Year: 2011

Muthanna Investment: The challenges of GCC banking

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The GCC banking sector has emerged as a more positive sector, despite its ties to the real estate and investment sectors across the GCC. With the exception of Oman, the banking industry recovered from its two-year losing streak, aided by governments’ full support and a proper liquidity infusion to various financial entities.

In 2010, banking stocks continued to announce healthy quarter-by-quarter earnings; but the boom in earnings was mainly a result of lower provisions, rather than any healthy growth in top-line areas, as the sector saw weak banking business aspects. Loan books were almost stagnant, while customer deposits and cash in hands surged together, mainly on the back of weak credit growth.

Total GCC banking profit jumped up by 13.8 percent to reach $16.85bn, from $14.80bn a year ago. Key performance parameters like RoE and RoA have also been strong: average return on equity stood at 11.74 percent, compared to 11.31 percent in 2009, and return on assets stood at 1.62 percent, against 1.52 percent in 2009.

Inflating profit pushed up total shareholders’ equity by 9.7 percent, to reach $143.58bn by 2010. Total assets grew by around seven percent ($66.28bn): Qatar’s banking sector emerged as the leader, reporting a surge of 20 percent ($21.60bn), whereas Dubai reported a mere two percent growth ($2.95bn). Among several other weak factors in Dubai, loans and advances reported a drop of 1.1 percent (down by $6.57bn). Total GCC cash and equivalents soared by 14.7 percent ($14bn), thus cementing a slowdown in lending.

Superior to market indices
Of the seven regional markets, five banking indices ended the year on the green turf, while Oman and Dubai declined by 11.25 percent and 3.06 percent respectively during the year. Stable lending rates, a curb on poor assets, specific attention towards quality of new credits and declining provisions, along with proper debt restructuring procedure for banks in the troublesome investments and real estate sector, marked banking as an attractive investment avenue for 2010. 

Kuwait’s banking index outshone all others with robust growth of 42.50 percent. Qatar ended a bullish journey with a hefty gain of 37.18 percent, followed by Bahrain, Saudi Arabia and Abu Dhabi. Overall, the GCC banking index reported a surge of 13.89 percent, whereas the GCC market index performed much lower at 3.72 percent.

Total assets of GCC bankers reached $1.04trn, adding $66.28bn, mainly sourced through ballooning customer deposits and poor growth in credit take-off in the real estate and construction sector, which were tagged as ‘limelight borrowers’ in past years. Guided by this, total cash across the GCC reached $109.22bn, up 14.7 percent year-on-year, despite the fact that many lenders used rising cash to pay off other liabilities. Also, bolstering cash increased its share in total assets to 10.5 percent, from 9.8 percent in 2009, as investors’ greater risk aversion forced them to move towards deposits. The total GCC loan book grew by just 4.2 percent, of which advances to deposits reached 0.95 percent from 0.99 percent, and its share in total assets also dropped to 61.5 percent from 63.0 percent in 2009.

On the income statement side, net interest margins (NIMs) remained almost unchanged, at an average of 3.3 percent. Abu Dhabi, Oman and Qatar emerged as the winners: their NIMs were fuelled by growth in interest-earning assets amid aggressive credit expansion due to favourable macroeconomics.

Despite flat NIMs, net profit was buoyed by lower provisions, along with improving non-core income and cost-cutting measures. Saudi Arabia took the greatest share of total GCC profit (34.8 percent), while Kuwait extended its share to 12.10 percent from 8.54 percent a year ago (see opposite).

On the cost-to-income front, the average GCC ratio remained steady at 0.34, while all banks maintained their respective ratios except for Oman (see below). Qatar continues to outshine its peers by having the lowest ratio, whereas Bahrain scored lowest on the efficiency scale.

The key to success
After a good 2010, 2011 will pose challenges for growing revenue, amid regional instability and limited investment venues; however, the sector can benefit from the evolution of market-driven services.
GCC banks are facing strong headwinds on local as well as global fronts, which have made them more risk-averse. In addition, their exposure to real estate, trading and stock market activities is further hurting them in terms of asset quality, as banks are still struggling to find new avenues to sustain their growth momentum. ‘Limited growth concern’ is an idea evidenced by various economic and political issues, appearing since the beginning of 2010.

Although piled cash surplus (courtesy of high oil and gas prices) in the last few years has provided much comfort to GCC governments to continue their planned projects, the GCC economies are imbalanced by having a closed structure on the front of growth and exposure. These are heavily dependent on oil and gas, which makes them quite vulnerable  to unhealthy developments in the global markets (as in the 2008 crisis), where oil prices reached a level of $30 from an all-time high of $147 within a few months.

Adding fuel, most of the businesses are still running under the roles of government and big family conglomerates, which in turn creates another puzzle for banks, as these institutions have concentrated borrowers with large borrowings. In the end, lack of diversification makes all banks vulnerable to political, economic and other global shocks.

Challenges ahead
Banks are in a transitional phase and facing five major challenges on the performance side. These are: business strength, growth, profitability, credit quality and efficiency. In the current and projected time frame, each lender in the GCC must evaluate itself and make peer comparisons based on these major criteria.

Business strength, in general, is reflected by strong banks, which is again a clear image of a strong economy. Depositors’ faith in their banks to repay (and vice-versa) is the foundation of the banking business. The ability of a bank to survive any financial turbulence is the test of this foundation. Though none of the GCC banks were bankrupted in the crisis, the continuous news stories are naturally frightening investors.

Growth is mainly achieved if efforts are directed in the right direction. Even the expansion of many banks across the MENA region brought a frightening prospect when the unrest spread in the fast-emerging markets of Egypt, Tunisia and other GCC countries, which ultimately cost banks dearly. However, this should not be a sole reason to restrict expansion, as diversification of business will remain a key essence of success for the GCC banks.

Maintaining profitability is the third but toughest task for lenders: any halt of infrastructure projects by governments or declining workforces (by job-cutting processes) will certainly impact negatively on the profitability of banks. To sustain good economic momentum, governments must initiate new projects so that lenders can lend; and intensify their efforts to restore old jobs, as well as adopt open business policies to create new ones. This in turn will help banks reinforce their business and maintain profitability for its shareholders.
Credit quality has become a focal point in post-restructuring debt and higher exposure to sensitive sectors in the economy. To overcome this daunting task, collective efforts should be put in by banks towards those impacted businesses by restructuring loans.

Under the circumstances where banks are feeling the pinch of low interest margins and declining income, it is quite obvious that to maintain their efficiency, they may go for cost-cutting measurements at various levels. However, it is believed that expanding branch networks into promising and untouched areas will help banks overcome this dilemma.

The long hard road
In short, the outlook for the sector is quite mixed, with several positive aspects hovering alongside multiple concerns. It is well accepted that hefty provisioning for NPLs have peaked, as 2011 earnings for the first and second quarter are quite encouraging, but slower growth in lending may continue amid cautious approaches. In addition, the long-term tilt towards energy exports and fewer business expansions outside the region, combined with sluggish recovery of real estate and construction, will continue to limit the GCC banks’ credit growth in coming years. The sector is not going to witness another period of ‘super growth’ any time soon.

Ernst & Young hopes for tax reform in Mexico in 2012

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It is likely that with the upcoming presidential elections in 2012, Mexico may see further substantial changes to its tax policy. The uncertainty of a solid economic recovery in Mexico until the US economy stabilises, coupled with the challenges faced by the Mexican government in its battle against the drug cartels may encourage the government to promote tax reforms in an effort to reinforce the country’s position in the international business community as having a competitive, yet stable and equitable tax regime.

According to the 2011 budget proposals, approximately 32 percent of Mexico’s annual spending is tied to revenues from the state-owned oil company, Petroleos Mexicanos. Most economists agree that Mexico must reduce its dependency on this company and increase its overall tax take by focusing on compliance and diversifying sources of tax income. Mexico’s total tax revenue as a percentage of GDP hovers around 17.5 percent: a rather low ratio compared with other OECD members, as well as to other countries in Latin America such as Brazil (currently 34.4 percent).

The current environment in Mexico includes tax assessments that may be large in Mexico because of interpretations of the law that are not always clear or in favour of the taxpayer, even in cases where tax planning is not involved.

Nevertheless, recently proposed reforms provide a framework for simplifying the system and laying the groundwork for positive changes that should relieve the tax environment in Mexico, increasing potential tax collections in a more equitable manner.

Current structure
Mexico’s current tax system consists primarily of three main federal taxes:
Income tax is currently imposed at a rate of 30 percent to net taxable income. Taxable income is generally determined on an accrual basis. One of the unique characteristics of the Mexican income tax is its use of inflation accounting. The corporate income tax rate was increased temporarily – beginning in 2010 at 30 percent – and is scheduled to be gradually reduced back to 28 percent by 2014.

Mexico currently does not impose a tax on dividend distributions once the earnings are subject to income tax. Individuals pay income tax at graduated rates, up to the 30 percent maximum rate (also scheduled to go down to 28 percent by 2014).

Mexico is one of the few countries left in Latin America still requiring inflation accounting for income tax purposes. With inflation in recent years at close to five percent or less, the administrative cost for taxpayers to maintain the systems required for these calculations would hardly seem to justify the impact on the tax returns. Moreover, Mexican accounting rules have eliminated the need for inflation accounting, unless the inflation exceeds certain thresholds, leaving the inflation accounting requirement applicable exclusively for tax purposes.

A flat rate business tax is imposed on cash received from most business activities, less cash-based costs and expenses. This tax, in effect since 2008, is imposed at a rate of 17.5 percent. The income tax is creditable against this tax. Although the flat rate business tax works as an alternative minimum tax to the income tax, unlike alternative minimum taxes implemented in other countries, the flat rate business tax, once paid, is not creditable or otherwise recoverable against income tax.

Notable aspects of the flat rate business tax include the non-deductibility of interest and royalties paid to related parties. Although it has resulted in tax collections over the income tax base, since its inception it has consistently failed to meet the expected collection goals set forth in the annual budgets, generally by 25-30 percent. As a result, and given the additional compliance requirements it sets for taxpayers, many are of the opinion that the Mexican government should consider whether the IETU should be eliminated or, at a minimum, modified.

A value added tax is applied at a general rate of 16 percent to the sale of most goods and services. Notably exempt are food and medicines. Historically, the controversial issue for VAT each year is whether the taxable base should be broadened to include all goods and services.

In an attempt to fight perceived tax shelters the administration has established rules which adversely impact tax planning as well as possible new investment in the country. As mentioned above, the flat rate business tax disallows deductions for interest as well as royalty payments to related parties. This rule does not distinguish between types of royalties, which may include software or technical assistance subsequently sold to clients, thus resulting in almost a gross tax.

Mexican tax audits are becoming more common and taxpayers must carefully monitor the process as tax assessments will include penalties that can reach 100 percent, as well as inflation adjustments and interest that can average one or two percent per month. With these costs to contend with, taxpayers must carefully evaluate tax positions prior to implementing transactions or structuring operations. The tax law is, in some cases, unclear and subject to interpretation, which mkes the evaluation process complicated. For example, transactions such as warranty or guarantee expenses can fall within the definition of penalties or fines which are generally not deductible. This wording of the lawputs the deduction of common business expenses at risk.

