The French socialist government presented its 2015 budget with the aim of reducing its public spending – almost the highest in the EU – and lowering its budget deficit.
The deficit is projected to reach 4.4 percent of national income in 2014 before dropping to 4.3 percent in 2015 and 2.8 percent in 2017. But the reduction is not enough to meet an EU target of 3 percent by the end of next year.
The EU deadline set for achieving the reduction to 3 percent had already been extended twice
The plans, which are the most drastic seen since Hollande came to power in May 2012, involve cutting the state’s budget by €21bn in 2015 to achieve an overall reduction of €50bn by 2017. Sectors targeted include the welfare system, civil servants and local authorities.
The EU deadline set for achieving the reduction to 3 percent had already been extended twice. But Finance Minister Michel Sapin said the most recent projections are “realistic” given the eurozone’s low inflation rates and the country’s slow economic growth. He told a news conference at the finance ministry: “We are committed to being serious about the budget, but we refuse austerity”. He added that “the French will not be asked to make an additional effort” for fear of damaging economic growth and causing a recession.
In 2016 France’s public debt is expected to hit a high of 98 percent of annual output. It reached a record high in the first half of 2014, topping €2trn.
The country aims to cut its structural deficit by 2.4 percent of GDP in 2014 but next year that reduction will slump to 2.2 percent. Public spending is set to reach a high of 56.5 percent of GDP in 2014 and drop to 54.5 percent in three years’ time.
According to the FT, France is set for talks with the EU, in which Sapin plans to maintain that the country’s situation is “legitimate and [well] argued”.
World Finance: 35 hour work weeks, strikes, astronomical tax, super-rich fleeing the country and getting citizenship abroad. That’s what we hear about France, and it sounds like bad news for the economy. But with a cabinet reshuffle, is there light at the end of the Eurotunnel? With me now is Gaspard Koenig, founder of the French think-tank GenerationLibre.
Public spending as a proportion of GDP is 57 percent, which makes it the seventh largest in the world, after countries such as Cuba and Lesotho. France is really doing extremely badly in terms of its public sector.
Another thing that is linked to that is weight of public investment in the country. France has built a traditional public sector, which in itself is not bad. It’s healthy. But it’s now tied with so many regulations – it’s stifled by so many statutes – that it is paralysing our economy.
World Finance: Well Francois Hollande, he’s the man who introduced a 75 percent tax on the rich. That can’t help the situation, so what was he thinking?
Gaspard Koenig: It’s a symbolic measure. You have to bear in mind for instance that income tax in France only makes up 15 percent of the state’s tax revenues. So people are always arguing passionately about the income tax, but it’s a marginal fraction of the tax that the state actually takes from people. It’s just that they don’t see it.
It’s a typical political trap, because it created enormous debate. It clearly tilted the election for Francois Hollande, because people thought, ‘Aw, finally this guy has guts.’ And it is just unimplementable, and actually not implemented at all.
And this is the kind of reform they don’t want to do, because they know it is stupid.
World Finance: The French do have a reputation for being a bit work-shy, with their 35 hour work weeks. Do you think this is fair?
Gaspard Koenig: Exactly like the 55 percent tax, the 35 hour week is merely symbolic, and doesn’t have much effect in the daily behaviour of workers.
[T]his is the kind of reform they don’t want to do, because they know it is stupid
So the average time that French workers do work in a week is 39.5 hours, which makes France among the 20 top countries where people work the most. And the productivity of workers is the third in the world.
World Finance: So why then did it ruffle so many feathers when Macron suggested abolishing the 35 hour work week?
Gaspard Koenig: Most of the people behind the scenes know exactly what needs to be done. But very few people can stand up politically to that, and very few people have the courage to confront the unions… and honestly, to confront the system.
You know, I was a speechwriter for Christine Lagarde for three years when she was a treasury minister. I got to see a lot of those meetings. And I think France is very corrupt. At the top of it, especially in the public sector or para-public sector, you have many people who hold each other.
It’s extremely difficult, where you don’t have a clear mandate. The only person who would be able to make those cooperations is a president clearly elected with a clear majority and a clear mandate.
World Finance: Well finally, how does France compare to more healthy economies such as Germany, and maybe even the UK, which is slated to take France’s place as the fifth-largest economy in the world by 2020?
Gaspard Koenig: Yeah, it’s been some years if not decades that the UK’s supposed to overtake us! I think we have a bit of time. Don’t forget the UK is the old fool. We still have some pride!
France is such a wealthy country compared to the UK
You know what really amazes me is that France is such a wealthy country compared to the UK. Especially when you live in the UK, when you drive through the UK. It’s a country that really made a lot out of very little. Because they took risks, because they encouraged people to come from abroad and to help them build an economy, and they proved to be rather pragmatic.
In France it seems we’re so jaded. We have everything at home: we have a country which is rather healthy economically, we have people who are well educated, good infrastructure, and we sort of mess it up with very, very, very bad policies. And that’s extremely frustrating. And this is part of the reason why so many people are active, in order to turn that around. Because we feel we have incredible assets, and they’re about to get lost if we don’t react quite urgently.
Pimco’s bond fund, once the largest in the world, suffered from redemptions totalling $23.5bn in September, making it the largest amount to be pulled from the fund in a single month in more than a year. That brings the total outflows for 2014 up to $50bn and sees the fund having dropped from $290bn in 2013 to less than $200bn.
