provide world-class support for new foreign investment projects and initiatives.

Companies like Citibank, JP Morgan, Capgemini and Shell have had success in Chile, taking advantage of government support, a stable economy and capabilities that are an integral part of the country’s business framework.

Cost effective
There are a number of reasons that investment in Chile is highly cost effective:

Chile’s economic stability offers predictability and greatly enhances investors potential RoC.

Chile’s low risk, stable economy and transparent business environment mitigates a number of the traditional risk factors and costs, often intangible, inherent to most of Latin American and other countries. As a result, companies and investors benefit from a lower total cost of investment in Chile.

Chile enjoys incredibly low workforce turnover in most sectors and boasts a well-educated and highly skilled talent pool. Due to the strength of Chile’s academic institutions and strong partnerships with the private sector, overall training costs tend to be low and Chilean businesses benefit from the increased operational productivity that accompanies employment continuity.

Chile boasts the most developed and scalable infrastructure in Latin America, with comprehensive fiber optic networks that meet and exceed global standards. As a result, companies can begin operations in significantly less time, with substantially lower costs.

Chile has signed Free Trade Agreements with most of the developed world, allowing for companies to easily export goods and services to all major markets.

Financial incentives
CORFO created the InvestChile program in 2000 to proactively seek out and support foreign direct investment across a number of sectors in Chile through incentives and services, as well as comprehensive information and assistance. InvestChile serves as a liaison between business and government institutions, arranging meetings for service providers and suppliers and connecting investors and key government members. Tax exemptions for services are available throughout the country (if the services are being exported to other markets) while tax exemptions for goods are available in designated free trade zones.

Additionally, InvestChile offers a series of grants to aid foreign investors, ranging from funding project launch assistance to training new employees to supporting the acquisition of equipment, infrastructure and property assets.
Prospective investors who would like to research specific industries and the related business environment in Chile are eligible to apply for a pre-investment grant, which covers up to 50 percent of their research costs (up to $30,000). InvestChile can also facilitate meetings with executives in similar industries and assist in finding optimal locations for specific business operations.

In Chile, foreign and domestic companies have the same rights and are required to follow the same regulations. There are certain rules pertaining to the hiring and firing of an employee, but these rules apply to all companies, regardless of nationality.

In summary, Chile is one of the most developed economies in the region, with a strong commitment to democratic governance, a stable, free market economy and well-developed, high-tech infrastructure and institutions, making it one of the most attractive up-and-coming offshore destinations in the world.

For further information www.investchile.com

Corporates incensed by US clearing plans

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If banks provide the fuel for modern economies, then corporates are its engines. Without them, we would earn and consume nothing, trade would evaporate, savings would be wiped out, banks would fail and tax receipts would plunge.

Care then is needed when drafting rules and protocols to ensure they do not drive corporates off the road. And in these most sensitive times for corporates, particular care should be taken. This makes it all the more surprising that the latest proposals from the US administration – to clear all standardised derivatives – rides roughshod over corporate interests. The corporate sector is rightly incensed.

Nicholas Scarles, chairman of the Investment Property Forum’s Property Derivatives Interest Group, admits there are benefits to be had from forcing most of the large derivatives users to pool their standardised activity on exchanges or within clearing houses, particularly the netting of counterparty risks. However, he warns there are legitimate collateral issues that could hurt a large number of commercial enterprises. An ordinary corporate, for example, will not derive the same benefit as dealers from netting because, typically, they will have only a handful of largely directional trades. And any move towards contract standardisation could be similarly detrimental; the standards might not match the needs of corporates and they would be deprived of devising tailor-made alternatives. Martin O’Donovan, assistant director at the Association of Corporate Treasurers, warns that such a move would carry substantial costs. Many corporates would need committed loan facilities to meet central counterparty margin calls. These are in much shorter supply today and obliging entities to use the few resources they do have in such a way would be far from ideal.

Balancing floats
What of the large derivatives users themselves? With a market cap of €10bn, Veolia Environment has €20bn of outstanding debt and €8bn worth of notional derivatives exposure. The French environmental services company uses vanilla swaps to switch a portion of its fixed-rate exposure to floating; cross-currency swaps to manage its emerging market payables; and index swaps to manage its inflation exposures. All those instruments would probably fall under the “standardised” derivatives rule. Baptiste Janiaud, head of market operations and corporate finance at Veolia, is far from amused by the proposals. Although he concedes there are benefits that accrue from clearing – notably the credit risk reduction and the accounting asymmetries that corporates have to deal with in the difference between fair and market values – he believes these would be outweighed by the disadvantages.

He said it would be very difficult for most corporates to use central clearing on at least three counts. First, because it would be harmful to their banking relationships.

Second, because of the additional funding costs that would arise from the need to post initial and variation margin, the associated forecasting work and the credit lines they would need to put in place. Third, there is administration – corporates such as Veolia do not generally have the administrative infrastructure to support margin movements. In the UK, National Grid has made more than 30 bond issues in the past 18 months. As well as hedging the interest rate risk on issuance, the firm actively manages its rate exposure over the course of a bond transaction and regularly uses the cross-currency swap market to hedge the foreign exchange exposure arising from its borrowing activity. Alison Stevens, senior capital markets manager at National Grid, said that having to meet CCP margin calls would be unwelcome for many of the same reasons that apply to Veolia. If companies such as National Grid were to be prevented from tailoring their transactions, Stevens said it would be problematic from both a risk perspective and an accounting angle. She cannot see any benefits in terms of narrowing the bid-offer spreads – which, she said, are already narrow for interest rate swaps. She worries that if corporates are able to continue as before, but banks are penalised for trading with them bilaterally, the bid-offer spreads for corporates will worsen. In all, she is concerned that any move to greater standardisation of clearing could lead to significant increased costs.

Hedging bets
In Germany, Siemens uses a range of over-the-counter derivatives for hedging purposes. Thanks to the firm’s strong rating and creditworthiness, it can easily enter into OTC contracts today, without having to pledge any collateral. The idea of being forced to use a CCP is therefore bad news for the company. Hans-Peter Rupprecht, head of treasury and investment management and corporate treasurer, said Siemens might at times benefit from the introduction of CCPs in terms of risk management, but insisted such gains would be outweighed by the attendant costs and operational issues.