Learn from the region
Recently proposed tax reforms attempt to simplify Mexico’s tax system, by eliminating the second tier of tax (the flat rat business tax). However, some of these proposals maintain the non-deductibility of legitimate costs of operating in Mexico, such as the cost of royalties. Mexico is, and will remain in the likely future, a net importer of technology and services. Although it should encourage local development of technology, it will not achieve that objective by simply punishing its importation.

Other countries in the region have been successful in raising tax revenues by leveraging the use of indirect taxes. For example, a common tax observed in several countries in Latin America is the tax on bank transfers. This tax has proven to be effective, as a permanent or temporary fixture in countries such as Brazil, Venezuela and Colombia. The effectiveness of this tax derives from its ease of administration, since the banks, which are part of the formal economy and are heavily regulated, collect and remit the tax, thus generating a reliable tax collection process with little incentive for non-payment. In the case of Brazil, the tax is designed to encourage longer term investment, by imposing higher rates on transactions which are likely to trigger instability for the currency.

Overall Mexico has a real opportunity with a new administration to make positive changes to its tax policy, offering increased stability and reassurance to otherwise concerned investors.

Signal the charge

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A decade ago, when the iPhone was just a twinkle in Steve Jobs’s eyes, few could imagine that the dull, uninspiring telecommunications industry of yesteryear would revolutionise the world in the 21st century. No one could have imagined how an online social networking service available on the phone could stimulate the Arab Spring and lead to regime change. And surfing the internet on a mobile – well, that was simply impossible.

But somewhere along the way, the impossible rapidly became the everyday, and telecoms became cool again – not just for twittering tweens, but for investors who recognised a lucrative revenue opportunity in a sector that’s now set to join automobiles, food and defence as one of the world’s few trillion dollar industries. The mobile revolution promises to be the most significant technological trend of our lifetimes: by 2020, the number of mobile devices (smartphones, tablets or car electronics) is expected to surpass 10 billion units; in comparison, the PC boom of the 1990s only sold hundreds of millions of units.

Of course, such a market commands fierce rivalry, with each mobile provider battling it out for a slice of the pie. And the competition is only getting hotter; earlier this year, Stephen Elop, chief executive of the now embattled Nokia brand, told staff that they were “standing on a burning platform,” with no choice but to jump into the “icy waters” below.

So what are the trends that will continue to drive growth and determine the battlefield landscape? What will firms need to do to stay competitive? And which firms will emerge victorious, and which will fall by the wayside?

A market of seven billion people
A key trend that will determine the success of mobile providers in coming years will be how they play the emerging markets opportunity.

Over the next five years mobile device subscriptions are expected to hit 7.1 billion, enough for every man, woman and child in the world. With developed markets heavily saturated, the emerging markets of Asia, Latin America and Africa will account for the majority of this growth, something that mobile phone providers have been buzzing about for a while now.

In 2000, developing countries accounted for approximately one quarter of the world’s mobile phones; in 2009, their share had grown to three-quarters. In Brazil, the number of mobile subscribers is expected to grow an astounding 39 percent between 2010 and 2015. Meanwhile, 60 percent of Spanish giant Telefonica’s sales now come from Latin America, while mobile connections in Brazil are expected to grow four-fold in the next decade and reach one billion by 2022.

Perhaps most astonishing is that within a few years, more than 40 countries will have more people with access to mobile networks than with access to electricity.

The emerging markets opportunity is obvious; but how to play it is less well known. Winners will be the mobile providers that recognise the differing needs between their customers in traditional markets and those in emerging markets.

Viva La Revolución
How a customer sees their mobile phone and what they want from it differs tremendously between the developed and developing world, something that Western firms have been slow to realise.

Phones are more valuable to those in poor countries as they provide access to telecommunications for the first time; access to a phone is a revolution rather than an incremental change. According to a recent report by The Economist, adding an extra 10 mobile phones per 100 people in a developing country boosts growth in GDP per person by up to 80 percent.

In rural areas where there is a lack of public transportation, mobile phones substitute for travel by allowing businesses to track deliveries virtually. Phones with SAP software, for example, can break down a buyer’s order without requiring an internet connection; orders can be done via bulk SMS, which can function with even the most basic mobile networks. In essence, applying mobile technology to traditionally labour-intensive activities boosts worker productivity. A customer therefore sees their phone as an investment, valuable for its utility and reliability.

In comparison, rich countries are more likely to prefer a smartphone that offers sophisticated features to build on what’s already available. Consider that while music downloads and mobile gaming are the preferred data services in developed markets, users in developing countries prefer to use their mobiles for agricultural advice, healthcare, and money transfers.

In the past five years, the battle-lines of the mobile technology war have been redefined, with home-grown mobile operators springing up in China, India, Africa and the Middle East, and challenging the previously dominant Western companies. Despite initially being seen as low-cost and low-quality producers, Chinese firms Huawei and ZTE have stolen market share from their Western counterparts, with subscriber numbers growing rapidly as networks in China and India are upgraded from 2G to 3G technology.

Local operators’ structures are different from their incumbent Western counterparts. In particular, nimble Asian firms such as Micromax and ZTE have mastered a business model which enables them to be highly profitable in servicing poorer customers, operating at higher margins than their larger competitors can afford to. Nokia, for example, has virtually been squeezed out of its own emerging markets space by local low-cost phone providers. The company recently made its second quarterly operating loss in a row, and as a last ditch attempt to resurrect itself, unveiled the Lumia 710 in October – the world’s cheapest Windows smartphone. Only time will tell if it will be able to pull itself out of the “icy waters” and back onto land. If Nokia’s plan works, it may just be able to shake up the smartphone duopoly of Apple and Android.

Of course, the success of telecommunications firms in emerging markets will also rely on their ability to recognise that people are aspirational. It would be dangerous to oversimplify the emerging markets opportunity by limiting products to fit today’s customer profile only.

As the middle class in developing economies grows, so too will the consumer’s penchant for more sophisticated products. Research in Motion (RIM) has cottoned-on to the value of the aspirational customer, maintaining the positioning of its BlackBerry line as the fashionable and slightly more expensive phone of choice. The company has had some success using this strategy, with Nigeria becoming one of its fastest growing segments globally. The firm has successfully weaved the brand appeal into the country’s social fabric; the local movie industry Nollywood has even made a movie, BlackBerry Babes, to capture the local youth’s fascination with the brand.

The need for speed
Beyond harnessing the potential of emerging markets, the winners of the new-age technology arms race will be those firms that are the most innovative in a post-PC world.

The convergence of numerous applications – from emails to maps to photos – onto a single mobile device has changed the landscape for technology firms by eroding the importance of the personal computer. It is predicted that by the close of 2012, annual shipments of smartphones will exceed that of PCs. The number of people using their mobile as the sole way to access the internet is expected to increase from 14 million in 2010 to 788 million by the close of 2015; an astonishing 56-fold increase.

This reflects a broader shift in the technology industry as a whole, with Western technology giants desperately trying to adapt to the changing shape of their industry. Mark Dean, IBM’s Chief Technology Officer in the Middle East and Africa, recently stated that the PC was destined to go the same way as typewriters and vinyl records, something he had “never expected” in his lifetime.

For Western power-brokers such as Microsoft, the downfall of the PC has created an inventor’s dilemma. Since the company came into existence, its value proposition has largely been in its Windows operating system; the company is practically wedded to it and up until now has been able to get away with simply rolling out a new version as the answer to every problem. For such a firm, it will be no mean feat to adapt to a world where the PC is less relevant, and it will have to uncover new revenue streams to stay afloat; since the start of the year, Microsoft is down nine percent.

However, Microsoft’s recent deal to provide the software for Nokia’s new Lumia line is a sign that the Western giant is, begrudgingly at least, trying to adapt to the new world order. How its operating system compares to Apple’s new iOS 5 system will make for interesting watching in the coming months.

Redefining innovation
The definition of innovation in the mobile space is quickly changing, and now goes beyond simply ensuring quick time to market.

It also means consolidating and buying up the intellectual property used to create a phone: everything from the design elements (Apple now owns the ‘slide to unlock’ patent on smartphones) to the operating systems (think Google’s very own Android system).

Apple leads the pack in this space, owning its entire phone ecosystem, from the design to the operating system to the software and the hardware. Of course, there is a big question mark hanging over whether Apple’s product innovation – largely rooted in its simplicity – can be maintained without Steve Jobs at the helm. While iPhone 4S sales topped four million within three days of its launch in October, it remains to be seen whether the company’s products will maintain their innovative simplicity and avoid the ‘feature-creep’ (the tendency for new and often unnecessary features which serve only to complicate design to be added to a product throughout development) which Jobs fought so hard against.

The importance of owning the entire bionetwork of product design has been recognised by other large players. Recent takeovers, such as Microsoft’s $8.5bn purchase of Skype and Google’s $12.5bn acquisition of Motorola Mobility were motivated by the need to build up patent stockpiles.

Patent wars are becoming increasingly fierce and the success of mobile firms will depend on how well they can navigate the prickly issues of litigation. The number of handset patent infringement filings to the US courts grew from 22 cases in 2006 to 84 cases in 2010. The speed of innovation has been blamed for the increase in filings, all of which involve an increasing amount of intellectual property as phones continue to add more features: from cameras and internet browsers today, to potentially credit cards in the future.

The latest round of patent wars has seen a number of the larger Western firms line up their legal ranks, including LG, Sony, Ericsson, Kodak and Nokia.

This is not to exclude Apple, however, which has so far been the most successful at protecting its rights through design-related lawsuits. It has filed lawsuits to successfully stop Samsung Electronics from selling its Galaxy Tab 10.1 tablet in the Australian and German markets. The Asian firm has since counter-filed in an attempt to ban iPhone sales in Japan and Australia, but has so far been unsuccessful.

Recently, Microsoft sued Motorola Mobility for use of video coding; the company is counter-suing over Microsoft’s implementation of email and messaging devices. Motorola Mobility is now being taken over by Google, which in turn is being sued by Oracle over Java programming in its operating system.

The heat over ideas and who owns what is perhaps best demonstrated by Steve Jobs, who stated he was “willing to go thermonuclear” over Google’s Android software, elements of which he claimed had been copied from the iPhone.

Victory is spelled survival
The complex web of patent infringements is likely to get more and more tangled as new products continue to be launched.

Mobile companies around the world seem to be heeding Chinese philosopher Sun Tzu’s advice from The Art Of War: “If you are far from the enemy, make him believe you are near.” With firms’ rankings changing almost as quickly as new products are launched, who is near and who is far in the technology race is still up for debate.
In the coming years, the most victorious firms will be those who know how to play the emerging markets opportunity right; those that innovate and iterate their way through a harsh terrain; and those that steer their course successfully through the complex web of patent wars.

Perhaps the late Jobs put it best when he spoke of Apple in 2001, before it had resurfaced: “Victory in our industry is spelled survival… the only way we’re going to survive is to innovate our way out of this.”

Cleaning up its act

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While Europe’s very own Greek tragedy (or Franco-German banking crisis, as some would argue) has continued to play out over the last few months, the Indonesian economy, like others in the Far East, has so far escaped relatively unscathed.

