2014 | World Finance

The private equity market is Bangladesh’s ‘biggest opportunity’, says LR Global

Posted on July 29, 2014October 17, 2014 by Ashton Wenborn

Bangladesh has seen an uptick in economic growth in the past few years, but have richer investment opportunities followed? World Finance interviews Reaz Islam, Managing Partner of LR Global Bangladesh Asset Management Company, to discuss the country’s economic growth and potential.

World Finance: Now a significant portion of Bangladesh’s economy is the export-oriented textile industry. Would you say that this strong growth is sustainable over the next five or 10 years?

Reaz Islam: The labour cost in Bangladesh is about one fifth of China, and about half of India. So that gives you a great idea in terms of the numbers.

The export – you know, I expect this to grow further. It’s about $22bn plus. So Bangladesh has reached a position in terms of value addition, and basically has become the priority, and the choice, for the importers to essentially have a manufacturing base in Bangladesh.

World Finance: What are the other industries that are likely to come to the fore in the near future?

[E]ssentially any kind of manufacturing sector will be very attractive

Reaz Islam: You have on one hand, a huge supply of labour. So essentially any kind of manufacturing sector will be very attractive, and we see has a high potential.

The second thing is the consumer base. So essentially when you have per capita income going from $700 to $1000, all fast-moving consumer products have huge potential, we believe.

The third one, which is somewhat related, is infrastructure. With this GDP growth there is a huge amount of infrastructure required in Bangladesh. Bangladesh has done fairly well in the power sector, covering that gap; but essentially airports, roads, highways, the ports and so on – we see anything related to that in terms of construction and material related companies have huge potential, we believe.

World Finance: How mature is the investment management sector in Bangladesh?

Reaz Islam: So the investment industry is actually very very small, relative to our peer countries. And there are various reasons for that.

If you look at the market cap of the mutual fund industry, which is approximately one percent of the market cap, and very very small for a country like Bangladesh, with a GDP approaching $130bn plus.

Given the size of the market, we see substantial growth potential. But Bangladesh is still a relatively new country, and the depth is less, but we expect this industry to grow significantly over the next few years.

World Finance: Now your client base includes local as well as offshore investors; can you tell me what type of investments are the latter group looking for?

Reaz Islam: Generally the offshore investors are I would say, in terms of priority, most interested in the stock market, because it’s liquid, and it’s more transparent companies.

Number two, the fixed income market. Bangladesh has recently been rated BB- Ba3 by S&P and Moody’s, and we understand Fitch is also looking at it.

Given the size of the market, we see substantial growth potential

And the spread that you get for taking that risk is substantial. The reason I say substantial is, in our view, adjusting for certain factors, Bangladesh probably deserves a BBB- rating, which is in line with India in terms of actual raw, fundamental numbers. Obviously rating agencies look at other things. But from a risk-adjusted basis, if you look at debt-to-GDP and other fundamentals. So we have seen substantial demand over the last six months to maybe a year, once this rating kicked in.

Where I think Bangladesh has the biggest opportunity, which is yet to be explored in a substantial way, is in the private equity market.

The reason is, the cost of funds is very high in Bangladesh, and most of the projects and other initiatives are funded by banks.

Recently we have seen a few private equity funds coming in, setting up their offices here, and there are one-off investments that are done in conjunction with the IFC. But the highest potential we think is there, and we think it’s on that trajectory in terms of opening up that space for foreign investors in the near future.

World Finance: How else can the Bangladeshi government work to create new international investment opportunities locally?

Reaz Islam: You’ll be surprised; if you look at the laws on the book about foreign investments, Bangladesh is probably one of the best. You can own 100 percent of a private company; the repatriation issues have been about 95 percent resolved, in terms of dividend payout and taking capital out.

Bangladesh has the biggest opportunity, which is yet to be explored in a substantial way, is in the private equity market

But the problem, or the challenge, in a country like Bangladesh, is coordination. So basically you have the Central Bank, which manages the capital account. And then you have the Board of Investment. And then you have the Ministry of Finance. And then you have the NBR, which is revenue collection.

I personally believe there must be more coordination among these regulatory entities. And me, as a foreign investor in Bangladesh, would like to see a one-stop shop so that these laws, or rules, which are actually quite attractive, are properly functioning.

So my suggestion to the government, officials, and leaders, would be: we’ve got great laws on the book, let’s mobilise this! There’s a great shortage of capital, and for Bangladesh to grow at 8-9 percent rate will require substantial foreign investments. And I think fixing some of these issues will definitely improve the plumbing to attract foreign investments.

World Finance: Reaz, thank you so much.

Reaz Islam: Thank you.

Illiquid assets are ‘the way to go’, says Futura Investment Management

Posted on July 28, 2014October 17, 2014 by Ashton Wenborn

Adequate risk and return investments have proved illusive following the global financial crisis, where governments have implemented quantitative easing and, as a result, low interest rates to boost economic recovery. World Finance speaks to Alberto Matta from Futura Investment Management about which investment opportunities are the most buoyant.

World Finance: Now Alberto, Futura Investment Management focuses on niche markets, so why was the company set up and what’s your investment style?

Alberto Matta: If you look at banking and asset management, they both work as completely separate industries. In banking you have financial sophistication, you have flexibility, you have balance sheets, and you can provide investors with tailor-made solutions that work according to the specific needs they have.