The fund is well positioned to meet potential redemptions – Pimco
The unprecedented departure of the fund’s co-founder and Chief Investment Officer Bill Gross sparked an immediate and abnormally high succession of outflows. The Wall Street Journal reported redemptions reached $10bn after the news of his exit, with outflows then slowing after the first few days, according to Pimco.
Morningstar consultancy downgraded the fund’s rating from Gold to Bronze. Eric Jacobson, Senior Analyst in Active Strategies, said the downgrade “reflects Morningstar’s high level of confidence in Pimco’s resources and overall abilities but also the uncertainty as to exactly how all of these parts will mesh in the wake of Gross’ departure”.
Competitor funds have felt the benefits, with DoubleLine reported to have received a boost of $800m from new investors over the space of three days. Rival Vanguard was even rejecting investment offers to ward off those only in it for the short-term.
Investors had been pulling money from the fund since the Federal Reserve’s announcement last year that it would tighten monetary policy.
Pimco said it was able to cope with outflows, commenting in a statement: “The core fixed income market in which the Total Return fund invests is one of the largest and most liquid markets in the world, trading on average $700bn of securities a day”. It added: “The fund is well positioned to meet potential redemptions, and short-term cash management is an area of expertise and strength at Pimco.”
But analysts believe that more money may soon be pulled from the fund. Pimco’s new managers have been discussing the matter in conference calls with investors in an attempt to stabilise the situation.
World Finance: So: a new economy minister for France. Is he the man to turn the country around?
Gaspard Koenig: He is clearly well-educated, understands the economy… has a grasp of it, at least. Much more than his predecessor.
Belongs to the modern, reformist, new-labour sort of the left. So it was extremely encouraging, and not only for him, but also there were many other appointees under him. They all belong to the same generation, and I thought clearly Valls – the prime minister – is about to wipe out the socialist party! And replace the old grandees with this young generation, which is globalised, knows the economy, and could really move the country forward.
World Finance: Well the former economy minister Arnaud Montebourge, he was known for turning away steel company Mittal, saying it wasn’t welcome in France. So now this new economy minister – is this the start of France turning its back on its socialist roots?
Gaspard Koenig: Montebourge was very vocal in the fact that he was a protectionist. He really wants to revive Colbertism, to revive borders, to repatriate all industries in France. So he’s living in the old industrial age.
Clearly Valls, the prime minister, is about to wipe out the socialist party, but it lasted for about 14 days. Because the majority is so slim in parliament: the socialist party only has a one member majority, and among their 300 plus MPs, there are between 50 and 100 of them who are strongly opposed to the new policies of the government because they’re really lefty.
World Finance: So socialism and economics; do they work together, and are there lessons to be learned from France?
Gaspard Koenig: The agenda of Ed Miliband is very similar to that of Francois Hollande at the beginning of his tenure, so I think you should be very careful in the UK not to replicate the same mistakes.
It’s all a question of principles. There was this little pamphlet by Jonathan Swift at the beginning of the 18th century. And at the time there was a very big crisis in Ireland, because people were starving and there were too many children.
Just for fun, if you want – to be provocative – he said, ‘Well, people should eat the children, and then you resolve both problems at the same time.’
The thing is, economically, it makes sense. Economically, if you have a problem with pensions, you could send all the pensioners overseas. It makes sense economically. But why don’t you do it? Because you have principles which are not economic: which are philosophical, if you want.
And so, if you believe in socialism, you’ll find an economy that will make it work. If you believe in capitalism, you’ll find an economic way to make it work.
In regards to its economy, France has been called the ‘sick man of Europe’. But does it deserve such a reputation when compared to economies such as Italy and Greece? World Finance speaks to Gaspard Koenig, President of the think-tank GenerationLibre, to hear his views.
World Finance: France is known as the ‘sick man of Europe’. But is this fair, considering the state of economies such as Italy and Greece?
Gaspard Koenig: It’s a situation many countries went through. The UK was branded the sick man of Europe in the 70s, and Germany in the 2000s.
France is the man that is the most problematic to Europe. Greece represents one percent of European GDP, so we can still come together and help Greece out. The problem is that France’s economy is structurally embedded in the European system, and in a way I think a model for many Mediterranean countries.
The day when France starts reforming itself, I think the rest will follow.
World Finance: But with inflation down to just 0.4 percent – way below the European Central Bank’s target – and France not likely to meet its EU deficit target until 2017, many are blaming French president Francois Hollande’s administration.
Gaspard Koenig: Structurally, Francois Hollande has only pursued the economic policies of his predecessor. There is very little difference between Francois Holland and Nicolas Sarkozy. Sarkozy’s public investment was up to €2.3bn a year, and Francois Holland’s is €2.2bn.
They cannot think in terms of major structural reforms. They haven’t for decades.
World Finance: But still as the world’s fifth-largest economy and Europe’s second, France – despite its ailments – is still a force to be reckoned with. And with a new economy minister in place, the world is watching to see if reform is genuinely on the cards.
The Czech banking landscape is known for its strong risk-adjusted stability, and with prudent macro-economic policies and government finances, the country offers a stable operating environment for banks. World Finance speaks to Equa Bank’s Chief Financial Officer, Monika Kristková, and Head of Retail Banking, Jakub Pavel to find out more.
World Finance: Well Monika, if we might start with the Czech economy, how is is structured exactly?
Monika Kristková: The Czech Republic is an open, small, export-driven economy. Eighty percent of its GDP is comprised of exports, mainly automotive, and the engineering industry. We have very skilled, still cheap labour force. We have one of the lowest unemployment rates in Europe, 7.4 is the latest figure. The financial system is mainly bank based, we are operating in a low interest rate environment, and low inflation environment, as the rest of Europe right now.