Economic growth in the world’s fourth most populous nation and third biggest democracy came in at a healthy 6.1 percent (to $707bn) in 2010, after a mild slowdown (to 4.6 percent) in 2009, giving a five-year average of 5.7 percent per annum. Underpinning growth has been buoyant domestic demand accompanied by a stronger rate of investment (32.5 percent of GDP in 2010 vs. 24.9 percent in 2009), according to Fitch Ratings.

Largely absent has been the emergence of potentially risky external imbalances, given that rising savings rates have largely matched rising investment. Against this backdrop, the ratings agency in February 2011 raised its outlook for the Indonesian economy to ‘positive’ from ‘stable.’

In a note, Andrew Colquhoun, Senior Director and Head of Asia-Pacific Sovereign Ratings at Fitch, said: “The positive outlook reflects Fitch’s view that Indonesia’s favourable macroeconomic prospects are likely to see the credit profile strengthen further over the next 12 to 18 months, despite near-term risks from inflation and potentially volatile capital flows.”

Colquhoun also noted faster progress in tackling long-standing issues including the low tax take, infrastructure deficiencies and corruption. But these problems are lingering.

Local and foreign-currency debt is presently rated at BB+, one step below investment grade, and followed Moody’s upping of Indonesia’s rating the previous month to the corresponding grade of Ba1.

In April, Standard & Poor’s followed suit, increasing the country’s long-term foreign currency rating one notch to BB+ from BB, with a positive outlook – the rating also one level below investment grade. In August, the Japan Credit Rating Agency raised its outlook to ‘positive’ from ‘stable.’

The recent upgrades mark the first time in a decade that Indonesia has been just one notch away from an investment-grade credit rating – in part due to President Susilo Bambang Yudhoyono targeting economic growth of as much as 6.6 percent per annum on average through the remainder of his term, ending in 2014.
It wasn’t always this way, of course. In 1998 the economy was in a perilous state as the East Asian economic crisis unfolded.

Real GDP contracted by 13.7 percent, with the economy hitting its low point in mid-1999. Inflation, which reached 75 percent in 1998, slowed to two percent in 1999 as the country implemented structural economic reforms in agreement with the IMF.

Later, inter-communal violence reared its ugly head – a three-year conflict on the Maluku Islands leading to thousands of deaths and the displacement of many others. Inter-religious problems were eventually resolved and proved that in this part of the world at least, differences could largely be overcome.

Modern prospects
Fast forward to 2011 and the inflation picture for the country remains a relatively benign one – consumer prices in September 2011 were up 4.61 percent year-on-year, against 4.79 percent the previous month and 7.02 percent in January. Core inflation, which excludes volatile and administrative price components, was 4.93 percent up on the year, easing from 5.15 percent in August.

However, Credit Suisse is forecasting inflation to pick up to seven percent by April 2012, largely due to depreciation in the value of the rupiah and a robust economy. It also envisages two interest rate increases of 25 basis points each in the second half of 2012. One caveat, though, is the rapidly changing global economic landscape as the eurozone crisis and structural problems in the western banking system continue to remain unresolved.

Because of this deteriorating economic backdrop, Bank Indonesia (BI), which has already noted the nation’s current-account surplus is on a downward trend, says it will likely move into negative territory next year as import growth outpaces that of exports, amid a robust domestic economy.

BI’s decision in October to cut its benchmark interest rate by 0.25 percent to 6.25 percent took many analysts by surprise, despite the bank’s announcement in September that it was shifting its emphasis to promoting growth rather than tackling inflation, which shows, for now, some signs of abating.

The wider narrative, as analysts see it, is that the eurozone debt crisis and relatively weak US economy will eventually hit Asia’s export-dependent economies. As recently as June, Indonesia was ranked fifth out of 27 emerging economies at most risk of overheating, according to the emerging-market overheating index compiled by The Economist.

The index uses six different indicators. These are: inflation rate, unemployment rate relative to its 10-year average, GDP growth relative to trend, excess credit (growth in bank lending minus the growth in nominal GDP), real interest rates, and forecast change in the current-account balance in 2011.

Countries are first graded according to the risk of overheating suggested by each indicator (two=high risk, one=moderate, zero=low). Hence, if growth in excess credit is more than five percent it scores two points, zero to five percent scores one point, and below zero percent scores nil. The scores from each indicator are then summed and turned into an overall index; a 100 value means that an economy is ‘red-hot’ on all six measures.
At the time Argentina had a value of 100 and Indonesia 83, along with Brazil, Hong Kong, Turkey, Vietnam and India.

If the Indonesian economy is still in danger of overheating (and the jury remains out on that one) much of it can be put down to strong consumer demand, with robust sales in the motor, motorcycle and durable goods sectors.

Data from the Association of Indonesian Automotive Industries shows car sales for the July-September period up 30 percent (to 242,172 units) compared to the same period in 2010.

Meanwhile, investment in the more general economy rose by 15 percent to IDR 65.4trn ($7.3bn) in Q3 2011, according to data from the Indonesia Investment Coordinating Board. Of this, foreign direct investment made up IDR 46.4trn, or more than 70 percent of the overall total.

Elsewhere, credit growth remains high. However, BI recently announced that, effective January 1 2013, an individual will only be eligible for a credit card if they make at least IDR 3m ($335) per month. In addition, they will only be able to hold two credit cards if their monthly income exceeds IDR 10m and are at least 21 years of age.

Figures from BI show credit card transactions rose to IDR 163.2trn ($18.1bn) in 2010, up from IDR 72.6trn in 2007 ($8.1bn). In the first nine months of 2011, card transactions hit IDR 120.9trn ($13.4bn) in value.

Bad loans have yet to become a major issue though. Indeed, they were down 36 percent year-on-year through August 2011. However, BI does have the inevitable interest rate weapon at its disposal – one it has already exercised with a proposed three percent per month cap banks may charge on cards vs. the current 3.75 percent.
If the government is looking to curb credit growth, then so too is it committed to reducing expensive energy subsidies. While this may have a negative impact on inflation, assuming electricity tariffs are increased next year, and fuel price hikes kick in, the government should be able to adjust policies to ensure those price adjustments do not spill over into overall inflation.

Long-term development
One major economic issue that still needs to be addressed is the state of the nation’s infrastructure. President Yudhoyono plans to double spending on roads, ports and airports to $140bn. He will need to, given that an estimated 15 million households presently have no access to electricity. The objective is to build 20,000km of roads and add 15,000MW of power generation by the end of his term in 2014.

In September the government confirmed it is ready to offer 17 infrastructure projects worth $9.98bn under the public private partnership scheme to investors via open tender – including a railway project in Central Kalimantan worth $2.1bn.

Already on the radar, a consortium comprising Japan-based utility J-Power, Japan-based trading conglomerate Itochu and Indonesia-based coal miner Adaro Energy has been selected as the preferred bidder for the Jawa Tengah plant, estimated to be worth IDR 30trn ($3.3bn). The project involves the construction of two 1,000MW coal-fired power plants in the district of Pemalang and is expected to be completed by 2017.

The projects form part of the nation’s 2011-25 Master Plan for the Acceleration and Expansion of Indonesia’s Economic Development (MP3EI). Implementation of MP3EI will include eight main programmes comprising 22 main economic activities.

The programme aims to develop the regional economic potential in six Indonesian ‘Economic Corridors:’ Sumatra, Java, Kalimantan, Sulawesi, Bali-Nusa Tenggara, and Papua-Kepulauan Maluku.

It is also designed to promote increased national connectivity locally as well as internationally, and will complement existing development planning documents such as the Long Term National Development Plan and Medium Term National Development Plan.

The economic objective of MP3EI is to raise GDP to $4.0-4.5trn and GDP per capita to $14,250-15,500 by 2025. To achieve these objectives, says the government, real economic growth of 6.4-7.5 percent is expected for the period of 2011-14, while inflation is forecast to fall from 6.5 percent in 2011-14 to 3.0 percent in 2025.

With the implementation of the MP3EI platform, the country aims to position itself as one of the world’s main food suppliers, as a processing centre for agricultural, fishery, and natural resources, and as a centre for global logistics, by 2025 or earlier.

In a May 2011 note, Morgan Stanley economist Deyi Tan said Indonesia, with a public debt ratio of 26.1 percent (one of the lowest in the Association of Southeast Asian Nations), has room to take fiscal deficits higher in order to support infrastructure projects, without jeopardising the public balance sheet or liquidity conditions.

Lingering corruption
Of more pressing concern, however, is the issue of graft, which continues to cast a shadow over the Indonesian economy.

While President Yudhoyono may have promised “shock therapy” back in 2004 to address it, he has struggled to reverse old practices, as an underlying threat of corruption and a lack of transparency in the tendering process remains.

In August Muhammad Nazaruddin, the former treasurer of the country’s Democratic Party (the largest party in the governing coalition) was arrested in Colombia after being on the run for weeks. Nazaruddin stands accused of accepting bribes worth almost $3m in connection with tenders for the South East Asian games, to be hosted by Indonesia this year – allegations he has consistently denied.

Closer to home, anti-corruption authorities recently seized IDR 1.5bn ($168,600) in cash found in a fruit box at the country’s Manpower Ministry. The cash related to a major infrastructure project in West Papua province.
In fact, 13 years after the demise of the corrupt Suharto regime, it has seemingly been ‘business as usual;’ with government officials, businessmen and lawmakers continuing to collude on the awarding of state contracts, commercial deals, and even tax breaks, in exchange for a piece of the action.

Even where corruption has been uncovered, recent acquittals in the courts have only served to highlight flaws in existing anti-corruption legislation – not least the requirement that anti-graft courts be set up in each district and municipality. Critics say this leaves the system vulnerable to the varying quality of judges presiding over trials. Factor in the low regard in which judges are held by the general public, and the system’s overall credibility comes into sharp relief.

For its part, MP3EI calls for the creation of an effective bureaucracy supported by ‘strong and effective institutions,’ including a ‘responsible legislature’ and independent judicial organs. However, a recent raft of proposals, if approved, will actually undermine current anti-graft laws, some critics argue.

While the government recognises corruption as a major issue and is intent on attracting private investors to the country by making the economic climate more business-friendly, the proposals could yet prove to be a major shot in the foot for the country. The years ahead, in this area at least, promise to be a long hard slog unless the political will is there.

The George Clooney of banking?

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Mark J Carney has a CV that any central banker would die for. Having succeeded to the top job at the Bank of Canada in late October 2007 – that is, just before the financial crisis – he steered it through the turmoil without a single bank failure.

A graduate of Harvard and Oxford, he’s got another three years to run at the Bank of Canada, but earlier this year was short-listed for managing director of the International Monetary Fund before French finance minister Christine Lagarde won it with the help of strong European lobbying.

However, he got a handsome consolation prize when in November 2011 he was named as head of the Financial Stability Board, the global body that’s laying down the law to the ‘too-big-to-fail’ banks. It’s only a part-time job for Carney, but he will have a big hand in shaping the regulatory environment for decades to come.
Last year he was named by Time as one of the world’s most influential people. And although it’s not something he can put on his CV, he’s undeniably handsome; indeed, the George Clooney of central banking. And he’s still only 46.