As a corporation, Siemens has cash rather than securities – and that cash is used to support its ordinary business. To meet CCP margin calls, Siemens would therefore need additional cash or committed credit lines. These would not only come at a cost, but might also raise issues with the pari passu clauses it already has in place with its lenders. Ideally Rupprecht would like to have as much freedom as possible – to clear what he wants and to use whichever instruments best meet his economic needs.

So what should the rulemakers take away from this? If all standardised derivatives have to be cleared, Janiaud said corporates will either hedge less or they will use more non-standardised derivatives – driving business in the opposite direction to that intended. Corporates are not the only entities that would struggle with using CCPs for all their standardised OTC business; rulemakers won’t want to hear this, but there are also any number of instances in which banks, hedge funds, sovereigns, structured product originators and others would legitimately not want to clear even the most standardised of instruments.

Blanket rules simply will not work, even for them. Rupprecht said the proposals would make the position substantially worse for corporates. This, he believes, is surprising on two counts. First because the corporate sector was not responsible for the sub-prime crisis and the current economic malaise. And second, because derivatives are not one of the main problems that need to be fixed. O’Donovan warns that this particular part of the regulatory backlash – if implemented as suggested – addresses markets that are not in need of reform and imposes potentially punitive or restrictive measures on sectors, such as the corporate one, for crimes they have not committed.

© Efinancial News 2009, www.efinancialnews.com

Exceeding expectations

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Islamic banks are one of the few institutions which have been left unscathed by the financial meltdown, Adnan Ahmad Yousif, the chairman of the Jordan Islamic Bank, says. The crisis has pervaded every country and affected almost every industry. Yet, in contrast to the majority of banks around the world which suffered record losses last year, JIB experienced unprecedented growth in 2008.

Other Islamic banks find themselves in a similarly strong position, Yousif says. The reason, he says, is that by basing their businesses on Islamic principles, such banks have been protected from the crisis.

Islamic law, Sharia, dictates that interest not be charged, hence JIB does not deal in any interest-based securities, Yousif says. As a result, the bank has escaped the follow-on problems which are created by a revenue system based on charging interest.

But there is another reason why Islamic finance is defying the downturn, Yousif tells World Finance. Conventional banks in industrialised countries lack trust with their customers, he says. JIB’s strong relationship with its clients is one factor that has helped it weather the economic turmoil. 

Islamic banking has caught the eye of non-religious institutions, Yousif believes. They are intrigued by a system which is free of so many problems which seem to plague traditional banking: a need for liquidity, problems with bad debts, and the inevitability of writing-off part of their assets.
 
Stand-out success
JIB certainly makes an impressive poster-child for the Islamic banking system. If Islamic banking is doing well overall, JIB has a special edge. It stood out among its counterparts to win World Finance’s award for the best Islamic retail bank this year, after it posted record growth in 2008.

That year, JIB’s total profits were up 52 percent on the one previous, reflecting significant increases in its deposits, financing, assets and equity. Overall JIB’s financing activity grew 21 percent, and its ownership equity 20 percent, in the 2008 year.

Musa Shihadeh, the bank’s vice chairman and chief executive, says JIB is very pleased with its impressive achievements, but that its ambitions remain high.  Thanking god for JIB’s successes so far, Shihadeh says the bank will look at new opportunities to continue its stellar growth.

The bank, which offers retail, corporate and commercial banking services to private and public sector clients, has come a long way since its beginnings in 1978. When its first branch opened the following year, it held a modest capital of 2 million Jordanian Dinars. Ever since, it has grown steadily. In 2008, JIB lent for retail customers a total of 262 million Jordanian Dinars ($370 million) to its customers. Now, the bank  has 56 branches and 12 cash offices across Jordan, staffed with more than 1,600 employees. It has a local market share of around 11 percent, and Shihadeh says the bank hopes to increase its current number of 700,000 customer accounts in the future.

The principles for all of JIB’s dealings is Sharia law, and every contract is checked by the bank’s Sharia supervisory board. But it does not restrict its customer base solely to practising Muslims. JIB offers services to any Jordanian who accepts the principles of Islamic banking, regardless of their religion.

JIB sees itself as more than just another bank. JIB states its priorities as to offer not just banking services, but social services – “to serve our community as a whole”, explains Shihadeh. So on top of its traditional banking business, JIB offers Jordanians a number of extra social services, in the hope of assisting the country’s development.

One of the services is an interest-free loan for social purposes. Jordanians who need to borrow money for education, healthcare, or a wedding, for example, can apply for the bank’s Al Qard Al Hassan loan. Another is its joint insurance fund. Through this service, the bank’s clients jointly indemnify part of the damage that may be inflicted on any of them to pay his debt to the bank or part of it in some certain cases.

And then there is JIB’s Craftsmen programme. Through this system, the bank encourages young men and women who want to develop a career as entrepreneurs and a small producer, and supports their projects. The intention is to give something back to Jordanian society, Shihadeh explains. The bank hopes that the programme will help reduce unemployment and combat poverty in the kingdom.

JIB can display such generosity in its social programmes, even during the recession, in part thanks to its record growth during the tough times.

Last year Jordan was affected with world crisis. The international financial crisis has seen oil prices fall and foreign direct investment drop. As a result, there is less influx of money in the country.

But Shihadeh explains that JIB’s Sharia  applications have set it in good stead to weather the economic storm. For a start, the bank has a strong, loyal customer base. Shihadeh puts this down to the bank fostering solid relationships with its clients, based on mutual trust – a crucial element in banking.

Weathering the storm
In turn, the good relations with clients boost the bank’s reputation and generate more customers. Shihadeh says that Jordanians increasingly want to deal with JIB because it provides such a high level of customer satisfaction. It is a win-win situation, he believes.

“Our shareholders, customers, staff are very sincere and faithful to the bank,” Shihadeh explains.