World Finance: And Czech banking, obviously a stable industry, but how developed is it?
Monika Kristková: There are a few new players in the market right now, who bring a new competitive environment to the banking sector, they bring new technologies, new product innovations. In general, we are one of the countries that has most rapid penetration of mobile banking, online banking, the contactless payment or credit cards are a big trend right now. We have one bank account per inhabitant, one card per inhabitant, and 70 percent of all accounts have online banking services.
A certain slowdown on the German economy could jeopardise the fragile Czech growth
World Finance: Well consumer and business confidence is closely tied to external developments, and the Czech economy is highly export oriented. What challenges does this pose, and how does Equa Bank approach them?
Monika Kristková: Indeed, the Czech economy is highly dependent on foreign demand, therefore a certain slowdown on the German economy could jeopardise the fragile Czech growth. Indeed, we would not have to want to face another wave of recession. However, it needs to be said that the Czech national bank has the ability to use the floating exchange rate to mitigate the deflation tendencies from abroad. Therefore, the risk is lower. Equa Bank has demonstrated an ability to grow even in the stagnations times during the last two years, for twofold growth every year. Our loan portfolio has grown 96 percent, our deposit has grown 112 percent. Therefore, we are not afraid.
World Finance: Well according to the Czech national bank, Czech household debt increased annually by over 43bn CZK, and analysts have suggested that record mortgage rates are a contributing factor. Do you think this is fair?
Monika Kristková: According to the latest data, consumer debt has grown even 53bn CZK, and out of that 48 is household debt, and our mortgage rates are indeed in record lows, already for 1.5 years, so indeed that’s a major factor. On the other hand, consumer confidence was very strong in the first quarter of 2014. Also, terms and conditions, especially the fee conditions due to the strong competition in the banking sector, are tending to ease. At the same time, the underwriting criteria and standards have been kept the same. So all that together definitely impacts the increase in household housing debt.
World Finance: Well Jakub, over to you now, and mortgages are a large part of Equa Bank’s business. How have you adapted to client needs?
People in Czech Republic are very conservative, especially the cash-loan segment
Jakub Pavel: Actually, we didn’t have to adapt only to the client needs, but also to the needs of brokers who sell more than two thirds of all the new mortgages in the Czech Republic. So, as we had a few branches at the beginning, we actually had to tackle both the product propositions and the sales channel proposition. We started with refinancing. Refinancing was a big opportunity at the time, the big banks mostly neglected it, and a large portion of the mortgage portfolio, the interest rate fix was actually expiring. So we came up with the easiest refinancing product on the market, which was also a nice tie to the broker strategy, because they would call, before the end of the interest rate fixed period, they would call the client typically and offer a better rate. So our product came in very handy at the time, and gradually we were adding more and more mortgage products to the mix, but the refinancing product helped us to book great volumes at the very beginning.
World Finance: And what areas are you focusing on for future development?
Jakub Pavel: We are looking at sales channels, we would like to more than double the number of branches we would have by the end of next year. The reason being, people in Czech Republic are very conservative, especially the cash-loan segment. We will be building mortgage centres in order to be able to approach mortgage brokers who don’t want to deal through front-end systems, but rather face-to-face with the bank, there are still many of those. In terms of products, we are looking into tapping into a more affluent segment with more affluent debit cards with products attached to it such as assistant services or insurance services. We are looking into broadening our range of savings accounts products, In terms of lending, we are working on consolidated loans, not only on personal basis but also on a family basis. Going into the future, we are trying to implement pre-approved loans, also personal and family. Consolidation going into the future, that about sums it up.
In a series of World Finance interviews, we speak to Professor Janet Hunt, Economic Historian at the London School of Economics and Political Sciences, about the impact Abenomics is likely to have on Japan’s economy.
Part 1: Can Japanese PM Shinzo Abe end the country’s deflationary spiral?
World Finance: Janet, a lot of money and effort has been spent on getting Japan away from its dark deflationary past; do you think Japan is on the path that it needs to be on, in terms of its economic progress?
Janet Hunter: There’s a lot of evidence that it has increased confidence, it has increased the extent to which people are willing to spend. That in terms gives a stimulus to growth.
Whether it has progressed as far and as fast as people would like – that’s much more difficult. Because I think one of the things that we have to remember is that the sort of, third arrow of Abenomics, was structural change in the economy.
If the stimulus from the shorter-term fiscal policy is going to be sustained, he really has to deliver on structural change, and that’s a very difficult thing to do – particularly over a short time period.
There are clearly significant political constraints.
It is probably the only Japanese political party that has a degree of credibility
What I think we do have to remember is that Abe leads the largest party. It is probably the only Japanese political party that has a degree of credibility, and outweighs the other political parties collectively.
However, it is not unified within itself; it is divided; there are different views as to how best to go forward.
In some ways, politically, Abe has probably got the best chance of any political leader trying to carry this sort of thing through.
But he has to cope with his own party, he has to cope with the constraints of two houses of parliament, local government, local interests.
But I think the other thing that makes that the kind of radical, fast reform very difficult, is just people are conservative. Organisations are conservative. It is very difficult to change the way that people think, and act, and organise themselves overnight.
Part 2: Why is structural reform so hard to achieve?
World Finance: Take me into the Japanese psyche and explain to me: why is it so difficult for them to be open to change that in any other modern democracy, any other robust economic system, has already become commonplace?