Asset management works in exactly the opposite way. Asset management was very much a value creation, or there was a culture for value creation – from alignment of interests, which is very important in asset management. And also in a way, a transparency; but of course there, there was no flexibility.

Most asset managers were creating a product that investors either liked, or didn’t like. So what we try to do with Futura is really to try to merge the two cultures.

What we see right now is an undue reward for illiquidity

World Finance: Where are you concentrating funds currently and where are the best investment opportunities?

Alberto Matta: It is a difficult market environment at the moment. What we see right now is an undue reward for illiquidity. So if you look at the illiquidity premium, i.e. the excess return you get from illiquid assets, we think that this premium does not justify the real risk of illiquidity.

We are in an environment where interest rates are very low again, so it’s very difficult to make money for you as an asset manager. We try to focus on illiquid assets because we think that that’s where the value is. Coming from a risk return point of view, that is where most of the value is. And we have the type of investors that allow us to do that.

So if you look at, for example, investors that have long-term investment horizons like 15 years, if you look at a pension fund or an insurance company, they don’t need their liquidity. So it’s actually a sin for them to go after liquid assets, because they lose out on all the extra premium they could get, and they really don’t need it because they have long-term liabilities and should have long-term assets. So we try to focus on these type of investments, and this is why one of the main focuses for us is real estate, we also look at secondaries of private equities.

World Finance: What are the challenges of investing in these areas and how do manage risk?

Alberto Matta: You know how it is, investors sometimes change their minds or their objectives change, and all of a sudden it’s difficult for us to liquidate a portfolio, if an investor decides that they want to only invest in liquid assets. So we always have to keep a clear balance between our full investment portfolio, also allowing for that one or two investors that might change their strategies.

In terms of risk, the way we try to de-risk the portfolio is first of all with local presence and local expertise

In terms of risk, the way we try to de-risk the portfolio is first of all with local presence and local expertise, because at the end of the day, the more you know about what you are buying, the lower the risk you are going to take.

Secondly, we try to have a match between the liquidity of the assets that we own and what we say in the documentation. We don’t promise the possibility to instantly redeem the funds, so investors that are coming into the funds know that they are there for the long run, so that we can exploit the strategy.

World Finance: Well you are based in Malta, and the tax structure in Malta is significant for investors – what are the incentives?

Alberto Matta: That’s not the main reason why we are in Malta. I mean Malta is a hidden pearl in my point of view, because you have availability of skills, which is unprecedented. You have this real eagerness to succeed and to work.

The responsiveness you have from the MFSA, which are the regulators, is exceptional. So the reason that we are in Malta is really for that. We were trying to have an alternative market for Luxembourg, but we also have a Luxembourg platform.

Malta is, you know I always say, they have the mind of the English and the heart of the Italians, and luckily it’s not the other way round. It’s really a place where people, they want to do business and it’s something which is very much appreciated.

Unfortunately if you look at Luxembourg, which is a competing market, in fact it’s a leading market; I think they are being so successful that they are becoming a bit complacent. And I think the responsiveness you get from the regulators, from the lawyers, from the service providers there, reflects a lot of opportunities for them. So they’re not as responsive, whereas in Malta, everything works like a Swiss clock.

World Finance: You have a close partnership with Optimum, why is this beneficial for your clients?

Alberto Matta: Unfortunately the only, let’s say, black mark of Malta is perception. So a lot of institutional investors don’t like Malta, and they prefer Luxembourg for some reason; it is more due to past reasons, or perception.

Malta is a hidden pearl in my point of view

At the end of the day, Malta is a member of the European community, so there is no reason why there should be more recognition to Luxembourg than Malta. But that’s the way it is, and unfortunately we have to adjust to what the market wants.

So why Optimum; Optimum is our Luxembourg platform and a lot of the investors don’t want to invest in Malta, they want to invest in Luxembourg; so we need to provide the two alternatives, in order to attract investors and give them the choice.

World Finance: So finally, what plans do you have for future growth?

Alberto Matta: We will continue to be in illiquid assets, because we really believe that that’s the way to go, and that’s where the opportunities are. So right now we are in a number of markets, real estate markets, around the world.

We would like to launch a second US fund, we think the US market continues to offer great opportunities; it is probably one of the only economies that is growing significantly and consistently.

We would also like to go into emerging markets, so that is something that we might do in the next two to three years. But I would expect to launch a second US fund very soon.

World Finance: Alberto, thank you.

Alberto Matta: Thank you very much.

It’s time competition in the current account market heated up

Posted on July 28, 2014July 11, 2014 by Ashton Wenborn

The Office of Fair Trading (OFT) last year published a review of the personal current account market, only to conclude that the market was lacking in competition and failing to consider consumers’ best interests. “Concentration remains high, new entry infrequent, and switching low,” read the report, causing consumer scepticism to mount and talk of a full-scale investigation to gather support.

However, alternative sources accused the OFT’s findings of being ill-founded, pointing out that many banks had introduced attractive interest rates and tackled rival institutions head-on with increasingly competitive offerings. Deloitte’s lead Financial Services partner Nick Sandall, for one, contradicted the claims made by the OFT and highlighted the various ways in which the market was improving. “It is optimistic to think that market forces alone will bring about the change in current account pricing that the OFT is seeking,” he wrote in a press release.