But there are a number of other aspects of Islamic banking which have given JIB an advantage during the downturn.
The bank has high level of concern over liquidity and does not deal in bonds or other interest-based financial papers – two factors which help ensure the bank maintains a stable market position, Shihadeh says. Additionally, JIB has a policy not to open a credit line to customers. In line with Sharia law, instead of loaning cash to a customer, JIB buy a product on behalf of its client, who then repays the bank the full amount, plus an agreed profit margin. 
 
Grand plans
JIB aims to continue being a pioneer in Sharia-based banking services, Shihadeh says. That takes the bank beyond the hard and fast commerce of Western banking – it wants to continue supporting growth in the national economy and development in the community, he says.

JIB’s specific plans for the future are broad-ranging. The bank intends to continue expanding its presence throughout the country, opening more branches and extending its network of ATMs.

Within its branches, JIB wants to remain innovative but to keep steady on a sound ISLAMIC Application. The bank intends to develop and introduce new banking and communication technology for its services, at the same time as it strengthens and develops the bank’s institutional governance principles. JIB is also in the process of implementing Basel II recommendations – a framework of principles intended to bring stability to the international banking system. He says it is committed to continuing to bring its business in line with the requirements, which include stipulations on institutional disclosure and minimum capital holdings.

And it has grand plans for the products it offers. JIB wants to expand its financing programme for craftsmen, amplify its rent-to-own loan programme, and increase the number of muqaradah bonds issued. Muqaradah bonds are Sharia-compliant financial securities, whose holders share the profit or loss of the bonded business. They are the Jordanian equivalent of Sharia-compliant sukuk bonds, which are currently unavailable in the country.

For JIB, banking is more than mere business. It is a way of helping fellow Jordanians. The bank states its main mission is a commitment to consolidating the values of Sharia in all its activities to serve its community as a whole. It aims to lead the way in the Sharia banking world. And to always exceed its customers’ expectations.

A worldwide mission

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Banco Espírito Santo Angola is not only known for its financial performance, but also for its hard work in corporate citizenship. In economic sustainability, BESA was honoured by UNESCO and the International Committee for the Development of Planet Earth for promoting sustainability in Angola. It was crowned ‘BESA, the Bank for the Planet’, which means it will be able to mark a presence at all the International Year of Planet Earth activities. BESA, in this manner, has the chance to express its concern for the promotion of sustainable development.

Since 2007, it has worked with the UN High Commissioner for Refugees in supporting the return and reintegration of Angolan refugees, as well as refugees from other African countries. Over several years, it has sponsored the implementation of a Portuguese Language Teaching Programme for thousands of people, both adults and children.

Established projects
BESA and the Banco Espírito Santo group will be present at the Planet Earth summit taking place in Lisbon in November 2009, which will be attended by heads of state, the UN Secretary General and King Gustav of Sweden among others, as well as various entities promoting sustainable development.

In partnership with the Angolan Government, BESA is also playing a part in organising the African Forum for Sustainable Development, to take place in Luanda, Angola, in 2010. This event supported by the United Nations, which will be held every two years, aims to discuss the best solutions for Africa’s environmental problems.

The various research studies published each year in Angola and others by prestigious institutions from all over the globe attest to Banco Espírito Santo Angola’s prestige and financial soundness. Aside from its banking sector performance, BESA is notable for its activity in social responsibility.

The BESAcultura project is unique in its dedication to holding initiatives which valorise Angolan cultural roots, expressed through contemporary art.

In 2009, BESA will hold the photography competition for the second time, this being an eagerly awaited initiative. BESA foto2009 will be organised in partnership with World Press Photo (WPP), the prestigious and world famous organisation. Alongside the competition, a travelling exhibition of the best entries will be organised, which will stop at various cities in Angola. The aim is to promote rising new artists and to take Angolan photographs and culture beyond Angola’s borders.

In 2009, BESA and WPP are promoting a project linked to UNESCO’s Year of Planet Earth, selecting 5 photographers from Angola, Tanzania, Namibia, Nigeria and Zimbabwe to produce different works on the subject of Planet Earth, resulting in a travelling exhibition which will be present at the World Planet Earth Summit in Lisbon and will circulate through all Angola’s provinces.

“A worldwide mission” is the tagline for BESA’s new campaign, which reinforces its leadership position in the Angolan financial market while at the same time staking its claim as a frontrunner in offering the market high quality products and services and as an entity fostering and disseminating Angolan culture and, above all, sustainable development.

For further information: tel +244 222 693 600;
www.besa.ao

Solving the gas crisis

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Gas companies across Eastern Europe have had a tough time of late. A long-running dispute over supply and pricing came to a head in January, with Russia turning off the tap on its gas supply to the Ukraine. The Ukraine claimed Russia was using a sharp price-hike as punishment for its government’s West-looking stance; Russia maintained it just wanted a fair market price for its gas. Regardless of the politics behind the dispute, when the Ukraine refused to settle its bill, Russia cut supplies.

It was not just the Ukraine that suffered the consequences. Other countries which were not involved in the dispute but downstream in the gas delivery chain – receiving their gas supplies from Russia via a pipeline through the Ukraine – also saw their supplies dry up.

Serbia was one of the worst-affected countries. It relies on Russia for 92 percent of its natural gas. When the gas supply ran out in January as a result of Russia’s dispute with the Ukraine, outdoor temperatures were reaching lows of around -15° Celsius. The lucky few with electric heaters in their homes were warned by the electricity suppliers to minimise their use, lest the entire power grid be overwhelmed by an extreme spike in demand. The whole debacle meant that many Serbians spent their Christmas to January 7 shivering under blankets in the bitter cold.

Neighbouring countries with more secure supplies chipped in – Austria, Hungary and Germany all offered to help Serbia see out the crisis. And eventually, the Ukraine and Russia sorted out their differences, the gas supply resumed, and Serbians could again heat their homes.