Janet Hunter: I’m not actually convinced that change in other places is that easy either!
World Finance: But there is more of an appetite for change…
Janet Hunter: There may be more of an appetite for change.
World Finance: …you could say, in for instance the UK and the US.
Janet Hunter: Perhaps there is, and I think, as you indicated earlier, part of the answer to that lies in the nature of the political system and the way that people vote.
Any system that appears to deliver success generates vested interests, which make it more difficult to change.
If you can say that something has worked for 30 years, then it takes people a while to realise that it’s not working anymore. And it also makes it much more difficult to see what is going to work.
There’s quite a big appetite for change, but there’s also a feeling that they shouldn’t throw out the good things that they have, and a reluctance to do exactly what America might do, or England might do, or whatever.
So the question is really: who is going to bear the cost of the change?
World Finance: But there is a certain reality that everyone has to confront. And that’s economic reality the country’s in, they wouldn’t be pushing for such dramatic stimulus programmes if there wasn’t a need. Is that not enough to get people to want to change?
Janet Hunter: It’s clearly a significant factor, that people do recognise they have to face reality. And almost any Japanese person you might talk to will say, ‘Yes, we do need to change.’ But what we have to remember is that change comes at a price. It has a human cost.
And in any environment, if the cost is your job, or your livelihood, then change is going to be more difficult.
So the question is really: who is going to bear the cost of the change? In an environment where you have very strong vested interests, and really quite a conservative way of doing society?
Part 3: Will cutting corporation tax help or hinder Japan’s recovery?
World Finance: A slash in the corporate tax rate from 35 to 29 percent – are we seeing a system that is being structured in a way that will allow money to filter from the top to the rest?
Janet Hunter: In relation to the corporate tax, I think those of us outside Japan tend very often to forget that small businesses, family businesses, are enormously important in Japan.
I think the image that we often have is that the big businesses – the Toyotas – that is what Japanese business is. And clearly it’s a big part of Japanese business. But if you look at the predominance of small business and family business in Japan, it is far far greater than in England or the US. It is more comparable to what you’d find in, say, Germany. It’s a very big part of the economy.
So you could argue that by reducing corporation tax, you’re also assisting the smaller elements in Japanese business. And that’s very important for the domestic market and also for the external market.
As you say – quite rightly – you’ve got a situation in which there are lots of people who aren’t involved in business who aren’t going to be affected by that. Interest rates remain incredibly low in Japan, so for example, taking out a mortgage is not costly at the moment at all. It also means that saving is not very well remunerated. So in theory, people ought to be spending.
Where I think the problem has been is almost in terms of confidence. Not that people don’t have the money to spend – they just don’t have the confidence in the future. And that is one of the things that is very difficult to turn around. And I think Abe has to some extent begun to turn it around. But I think it’s really difficult.
Part 4: Will Japan’s special economic zones work?
World Finance:Now let’s talk about the Special Economic Zones that Abe is creating.
Janet Hunter: An economic zone in the same way as China in the 1990s developed economic zones, is not going to work in a very high income, high industrial economy such as Japan.
[H]e will be credited with some of the success for bringing Japan out of what has really been two decades of economic problems
I think if you see an economic zone as a way of trying to open up the Japanese economy – to deregulate what’s already there, to try to encourage foreign firms to come in – then clearly that may have significant advantages.
But Japan, as you will be aware, has conventionally had – in some respects – a very highly regulated economy. And there’s got to be a lot of evidence that it’s going to work, to attract people.
And I think the other thing is that conventionally, special economic zones have often been – as they have been in other parts of Asia – to allow foreign firms to come in and invest in local, cheap labour.
Japan’s labour is not cheap. At all.
There’s much less experience, I think, of how an economic zone might work in a country such as Japan.
Part 5: Is the outside world too judgemental of Japan’s economic efforts?
World Finance: Janet, do you think that I’m too judgemental? When I say me, I mean the outside world, who says Japan just has been getting it wrong all this time, and there isn’t this intimate understanding of how the economy is intertwined with culture?
Janet Hunter: I think we often are very judgemental. I mean, the Japanese themselves are pretty judgemental very often too.
You will find people in Japan saying, ‘We’ve got it wrong all these years!’
But if you look back to the 1980s, when the Japanese economy was doing well, you had people in the US saying ‘Oh well the Japanese have got it right! We need to do what the Japanese do!’ And it’s no easier to transfer that system to the US than it is to transfer a US system to Japan.
And I think what you need is a recognition that there are different strengths in different systems, which have evolved in different cultural environments. And there can be a mutual learning process, but if you just try and take something lock stock and barrel from one country and put it in another, it’s very unlikely to work.
If he manages to deliver on structural reform, if he manages to get re-elected, he will be credited with some of the success for bringing Japan out of what has really been two decades of economic problems.
But I think it’s very difficult. There is so much that has not changed, that probably does need to change.
Confirmation that the US housing market recovery remains on track came this week, when the Commerce Department announced that new home sales were up 18 percent from the previous month. August saw the market’s strongest sales pace in six years, and such heights have not been seen since May 2008.
Meanwhile, the re-sale of existing homes fell by 1.8 percent after four straight months of improvement, as investors who were previously snapping up and renovating distressed properties began to abandon the market. Investors accounted for just 12 percent of all transactions in August, the smallest share since November 2009.