“Deloitte’s research suggests that competition in the market for UK current accounts is fierce, with banks paying customers up to £200 to switch accounts. Meanwhile, high street banks are also investing in very innovative functionality around mobile access, loyalty programmes and banking applications – most of which are offered free.” The more optimistic outlook of the two appeared to be well founded when the Payments Council announced that the number of customers that had chosen to switch current accounts in December had risen 54 percent on the previous year.

Leading the charge
The rate of change in the current account market has since shown no sign of slowing, spearheaded by a number of path-breaking institutions whose goal it is to weather market changes by putting customers’ best interests front and centre. Lloyds Bank made its presence known in the revitalised current account market earlier this year by offering an interest rate – on balances between £4,000 and £5,000 – of four percent, rivalling even the rates on most savings accounts. The bank claimed savers could stand to gain as much as £196 in interest a year and, what’s more, promised a four percent interest savings account to match.

Even generous incentives are not enough to move customers from
the familiar

Not exclusive to Lloyds, various institutions are offering increasingly attractive packages for new and existing customers. The TSB Plus Account offers up to five percent interest on deposits of £2,000 or less, whereas Nationwide’s FlexDirect offers a five percent interest rate for deposits up to £2,500 for the initial 12 months.

These new and improved products have come as a response to various industry changes, one of which being increased competition from non-traditional retail banking rivals such as M&S Bank and Tesco Bank, who together pose a threat to the already established breed of high street banks.

“What M&S Bank does is provide our customers with convenience and choice,” said one M&S Bank spokesperson. “Our branches are open almost twice as long as traditional high street bank branches and our current account customers also have 24-hour access to a UK contact centre, as well as 24/7 online and telephone banking. Convenience and choice is critical to meeting customer needs and we’ll continue to see more innovation to deliver this.”

Although the influence of new market entrants is clear, the extent by which the market’s leading players look set to lose their oversized piece of the pie is not. “The new entrants must show they can deliver a genuine consumer-friendly alternative to break the unhealthy stranglehold of the six big banking groups which still control 94 percent of the current account market,” said a spokesperson for the consumer association Which?.

“In fact, the banking sector has become even more concentrated in the economic downturn and there are many signs the market is not working well for consumers, including a lack of innovation, lack of transparency around charges, and an inability to compare accounts.”

Switching issues
However, some well-meaning industry bodies have made it a priority to focus on account-switching initiatives in an attempt to undo the dominance of the industry’s leading players and boost competitiveness. The process of switching accounts has long been looked upon by consumers as an extraordinarily problematic and complicated business, despite there being a number of incentives for doing so.

Regardless of uncompetitive rates and a lack of consumer focus, the vast majority of customers have long been unwilling to switch to improved providers. Even generous incentives are not enough to move customers from the familiar.

Research conducted by Santander last year found that UK residents switched romantic partners more often than bank accounts, showing that the average account relationship lasted little over 16 years and that one in six stay with the same bank for 30 years or more. The research also coincided with findings by Mintel, highlighting how the current account market is dominated by the country’s big five banking groups – Lloyds, HSBC, Barclays, RBS and Santander.

In an effort to overturn this misguided sense of consumer loyalty, the Payments Council has recently introduced a mechanism that enables customers to switch accounts in no more than seven days, in effect ushering in a new era of competition. Covering the entirety of the current account market, the initiative means that any costs incurred in the switch from old to new will be carried over, and all payments that are mistakenly directed to the previous account are automatically redirected to the replacement.

“All in all, this provides a new switching service that is quick, simple, hassle-free and backed by a guarantee, thus eliminating the barriers to switching that previously existed,” said Mark Bowerman of the Payments Council. “Customers now have the confidence, freedom and flexibility to move to a new bank or building society quickly and simply, with no obstacles in their way.”

The introduction of the Current Account Switch Service also marks the first time that the process will be supported by a consumer guarantee, protecting customers from poor service and money lost as a result of the process. Ultimately, the mechanism lands a lot more power in the hands of the consumer, and means that retail banks will no longer be afforded the luxury of knowing that too many obstacles stand in the way of lost custom.

“Previously it was the norm to stay with one bank for several years, because when you weren’t happy with your current account, there was very little incentive to move elsewhere,” said Jafar Hassan, Personal Finance expert at uSwitch.com. “This has changed – current account providers are beginning to notice that more and more consumers are willing to switch when there’s the prospect of better service, interest rates, overdraft terms or even cashback.”

As a result of new and improved switching mechanisms, generous incentives are livening up the market for current accounts. For example, First Direct offers customers £100 for switching to their 1st Account, as does Halifax in the event of a customer switching to any one of their three current accounts. Alternatively, Secure Trust Bank – for a £5 charge – offers a four percent cashback perk on purchases in any one of its 35 participating high street partners.

“Recognising that it is now easier for customers to switch means that any current account provider ought to be able to increase their market share by offering a better service and better products than their rivals. In addition, banks and building societies will need to work harder to keep their existing customers,” says Bowerman.

The Centre for Economics and Business Research estimates that the initiative will increase the number of switchers by over a million annually, bringing the yearly figure to 2.5 million by 2023 – a far cry from the 1.3 million in 2012. However, some estimates aren’t quite as optimistic about the initiative’s effects. Research led by uSwitch shows that as little as two percent of people have switched accounts since the seven-day guarantee came in, estimating that only 4.2 percent will switch this year. “This suggests that seven day switching is not the game changer that will significantly increase competition in the market.”