No wonder Time wrote: “Central bankers aren’t often young, good-looking and charming, but Mark Carney is all three – not to mention wicked smart.”

What Time left out is that Carney, who worked in top jobs for Goldman Sachs, is totally un-intimidated by the heavyweights of the banking world. It was the Canadian who ticked off Jamie Dimon, head of JPMorgan Chase, in a backroom stoush in September last year when the latter complained about an alleged surfeit of regulation. It was also Carney who marched into the lion’s den – the Institute of International Finance, whose membership counts the crème de la crème of private banking – and basically told his audience to stop complaining, because they’d asked for everything they were getting.

For the sake of posterity, his exact words were: “The complete loss of confidence in private finance – your membership – could only be arrested by the provision of comprehensive backstops by the richest economies in the world. With about $4trn in output and almost 28 million jobs lost in the ensuing recession, the case for reform was clear then and remains so today.”

So saying, Carney went on to demolish in his speech every single objection that this august body has raised to the current, on-going comprehensive reform of the global financial sector. Music to the ears of beleaguered taxpayers who have bailed out the banks, he dismissed the “fatalistic” and “world-weary arguments” that insist any regulation will be arbitraged (exploited in some way), that the deposit insurance that most western banks enjoy must inevitably promote risk-taking, and that financial crises are inevitable.

Clearly, his part-time job is the one that will give Canada’s “rock star” banker – another epithet routinely awarded to Carney – the most influence. And here he’s on a mission. The Financial Stability Board is the first global regulator, and its job is to make sure the reforms thrashed out by the G20 are implemented in letter and spirit. His target includes not just mainstream banks but the shadow banking sector, which he considers extremely dangerous because it sits outside the pale.

In this task, he warned his audience, it has an important role: “Belief by the industry in the appropriateness of the measures will also aid their application. As you are well aware, you have the ultimate duty to ensure your institutions bear responsibility for the risks you are taking.”
If that’s not telling them, nothing is.

Carney has his critics. After all, it’s not as though he single-handedly saved Canada from the banking failures that hit Britain, Europe and USA. He inherited a famously responsible financial sector and a much-respected central bank. And some banking pundits rebuke him for insisting that banks should be allowed to fail while supporting them behind the scenes (in the crisis the Bank of Canada tripled its balance sheet to maintain liquidity in the sector).

But for anybody wanting a global view on just about everything related to systemic risk, he’s the first port of call. As Time says, “wicked smart.”

IAG trumps Virgin to €206.8m BMI deal

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The owner of British Airways, International Consolidated Airlines, on Thursday beat competitor Virgin Atlantic in the takeover battle for BMI, Deutsche Lufthansa’s loss-making airline.

IAG agreed to buy BMI for €206.8m in cash, but may end up paying less if Lufthansa fails to sell its small regional subsidiaries before the completion date. 

CEO of IAG, Willie Walsh, said: “Buying BMI’s mainline business gives IAG a unique opportunity to grow at Heathrow, one of our key hub airports.” Walsh added there will be job cuts in an effort to stem losses at BMI.

Reports suggest the sale will be completed in the first three months of 2012. 

LakshmiKumaran and Sridharan: Significant change in Indian tax landscape

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In keeping pace with a growing Indian economy, the legal field has been undergoing massive change in recent months. Legislators have been responding to increasing international interest in doing business with India, and a number of notable developments are likely to have a significant impact on the business environment, as well as the financial structures of domestic and international operations in the country.

Taxation
Before the business community could recover from ripples created by the tax liabilities arising from the judgment of Vodafone, the Bombay High Court has brought a fresh perspective to tax planning in its decision in the matter of Aditya Birla Nuvo Ltd (ABNL). The episode provided some important take-aways on availing the benefits of double taxation treaties (DTTs).

In the ABNL matter, the High Court held that capital gains arising from the sale of shares in Idea Cellular by its Mauritian shareholder, AT&T Mauritius, were not protected by the India-Mauritius DTT. The court affirmed the stance of the revenue department that the beneficial owner and investor in this case was New Cingular Wireless, which being a US resident was not protected under the India-Mauritius treaty.

This decision highlighted the importance of factual disclosures to the income tax department while availing the exemptions from deducting tax at source. Corporate planners should tread the Mauritius route with caution, as such peripheral and overriding agreements run the risk of being challenged by the income tax department.

Anti-avoidance rules
The vigilance and strict interpretation by the tax authorities is likely to continue in the coming years, with India re-negotiating DTTs with several countries known as tax-heavens, as well as introducing a general anti-avoidance rule (GAAR) in the direct tax code.

The code proposes certain provisions to act as a check on tax avoidance. It proposes to disregard and re-characterise transactions entered into by the assessees if they are considered to lack, inter alia, commercial substance. The application of a GAAR will also override the benefits availed under a DTT.

The implementation of such provisions is yet to be tested against the proposed objective standards promised by the government in the second discussion paper accompanying the bill. However, this is no guarantee that the noble objectives of the GAAR will not actually cause more hardship to the assessees, due to the unprecedented sweeping powers being given to the tax authorities to examine and challenge transactions.

Investments
The Indian government has proposed to establish a Pension Fund Regulatory and Development Authority, which may allow foreign direct investment of up to 26 percent in this sector, giving global players access to more than $2bn in assets. The new scheme is likely to be based on individually-defined contribution pension schemes. These would have unique features such as central record-keeping, and the selection of market players would be through competitive bidding on costs, fees and charges for the funds and fund managers.

The proposal to allow FDI in multi-brand retailing, after more than a decade of stagnation, has recently gained momentum with the cabinet, which passed a proposal to allow 51 percent FDI in the sector in November 2011. This follows from the sustained effort and debate which can be traced to the Department of Industrial Policy and Promotion (DIPP) floating a discussion paper in 2010 seeking the views of industry.

The opening of the sector will be conducted in a systematic and phased manner, with a clear set of conditions on procurement of farm produce, domestically manufactured merchandise, and imported goods. The 51 percent permit is to enable domestic players to enter joint ventures and benefit from the management practices, technology and know-how of foreign players looking to enter the market.

Intellectual property
The DIPP has issued a discussion paper mooting the idea of granting legislative protection for utility models. The discussion paper highlights minimal usage of the current patent system by India entities for reasons such as higher costs and complexities in obtaining a patent. The DIPP suggests that a variation of known technologies, as practised by Indian entities but otherwise not patentable, ought to be protected – albeit for a shorter duration.

The acceptance of the proposal may effectively circumvent the thresholds of the patent law, and undermine the IP portfolios of companies entering India. On the other hand, draft amendments to the Patent Act propose that India becomes an international search authority, which would provide huge cost advantages to companies intending to do prior art searches.

On the trademark and copyright front, India has adopted the Madrid Protocol by way of an amendment to the Trademarks Act 1999. The Madrid Protocol is an international treaty that allows a trademark owner to seek registration in any of the countries that have joined the protocol by filing a single international application.
The Copyright Amendment Bill 2011 seeks to introduce a unique concept under which even after assignment of a cinematographic work or sound recording, the owner of the work will continue to have the right to claim royalties for any subsequent assignments. In addition, the definition of an ‘author’ is sought to be broadened to encompass a principal director for a cinematographic work, and a producer for a sound recording. The proposals are expected to significantly impact all foreign production houses operating in, or seeking to enter, India.

For more information – Tel: +91 11 2619 2243; www.lslaw.in

Ecuador oil company in ESG drive

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Petroamazonas EP (PAM EP) is an Ecuadorian national oil exploration and production company. It started its operations in 2007 in Block 15 of the Ecuadorian Oriente Basin, producing an average of 88,173 barrels of oil per day (bopd), and reflected a market participation of 18 percent.

Nowadays, Block 15 is producing 103,000 bopd, and due to its efficient operation during 2007, 2008 and 2009, the Ecuadorian State has also assigned the operation of Blocks 7, 21 and 18 to PAM EP.

Currently, the company produces an average of 160,000bopd, which is 33 percent of the total national oil production, making it the oil company with the largest oil production in Ecuador.

During the period 2007-11, PAM EP maintained the lowest operating costs in the Ecuadorian market, and has efficiently used its resources, striving to develop the most important capital investment projects (approximately $2,800m during this period) which allowed the company to substantially increase its oil production and directly generate greater oil revenue.

Among PAM EP’s main investment projects are: (1) the Pañacocha Project, which incorporated a production of 18,100 bopd, and has been recognised for its high environmental standards used during the facilities construction and operation; and (2) the electric power generation optimisation project (OGE in Spanish), which allows the use of associated gas for power generation, reducing the oil operating costs, and saving important economic resources to the country by avoiding the use of diesel. In addition, this project brings important environmental benefits, by reducing CO2 emissions to the atmosphere.

PAM EP is also in charge of the development of Block 31, for the exploitation of the Apaika and Nenke fields. Their first oil production is expected in July 2013.

As part of PAM EP’s strategic growing plan, the company is working on the development of several blocks in the south-east of the Ecuadorian Oriente Basin, where there are very high probabilities of increasing the oil reserves to 110 million barrels.

The company is also working in the implementation of enhanced oil recovery techniques to enhance the recovery factor for fields currently in production, and also increase the reserves and production of the block administered by PAM EP.

PAM EP’s main factors of success are its management and administration structure, which highlight its corporate culture and human talent, rigorous internal control systems, modern technological systems, consolidated support processes for operations and administration activities, codes of ethics and transparency, stability and growth at top management levels, and a strong focus on safety, environment and social responsibility.

All of the above have allowed the company to work with the approval of the highest authorities of the country, and due to the important growth of PAM EP during the last four years, it will take over all state-owned upstream operations, becoming the only upstream national oil company in the country, with approximately 64 percent of the Ecuadorian market participation.

Due to Petroamazonas EP’s strength and knowledge of the Ecuadorian upstream petroleum business, the next step for the company will be to seek opportunities to expand its operations to other countries.

Reforming Germany’s tax law

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Germany is one of Europe’s leading European economies, having invested more than €200bn in both cash and guarantees in the European and international markets. It is not surprising, therefore, that the European debt crisis has for some time been top of both the economic and political agenda in Germany.

One of the most controversial talking points is the plan to establish a common European economic government with the power to coordinate economic and fiscal policies. One of the main powers of this proposed government would be the authority to impose a Financial Transaction Tax against speculative transactions, which would effectively force the German banking sector to commit to playing an active role in helping reduce the effects of the crisis.

However, despite the crisis, the German economy remains robust and is enjoying an increase in trade coupled with a decreasing rate of unemployment. In addition, Germany’s fiscal revenue in 2011 will be much higher than estimated.

Reorganising the tax law: a long-awaited decree
After a wait of almost five years, the guidance to the 2006 Reorganisation Tax Act has now been published. The main focus of the 2006 reform was to expand the act’s scope to include cross-border EU transactions. Several issues which had been common practice have now been regulated in a more restrictive way:
• The transfer of assets upon reorganisation of a business may be made tax-neutral at book value, even if the assets have been stepped up to fair market values in the German statutory statements;
• There is now also an option to step up the assets transferred to a value between book and fair market value. While it was common practice until now to step up in the first place all balance sheet assets before self-developed intangibles and goodwill, it is now law that there has to be a uniform pro-rata step-up of all assets, including also intangibles and goodwill so far not capitalised.