“Two years ago, US housing was very cheap and it was a big investment opportunity. But now that there’s fewer foreclosures and not so much of the distressed supply that investors can snap up cheaply, that opportunity is really dwindling quite quickly,” explained Paul Diggle, Property Economist at Capital Economics. He added that the withdrawal of investors from the US market is not a new trend, and is likely to continue for some time. Compared to August last year, sales of existing homes had fallen by 5.3 percent.
Two years ago, US housing was very cheap and it was a big investment opportunity, that opportunity is really dwindling quite quickly
New home sales in the West climbed a massive 50 percent in August – the highest since January 2008 – compared to 29.2 percent in the Northeast and 7.8 percent in the South, whereas there was no change whatsoever in the Midwest. Meanwhile, the median sales price of a new house sold in August fell by 1.6 percent, to $275,600; the first price decrease in four months.
Experts insist there is no cause for concern, claiming the 18 percent climb in the sale of new properties is more than enough to maintain market growth. Diggle is confident that relaxed credit conditions and stronger job growth in the US will create the right environment for the conventional buyer to return to the market and fill the void left by investors.
Director of the Securities Exchange Commission’s (SEC) Office of Compliance Inspections and Examinations, Andrew Bowden, has spoken out against hedge fund advisors manipulating their performance indicators to better reflect on results. Speaking at a CFA Institute conference, Bowden said the organisation’s quantitative analytics unit had uncovered evidence that as many as 13 funds had been assigning their trades to favoured clients, a practice otherwise known as ‘cherry picking’.
“We plotted the accounts that were allocated winning trades more often than losing trades. And we came out of that and found 13 hedge funds that had accounts that were being disproportionately allocated favourable trades,” he said. However, the agency official went on to stress that the investigation was yet to uncover conclusive evidence of misconduct: “I’m not saying it is a pinpoint but from an examination standpoint we’re zeroing in on issues that raise the spectre of improper conduct.”
The findings come as the SEC closes out a two-year examination of recently registered hedge funds, all of which are managing over $100m in assets and have agreed to comply with the SEC’s regulatory framework, which strictly prohibits cherry picking.
The agency has, in the last four years, ramped up its efforts to uncover instances of non-compliance amongst fund advisors, and while the investigations have uncovered a long list of deficiencies, many of them are due to the complexity of new regulatory requirements. The 2010 Dodd-Frank overhaul and the SEC’s investigations combined mean that a hedge fund industry that has, historically speaking, been subject to loose touch oversight is now beginning to feel the pinch of sharpened regulatory scrutiny.
Months after President Obama spoke out against companies employing corporate tax inversions to escape tax liabilities, the US Department of the Treasury and the IRS has taken action to close existing loopholes. The practice involves a US parent company being replaced by a foreign parent, therein exempting the company in question from paying US taxes.
In a bid to escape the country’s 35 percent corporate tax rate, increasingly, US companies are exploiting tax loopholes and relocating to foreign countries to take advantage of lesser rates. “You shouldn’t get to call yourself an American company only when you want a handout from American taxpayers,” said Obama to crowds gathered at Los Angeles Trade-Technical College earlier in the year.
You shouldn’t get to call yourself an American company only when you want a handout from American taxpayers
The measures unveiled by the IRS prevent inverted companies from accessing foreign earnings by way of “hopscotch” loans, and the tax inversion process will also be made more difficult, given that the owner of the company must now own no less than 80 percent of the combined entity. In short, the actions restrict inverted companies from transferring foreign earnings tax-free either through a foreign subsidiary, and should help prevent the loophole from eroding the country’s tax base.
“These first, targeted steps make substantial progress in constraining the creative techniques used to avoid US taxes, both in terms of meaningfully reducing the economic benefits of inversions after the fact, and when possible, stopping them altogether,” said Treasury Secretary Jacob Lew in a statement. “While comprehensive business tax reform that includes specific anti-inversion provisions is the best way to address the recent surge of inversions, we cannot wait to address this problem.”
The crackdown should succeed in reducing the benefits for those choosing to go abroad, though the actions are by no means exhaustive. “Treasury will continue to examine ways to reduce the tax benefits of inversions, including through additional regulatory guidance as well as by reviewing our tax treaties and other international commitments,” said the Treasury in a statement.
With approximately 50 percent of earnings coming from the international segment Scotiabank, Canada’s most international bank, is a leading presence in emerging economies. World Finance speaks to its Executive Vice President and Head of Global Transaction Banking to find out how to approach emerging markets.
World Finance: Well Alberta, Scotiabank offers financial services in over 55 countries, but looking at banking trends now there has obviously been a lot of interest in emerging markets in terms of trade finance, because emerging markets have grown a lot more than established markets. But are they still the investment they once were?
Alberta Cefis: We live in a time characterised by a lot of geopolitical unrest, and that is playing out very much in the emerging markets, but I think one has to remember that not all emerging markets are the same. Emerging markets are still at the heart of the recovery. Even this year, GDP growth, 50 percent of it will come from emerging markets, so they’re really coming into their own as a major force. The final point is trade. Emerging markets are growing two to three times faster than developed markets when it comes to world trade. So if one puts all of this in context, yes, emerging markets are still fundamentally important and very viable to growth moving forward.
Emerging markets are growing two to three times faster than developed markets when it comes to world trade
World Finance: Well I read that you helped to establish global transaction banking as a viable option for Scotiabank. Now how did you navigate the different markets in the different parts of the world?