What is crucial for the current account market moving forwards is that it fosters a culture of openness. Current accounts should be dictated not by some warped sense of loyalty, but seen as immediately accessible and comparable, with the deciding factor for customers above all else being value.

“Unless banks make it easy to compare the cost of running a current account, the new switching guarantee alone will not transform switching rates or significantly increase competition in banking,” says a Which? spokesperson. And while the past 12 months have certainly been a landmark year for current-account competition, the market must improve further still if consumers are allowed a fairer say in how they decide on the right account.

KAMCO on the MENA region’s ‘increasing opportunities’ for investors

Posted on July 25, 2014October 17, 2014 by Ashton Wenborn

The asset management sector in the MENA region, though relatively unexplored, is growing from strength to strength, with a wealth of investment opportunities. One institution that has capitalised on the industry’s boom is KAMCO. World Finance speaks to its Chief Executive Officer Faisal Sarkhou to find out more.

World Finance: Well Faisal, potential growth in the MENA investment banking industry is seen to be promising, with deal activities gaining momentum. So where would you say are the investment opportunities, and what is the size of the market?

Faisal Sarkhou: Last year was truly a good year. The financial crisis had hit a lot of companies in the region and a lot of business activity slowed down on the investment banking side. We saw a turnaround that resulted in 2013 being the largest in terms of deal value in the past five years, at around $73bn.

This year started well in the first quarter but slowed down again in the second quarter. We are expecting the second half of the year to be strong as well. In 2013 we saw some of the highest performing markets in the world and the region, in particular in the gulf and the GCC countries, that has resulted in an increased flow of foreign direct investment from all over the world.

In 2013 we saw some of the highest performing markets in the world and the region

This has made it more attractive as well for local investors, and has regained their confidence back into the markets. So opportunities are increasing.

On the investment banking side, we haven’t seen too many IPOs in the past period. There is a lot of talk of new IPOs in the UAE, and Saudi Arabia, and there is some talk in Kuwait, but we expect that once that begins to flow, sentiment will also gather momentum.

World Finance: The MENA region has seen its fair share of turbulence – how safe of a place would you say it is to invest?

Faisal Sarkhou: The region has had its turbulence for many years so we are used to having some kind of turbulence in different pockets of the region. However, GCC in particular has been very stable politically, despite any issues that happen; the stability factor has been important there.

What is more important is the stability in the policies of governments as they evolve and develop the markets; introducing new regulations, pushing markets to move from frontier to emerging status. Stability of currency is very strong, GCC and the MENA region being closely pegged to the US dollar has helped with having stability in the market during turbulent times. We are optimistic that political turbulence will result in a better and more efficient government, as the government strives to develop the infrastructure and the human capital.

We believe that this, along with stability, will result in a better operating environment.

World Finance: And how do you manage risk?

Faisal Sarkhou: We at KAMCO have a sophisticated and well-developed risk framework that was built over the years, even before additional regulatory reform and policy that has come in the past four years. This has allowed us to remain operationally profitable during the entire financial crisis.

GCC in particular has been very stable politically

World Finance: What do you see as the major investment trend for 2014, and what do you foresee as being the major events that will affect the market?

Faisal Sarkhou: Always remember the context. The young population’s diversification journeys in the GCC for example, focus on the energy sector, aiming to diversify economies and generate more jobs for the populations that are coming into the workplace. It is that, alongside significant infrastructure spending.

The planned infrastructure spending in the GCC is at around $2.5trn. This is lead by Saudi and UAE markets, with all other GCC countries putting in significant amounts to develop infrastructure. That infrastructure development will help mostly on the defensive sectors of the markets.

It will have an impact on the health-care sector, the education sector, the housing sector and all of this will result in more jobs, more activity and better capital market movement in the future.

World Finance: Looking at your KAMCO research now; emerging markets have had a difficult year, why do you think this is and do you see them picking up?

Faisal Sarkhou: The start of this year they have had a bit of a better pick up as currency and debt issues are being resolved. However the MENA region in particular and the GCC have had one of their best years in 2013, with some of the markets performing in the top tier and 90 percent of them giving double-digit returns in growth and investor returns.

This is one of the key reasons that there is the stability of the exchange, the GDP growth that has happened, and the stability of the oil prices. So the MENA region in general has gone through a good year in 2013 and we expect it to continue this year, despite the political turbulence that is there.

We at KAMCO have a sophisticated and well-developed risk framework that was built over
the years

World Finance: Looking to the future now: what markets will you target for growth and investment?

Faisal Sarkhou: The strategy is focused on growing our activities in the MENA regions at this stage. We believe the prospects are positive and will remain positive.

If you look at all economic indicators you have got strong GDP expectations, the MENA block is expected to be in the top three in the world in terms of GDP growth. The impact of surpluses will be there; extensive government spending on infrastructure and human capital will also fuel this positive expectation. More political stability will also add to this.

We at KAMCO have established, and are establishing, a number of products that are spanning the MENA regions from our base in Kuwait, and we hope to grow those products as we truly believe these regions are here to grow and in a faster manner in the future.

World Finance: Faisal, thank you.

Faisal Sarkhou: Thank you Jenny.