But for the company responsible for supplying gas to the country, the headache has lasted much longer. Maintaining continuous gas supplies is a big undertaking. Infrastructure for storing and distributing natural gas involves hefty amounts of long-term planning and substantial financial investment. Srbijagas, the state-owned company that distributes and sells natural gas to Serbians, is tasked with organising it all.

As a result of the increasing importance of ensuring an uninterrupted gas supply, and the requirements of conforming to international agreements, Srbijagas finds itself on the precipice of a series of developments which are unprecedented in its 40-year history. Currently, it has two enormous infrastructure projects in the works, while it simultaneously amplifies its domestic operations and adapts to a new regulatory framework.

The state-owned enterprise has expanded its domestic interests over the past months by taking a stake in industrial manufacturers in Serbia which had been badly knocked by the recession. And as the country pursues candidacy for the EU, Srbijagas has an important role to play in making sure the energy industry makes the grade.

But the biggest developments ahead for Srbijagas are its infrastructure projects: a gas pipeline and a storage facility. Strategically located between Western Europe and the natural gas-rich Caucasus, Serbia is in a prime location to transport gas between the two regions. An ambitious gas pipeline, currently at the planning stages, will allow Serbia to capitalise on its location in a new route between Russia and Western Europe. Coupled with a large underground gas storage facility due to open soon, the new infrastructure will elevate Srbijagas’ standing in the region, its director says.

More practically, the pipeline and underground gas store will help secure gas supply for a country that relies on imports from Russia via the Ukraine for most of its supply. The gas crisis in January made the importance of finding alternative supply methods very clear. The prospect of the stand-off between Russia and the Ukraine being repeated is a ‘major problem for the provision of a safe supply market in Serbia,’ Dusan Bajatovic, the general director of Srbijagas, says.

Maintaining stocks
One solution to limit such catastrophes in the future is for Serbia to hold its own gas reserves.

Currently being constructed is an underground natural gas storage facility at Banatski Dvor in the north of the country close to the Romanian border. A joint project between Srbijagas and its Russian counterpart Gazprom, the storage site will be the first of its kind in Serbia.

The facility is badly needed to reduce the country’s dependency on an uninterrupted supply. By holding its own natural gas reserves, Serbia will have a buffer if Russia cuts supply to the Ukraine in the future. While construction began on Banatski Dvor in 2005, the gas crisis earlier this year demonstrated just how vital the facility is.

Bajatovic describes the €100 million project as one of the company’s “greatest challenges”.

“For the Republic of Serbia, this is a strategic project that will provide security in case of repetition of the crisis in the month of January this year,” Bajatovic told World Finance.

The Banatski Dvor site is a work in progress. When it first opens, it will have the capacity to store 450 million cubic metres of natural gas. That could be enough to keep Serbia supplied for almost two months. Yet, it is set to get even bigger. In July, Gazprom and Srbijagas signed an agreement for a second phase of construction at the site, which will more than double its capacity to 800 million cubic metres. The project is a huge infrastructural effort: on the side a new pipeline connected to the Banatski Dvor site is under construction, which Srbijagas expects to be completed in the coming months.

Banatski Dvor may just be the beginning when it comes to Serbia’s natural gas storage potential, Bajatovic says. He cites estimates which suggest Serbia potentially has the space to construct storage for up to seven billion cubic metres of gas – enough to maintain stability of gas supplies in Serbia but it will also promote Srbijagas as the leader of storage and trading of gas in the region. In the future, the company would like to build several more storage facilities, Bajatovic says.

New supply routes
Maintaining domestic gas reserves is one way of mitigating the possible effects of future disruption to supply from Russia via the Ukraine, but the Serbian gas distributor is looking at all its options. Another way of securing supplies is to open alternative delivery routes, a strategy Srbijagas is investigating.

The most ambitious new delivery route is ‘South Stream’, a project initiated by Gazprom. This would see Russian gas piped directly across the Black Sea to Bulgaria, into Serbia, and from there onto other European countries.

The whole pipeline is an impressive proposal. It would involve laying 900km of pipeline across the Black Sea, up to two kilometres underwater at some points. When finished, it will be able to carry up to 63 billion cubic metres of gas each year – a large capacity which Gazprom hopes will future-proof the pipeline, amid predictions that Europe’s gas demand will increase significantly over the coming decades. Building the Serbian section alone will be a major operation – it is estimated that the pipeline’s construction could see up to €2bn of direct foreign investment go to Serbia. Srbijagas’ proud new storage facility at Banatski Dvor is on the South Stream route and will be connected to the new network.

Srbijagas signed up as junior partner to Gazprom in May for a joint venture to carry out a feasibility study on South Stream in Serbia. The study, which is due by the end of the year, will look at technical, legal and environmental aspects of constructing the pipeline across the length of the country. It is hoped that construction will start next year, with the pipeline being ready for use by the end of 2015.

There is another significant gas pipeline to Europe in the planning stages.

A competitor or a complement to South Stream – depending on one’s perspective – Nabucco will carry gas from the Middle East and Caspian regions to Western Europe. At 31 billion cubic metres a year, Nabucco’s planned capacity is much smaller than that of South Stream, but it is still a major international project. Current plans have it crossing through Turkey, Bulgaria, Romania and Hungary to reach an Austrian distribution hub. Serbia is not on the map at present, but Bajatovic has told national media that Srbijagas would be open to the possibility of joining the network, if it were invited.

“It would not be bad to link up with the Nabucco pipeline as well, even if it isn’t passing through Serbia’s territory, since gas would be arriving from the Caspian Sea and Central Asia via this pipeline,” Bajatovic was quoted as saying on the Serbian news website b92.

“If there is a possibility of receiving gas from different sources, and Serbia and the rest of Europe are in a situation where they can buy at competitive market prices, this is just one more reason to seriously think about these projects.”

However, Bajatovic said South Stream was the main priority for Serbia at the moment, noting that the gas supply for the Nabucco pipeline remained uncertain.

As well as safeguarding supply against further squabbles between the Ukraine and Russia, the Banatski Dvor storage project and the South Stream pipeline plan will elevate Srbijagas’ international standing, Bajatovic says. The company aims to lead the region in gas storage and distribution.