Alberta Cefis: We’ve always been a global transaction bank, before let’s say the use of this terminology. Trade and supporting trade corridors was always at the heart of Scotiabank’s mandate. For us, what global transaction banking has done is just put under the fold of one group capabilities around trade, correspondent banking, cash management payments, electronic banking and liquidity solutions to support our customers and to follow our customers wherever they might transact.
World Finance: Well what are the challenges in these regions for foreign banks and investors, and how do you approach these?
Alberta Cefis: For those that are doing business in emerging markets and are new to them, it’s so important to partner with the right financial institution. What we’ve seen in the past years, particularly since the global crisis, is that a lot of banks have pulled away from some of the emerging markets, or they downsize presence. So I think what’s important is to look for an established bank that knows the country, has local expertise, knows the culture, the language, how the business is done, but also has the network and that competence to follow their customers across inter-regional boundaries.
World Finance: How do you approach countries such as China, where national banks hold the monopoly?
Alberta Cefis: We have a rep-office, we have five branches. Our purpose there is not to compete at all with the local banks. It is again to be there to facilitate trade flows, and facilitate commerce. So we see our work in that region as one of, again, following our customers, supporting trade corridors so obviously China is an important trade corridor country for us, back to where we have the majority of our strength, which is the Americas, and North, Central and South America and supporting those trade flows for our customers.
Growth in the markets we’re in to further support our customers becomes really very fundamental for us now
World Finance: What do you see as the key trends in trade finance in emerging markets in the coming years, and what are the countries to focus on?
Alberta Cefis: Historically, trade was north/south, east/west. And now it’s south/south, meaning emerging market to emerging market. The other trend that we see is the emergence of Asia as the most important trading block. That’s for two reasons, inter-regionally and intra-regionally. So it’s expected that by 2020, Asia will account for 60 percent of world trade, so it’s just a tremendously large market. But what we also see is the importance of the China and India trade corridor, which is growing very very rapidly.
World Finance: What should companies be looking for when approaching these markets in terms of support?
Alberta Cefis: Given that one would have a business plan of what they want to do and what they have to accomplish, do they have a trusted team of partners that have both network capability, and that might be inter-regionally, intra-regionally, globally and then locally on the ground. Do they have the expertise, do they know the way to do business, can they support you on the ground with the ability to really transact and be operationally efficient. So again, when we think of the obvious partners one needs, which is a good high quality bank, which has the capital strength and the expertise necessary to operate in the market, and the accounting firms and the backup that are required, particularly around complex matter such as capital investment and tax. And then legal advice and legal expertise, because particularly in emerging markets, the regulatory framework is so different.
World Finance:Well finally, what are Scotiabank’s priorities for future growth?
Alberta Cefis: Growth in the markets we’re in to further support our customers becomes really very fundamental for us now, in a period of consolidation. Efficiencies and expansion within those markets.
Farazad Investments provides global access to capital and assistance in obtaining loans for industrial and commercial projects. World Finance speaks to company founder and CEO, Korosh Farazad, to find out about how these activities promote the growth of the global economy.
World Finance: Well Korosh, what role does structured finance play in the current economic climate, and what is Farazad Investments’ approach to this?
Korosh Farazad: Well structured financing basically is a key element of raising capital for various types of sectors and/or arenas in the funding world, and Farazad’s interest in these type of scenarios is basically to make sure that all the components in terms of a transaction is well prepared by the potential entity that wants to borrow, and we put those all into one package and present it to our institutional investors and/or private equity financiers.
World Finance: Well what services do you offer, and how do you tailor these products to your clients’ needs?
Korosh Farazad: Well in terms of tailoring, it’s case by case. There’s various types of scenarios or components that go into one deal that allows the transaction to be successfully funded. There is structured financing, there is conventional debts, and then you have your bonds funding in terms of rating bonds and then selling it into the market through the institutions which they will then go ahead and sell to their investors within their institution. It’s quite straightforward if you take the deals and understand what the client’s requirements are, and then implement a structure that would be tailor-made for the purpose of that transaction.
[W]e’ve managed to maintain a structure that complies with the regulations of whatever country we may be financing
World Finance: Well Farazad Investments is very well situated across five continents, so what advantage is this in terms of investment knowledge?
Korosh Farazad: You have to definitely have the knowledge in order to proceed into maintaining different cultures, different criteria, different compliances, regulations, etc, and having the know-how to adapt to those various cultures in terms of the regulations, compliance procedures, the knowledge within the ground and having the local sponsors to assist on those scenarios, it provides us with the comfort, and it provides the other side the comfort that we have the ability to finance the transactions in a successful manner. There is no transaction that is a perfect transaction, and it has to go through procedures in order for us to get to the end goal, which is to finance the deal and have our institutional investors and our private equity partners to feel comfortable that their capital will be preserved and they would make a return on their investment.
World Finance: Well obviously a lot of companies like Farazad Investments were hit quite hard by the global financial crisis. However, you’ve seen progressive growth, so what do you think your key to success would be?
Korosh Farazad: There has been a lot of problems. Throughout the financial crisis a lot of entities, both the private equity funds and the institutional front were hit hard, and the banks have now recently unstitched their pockets in terms of lending. The criteria are still the same, the capacity is still the same. In terms of compliance regulations, they’re making sure that all the components are in place. We’ve been fortunate to have the right partners in place, and that means we have our own preferred institutional lenders, and the private equity partners that we work with do know us. They know that we follow very strict criteria in terms of doing a provisional underwriting, if you wish to call it, and gathering the material, making sure that the information makes sense before we present it to the institution and/or the private equity investors. Even during the economic crisis, there was still an appetite to finance transactions, whether it was a combination of private equity and/or debts, or one or the other, but if there was not enough components in the transaction and if the borrower did not provide sufficient contribution to the deal, it would make it challenging. So we implemented a structure that we wanted to make sure that the borrower has some form of contribution, whether it’s 10, 20, 30 percent of the deal as a contribution in terms of either first charges on the assets, or in terms of cash. Once that was confirmed, then it made it easier for us to find the right partner to finance the deal.