In such cases, going forward, there will be a need to value any self-developed intangibles and goodwill for tax purposes, which will significantly increase the costs of the reorganisation. This new rule will be applied to reorganisations where the respective shareholder resolution or contribution agreement, respectively, are made after the publication of the decree in the Federal Tax Gazette (Bundessteuerblatt).  
• Spinoffs may now be made at book-value only if the assets transferred have the quality of an entire business or at least a stand-alone branch of activity. This differs from the previous rules in that it is now required that the branch of activity already exists at the effective date of the reorganisation for tax purposes.
• Where a corporation is being merged into a corporate subsidiary, being part of a German tax group (Organschaft) there are now additional requirements for a tax-neutral book-value transfer if the head of the Organschaft is an individual or a partnership held by individuals. In such cases, a tax-free transfer of reserves to the individuals could be possible if the assets transferred were stepped up to fair market value for German GAAP purposes. The decree now states that a book value transfer of the assets is possible only if the parties involved agree to tax any difference between a higher German GAAP value and book value of the assets upon reorganisation as a deemed dividend to the ultimate individual owner.

Common French-German corporate tax system targeted
It came as a surprise at a bilateral euro-crisis meeting in August 2011 that France and Germany unveiled plans to harmonise the corporate tax regimes in both countries as part of a range of measures for closer eurozone integration. The French and German finance ministers had been asked to prepare proposals aimed at having a common corporate tax base and rate in Germany and France from 2013. This first step towards a common corporate tax system is a revolution within the EU.

Even the proposal for a directive on a Common Consolidated Corporate Tax Base launched by the European Council in March 2011 has so far been considered to have no chance of political approval. The development of a common French-German corporate tax should provide new thrust to this project and could be a starting point for other EU countries to follow.

Withholding tax on outbound dividends violates EU law
According to current German tax law, dividends paid by a German corporation to corporate shareholders are subject to a 26.375 percent withholding tax (WHT). On the one hand resident corporate shareholders benefit from a participation exemption and a full WHT credit/refund. However, non-resident corporate shareholders can only reduce WHT to 15.825 percent according to German tax law or an applicable double tax treaty, provided the EU Parent-Subsidiary Directive does not apply. The remaining WHT can only be credited against domestic corporate income tax on the level of the shareholder.

The ECJ decided in October that this different treatment of domestic and foreign shareholders is not in line with the free movement of capital. EU shareholders of German corporations that do not benefit from the EU Parent-Subsidiary Directive should apply for a refund of German dividend WHT already paid based on the ECJ decision. However, the applicable statute of limitations for a refund has to be considered.

However, the Finance Ministry estimates that a budgetary impact of potential tax refunds for EU cases could reach approximately €600m. As a result, it might well be that the German participation exemption regime could be abolished with respect to non-qualifying portfolio shareholdings in the near future, to achieve an equal tax treatment of domestic and foreign shareholders. This would not eliminate the violation against EU law if the Parent-Subsidiary Directive does not apply for other reasons than falling below the minimum shareholding quota of 10 percent – for example, not meeting the minimum holding period of one year. Hence, these cases may still benefit from a WHT refund.

‘Serious doubt’ about validity of German minimum tax rule
Under the current German minimum taxation rule, taxable income up to a total amount of €1m can be fully offset by tax loss carried forwards. Any taxable income exceeding €1m can be offset up to 60 percent by tax loss carried forwards – i.e. 40 percent of the taxable income is subject to tax.

The minimum taxation rule is not considered unconstitutional as it merely defers the actual loss offset to a later period. However, combined with other tax rules or tax relevant events, such as loss forfeiture rules or a merger, the minimum taxation rule may trigger a final exclusion from loss offsetting.

In this respect the Supreme Tax Court confirmed a lower court’s suspension of execution based on serious doubt on the constitutional validity of the minimum taxation rule in August 2010. However, ‘serious doubts’ do not indicate that one point of view is more likely than the other: that is, a final decision would only be made in a full trial in the future.

The Finance Ministry finally decided in October 2011 to apply the aforementioned Supreme Tax Court order, but only with respect to the following cases of final loss forfeiture:
• Loss forfeiture rules according to Section 8c of the Corporate Income Tax Act, applicable until December 31 2009 (i.e. prior to the introduction of a group relief);
• Reorganisations under the Reorganisation Tax Act – liquidation of a corporation;
• Termination of the individual tax liability by death of the taxpayer.

In particular, the Finance Ministry does not grant a suspension of execution in cases of abuse of law or a departure of a partner. Taxpayers potentially affected by the order should be aware that it is currently unclear whether future loss forfeiture may have retroactive effect allowing an adjustment of tax assessment notices of former years. Therefore, it is crucial to apply for a preliminary assessment in this respect to benefit from a potential favourable court decision in the future.

Final report of the task force
According to the coalition agreement, the German government recently appointed a taskforce to evaluate alternatives with respect to the restructuring of the German loss offsetting rules and of the current tax group system based on the following considerations:
• The total amounts of tax loss carry forwards for corporate income tax as well as for trade tax have already exceeded €500bn in 2004. These figures are synonymous with an alarming future decrease in tax revenue of more than €150bn. Furthermore, the pending cases on the minimum taxation rule and the loss forfeiture rules gave rise to evaluate potential changes in the loss offsetting system;
• The Organschaft requires a majority shareholding and a five-year profit and loss pooling agreement. In particular the excessive formal requirements for the profit and loss pooling agreement based on tax and company law led to lively discussions with tax auditors resulting in countless court cases in the past.

Therefore, the task force was also asked to come up with ideas to simplify the group taxation system and to adapt it to international standards. The task force published its final report in November 2011. In a nutshell, it is business as usual. The German loss offsetting rules (including the loss forfeiture rules) as well as the Organschaft remain unchanged due to the budgetary impact of substantial changes. However, the task force announced the following preferred alternatives – assuming that revenue neutrality might become expendable as a decisive criteria in the future:
• The minimum taxation rule shall not apply in certain cases of final loss forfeiture;
• Termination of the minimum taxation rules over an eight-year period, i.e. decrease the amount that cannot be offset (currently 40 percent) by five percent a year;
• Time limitation for tax loss carry-forwards to a 10-year term.
The Organschaft system shall be replaced by a domestic group contribution system with the following key factors:
• Minimum shareholding of 95 percent;
• Minimum term of five years;
• Group contribution between all group members;
• Pre-existing loss carry forwards may not be employed within the tax group;
• The group’s consolidated trade tax income should be allocated to the group members to avoid arbitrage activity based on the different municipal multipliers.

However, it is unlikely that Germany may enact any of these recommendations on a stand-alone basis without considering the results of the German/French task force working on an adaption of their corporate income tax systems as well as considering the European Commission’s proposed Common Consolidated Corporate Tax Base directive that may enter into force in 2013.

Summary
As with the previous year, 2011 did not witness many groundbreaking changes in terms of German tax law, although there have been several significant court decisions and decrees. With the upcoming elections in 2013, the coming year is likely to be more interesting based on the outlook provided: a tax marketplace where the taxpayer needs to stay alert.

Cross-border banking in the balance

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The gravity of the eurozone crisis has finally sunk in. The stakes could not be higher. Governments and international financial institutions have scrambled to put together a solution within exceedingly tight political and economic constraints. Many questions have yet to be answered about the design; implementation will be at least as challenging.

Eurozone leaders must now aim to preserve not only the single currency, but also the gains from financial integration in Europe. No region of the world has benefited more from cross-border banking, yet these achievements are now at risk – and with them the European bank groups themselves.

The threat to cross-border banks comes not only from their deteriorating balance sheets in the face of lower sovereign-debt quality and weaker growth prospects, but also from the policy response itself. The fact that Europe’s banks need massive amounts of new capital is by now generally accepted. Yet, despite valiant attempts by the new European Banking Authority to mandate and coordinate the measures that are needed, a European solution must take account of the network of foreign subsidiaries across Europe.

Mobilising support for European banks will be hard; extending it to subsidiaries will be even harder. But, unlike the ill-advised exposure to sovereign debt across Europe, cross-border banking through foreign subsidiaries has been beneficial for investors, and for home and host countries alike – nowhere more so than in emerging Central and Eastern Europe, still the most important export market for the eurozone.

For core eurozone banks, this has been a region of extraordinary returns, and it is now integral to their operations. In emerging Europe, foreign subsidiaries have helped to build financial systems that are less prone to instability, and have helped economies to converge more rapidly with average European income levels.

When the global crisis erupted in 2008, there was no regulatory framework to protect the cross-border networks, and large vulnerabilities, in the form of excessive leverage and foreign exchange, were exposed. Much has been achieved since then: balance sheets have been strengthened and funding models adjusted. Along with institutional reforms at the European level – particularly the creation of the European Systemic Risk Board and the European Banking Authority – regulation and supervision have been reinforced in subsidiaries’ host countries.

Some of this might make finance more costly, but it will also make banking operations less risky. On balance, this is a good thing.

Even so, the threat to financial stability is possibly even graver today than it was in 2008, as the capacity of Western European governments to backstop banking systems is clearly reaching its limits.

Allowing foreign banks’ subsidiaries to become orphaned amid a worsening crisis in home countries would undermine confidence in emerging Europe’s financial systems, which could trigger asset-price declines and precipitous contractions in credit. Ultimately, this would boomerang back on Western European banks, given their deep financial and real linkages with the region.

Vienna 2.0
In 2008, such a catastrophic scenario was narrowly avoided, owing to policy intervention, including the coordination effort under the so-called Vienna Initiative (in which the European Bank for Reconstruction and Development, among others, was involved). A new pact to secure the achievements of financial integration is now urgently needed. Authorities from these banks’ home and host countries must sit down together.

As with the Vienna Initiative, a “Vienna 2.0” would require commitments by all concerned parties. In responding to the higher capital requirements imposed by authorities, and choosing whether to raise more capital or sell off assets, the banks must take into account the important role that their subsidiaries play in many countries. For many banks, this happens naturally – their subsidiaries, as important value creators, are critical to their business models. For some, however, the subsidiaries are smaller relative to the parents’ size – and thus less central to their strategies.

Home countries must also contribute. Within the eurozone, any recapitalisation, guarantees, and other funds offered to parent banks should be made available to subsidiaries in equal measure. Any restructuring requested in return for capital support should take into account the cross-border nature of the groups, and not discriminate against subsidiaries abroad.

Subsidiaries’ host countries, for their part, must reassure parent banks that financial regulation will remain predictable. Some of the recent abrupt – and at times overly ambitious – measures to tax the industry or redistribute the burden of foreign-currency loans have undermined capital cushions and set back recovery in credit and growth.

All of this requires coordination. The European Banking Authority has a chance to establish itself. It must ensure that national interests do not undermine the integrity of the cross-border bank groups. Ultimately, we need a Europe-wide deposit insurance and bank-resolution authority that can take over and restructure failed banks.

Just as the eurozone has fostered financial development and economic growth among its members, the current crisis now risks inflicting severe collateral damage far beyond its borders. Any sustainable solution to the crisis must ensure the integrity of the bank groups and respect the interests of these banks’ home and host countries. Ultimately, it is cross-border banking that is in the balance.