“That means the market competitiveness and efficiency in all activities of the company, a high quality, stable market supply… and [for natural gas to be] a priority fuel in relation to other conventional fuels,” Bajatovic says.

With these two big projects in the works, he is “convinced” Srbijagas’ goal is realistic, he says.

Currently, the company has subsidiaries in neighbouring countries, and if South Stream goes ahead, it would be on the gas supply route for Austria, Hungary and Slovenia. Srbijagas has plans to extend its distribution networks across major Serbian cities and build more gas storage facilities around the country.

The gas supplier is also expanding its influence across other industries in Serbia. On August 1, it took an 81 percent stake in Serbian fertiliser manufacturer Azotara. The new subsidiary had been heavily indebted when Srbijagas stepped in with the Serbian government to hold it back from bankruptcy. Accountable for around 10 percent of Serbia’s entire gas consumption, it made strategic sense for Srbijagas to keep Azotara afloat.

In July, Srbijagas carried out a similar operation with the Serbian Glass Factory, buying a majority stake from the factory’s Bulgarian owners and also company MSK the town of Kikinda.

As well as diversifying Srbijagas’ operations, the rescues boosted the company’s efforts to be socially responsible, Bajatovic says: “We believe that today it is especially important to save every job.” It is estimated 1,700 jobs were retained as a result of the glass factory deal.

As for other similar ventures, Bajatovic takes a pragmatic approach. Such initiatives would bring benefits, but would also require a lot of work and sound management, he says. Every acquisition will be a story of its own, and in every acquisition Srbijagas will search for different strategic partners who will truelly increase capital.

Srbijagas is a paradox: it is a young company with a long history. The state-owned enterprise was formally established in 2005 when the Serbian government restructured the national energy company, separating the petroleum and gas businesses. Its predecessor had been around for decades. Hence, Srbijagas’ history stretches back to the 1960s, even if the company in its present incarnation did not come about until four years ago.

For most of its history, the Serbian national gas operator has worked closely with Russian and Hungarian gas suppliers. Srbijagas’ ‘most significant’ partnership is with Gazprom, a company with which it shares ‘extremely high quality’ business relations, Bajatovic says. Serbia first imported natural gas from the Russian gas giant in 1979, and the relationship has continued up to the present day, with Gazprom lending a hand to the country’s gas projects.

Srbijagas works with Gazprom on a number of initiatives. One of their most significant joint ventures is Yugorosgaz, a company which develops pipelines and other gas infrastructure in Serbia. The firm was established in 1996 by Gazprom and the Serbian national gas administrator, and today Srbijagas is looking to expand its share of the company from 25 percent to 49 percent.

Serbia’s other long-standing partner is Hungary, another transit country for Russian gas. The neighbour is more than just one more country on the distribution route, though. It came to Serbia’s aid in the January gas crisis. Bajatovic speaks highly of Hungary’s assistance when Serbian supplies were cut. The neighbouring country exhibited solidarity and “great help” in trying to maintain gas supplies to Serbia, Bajatovic says.

Over the course of its history to date, Srbijagas has grown and developed in line with Serbian gas demand, expanding the country’s natural gas infrastructure and negotiating supply contracts. Milestones listed by Bajatovic include opening the pipeline to Hungary, and establishing a network to distribute gas around the country from Serbia’s own Vojvodina gas fields.

But there is virtually no industry which has not been affected over the past year, in some way or another, by the economic downturn. The gas market is no exception. As a supplier, Srbijagas has found itself at the mercy of recessionary markets, squeezed between rising wholesale prices and shrinking consumer budgets.

Until the first quarter of this year, wholesale gas prices rose continually, Bajatovic says. At the same time, some of Serbia’s biggest gas users, such as industrial manufacturers, either slashed their expense budgets to a minimum or “completely stopped spending”, he explains.

The situation was exacerbated by the Serbian government’s actions, which tried to shield citizens from jumps in the gas price. The government decided not to raise consumer gas prices in accordance with the international market value at the end of 2008 and beginning of 2009, says Bajatovic, “in order to decrease pressure on the household budget of our citizens”.

As if that were not enough, Srbijagas predicts that Serbian gas consumption in 2009 could drop by more than 20 percent on last year. The company has ordered up to 2.4 billion cubic metres of gas from Gazprom for 2009 – although now it estimates demand may only reach 1.8 billion.

But there is a light at the end of the otherwise dim recessionary tunnel. Globally, natural gas prices are falling, which should take some pressure off Srbijagas’ margins, Bajatovic predicts. And in Serbia, consumer spending is beginning to pick up, he says. As soon as the third quarter of 2009, Srbijagas expects overall business performance will begin to improve, Bajatovic says.

Bright prospects
While the current economy is hurting almost everyone, in the long term the outlook for the natural gas industry is very good. As the world continues to grow increasingly cautious about high levels of carbon dioxide emissions, natural gas is seen by many as a sure step in the right direction. It is the cleanest of the fossil fuels. When burnt, it produces around half the carbon dioxide that coal does. That makes it a favourite for industries that envisage being pinched increasingly by emissions restrictions and charges under the Kyoto Protocol.

Serbia is classified as a developing country under the Kyoto Protocol, meaning it faces less pressure to reduce greenhouse gas emissions than developed countries. However, it is still obliged to work towards restricting emissions. So natural gas is getting a solid push from within Serbia.

Under its energy development strategy, the Serbian government is promoting the expansion of the domestic gas supply network to encourage a transition to cleaner fuel. As more people have access to natural gas across Serbia, the more the country’s energy sector will become environmentally friendly and sustainable, Bajatovic says.

Increasing the use of natural gas across the country will also help Serbia’s bid for EU membership. Before it could join, Serbia has been told it needs to step up environmental monitoring of energy plants and to implement a long-term, environmentally sustainable energy policy. Srbijagas’ efforts to increase the stability of natural gas supply contribute to the country’s membership requirements.