We are seeing a lot of interest in terms of bond financing, whether they’re Sukuk bonds, which are the Islamic way of doing Sharia compliant bonds
World Finance: Well looking at regulatory compliance, and what impact has this had on your business?
Korosh Farazad: It definitely has impacted the business, and that’s because of the fact that there has been so many new reforms made in the financing world, especially again after the 2008/9 crisis. In some cases the new regulations have caused transactions to fail, but we’ve managed to maintain a structure that complies with the regulations of whatever country we may be financing, or that particular jurisdiction, and at the same time it allows comfort for again the institution and/or private equity financiers, lenders, to accelerate their interest in financing the deal.
World Finance: Well looking to the future now finally, and what major tends or developments do you think are going to influence investments over the next 12 months?
Korosh Farazad: We are seeing a lot of interest in terms of bond financing, whether they’re Sukuk bonds, which are the Islamic way of doing Sharia compliant bonds, we are beginning to see a lot of interest in that arena. We are also seeing more interest in rated bonds. The company is obviously a revenue-generating entity, and they get one of the top majors, like your Standard & Poors, your Moodys, your Fitches, to come in and rate or grade their company in order to attract more investments, and we are seeing that happen. On the other hand we are also seeing a lot of conventional funding taking place, but the conventional funding is a two part structure. One, in order for us to finance a deal, we want to make sure that the client does have enough capacity in terms of cash reserves, so then we can do an entire package of two parts, one part being providing project financing for that particular transaction, and establishing private banking and relationships.
When Lehman Brothers crashed in October 2008 and precipitated the financial crisis, some of the world’s biggest banks were put on life support as the contagion spread around the world. In America, Britain, Switzerland, Germany, Greece, Spain and even Iceland, institutions considered to be impregnable suffered near-death experiences.
But you would never think so now. Nearly everywhere you look, banks that were once terminally ill have made rapid and in some cases pretty miraculous recoveries. Albeit with the benefit of taxpayer-funded rescues, most of Wall Street’s giants were very much back in business within two or three years and are now returning handsome profits.
However, the crisis left its mark, even among that vast population of banks that flew through it. It has to be remembered that most firms in Asia, Australia, New Zealand, Canada and Latin America weathered the storm well. After all, it affected not so much individual banks, barring a relative handful of famous names, but the financial system as a whole.
A new breed of banking
Despite that, the banking landscape has changed as a result, especially in Wall Street. Bear Stearns, the first to fail, was absorbed by JP Morgan Chase. Merrill Lynch merged with Bank of America – and it wasn’t a merger of equals. Morgan Stanley and Goldman Sachs converted themselves into commercial banks. And Citigroup used its time in bail-out to raise cash and shed assets at a furious rate. So they’re not the banks they were.
And although it’s not something that the public notices, behind the scenes the biggest banks, collectively known as Sifis (systemically important financial institutions), have undergone a dramatic spring clean of their capital, admittedly under pressure from governments and regulators. Take just the one issue of leverage – the amount banks raise in various forms of debt for every dollar they hold in deposits. Some were leveraged as high as 50 to one – hedge fund-style levels – while 30 to one was relatively common. As for Lehman Brothers, it had no deposits at all, precariously funding itself on the overnight market. But not any more. According to recent figures from the US Federal Reserve, financial sector debt has shrunk over each of the last four years and had fallen to $13.9trn last year compared with $17.1trn at the onset of the crisis.
“We may still hate the [American] banking system,” observes trenchant US columnist Daniel Russo, “but the reality is that it is much better capitalised than it has been in years”. Russo says that fewer banks are failing – in the years immediately after the crisis regional institutions were toppling almost on a weekly basis in the US. In fact, federal supervisors had got so adept at shutting down ailing local banks that they were arriving on a Friday and leaving on Monday morning after merging the mismanaged firm with a stable rival and changing the nameplate. Outside the US, few appreciate the rate of consolidation in its banking sector. According to the Federal Deposit Insurance Corporation, there are now some 1,600 banks less than there were at the end of 2007, down about 20 percent.
Although the scale is different, much the same phenomenon has occurred around the world as banks hastily repaired their balance sheets. Take the issue of leverage again, if only because it’s a major focus of regulators who are working on an easily explicable format for measuring just how indebted banks really are. Banks now take it for granted that they will no longer be able to design their own leverage ratios under proprietary models, as they did before the crisis. As the Bank of England’s Deputy Governor for Financial Stability Sir John Cunliffe pointed out recently, the whole concept of firms coming up with their own ratios is full of “inescapable weaknesses”. And so it proved.
The global banking sector, however, has actually changed its ways. It has collectively adopted more responsible lending policies and the quality of loan books has improved as a result (see Fig. 1). Bit by bit, low-quality assets have been sold off to shadow institutions that specialise in the management of higher-risk debt. Vitally, the investment banking divisions whose reckless accumulation of suspect debt instruments wrought most of the havoc, have been split – or are in the process of being split – from the deposit-taking divisions.