Erik Berglof is Chief Economist, European Bank of Reconstruction and Development

Are your people a cost centre or a profit centre?

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We see it every day in the media, particularly over the past few years: “Top company cuts thousands of staff.” All too often, senior executives and managers leap to the belief that headcount equates to only cost, neglecting the value side of the equation. They look over the numbers for staff pay packets, staff benefits and various staff facilities, and panic about how much their costs are adding up. What senior executives don’t often realise is that headcount is also about driving increases in revenue and profit. As a result, most organisations are underperforming, in some cases dramatically, and don’t know why.

The good news is there is a little-known solution lurking just around the corner, ready to be brought to bear to help increase shareholder value. This solution is workforce analytics – an important tool to help companies develop a clear understanding of the value of their people and the levers that can be pulled to increase revenue and profit. These levers are simple: accurate data about getting the right number of people in the right place at the right time. Workforce analytics has been proven to help senior executives understand the contribution of headcount to profitability, and how an increase (and effective deployment) of the right kind of staff can be beneficial to the company and for shareholder return.

Indeed, while researching workforce analytics during the process of writing the upcoming book, Calculating Success, we came across evidence that leaders in many companies are managing workforces without knowing how many employees they have or how they are deployed, let alone how many more or what type of staff are needed in order to grow and expand the business. As a result, following headcount reductions caused by the financial crisis, many workforces are simply overheating under an increased workload, with too few people trying to complete too much work (and sometimes two people working on the same task without even realising it).
These are all problems that effective workforce analytics could solve.

A six-step model
Understanding workforce analytics is a discipline. It involves implementing clear set processes, creating a robust system for predictive data analytics, training up staff and getting people’s heads around it.

In Calculating Success, we developed a six-step model to simple, but effective, workforce analytics.

First, it is necessary to frame the central problem. This involves taking time to really understand the organisational issues at hand. This may involve interviewing key managers across HR, finance and other functions, as well as reviewing documents that provide context, such as organisational structure, central business initiatives and project plans.

Once the organisation issues and the problems to be solved are defined, step two involves applying a conceptual model to guide the analysis. This means it is necessary to identify workforce and business variables which are likely to have associations with the problem outcome. This may involve being alert to idiosyncratic events and additional data that could be relevant.

The third step involves capturing the relevant data across all the relevant business units, be it HR, operations, finance or marketing. Any differences in definitions, codes and time frames can then be reconciled while valid data is stored in analytical databases.

Formal quantitative techniques can then be applied to this data, looking for stable patterns over time. This fourth step is where insights to solving the business issues are developed – valid data that tells us what the real story is all about. Using this data, statistical findings should be worked through with key stakeholders to gain buy-in and take decisions at the fifth step. It is essential that these results are presented in a way that is understandable to managers who do not have a statistical background. In this stage, any new problems that surface can be considered, along with any issues which require further analysis and understanding.

Finally, action must be taken to implement solutions. This may involve operational changes in policies, procedures and management actions regarding workforce recruitment, development and deployment: designed to produce the desired changes in workforce performance. Any changes in actions should then be monitored and updated; and the six-step cycle begins again.

Counting value over cost
If more companies gain a better understanding of the value – instead of just the cost – of their workforce, they will increase productivity, and thus improve revenue and profit. In our experience (and recent studies show), organisations that see people as profit centres tend to grow in size and value, and ultimately hire more people. In many countries unemployment and underemployment is at an all-time high – but if organisations came to understand the actual value of people, this wouldn’t be the case.

The big question is, “Is your HR organisation up to the task?” And sadly, the answer tends not to be a positive one.

HR guru Professor Dave Ulrich, best known for his eponymous HR Roles Model, recently spoke at Maxxim Consulting’s recent event, “Whats next for HR?” which looked at the importance of workforce analytics in the changing HR landscape.

According to Ulrich, when HR workers are asked about the biggest challenge in their jobs, he found the answers tended to range from “building credibility with my line managers,” to “bringing in new talent,” or even “handling employee grievances.” Although all of these concerns are essential to HR (there is no opportunity for development if you cannot do the basics well) these are all problems which are associated with the administrative functions of HR, or the design of innovative practices surrounding rewards and communication. The future for HR, however, is to be able to apply HR practices to respond to external business conditions.

In other words, it is no longer enough to just think about creating value by serving employees, but by making sure that services offered inside the company align to the expectations outside of it. Every HR practice can be transformed by seeing the value that it creates for those outside of the company. This positions HR not just to respond to strategy but to helping shape and create it.

Outcomes, not actions
In order to achieve this, Ulrich says, a seismic shift needs to take place to transform the way HR is considered today. HR professionals need to begin to think more in terms of consequences, instead of actions, and focus on the phrase ‘so that.’ By appending ‘so that’ to their aims, achievements and challenges, HR professionals are pushed to see the outcome of their work – not just the work itself.

Even better, says Ulrich, is when two ‘so that’ stages can be incorporated, to connect HR with the broader context of a business. It is no longer enough to merely think “My challenge is to build credibility with my line managers.” Instead develop the statement into, for example, “My challenge is to build credibility with my line managers; so that we can make better investments that help the business reach its goals; so that we can anticipate and respond to external business conditions and deliver value to customers.” In this way, HR professionals are no longer merely responding to the administrative functions of HR, but are looking at the greater business context and expectations outside of the company.

This shift in the thinking of HR professionals, however, is highly dependent upon those professionals understanding their business context and the value of people. Unfortunately, in Ulrich’s research on HR competencies, he found that HR professionals were consistently lacking in business acumen. Indeed, many HR professionals went into HR to avoid the quantitative side of business in the first place! However, in order to move with the future of HR, it is no longer possible to side-step data, evidence and analytics – disciplines which bring rigour to HR.

As HR has become increasingly aligned with business, workforce analytics have become increasingly important. While many HR decisions require insight and judgment, improved workforce metrics helps HR move towards professional rigour. This is where workforce analytics, the topic of Calculating Success, is so essential to help HR stay ahead of the times, and become an essential component to the development of any business.

For more information – www.maxximconsulting.com

What Costa Rica’s legal reforms mean

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Opting for arbitration over costly litigation as a foreign company in Costa Rica has not always been easy. But a new arbitration law in Costa Rica has triggered a huge sigh of relief among the country’s legal community. Oller Abogados is certainly hopeful: the law firm believes that this extraordinary legal development has done wonders for the Costa Rican jurisdiction. It has turned the country into an attractive place for international commercial arbitrations.

Established in 2000, Oller Abogados has borne witness to the region’s transformation over the past decade. Latin America has emerged as one of the globe’s most economically vivacious areas. In this internationally unpredictable financial climate, South America’s emerging nations have managed to avert collapse. Pedro Oller, a founding partner at Oller Abogados, feels that Costa Rica is one of those countries. It has continued to grow at a record pace and is now at the forefront of Latin America’s economic revolution. Costa Rica’s integration into the global economy resulted in a heightened interest in international arbitration and led to an increase in local arbitration institutions and organisations – all of which are clear indicators of the growing importance of arbitration in the jurisdiction.

In recent years this reorganisation of domestic arbitral law and practice has taken on a surprisingly quickened tempo in Costa Rica, according to Oller Abogados. A reformation of laws was needed to render them more internationally competitive, and make them attractive to foreign investors. The near-complete reform that Costa Rica enacted on its outdated and criticised law of arbitration has been among the most noteworthy developments. The legal change is strongly supported by Costa Rican practitioners who recognise the increasing prominence of arbitration in Central America, says Oller.

Costa Rica’s new arbitration law
Oller Abogados has played a key part in the implementation of the new law, which involved timely deliberations before it could be passed. Oller himself discussed the law with the Minister of Justice and Peace, Hernando Paris, years before it was applied.

“Minister Paris was pushing in Congress during the latter stages of the Arias Administration for the act’s enactment,” Oller says. “At the time I took part in two interesting conferences on International Arbitration in Spain and Mexico, where I served as a panellist. When Minister Paris learned of this he invited me to discuss International Arbitration and to help him in his efforts to get the UNCITRAL [United Nations Commission on International Trade Law] model law enacted. I was extremely proud to be of assistance.”

Costa Rica’s new arbitration law is chiefly based on the UNCITRAL model law on International Commercial Arbitration as amended in 2006. Oller says this is a highly advantageous development for the region, as it now places Costa Rica on a level with Mexico, Honduras, Nicaragua, Venezuela, Guatemala, Peru, Paraguay, Chile and the Dominican Republic – all nations that have implemented the arbitration law based wholly or in part on the model law.

The adoption of this model, viewed in the context of the existing arbitration boom that is engulfing Central America, can be interpreted as representing significant progress. The legal society and foreign investors alike see it as an extremely welcome adjustment. Practitioners at Oller Abogados enthusiastically highlight that the new arbitration law will assist Costa Rica in becoming a regional arbitral centre. According to Oller Abogados, it also helps that the country has established a reputation for comparatively steady governance and a well developed transport infrastructure.

In the absence of a Latin American international arbitration centre, and considering Costa Rica’s strategic geographical location and legal culture, the country can position itself as a very good alternative for the region, Oller believes. “The new arbitration law will bring the possibility of international arbitration to Costa Rica. The enactment of the law will slowly begin to evidence its benefits once the country has instituted a credible global reputation and infrastructure; and once the world’s economy peaks again,” he says.

Advantages over previous laws
The country’s previous arbitration law was perceived burdensome even by regional standards. Under the old law it was obligatory that proceedings be held in Spanish and exclusively conducted by Costa Rican lawyers. These burdensome requirements were highly controversial, considering that the nation wanted to be recognised as an international player. But the effect of the 2011 arbitration law reform is certainly unmistakable. “The prohibitions of the old arbitration law were not based on the UNCITRAL model. Through its implementation all of that has now been rectified. We look forward to a striving arbitration culture in Costa Rica,” says Oller.

Oller Abogados points out that Costa Rica’s amended arbitral law departs from the UNCITRAL model law only minimally. The one key variation will serve to protect the various parties involved by requiring that arbitration proceedings be confidential. This is achieved by obliging that in judicial proceedings information regarding the arbitration may be revealed only to the parties and their representatives concerned. Although the new law has been received with open arms within the international arbitration community, its application by domestic courts will have to be closely monitored in the coming years, says Oller.

FDI legislation changes Costa Rica aid standing
Keeping in line with foreign influences has also played a crucial role in the implementation of other legislation in the country. Oller believes that foreign direct investment (FDI) has over the last 10 years significantly altered Costa Rica’s socio-economic and legal environment. “FDI has transformed a traditionally agricultural economy into one focusing on services and knowledge,” says Oller. “The country is currently in third place globally in terms of outsourcing. We primarily provide the outsourcing to G-12 countries.”

But it was not always possible, and at first required legislation that was sympathetic to FDI, says Oller. It was not until the end of 2009 when change occurred in aid of FDI. That was when the Free Trade Zone Regime (FTZR) was reformed to comply with the commitments Costa Rica entered into with the World Trade Organisation.