In a separate EU initiative, Serbia is working toward further regional targets as a member of the Energy Community of South East Europe. An alliance of Albania and the states of former Yugoslavia, the Energy Community was established in partnership with the EU. Its purpose is to build a competitive and stable regional energy market. Many of the regulations in the founding treaty refer to EU directives, in an attempt to streamline standards in the greater Europe region.

When the treaty was first signed, Serbia restructured its natural gas markets and rewrote its energy law to conform, Bajatovic says. Now, as Srbijagas develops its projects and business ventures, it must make sure they fall in line with the Energy Community’s stipulations.

Still on the company’s ‘to do’ list are measures to open the gas market to greater competition, as required by the Energy Community through its links to the European Union. In particular, Srbijagas has been asked to develop a sustainable tariff system and to unbundle distribution and supply operations.

Times of change
As Srbijagas develops and progresses in line with the evolving natural gas industry, it moves closer to its goal of becoming a regional leader in storage, transport and distribution of the product. With the new storage site at Banatski Dvor, Srbijagas will be less vulnerable to disruptions in international gas supply in the future. The South Stream pipeline project will put Serbia on the international gas transit map, and see Srbijagas strengthen its relationship with counterparts in neighbouring countries.

The two infrastructure projects will elevate the company’s standing within Serbia, as the country benefits from a more reliable, uninterrupted gas supply. In turn, more reliance on natural gas over other, less clean fossil fuels will help Serbia meet the environmental criteria necessary to become a member of the European Union.

Srbijagas’ developments will, Bajatovic says, help shore-up the company’s position as a “modern, organised, profitable and long-term successful company with leading position in the domestic market and the market in the region.”

For further information www.srbijagas.com

Jacques lowers an iron curtain

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With the backing of 82 year-old Paul Volcker at Obama’s side and a like-minded Mervyn King (a mere 61), he’s reshaping the operating conditions of the western world’s financial sector. The last time anything on this scale happened was 75 years ago, and then only in the US.

Far from taking his time, as might befit a man nearly 15 years past official retirement, de Larosiere has moved so fast he’s caught the financial sector napping. Before they knew it, they’ve been encircled in exactly the web that Sarkozy, a confidant of de Larosiere, has wanted ever since the meltdown. Soon the banks will be under the relentless scrutiny of a council of systemic surveillance sitting on top of three other organisations responsible for banking, insurance and markets. All these bodies will have the power to overrule national regulators. Done and dusted.

Some financial sector bodies are complaining – notably the insurance sector which, after all, had nothing to do with the meltdown. Their argument is that de Larosiere’s group didn’t listen, has acted too soon and many innocent banks are being punished. Some of this is transparently true, but all complaints will prove futile. The oldies think they know better and the kids have been grounded.

In this fait accompli, France’s pre-eminent central banker has acted true to form. Here’s the consummate performer behind closed doors. It was de Larosiere who, as MD of the IMF sorted out the Latin American crisis in 1982 by summoning the creditor nations to New York and putting a gun to their heads. They either found $6.5bn to bail out Mexico and Argentina or they could forget about any IMF loans in the future. They found it.

After a further five years at Banque de France, he was parachuted into another crisis at the European Bank for Reconstruction and Development. Acting like a company doctor, he scrapped the executive dining room, cancelled business-class travel throughout Europe and quadrupled the loan book. In other words he turned it back into a bank for reconstruction and development.

For this latest job, Sarkozy wanted a trouble-shooting banker and so did the Americans who know and like de Larosiere as a member of the Washington-based group Thirty, the high-level think tank on economic and monetary affairs. Certainly nobody wanted a slow-moving Bank for International Settlements kind of guy.

From his extra-curricular interests, you might take de Larosiere for a lofty intellectual rather than a central banker in a hard hat. His private passions are classical music, 18th century French history and 19th century French literature. But he’s also a student of the robust theology of the late Henri-Marie Cardinal de Lubac, the Jesuit priest who refused to toe the Vatican line and was not afraid to say so. 

Like the cardinal, France’s top central banker has thought his way through to his present hard-line position on regulation, greatly influencing the rest of the club. Lately, the mood among regulators has changed right across the regulatory spectrum. As Alexander Justham, director of the markets division of the FSA, observed recently, a society bleeding savings, investments and trust now wants and expects their banks to serve them, not crucify them: “[Bankers] should do the right thing and if you don’t you run the risk of having your head put on a spike.”

That’s the sort of thing Jacques de Larosiere has been saying for some time. He believes the days of self-regulation are dead and buried for ever.

Global round-up

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Caribbean
As many attack so-called “tax havens”, Natalie Shaw speaks to Shawna Lake, whose firm SKIPA promote development in St Kitts & Nevis

France
Companies have been going wrong and being bailed out globally. Liam Vaughan suggests that France is offering less protection for creditors than, say, the UK or the US. Vaughan goes on to say that investors in ailing corporations have taken substantial write-downs in the restructuring process.

Chile
There are not many success stories to come out of the global financial crisis but Chile can feasibly hold its head high as being the only investment-grade country to be upgraded by Moody’s in recent times. The country’s success is through a selection of rigorous laws and disciplines to ensure financial stability.

Brazil
As with Chile, Brazil has been recognised as one of the few countries who have come out of the financial crisis relatively well. BRIC has been benefitting from the positive performance of the country and the outstanding perception of the financial facet that is Sao Paolo.

Bahrain
It has long been assumed that Dubai is the precious stone in the crown of the Middle East, but Bahrain has been quietly sparkling with its strong financial regulations, economic and political stability, strategic location and strong legal framework for a while. These days, the country is gaining more recognition as investors flock to it and reap the benefits.

India
Raian Karanjawala started his own law firm, Karanjawala and Co in 1983 and has been gaining recognition ever since. These days he represents some of the most prestigious clients in some of India’s top cases. Karanjawala argues that his in-depth knowledge of the Indian law system has helped his company gain the praise they deserve.

Greece
KLC Law Firm speak about collective dismissal and employee benefits in Greece. The law firm tells World Finance of the protection Greece offers its workers in the case of dismissal. Employees are guarded from ‘opportunistic’ dismissals but, as KLC say, even fair dismissals have become a costly factor to employers.