Shocked by what happened and by what they subsequently discovered about the habits of some of the systemically important firms, in the intervening years regulators have subjected them to a blizzard of reforms designed to make them more stable. Although some institutions lobbied hard against certain aspects of the regulations, all are moving quickly to meet much higher standards of, for instance, capital buffers. Indeed, bowing to the inevitable, most banks are ahead of the official timetable.
In a complete turnaround of the laissez-faire style of regulation that prevailed before the crisis, the authorities are coordinating their efforts through global bodies such as the Financial Stability Board. The goal is to subject banks to common, cross-border standards that, as far as is possible, allow authorities to make internationally transparent assessments of their soundness. Also, they are determined to prevent firms exploiting opportunities in “regulatory arbitrage” by setting up operations in a jurisdiction with softer rules than elsewhere.
Of course it’s not possible to entirely repair such a heavily damaged sector within a few short years. After all, globally, banks lost $1.5trn in just two years, between 2007 and 2009. Ever since, liquidation experts have had a field day – in Germany, for instance, Lehman Brothers Bankhaus collapsed owing the Bundesbank €8.5bn, and it has taken years to sort out the mess. Now, however, the global tidy-up operation is nearing its end.
Work to be done
If they haven’t read it yet, most senior bankers could do worse than obtain a copy of a book that has greatly influenced regulators: The Bankers New Clothes: What’s Wrong with Banking and What to Do About it. Written by Anat Admati of Stanford’s Graduate School of Business and Martin Hellwig of the Max Planck Institute, its premise is that higher capital ratios were the starting point for reform.
According to the authors, banks had rendered themselves unsafe because they made money out of their fragility – their self-designed ratios for capital and liquidity were daringly low, mainly because they permitted sky-high leverage ratios. As it happens, the influential Financial Times economist Martin Wolf, a member of UK’s Independent Commission on Banking, agrees wholeheartedly with the main proposition of The Banker’s New Clothes. He wrote last year: “It makes no sense to build either bridges or banks that collapse in the next storm. One makes banks stronger by forcing them to fund themselves with more equity and less debt.” Although not many banks are moving towards an equity ratio of 20-30 percent, which the authors suggest is the more appropriate number, they are rapidly heading in the right general direction.
So how much safer are the banks? The main reform is that the minimum tier one capital ratio has been raised for most banks from a lowly four percent to a more robust six percent of risk-weighted assets. Also, the actual composition of tier one capital has been revised to make banks safer in the event of a crisis. Further, there is now a countercyclical capital buffer that can be raised or lowered according to the growth of credit. If regulators judge that too much credit is being handed out, they will insist on a compensating increase in the buffer.
The truly giant institutions will be required to build a risk-based capital surcharge that reflects the degree of their systemic risk. In short, the big boys must take a hit for the heightened danger they are judged to be running. Boardrooms have raised their game, also under pressure from regulators following another avalanche of research about directors’ responsibility for the crisis. “During the financial crisis it came to light that many of these risks [in bank governance] had been neglected, underestimated or – particularly in the case of systemic risks – not understood and taken into consideration,” pointed out Klaus Hopt of the Max Planck Institute, a German research institute, in a recent paper.
Unless they stumble onto the road of reform, the big institutions are very much in the eye of relentless regulators. In August, Standard Chartered took a $300m hit from probably the world’s most aggressive agency, the New York Department for Financial Services. Its heinous crime? Alleged deficiencies in its information technology systems. No overt damage was caused, no money-laundering rules breached, and no Libor was rigged. As one analyst wrote: “there appears to be no suggestion by the NYDFS of any wrongdoing or breach of regulations by Standard Chartered”. So in this new environment, banks can be punished merely for being fallible.
In the World FinanceBanking Awards 2014, we highlight the banks and leaders who have helped to rebuild an industry. There is also a selection of expert commentary, making the supplement the ideal companion for those in the industry, and for those who need to know who is defining the markets, and where.
The move will enable the fund, established in 2012, to raise permanent capital, opening the doors for bigger investments by reducing investor redemptions.
The IPO will offer shares at $25 each. $13bn firm PSCM, which manages but remains separate from PSH, is set to invest $100m. The $2bn investments would add to the $1.5bn already secured from 30 cornerstone investors – including European pension funds, private bank clients and other US hedge funds – making the fund’s market capitalisation a minimum of $5bn.
Pershing Square Holdings has seen a successful year with returns in excess of 30 percent for its investors
The announcement fulfils expectations set out earlier in the year. In August Ackman sent a letter to investors confirming rumours of a future IPO. “Because we are an active, control and influence-oriented investor, we have avoided being fully invested because of the risk of investor redemptions”, he wrote. “We will hopefully begin to address this issue with the initial public offering of Pershing Square Holdings, Ltd.”
Pershing Square Holdings has seen a successful year with returns in excess of 30 percent for its investors. Ackman hopes to increase that further by raising public money through a closed-end fund and following similar recent moves by other key hedge fund players such as Alan Howard and Daniel Loeb. He said in a statement: “We expect that the public listing of PSH will substantially enhance the stability of our capital base enabling us to invest a greater percentage of our assets in activist commitments on a long‐term basis, and improving our ability to take advantage of market dislocations when they arise”.
Earlier in the year Ackman joined forces with Canadian pharmaceutical firm Valeant in a bid to purchase Botox-maker Allergan for $53bn, adding to its current 9.7 percent stake in the company, but its efforts have so far proved unsuccessful.