Managerial roles diversify at investment firm MASIC

Posted on July 25, 2014July 11, 2014 by Ashton Wenborn

Perhaps the most significant challenge faced by any family-run business is longevity. There is a strong body of evidence to suggest that the founding family should relinquish control of a company within three generations; a mere four percent of firms survive into the ownership of the fourth generation, according to several academic studies on the subject.

The transaction is the largest private equity deal in the MENA region so far this year

Long-term survival was certainly one of the factors that prompted Mohammed Alsubeaei & Sons Investments Company (MASIC) – one of Saudi Arabia’s most prominent firms – to change its managerial model. The Riyadh-based company manages assets including equities and private equity funds, and generates returns through direct investments in a range of sectors including real estate. “Three years ago we decided to institutionalise, and move towards a more professional management structure,” said Ihsan Abbas Bafakih, MASIC’s CEO.

“We started implementing the changes, putting in place new legal structures that separate family from day-to-day management. So there are family members on the board of directors and the executive committee, and they can continue to be a great inspiration and generate ideas that contribute to the overall success of the firm through a best-practice structure that carries on their legacy.

“The transition has been difficult at times but the positive aspects make it worthwhile. Other companies respect you more, banks look at us more favourably when considering lending to us, but I think for us the main incentive was longevity, ensuring our business is sustainable in the long term.”

Far-reaching deals
Impressive growth, domestically and internationally, suggest it was the right move for MASIC, as do the recent nominations for two World Finance awards, in the categories of Best Family Owned Investment Company and Best Private Equity House in the GCC. MASIC’s assets under management have doubled in the last three years, and its overseas investment portfolio has grown exponentially – with investments spread across the board in sectors such as financial services, real estate, agricultural (aquaculture), manufacturing, industrial and retail.

In recent years, the firm has been involved in some landmark deals, including the redevelopment of London’s iconic King’s Reach Tower (now known as the South Bank Tower) by providing £145m of funding through the largest sharia-compliant mezzanine facility of 2012. And just this month, MASIC’s Fajr Capital led a consortium that announced it is buying the Dubai-based oilfield services company National Petroleum Services. The transaction is the largest private equity deal in the MENA region so far this year.

Despite its ascent into the ranks as one of the kingdom’s most respected companies, MASIC refuses to lose touch with its family roots and the principals of its founder, Sheikh Mohammed bin Ibrahim Al Subeaei. An astute but modest businessman, Sheikh Mohammed instilled a strong sense of social responsibility in the company, and these ethics and values have been transferred to his sons, and instilled in the current members of the management.

Source: International Monetary Fund. Notes: Post-2013 figures are IMF estimates

The Mohammed & Abdullah Al Subeaei Charity Foundation epitomises this, which supports humanitarian, religious, cultural and social projects in the kingdom over the last 10 years since it inception. “Our founder was well known as a very ethical man,” said Bafakih. “He wanted his company to behave ethically and demonstrate a strong sense of social responsibility, and that governs how we do business today.” Other examples of corporate social responsibility include the MASIC Annual Forum – now in its sixth year – which helps attract investment to various projects that underpin the development of the country. Another important founding principal, and one that guides all MASIC’s investment decisions, is that of sharia-compliance.

“When companies come to talk to us, sometimes they have to go back and do something differently before we’ll invest, so that’s forcing what we see as positive change on certain other firms, and in the long term, throughout the business environment,” Bafakih explained. To this end, MASIC also sponsors Harvard University’s Islamic Finance Project, which conducts research into the theory and practice of sharia-compliant finance.

The Al Subeaei family business started life as a trading house founded in Mecca in 1933 by brothers Mohammed and Abdullah Ibrahim Al Subeaei. The family group of companies grew with the fortunes of Saudi Arabia following WWII, and the founding of The Al Subeaei Currency Exchange Company marked its formal entry into the financial services business.

MASIC is fiercely proud of its Saudi heritage and maintains a strong bias toward investing in domestic markets (see Fig. 1). Among MASIC’s key investment assets are Alargan Projects, Bank AlBilad and Jadwa Investment, the biggest independent CMA-licensed investment company, which has been able to gain market share from bank-backed investment firms established in the 1970s. “Our roots are in Saudi Arabia, so the family feel they have a duty to the local society,” said Bafakih.

Addressing local unemployment
Nurturing local talent among a young Saudi population is something the firm is actively involved with. MASIC has developed strong links with local universities and colleges, offering the sort of compensation packages likely to attract high-quality local graduates. The government has been addressing the kingdom’s well-documented skills shortage by investing heavily in education and vocational training.

Such reforms, aimed at bringing down high youth unemployment, have enjoyed a degree of success. The Labour Ministry recently reported that the number of Saudi citizens working for private companies has doubled in the last two and a half years. “We need to get more of our locals working for the private sector. Yes, there’s a need for people to receive the right kind of education, but there’s also a responsibility on companies to hire local talent. You find some companies want to hire less expensive, foreign labour, and that’s something that needs to change,” according to Bafakih.

“At MASIC we have a policy of working with educational institutes, aiming to network with universities and be in touch with talented locals. Companies must offer good benefits and professional development opportunities in order to compete with government jobs and attract young Saudi nationals.”

The company has every reason to be optimistic about the future. Its three-pronged approach to generating returns, through asset management – including equities, fixed income and private equity funds, direct investment and real estate – has proved highly successful. Bafakih said the company will continue to focus primarily on domestic markets while at the same time increasing its rapidly expanding foreign portfolio. “A lot of our growth is down to a strong Saudi market,” he said. “But the larger you grow, the more global you want to become, so we definitely want to increase the international portion of our assets.