All roads lead to a universal currency

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China is worried about the long-term decline of the dollar, mainly because it holds somewhere north of $1,000bn in US government debt. As a Chinese economist notes in a masterly piece of understatement, “a trillion (in greenbacks) is a hot potato.” Several other Asian countries holding vast dollar amounts are worried for the very same reason, and are starting to shift in their seats.

Then there’s Russia, which wants oil and other commodities quoted in another currency, if only because the rouble is in a hole. Finally, many commentators are beginning to think that this might be the right time to tame the forex jungle once and for all. If anything, it may hold in place the possibility of political appeasement.
As Financial Times columnist Martin Wolf suggests, perhaps it might be worth research, or indeed to “have a stab at a world currency.” History tells us this just might be possible. The great gold coins of yesteryear, especially Roman-minted ones, served as international currencies across much of the known world at the time.
 
They also had tremendous staying power – some of the coins were bona fide tender for centuries. For over 600 years, it was possible for a traveller to journey across vast swathes of Eastern Europe and well into Araby, paying his way with the denarius. And as gold historian Jill Leyland points out, as little as five coins were able to “span two millennia from the first century BC to almost the present day”.

A little over 2,200 years ago, the known world got its first international currency in the form of the Roman denarius. A handsome silver coin, it provided “the financial backbone for Rome’s climb to power,” says authority Richard G. Doty.

About 100 years later, in the 1st century BC, Rome issued the gold aureus, mainly for paying taxes. Worth 25 denarii at first, the coin had such enduring commercial integrity – it was 99 percent pure gold – that it was valued at 4,350 denarii by the fourth century AD. Between them, the aureus and denarius bought goods and services across the entire Roman empire for nearly 600 years.

Around 300AD the bigger solidus – or nomisma in the Greek-speaking world where it was also legal tender – replaced the aureus as Rome’s premier gold coin. Strictly speaking, the solidus wasn’t supposed to circulate outside the Byzantine empire but its reputation was so, well, solid that it jumped imperial boundaries and became the money of choice in bazaars and markets even in Arabic countries.

From the seventh century, Arab kingdoms copied the solidus, simply changing its name to the dinar (or bezant). Well into the tenth century, deals were still being done in the dinar.

After a period of wilderness for international currencies, the next cross-border coin was the Venetian ducat. First introduced in quantity in 1284, it gradually became standard currency throughout Europe, especially from the 16th century. Indeed it was still possible to buy and sell with ducats right up to the first world war.

The last great international coin, the sovereign first saw the light of day in 1489 and British governments were still using them in the 1950s in foreign climes, notably the Middle East where it was much-prized. Next? It could be today’s equivalent of economist John Maynard Keynes’ Unitas, the name he suggested in the thirties for a neutral international currency.

Debtholders make tracks for a fairer deal

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Restructuring struggling businesses in France has been slower, less efficient and less creditor-friendly than restructuring businesses in the UK. Banks and funds that hold debt in French companies are subject to less protection when those companies go wrong than lenders to UK companies but, as the number of restructurings shoots up during the downturn, disgruntled debtholders are fighting back.

Thomas Gaucher, director in the European restructuring and debt advisory group at Close Brothers based in Paris, said: “The business of restructuring is newer in France and there are fundamental differences in culture and legislation. Here, the company and its employees – rather than the creditors – are most important, which is very different from the UK model. It has traditionally been less favourable for banks than in other jurisdictions, although things are starting to change.”

In some cases, creditors have been forced to take substantial writedowns on their debt to ensure the survival of the company. Hit by the slump in sales in the global car industry, private equity-owned Autodistribution was struggling to service its €600 million debt pile.

The outcome of a long restructuring battle was that lenders, led by Citigroup, took a big writedown on their debt and ended up with just 21.5 percent of the equity in the surviving business. Private equity firm TowerBrook, after agreeing to invest €88 million in the company as a going concern, ended up with 62.5 percent. The backers of Eurotunnel, the Channel Tunnel operator, also lost billions when a 2007 restructuring resulted in the beleaguered company’s debt being reduced from £6.2 billion to £2.8 billion. One problem for lenders lies in the procédure de sauvegarde pre-insolvency process introduced in 2006 and touted as an equivalent to Chapter 11 in the US.

Under sauvegarde, a company facing impending financial difficulties can apply to the French courts for protection, effectively freezing the right of creditors to enforce the terms of loans that could, in the UK for example, force a liquidation of the company or lead to the creditors taking ownership.

Rod Cork, a restructuring partner at law firm Allen & Overy in Paris, said: “The courts in France will do everything they can to protect debtor companies and their shareholders, but much less to protect the rights of the creditors. The introduction of sauvegarde has exacerbated the difficulties faced by banks and funds which are lenders to companies involved in a restructuring process. It is a very difficult environment for banks and, as the number of leveraged buyout companies facing difficulties increases, that will get worse.”

Another high-profile case, that of building materials group Monier, gives some cause for optimism to lenders. Following a battle between private equity owner PAI and a group of lenders led by Apollo Management, TowerBrook and York Capital, it was the lenders that eventually won control of the business after securing agreement for a substantial debt-for-equity swap. Banks will hope the Monier case represents a precedent and that the balance of power is starting to shift away from equity holders in favour of lenders.

Commission-sharing provides halfway house

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While the UK’s FSA’s rules on unbundling may not have radically reformed the trading landscape, they have subtly altered the terrain. Commission-sharing agreements have become the status quo and the remaining bulge-bracket sellside firms continue to capture the lion’s share of both execution and research business.
A split between the two activities as envisioned in the original Myners report is unlikely to happen in the current environment as fund managers do not want to dig any deeper into their own pockets. Reinder van Dijk, managing consultant at Oxera, which was commissioned by the FSA to compile a progress report on unbundling, said: “Progress has been made but it definitely has not resulted in the second big bang which many people thought would be the case when the FSA first introduced unbundling.