This legal overhaul brought major innovations in support of FDI to the country, says Oller Abogados, which offers expertise second-to-none in this knowledge area. According to the firm, income tax is now set at a rate of five percent for those enterprises that are part of the strategic sector, or that are in less developed areas. “Companies within the strategic sectors which maintain an investment of $10m, through a programme of investing for eight years and contracting over 100 workers, are able to keep their existing conditions,” says Oller. “Additionally, there is a tax credit of 10 percent for the reinvestment of profits, costs and training. This is done in order to promote the reinvestment of profits in Costa Rica, the training and education of local workers, as well as small companies that supply FTZR entities.”

Impact of international trade agreements in Costa Rica
Other investment barriers in Costa Rica have widely been banished with the signing of vital international trade agreements. “Costa Rica has positioned itself as a key global player with a range of free trade agreements. The CAFTA-DR [the Central America – Dominican Republic Free Trade Agreement] is one of the important ones, but there are others: such as an association agreement with the European Union that includes the various Central American countries,” says Oller. The firm also considers the bilateral FTA with China, Chile, Canada, Mexico and the upcoming agreements with Singapore and Peru are of significant importance. “All these agreements prove the country’s growing commercial strategy and push law firms and lawyers to keep up and be proactive in an international context,” Oller says.

The CAFTA-DR has established a secure and predictable environment for international investors operating in Costa Rica. The country has made important changes in its legal and regulatory framework in order to prepare for future changes and an increased international client base.

To Oller Abogados the impact of CAFTA-DR has been most visible in telecommunications and insurance, two areas the country had previously reserved to be represented exclusively by the government. Under the agreement, Costa Rica made a commitment to open sections of its insurance and telecommunications market, including internet, private network, and wireless services. CAFTA-DR also authorised six insurance companies, including a US-owned company, to compete with the former monopoly state insurance.

Oller Abogados has since observed a swelling interest in both insurance and telecoms, and has made it its business to become closely acquainted with the particularities of those sectors. “We are seeing the difficulty of adjusting to the new realities of a competitive market scene, where supervising entities are still getting their feet wet. The turnaround and specific implementation have proven cumbersome and the rules not exactly clear.”

International developments
In spite of the country’s legal evolution creating onerous new questions, Oller Abogados has stayed on top of new international laws and its clients’ needs. It predominantly serves corporate clients in a variety of sectors, including energy, agribusiness, aviation, banking and finance, IT and the environment. It excels at advising customers in the most important junctures including M&A, corporate reorganisations, litigation and project finance.

The expert team at the firm is not limited by the inflexibility of the law or a customary point of view. It goes the extra mile to apply its experience to the new arbitration law, or any other legal issue thrown at it, in a timely and reliable manner. Its expertise in government agencies and the business world has allowed it to bring a unique perspective to the corporate environment. Both domestic and international clients can rely on Oller Abogados, which has access to any jurisdiction via well-established relationships and resources.

Business, corporate and commercial representations are also at the forefront of services offered at the firm. “At Oller Abogados, we come from a long-standing family tradition within the business world. A commitment to excellence, ethical, and knowledgeable service, are the bedrock values upon which we base all of our work,” says Oller.

Oscos Abogados: insolvency legislation needs updating

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Despite the economic gains made by the world’s 11th-largest economy – the World Bank predicted Mexico to expand four percent in 2011 – its insolvency culture remains worryingly fragile and ineffective.

The issue is pressing because the US and Mexico are commercial partners under the North America Free Trade Agreement (NAFTA), worth as much as $400bn a year to both sides. But despite gains in corporate law that have strengthened the hand of some investors, and attempts to deal with bankruptcy law through the late 1990s, legislation remains mired in ideological, political and economic differences – differences that go back many, many decades.

Historical distress
More than a decade ago, the law governing the Mexican insolvency regime – the Ley de Concursos Mercantiles – arrived. Although an upgrade on its predecessor (the Bankruptcy and Suspension of Payments Law 1943), the new 2000 legislation did not, says Darío Oscós, supply the protection many still need.

“This law provides for a monolithic proceeding made up of two major stages,” says Oscós. “One, conciliation for the plan of reorganisation, and second, liquidation in bankruptcy. If no plan is reached within 185 calendar days with two possible extensions of 90 calendar days each, subject to creditors approval of 66.6 percent for the first, 90 percent for the second extension, the proceeding turns liquidation into bankruptcy.”

But in 11 years, says Oscós, there have been just 440 insolvency filings: fewer than 40 filings a year, on average. One cause is that under the former law, the debts of banking and the financial sector did not lead to insolvency proceedings. “Another cause might be that Mexican insolvency statutes remain riven, still, with the old Spanish laws of another century. That is why it is of essence to have in Mexico a new 21st century insolvency law.”

Oscós feels his law firm has set a milestone, by “successfully adjudicating the first and second case ever in the world that recognised and fully enforced another country’s insolvency proceedings under the UNCITRAL [UN Commission on International Trade Law] model law on Cross-Border Insolvency,” he says. This move has also been adopted, inter alia, by the US, UK, Canada and Japan.

Milestone
But protection is still needed, especially when trouble blows up. Following the credit seizure of 2008, many large Mexican corporations quickly ran into debt-servicing difficulties, which severely tested the strengths and weaknesses of the current regime. The law was found, in many cases, severely wanting.

Look no further than Mexican glassmaker Vitro SAB (see below). It makes everything from perfume containers for luxury fragrance and cosmetics brands, to beer bottles; and has defaulted on $1.5bn of debt. Not surprisingly, lawmakers are unhappy about Vitro’s use of up to $1.9bn (estimated figures) of debt to control bankruptcy proceedings in Mexico.

However, Oscós Abogados is now playing a major role in the insolvency proceedings of this case, following previous wins, helped by close, clever argument.

The issue has even roused three US Republican Representatives, who are lobbying Secretary of State Hillary Clinton about the issue: warning of the dangers of Vitro being permitted to move forward with a restructuring plan despite the objections of major US bondholders. The Dow Jones Daily Bankruptcy Review reported recently: “If allowed to stand, Vitro’s manoeuvres will have a chilling effect on US investment abroad, particularly in Mexico, and will set a dangerous precedent for companies seeking to mitigate equity loss when faced with bankruptcy.”

And the accompanying costs could be dramatic, with additional risk premiums being charged or attached. Mexican companies, be in no doubt, will pay the price; international investors may also fight shy of putting their money into Mexican companies that are not listed on the NYSE, LSE or other exchanges.

Double trouble
But in order to understand the need for change, some understanding of the past is needed. What went wrong with the 2000 legislation, the Ley de Concursos Mercantiles? Was it that bad? “It was guided with the help of the World Bank and the International Monetary Fund comprising the newest regulations at the time. However, the statute failed to incorporate all of them,” says Oscós.

Disappointingly, this 2000 Ley de Concursos Mercantiles was intended to be the model for other transformative business legislation, he says. So the impact has been considerable – not all for positive reasons – in other areas.

In fact, Mexico has a double insolvency system. The first, concurso mercantile, is for commerce; the second, concurso civil, is aimed at non-commerce or consumers, both individuals and legal entities. “Concurso mercantil is governed by a federal law, Ley de Concursos Mercantiles, enacted in May 2000,” explains Oscós. “Concurso civil is an estate regulation, governed by each estate’s civil code, patterned in the Civil Code for the Federal District, enacted 1932. Insolvency petitions are not mandatory. In case there is no plan of reorganisation, estate assets can be liquidated.”

Mind the gap
But there are no provisions in either concurso mercantil or concurso civil for discharge, except with creditors’ approval. Nor does either system provide for dischargeable debts. Under both concurso mercantil and concurso civil, the debtor remains liable after liquidation for any deficiency owed to creditors after liquidation and/or distribution: there is no fresh start, Oscós warns.

As mentioned at an earlier stage, between 2000 and July 2011, there were just 440 applications filed for concurso mercantil, involuntary and voluntary. “From these 440 applications only 267 were adjudicated in concurso mercantile,” clarifies Oscós. “Of which 245 have been terminated for different causes, and of which only very few were terminated by the plan of reorganisation – less than four percent. In this mater, less than one percent of the plan of reorganisation cases have been successful.”

Furthermore, in a closer analysis, in the first half of 2011 there were 39 petitions for concurso mercantil filed, of which 79.9 percent were involuntary.

Stay or run?
For the time-being, debtors are seeking out-of-court reorganisations and settlements, says Oscós. “As the financial situation becomes worse, and with rescue programmes being insufficient, it is expected that there will be an increase in insolvencies and eventual liquidations. In some cases there may be a plan of reorganisation settled by debtors and creditors to overcome a financial distress situation as a transitory vehicle.”

On the other hand, distressed financial entities may just shutter their business and attempt to run. Oscós Abogados also anticipates that more creditor foreclosures will occur, since concurso mercantil (insolvency) is not mandatory, he warns.

The future
A new insolvency system, Oscós says, should ensure bankruptcy protection, even before a company gets even close to becoming insolvent, eliminating the current insolvency standard. “There should be voluntary or involuntary reorganisation and liquidation in bankruptcy in separate independent proceedings upon petition of debtor or creditors, and it should incentivise legal discharge for a fresh start, when viable, whether in reorganisation or liquidation, providing for timely, orderly, efficient and effective liquidation.”

There should also be room for post-insolvency financing, effective enforcement of voidance actions of fraudulent preferences, transfers and conveyances – plus a regime for groups of companies and consolidation, as well as joint administration of insolvency proceedings, provisions on intercompany debt and adequate provisions to privilege a reorganisation plan in any reorganisation or liquidation. Quite a list, all in all.

“In essence,” says Oscós, “There is an urgent need for an insolvency regime that timely and efficiently prevents, when possible, insolvency; as well as a regime that timely and efficiently protects from insolvency; comprising in the respective regime, if not all, then at least most agents of the economy, whether consumers or legal entities in general.”

All eyes on Davos

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Every year the founder of the World Economic Forum, Klaus Schwab, draws up a highly intellectual agenda to focus the minds of the heads of state, Fortune 500 chief executives, billionaires and heads of charities who attend its annual meeting in Davos, high on the ski slopes of the Swiss mountains.

But generally, according to veterans of these five days of seminars, inspiring speeches, private conversations and back-slapping, most attendees ignore Schwab’s riding instructions.

Instead they stick to their own agenda, which is to get their money’s worth from the year’s most expensive conference, with furious networking, deal-making and profile-building. But for the 2012 version of this long-running event, the stakes have never been higher; as the global elite face what Schwab has labelled “The Great Transformation.” The big issue will be whether the world’s most influential people can make the difference that is expected of them.

So far their score is probably a pass, at best. Can Davos Man rise to the occasion?

Who is Davos Man?
A term coined by the late American political scientist Samuel Huntington in 1977 – just as the modern version of the meeting was taking shape – Davos Man is an elite individual dedicated to the advancement of his own interests and those of his fellows, rather than to the betterment of the world. As Huntington described them, such people “have little need for national loyalty, view national boundaries as obstacles that are thankfully vanishing, and see national governments as residues from the past whose only useful function is to facilitate the elite’s global operations.”