“We’re not trying to double the money next year, we have a focus on generating income through things like real estate,” Bafakih explained. “We have a large amount of investment in office space, and we have companies that do residential leasing, for example. “Our recent expansion in the services sector catered to logistics. While Saudi Arabia is the most advanced in the industry regionally, it falls behind in logistics.

“Our recently launched initiative will cater to this gap in our local offering. “We have a long-term perspective. We’re not a hedge fund or a fly-by-night operation, we want to still be around in three or five hundred years Insha’Allah [God willing].”

With a new management structure in place, a growing portfolio of global and domestic assets, and a strong reputation for building successful long-term partnerships with stakeholders, Bafakih sees no reason his company won’t be a premier Saudi investment firm, deploying strong investment practices delivered by a team of professionals all sharing a common set of values.

“We feel we are in a very strong position indeed,” he said. “Although our heritage and the legacy of our founders is central to what we do, we are moving with the times, always adapting to a constantly evolving business landscape. I believe that’s what makes MASIC unique and gives us our competitive edge.”

KAMCO accelerates GCC region’s economic growth

Posted on July 25, 2014July 29, 2014 by Ashton Wenborn

Last year was a positive year for Kuwait, which, along with most major equity markets in the region, managed to build on the previous year’s positive performance, coming off the back of a particularly tough 2011.

Investor confidence in capital markets has grown and this is reflected by increasing investor demand for a wider range of investment opportunities, services, and better returns in the low interest rate environment. This client-driven demand has created incentives for KAMCO and other major regional investment companies to further enhance existing platforms in order to deliver solutions and opportunities to help investors achieve their investment goals.

Despite ongoing political instability seen in some nearby countries, most regional equity markets have achieved double-digit returns. All of the GCC capital market participants are working to further build robust financial institutions with stronger and evolving regulation.

Despite the challenges, the region’s capital markets are expected to see growth in returns, as well as higher activity, investment flows and liquidity

With MSCI upgrading the UAE and Qatar to emerging market status, other countries are working to develop their markets to international standards. We at KAMCO expect that in the coming five years, more regions will be considered as emerging markets, thus adding more liquidity to the region, in line with strong private sector growth and development expectations led by strong oil prices, government infrastructure spending and human capital development.

Looking forward
So far, 2014 has been a good year for all MENA regional equity markets. Expectations for the rest of the year are positive. With recovery signs well in place, the MENA region is expected to see further growth as its economies prosper.

Even though the year is expected to see some volatility in regional capital markets, if the geopolitical scene continues to improve, the area is expected to perform well overall, with most markets set to achieve double-digit returns. This maintains our expectations, in line with most other analysts, that if there are no major shocks, growth is expected to continue, especially in a low interest rate and inflation environment. Certain sectors will benefit from the anticipated growth more than others, such as real estate, services, consumer and trade finance sectors. We at KAMCO are looking into launching products that meet growth prospects and investor needs, and have launched MENA-focused managed equities and real estate funds in the past 12 months, as well as a new MENA fixed income fund. We are also gearing ourselves up to play a leading role in managing new capital market issuances.

Despite the challenges, the region’s capital markets are expected to see growth in returns, as well as higher activity, investment flows and liquidity. With those anticipated capital inflows – combined with significant developments in regulatory frameworks, including enhanced corporate governance and transparency initiatives – we anticipate a transition to strong growth in terms of depth and breadth of markets, with blue chips and growing medium-sized enterprises benefiting the most in 2014. Since Qatar and the UAE were upgraded to emerging markets status by MSCI, Kuwait has been present on the MSCI Frontier Markets Index, which makes Kuwaiti corporates more visible, attracting interest from major international equity investors.

Along with the anticipated growth in capital markets, we expect to see more development in regulation, which will bring higher costs and compliance risks, especially in the short term. Furthermore, keep in mind that regulators and policymakers alike have become extremely cautious in overseeing and managing growth, having learned from previous bubble experiences.

Nonetheless, given the current strong liquidity available with regional banks, there will be stricter limits imposed on financial institutions in order to avoid overexposure to any particular sector. Banks will be encouraged to use a risk-adjusted capital management framework for lending, as well as dealing with the operating implications of Basel III and other international issues, such as FATCA.

This could present an opportunity for local investment houses like KAMCO and international players to play a major role in developing more sophisticated capital market solutions that meet growth needs.

The region’s capital markets are still in their infancy, with limited depth and breadth, but are quickly evolving as the private sector grows and markets develop, with more instruments being introduced along with new regulations and government policies focusing on developing markets.

Such developments are needed, especially in GCC countries like Kuwait, which are considered fiscally sound markets that offer ample opportunities to investors across various sectors, including real estate, infrastructure and consumer goods sectors.

Dealing with debt
The debt situation in Kuwait and the GCC remains dominated by bank financing, and markets remain thin and limited to traditional forms of debt financing and products. They do not yet have the structured and tailored financial products seen in more advanced markets.

One key reason for the slow growth in debt issuances in Kuwait and the GCC is that the region’s sovereign debt markets are relatively underdeveloped. Investors are also not well versed in investing in local or regional debt products, meaning the market lacks depth. Stable and high oil prices have led to strong fiscal surpluses, making government activity in developing the situation a lower priority. We believe that sovereign action is needed, and that sovereign issuances are central to developing the regional debt markets through the appropriate establishment of yield curves, which is an essential base for debt management.