The use of commission-sharing agreements has risen and there is clearly a greater separation between the purchase of trade execution services and research.

“On the other hand, one interesting statistic we found in our study was that the bigger brokers are still the main providers of both research and execution. Investment managers were asked what proportion of their 10 largest research providers were also their top 10 executing brokers. The mean proportion between the two was 75 percent.”

Oxera canvassed 21 large investment managers, 11 brokers, eight retail fund providers and six pension fund trustees last August and September. Published in April, the study showed that the amount investment managers spent on bundled equity research and trading commission packages had fallen to 36 percent at the end of 2007 from 48 percent in 2006. At the same time, there was a jump in the number of commission-sharing agreements, which are designed to allow firms to choose a broker for execution and direct the research portion of the commission to another broker or independent research provider. In terms of the split between the two, commissions had remained relatively stable since unbundling: 45 percent for execution and 55 percent for research.

The popularity of commission-sharing agreements in the UK reflects the global trend, although the country has the highest penetration of such arrangements in Europe, with around 64 percent of firms using them, according to a Tabb Group report published last year. Regulators put unbundling firmly on the map in the wake of the dotcom crash amid anger over biased research that led to overinflated technology shares.

In the UK, this led to a report by Paul Myners in 2001. Five years later, the FSA launched rules on the use of dealing commissions. The aims included increasing transparency and breaking down costs to the end users as well as encouraging the use of payment mechanisms to enable services from brokers to be purchased separately.

While the industry has applauded the FSA’s efforts and the progress being made on unbundling, views are mixed as to whether commission-sharing agreements – the industry’s response – are the best solution.
One main concern is counterparty risk, especially after the demise of Lehman Brothers and Bear Stearns. There is also apprehension about leaving large CSA balances at investment banks, as there is a perception that some can drag their feet when making payments to research providers. For example, banks that remit payments only a few times a year may be carrying sizeable CSA balances that are neither segregated nor insured.

The Lehman collapse revealed that the fate of these assets is uncertain in the case of a bankruptcy. Some fund management groups, such as Scottish Widows Investment Partnership, are happy with the current state of affairs. Tony Whalley, investment director at Swip, said: “We were one of the first institutions to draw up commission-sharing agreements and it has enabled us to fully unbundle.

“We receive research from the firms we want to and not what our counterparties think we should receive. Before we unbundled, about 70 percent of our research commissions went to the large brokers and that number is now more like 60 percent, with the remainder used to pay for more niche operators who often do not offer the execution capabilities that we require.

“One of the most important points about using commission-sharing agreements is to make sure you are continually monitoring the situation to ensure that commissions and payments are broadly in line.”

Many on the sellside note that commission-sharing agreements have forced them to take a harder look at their product offering. Chris Newson, who has sat on both sides of the fence having worked at Fidelity and now as director of global commission management at Bank of America Merrill Lynch, said: “The bulge brackets have concentrated on providing an integrated service and it is not a surprise that there is a reasonable degree of correlation between those firms providing both high-quality research and execution.

The cost of boldly going…
“The benefit of commission-sharing agreements, together with broker voting, is that they make the process more transparent. They enable the buyside to compare and contrast the research providers and brokers, while allowing the brokers to address client coverage requirements and improve their services to better meet their clients’ needs.”

Steve Kelly, global head of Thomson Reuters Extel Surveys, also believes that “commission-sharing agreements have played a role in the growth of boutiques and independent houses. They have made it much more straightforward for the buyside to take research from these firms. Our studies have shown that not only is there a marked increase in the number of these firms but also they are scoring higher on fund managers’ rankings”.

However, some market participants see commission-sharing agreements as a halfway house and would instead prefer adherence to Myners’ original recommendations that stated “clients’ interests would be better served if fund managers were required to absorb the cost of commissions paid, as this would provide appropriate incentives for fund managers to manage these costs”.

Richard Balarkas, chief executive and president, Instinet Europe, said: “Commission-sharing agreements are not a satisfactory answer. I would argue that while they can facilitate the separation of a bundled commission into two separate payments – one for execution and one for research – they are insufficient to ensure true unbundling.

“What needs to happen is for the trading desk to have complete control of the broker list for execution and choice of broker for each trade. At the moment, this is not the case and the power base in many fund management groups is still the portfolio manager. They are using trading commissions to pay for non-execution services such as research, company access and initial public offerings.”

Chris Angel, a principal at Mercer Sentinel, said: “According to the Oxera report, commission-sharing agreements have achieved the transparency and separation that the FSA requires but they fall short of total unbundling. Pension funds may have a better idea of where the money is going but they now have no control.
“Also, while commission rates have fallen, it has not been that much, with the average bundled commissions still costing around 12 to 18 basis points. This suggests fund managers are still paying too much for research at the investors’ expense.”

Putting a value on research, though, has been an age-old problem for fund managers. Very often, a 30-second call from an analyst may be most valuable, while the stacks of reports that clog the inbox are worthless.
Jim Connor, director of European investment management services at Navigant Consulting, said: “It is not simple and there is no perfect model. You cannot underestimate the price that a fund manager will pay for being first in the queue for a call or to receive good quality investment ideas.

“The other factor is the increase of dark pools and where they fit in a commission-sharing agreement. I think this will eventually lead to managers re-evaluating their strategies and this could facilitate further unbundling.”
What is unlikely to happen though is that fund managers will pay for the research from their profit and loss account. Tim Tanner, equity business manager at Aviva Investors, said: “Commission-sharing agreements are just a step in the evolution of unbundling, but they are not a complete solution. The question of whether fund managers should pay from their P&L has been on the agenda for a long time and there have been several conferences on the subject. I do not see it happening in the near to medium term as it would have significant implications for a fund management company’s profitability.”

Richard Phillipson, a principal at Investit, said: “I do not see the model changing as asset owners have not applied the pressure while asset managers have so many other things to think about in this environment.
“However, I think if fund managers were paying out of their own pocket they would try to be more careful about what they spent.”

© Efinancial News 2009, www.efinancialnews.com