Come January, Davos Man needs to prove Huntington’s description wrong. As the globe’s power brokers, the 2,000-odd attendees have never been under more pressure to come up with answers to a towering set of global challenges. An old Europe facing a lost decade, the fading influence of America as the world’s economic powerhouse and moral leader, ruinous turmoil in currency markets, upheavals in the financial sector, sky-rocketing young unemployment throughout entire regions, actual and imminent collapse of dictatorships in North Africa and the Middle East: these are some of the cataclysmic issues that, whether they like it or not, have landed in the lap of the World Economic Forum.

So are they up to it? The atmosphere should help. This is purpose-designed as neutral ground. One of the genuine advantages of Davos compared with, say, a G20 meeting – with its grand-standing, politicking, protocol-conscious, head-of-state atmosphere – is that it’s the exact opposite. The only protocol is informality: slacks and jacket for men, jeans and whatever for women, are practically de rigueur. Heads of state attend, but only as individuals, without plane-loads of advisers.

Nor does grandstanding work well in a deliberately informal exchange of ideas. Besides, any attendee can simply fire through a request for a chat via the in-house computer system, and so can outsiders put a question to presidents and billionaires alike via YouTube. The most valuable intellectual property at Davos is the two-inch thick volume of the attendees that every arrival is given when they register.

And while attendance is not officially required at any of the seminars or 200-odd informal sessions, it’s frowned upon to spend the five days closeted in back rooms doing deals. Some show of public-spiritedness is considered part of the Davos obligation.

Intellectual firepower
But how much can be achieved in five days? For a start there will be plenty of financial and intellectual firepower present. According to Forbes magazine, no fewer than 69 billionaires from 20 countries attended last year’s event, and their combined value is likely to be much the same in 2012. In purely financial terms, they represent something like $427bn.

For security reasons the names of the VIP guests are not released until the last minute, but many would like to see a more convincing presence than hitherto from the Obama administration. So far the US president has sent only a token representation, quite unlike Davos fan Bill Clinton, who was the first incumbent president to make the trip to the wealthy little mountain resort.

Also notable by their absence are church leaders, who are outnumbered by businesspeople at a rough 100-to-one ratio. Union bosses are in much the same position.

Most of the billionaires will come from the US, followed by India, and probably Russia in third. Last year president Dmitry Medvedev had nine oligarchs in tow. Among the big names expected to attend again are Stephen Schwarzmann and Henry Kravis, founders of private equity giant KKR; hedge fund legend and philanthropist George Soros; Google founders Sergey Brin and Eric Schmidt; and India steel baron Lakshmi Mittal.

And Bill Gates, who will celebrate his 17th year, wouldn’t miss it. But as he has pointed out, today’s gatherings are very different from his first. “When I started going in 1990, the focus was on the wonders of technology, and the hot panels were the ones where engineers like myself would discuss how things would improve using technology,” he said in 2010.

That idealism has since been replaced by the realisation that technology hasn’t got anything like all the answers, and that we have arrived at a great transformation that requires much deeper answers than faster internet, dazzling software or iPhones.

On the bright side, some participants think they can see a deeper appreciation of the world’s problems than that displayed by the nerds of yesteryear. “I witnessed more honesty and straight talk between the private sector, multilateral agencies, governments and NGOs as they look to de-risk the planet,” said Mark Foster, a senior executive from consultancy Accenture, of the 2011 event.

However, if Davos is to establish itself as a forum of real importance, it will have to do better on these towering Richter-scale issues. Despite the presence of senior bankers, heads of state, the biggest investors, global consultancies and the requisite billionaires at the last two forums, none of the looming, post-financial crisis issues are any closer to a solution.

Looking for the next Infosys

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Sachin Bansal and Binny Bansal are not identical twins, or even related, but they should be. They both grew up in Chandigarh in north-west India, studied computer engineering at the Indian Institute of Technology Delhi, and spent a brief stint working for the same American technology firm. Two years after meeting in Delhi in 2005 they took $10,000 of their savings, set up shop in a flat in Bangalore and began an e-commerce business that delivered books to people’s homes – like Amazon, but with an Indian twist.

Making the leap, says Binny Bansal, “wasn’t difficult.” Today the firm they co-founded, Flipkart, is one of India’s hottest internet businesses, selling everything from books to phones. The site clocks up sales of $10m a month from over one million registered users. Flipkart is said to be negotiating a fourth round of funding from venture-capital firms at an appropriately stonking valuation.

Such success stories should be what India is all about. But there is a nagging worry that there are far more consultants, bankers, academics and journalists celebrating India’s entrepreneurial zeal than people actually starting new companies. Take the latest figures from the Indian Institute of Management Ahmedabad (IIMA), India’s leading business school. Of the 314 graduates from its flagship programme, only seven started a business. An amazing 187 joined the gravy train and got jobs in consulting or finance – the kind of statistic common in rich countries, which is now taken as a symptom of their decline. One bigwig at a large Indian firm says he implores his younger relatives: “Make something. Don’t just look at numbers and criticise things.” But he admits defeat. They are all becoming spreadsheet wizards at banks.

The sense that entrepreneurs have not made the kind of mark they should have in the past decade seems to be true across the Indian economy. In a paper published by the IMF in January, three economists, Ashoka Mody, Anusha Nath and Michael Walton, looked at the Bombay Stock Exchange, a decent proxy for India’s formal business sector, with thousands of firms listed on it, many very small. They concluded that in the 1990s there was a surge of new firms without affiliation to established family-controlled houses, but that in the past decade the process of new entry “virtually stopped.”

Similarly, the share of profits from new, independent companies, having risen rapidly in the 1990s, has since stagnated. Many business folk reckon that the relatively few newcomers that have made it big since 2000 are in old-economy “rent-seeking” sectors that require more brawn than innovation.

It’s not difficult to rustle up some possible reasons for all this. India scores abysmally in the World Bank’s global surveys of how easy it is to start a new firm. Given the propensity of established firms to diversify into new areas, it seems likely that start-ups are sometimes crowded out. India’s banks are not huge fans of lending to small firms; they often demand onerous amounts of collateral or security on fixed assets, exactly the kinds of things start-ups cannot provide. There is a decent enough venture-capital industry, but even so, new firms face hurdles that do not exist in other countries, which may require them to invest more heavily upfront. Flipkart is a good illustration of this – with a happy ending.

It began as a Western firm might, as the middleman between book wholesalers and its customers, using third-party couriers to deliver to people’s homes nationwide. But Flipkart soon overwhelmed the local wholesalers and courier firms in Bangalore. To cope, it has now built five warehouses nationwide and hired an army of delivery staff. In India “you don’t have reliable service providers like DHL,” says Binny Bansal. A round of fund-raising in 2009 helped pay for these investments. By 2010 another problem had to be addressed: not many Indians have credit cards, and those that do worry about security. The solution was to accept cash, or more recently credit cards, at the doorstep. Meanwhile, Flipkart must also contend with the big business groups, like Reliance Industries, which are interested in retail. The hope is that Flipkart’s heavy and early investment in its brand, including a big television campaign, will be enough of a defence when the big boys move in.

To succeed in India, then, Flipkart, like most bigger firms, has had to integrate vertically, taking on more processes itself, from storage to delivery and payments. That costs serious money. And from an early stage it has had to anticipate a competitive threat from the big family giants. The upshot is that although India’s e-commerce opportunity is huge, the barriers to small firms are quite big too, requiring more capital, earlier, than might otherwise be the case. In the dotcom industry such funds are at least relatively easy to obtain. Ashok Kurien, the former Thums Up marketer, and since then a serial entrepreneur, is involved with several websites. One of them, called Bollywood Life, received two million unique visitors within 90 days of launch. He has already had “ridiculous offers” from outside investors, he beams.

Outside the dotcom industry, though, raising money is more of a slog. And there are big barriers to entry, just of a different sort. Memories of how much effort it took to succeed are common the world over, but in India, it often seems that an extra push was required. Haresh Chawla, the chief executive of Network 18, a broadcaster, says that when it launched its news channels in 2004-5, in partnership with CNN and CNBC, it threw everything at it. “Consumers only give you one chance,” he says. In 2008 his firm launched Colors, a Hindi entertainment channel that became top-rated within nine months of its launch. It spent $125m up front on programming and promotions rather than engage in a long war of attrition with the established channels. “You cannot tiptoe in India,” he says.

Just fill in a few forms first
Banking may present start-ups with the most formidable hurdles of all, in the form of India’s financial regulators, and consumers’ preference for established lenders, particularly state-owned ones. Rana Kapoor, who in 2004 founded Yes Bank, now one of the larger private players, jokes that getting a licence was a “Himalayan task,” taking over a year, while building the business was a “Herculean” one. “As part of our business culture, nobody helps the underdog,” he says. Yes Bank broke through, Mr Kapoor says, partly by focusing on squeaky-clean corporate governance from day one, and listing the firm as soon as possible to gain attention and credibility.

And yet, for all these barriers, new firms are emerging in unexpected places. Vinayak Chatterjee, who graduated from IIMA in 1981, first joined a consumer-goods firm. After deciding against a life-sentence of selling soap, he went on to establish Feedback Infra, an engineering and consulting firm in Delhi that specialises in infrastructure projects. With 1,250-odd staff, half of them engineers, and a list of blue-chip and government clients, it exemplifies the kind of high-end services that India could excel at. Mr Chatterjee reckons his costs are a quarter of rich-world firms’. Big parts of this business are “no different fundamentally from IT outsourcing,” he says. The priority for now, though, is to build scale at home. With about $50m of revenue, growing by about 30 percent a year, the firm is on its way to that goal. A flotation would be a natural next stage in a few years’ time.

Almost every investor and financial rag has a list of their favourite entrepreneurs. The question for India is whether a few impressive examples here and there add up to a trend. The data for the past decade look disappointing, suggesting that things have deteriorated since the 1990s. The hope is that this is a backward-looking signal about the dynamism of Indian capitalism. Vijay Angadi, a veteran of small-company investing in India who runs Novastar, a $200m fund, is confident that a new generation of firms will come through eventually. He reckons that the first initial public offering of a venture-backed start-up in India took place only in 2004. He is optimistic that the venture-capital industry has become more open-minded, and is no longer obsessed solely with technology firms. Wealthy angel investors are becoming more important, too. A decade ago, approached by an entrepreneur who was not in the family, “they would have laughed him out.” Now, however, they might write a cheque.

And when it comes to small firms, India certainly has a lot of raw material. W. Sean Sovak of Lighthouse, a private-equity fund based in Mumbai that is focused on small companies, reckons there are some 2,000 firms listed on Mumbai’s stock exchange that are active and have market values of below $200m. He first visited India in 2004 and was “blown away” by its vigour. He and his co-founder, Mukund Krishnaswami, an American whose parents emigrated from India, both chucked in careers in America investing in small firms and headed to Mumbai to set up Lighthouse in 2006. Mr Sovak cautions that all is not rosy; many small firms are in commoditised businesses, he says, and even high-quality firms “face lots of challenges” and may struggle to manage their growth. But he too is optimistic. “We’ve seen some of the best entrepreneurs of our lives here,” he says.

Will they succeed? Mr Bansal of Flipkart reckons so. “Between 2004 and 2009 there was not a lot coming out in terms of entrepreneurs,” he says. But over time they will begin to challenge the established business order. “In five to 10 years you will see a shift happening,” he predicts. It is vital for Indian capitalism that he is proved right.