Having said that, some GCC countries like Qatar, the UAE and more recently Saudi Arabia, are developing their debt markets by issuing conventional and Islamic debt, as well as forming policies to develop such instruments.

Source: International Monetary Fund. Notes: Post-2010 figures are IMF estimates

The interest rate environment in the GCC is low at present, making the debt market a viable financing option for businesses. However, the presence of challenges that limit the depth and breadth of solutions makes it costly and difficult to consider such solutions by businesses raising debt financing. Another important element is the increasing awareness and understanding of debt financing and its benefits with or over equity funding. Companies need a better understanding to strike the right balance between debt and equity so as to optimise the cost of their capital structures.

The impact of oil
The six nations of the GCC had a combined nominal GDP of $1.45trn in 2011, which accounted for two percent of global GDP. This figure is estimated to have reached $1.58trn in 2012, while the IMF 2013 estimate for 2013 is $1.60trn.

The GDP of the GCC region has almost quadrupled in nominal terms since 2001, growing at a compound annual growth rate (CAGR) of 14.5 percent. This has led to a near doubling in its percentage share of global GDP from 1.1 percent in 2001 to two percent in 2011 (estimated to be 2.2 percent for 2012).

The rise in the GCC’s weight in the global economy is a result of both high energy prices and rapid real economic growth supported by government spending on production and infrastructure projects. GCC real GDP grew at an average annual rate of 4.86 percent from 2007-11 compared with a world average growth rate of 3.4 percent, making it one of the fastest growing regions in the world. The IMF estimates that real GDP growth in the GCC reached five percent and 3.7 percent in 2012 and 2013, respectively, outperforming global GDP growth expectation of 3.2 percent and 2.9 percent.

The size of the GCC economy has been supported by the hydrocarbon sector, which has been the backbone for an economy driven by elevated oil prices. However, a global economic deceleration can severely impact oil prices, with weaker demand leading to weak economic growth; this despite the fact that many countries have the buffers to withstand short-run oil price volatility, yet a sustained drop in oil prices resulting from a further slowdown in global economic activity remains a key risk.

Kuwait is the second-wealthiest country in the GCC on account of its substantial oil resources, and the fourth-largest economy in the region with an estimated nominal GDP of $199.3bn in 2013, according to the IMF. The economy remains dominated by oil and gas production, which comprised an estimated 63 percent of nominal GDP in 2012, and contributed to around 94 percent of the government’s revenues.

Economic growth has been strong, with constant prices GDP growth of approximately 8.2 and 6.6 percent in 2011 and 2012, respectively, as the oil sector expanded due to capacity increases and the mandated production cuts by OPEC introduced in 2010. Going forward, the Kuwaiti economy is forecasted to continue posting healthy growth rates in the medium-to-long term (see Fig. 1).

Global review: a look at the WEF’s Enabling Trade Index 2014

Posted on July 24, 2014July 24, 2014 by Ashton Wenborn

Rankings are based on the quality of institutions, services and policies that allow the trade of goods over international borders. The higher the ranking the better the trade.

Singapore (Rank 1)
Singapore’s government has been positioning the country as a global business hub for a number of years, welcoming global trade. It has topped the report for four consecutive years, reflecting the way in which it has opened its borders to international trade. It scored top marks on the four key sub-indexes of market access, border administration, transport and communications infrastructure, and business environment. Singapore is regarded as a highly developed trade zone that is the most open in the world, with very low tax rates that represent 14.2 percent of GDP. This year, the economy is expected to grow at 3.8 percent, with exports falling slightly.

Netherlands (Rank 3)
Widely seen as having the best port infrastructure in the world, the Netherlands is the highest-performing European country in the index. The country was also praised for its entire transport infrastructure network, as well as its advanced and extensive use of IT for its trading operations. Border administration is both transparent and efficient, although far more expensive than Singapore and Hong Kong. Despite its strong performance on infrastructure and transport, the Netherlands performed slightly worse in terms of market access, coming in at 75th. Improving this access for overseas businesses would help the country climb up the rankings.

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UK (Rank 6)
The UK is described as having a world-class border administration and infrastructure by the report, something that might come as a surprise to those that frequently use its airports. Trading in the UK has been made considerably easier in recent years, with a commitment to encourage cross-border business as a way of boosting the economy. Transport services enjoy positive logistical competence and tracking ability, as well as efficient delivery of goods. It also has an advanced IT infrastructure, coming second globally to connect businesses and consumers online. However, it was criticised for its market access and ‘high complexity’ of tariff structure.

Canada (Rank 14)
Canada’s relatively high performance is largely down to its attitude towards imports, with a reported 89.4 percent entering the country free of duty. It is described as ‘one of the most accessible among advanced economies’ in the world, although its performance in other areas hampered its score. The nation’s high tariffs mean that it scored poorly on the index for importing and exporting goods. It is the high tariffs and overly complicated import procedures that most companies feel are the main issues for importing goods into Canada. There were also concerns over restrictions on the amount of multilateral trade, as well as difficulties in the hiring of foreign labour.

Australia (Rank 23)
Australia was praised for its consistency, particularly in IT use and transport infrastructure. Despite this, the WEF says that the Australian government needs to improve both its port and railroad infrastructure if it is to continue to cater for its booming mining industry, as well as other trade, and avoid potential bottlenecks. Its border administration is efficient, even though the costs are relatively high. Australia employs high tariffs for exporters, meaning that foreign market access is especially difficult for traders. According to the report, a shipping container from Australia costs $300 more than from nearby New Zealand.

Taiwan (Rank 24)
Jumping five places up the index, Taiwan has undertaken a series of public sector initiatives designed to boost trade and improve economic efficiency. It was rated highly in the report for its efforts to simplify border administration, although saw a drop in terms of market access. The country did finish top for customs transparency and terrorism incidence, as well as fifth for trade finance. While the rise was a positive step for Taiwan, it performed poorly in terms of margin preference for destination markets, coming 134th out of 138, showing that the country is not integrating fast enough with its local neighbours, preventing domestic firms from expanding overseas.

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Mexico (Rank 61)
Mexico’s performance has been mildly better than its Central American and Caribbean neighbours, with market access being cited as one of its competitive advantages. As much as 83.7 percent of imports enter into Mexico free of customs duty, meaning it is relatively welcoming of overseas trade. However, it is criticised for its lack of infrastructure, and its poor quality of transportation. A dramatic improvement of Mexico’s rail network would help to boost trade, as well as making the postal system more efficient. Marked down for his lack of accountability of public institutions, President Enrique Peña Nieto has however, been praised for being open to FDI.

Argentina (Rank 95)
Populist and anti-business measures by the government have meant companies are wary of doing business in Argentina. Border administration was criticised, with imports and exporters suffering from costly and prolonged procedures. The WEF say the government should look to speed things up by employing useful IT services to improve transparency and accountability. There are also concerns over the country’s business environment, and in particular the protection offered over property rights, FDI rules and access to finance. If Argentina is to improve the business environment for importers and exporters, it will need to relax its protectionist policies.

Banca CIS on San Marino’s economic potential

Posted on July 23, 2014October 17, 2014 by Ashton Wenborn

The Republic of San Marino is a small state inside Italy, yet is renowned for its banking sector. One bank that has firmly built its routes there is Banca CIS. World Finance speaks to Professor Massimo Merlino and Daniele Guidi from the company to discuss San Marino’s economic potential, and the opportunities open to investors.

World Finance: Well Massimo, if I might start with you, San Marino – what’s its economic potential globally?

Massimo Merlino: San Marino is a sovereign state, having its own autonomy from three centuries after Christ’s death, so it’s an unbelievably long story of the republic. It’s very very integrated with the world, it has a lot of relationships with more than 100 countries around the world, so it’s commercially and financially also integrated we must say.

[A]ll the small states are leading globalisation

Of course, we can do more; the potential of small states in globalisation is very high, as you know. Because all the small states are leading globalisation and also San Marino can offer to the world a lot of its own competencies and a lot of its own experiences. Normally we are not so known like very old financial platforms, like in Asia or in Europe, but we can of course have a very similar role in the future.

World Finance: What can you tell me about the region’s financial system from an international perspective?

Massimo Merlino: All the micro-states in Europe are moving to more integrating agreements with Europe, with the US, with international markets. And San Marino has proven to do very accurately all these steps, of integration internationally and agreement to be signed with the US and with Europe, and so now it’s ready to be completely open to the world.

The recent fiscal agreement with Italy has at least finished a long discussion with the Italian government. San Marino is on the White List of all OECD organisation countries, but was not with Italy, so now everything has been solved and San Marino is ready to go on the world stage. Of course we have a lot of things to learn in techniques, in competencies, and a lot of new human resources to be educated to international financing.

World Finance: And how is Banca CIS positioned in the region?

Massimo Merlino: Now it is a bank of about 8,000 clients, about 90 employees in the banks and collecting total assets of €1bn. So it’s a medium bank, and of course very active in retail but also in private, because it’s the result of a fusion of previous institutes operating in San Marino.

In the private segment we have the longest periods, from one of these institutions which were connected all together in this Banca CIS. And our private experience is particularly strong because we have a financial company, which is called Scudo Investimenti.

This company is managing 15 funds of San Marinese law and this fund has a lot of advantage from a fiscal point of view, because of San Marino’s lower regulation. And we can also, through Scudo, engineer new products and new funds for other banks according to their specifications.

World Finance: Well Daniele, over to you now: how is the banking system in San Marino structured?

Daniele Guidi: In the past there were 12 banks and about €14bn managed by our whole financial system. But the crisis beginning in 2008 and also the fiscal amnesty in Italy have reduced the potentiality for about 50 percent of deposits. Now we are only seven banks after a process of consolidation and merger acquisition.

The system is in this moment stronger. Also the Central Bank of San Marino’s Annual Report has recently certified the potentiality of the system. And just to give you an idea, the supervisory regulation required for our bank is a minimal level of service duration of 11 percent, so all the system is more than 11 percent. To make a comparison with Europe, Europe is at six, seven or eight percent.

But there are a lot of opportunities: in the last two years our government has improved a lot of laws for residential and fiscal opportunities for foreign investors

World Finance: Well what opportunities do you see for foreign banks and firms in San Marino?

Daniele Guidi: We know very well that San Marino is not acknowledged in this moment as a financial opportunity for foreign investors. But there are a lot of opportunities: in the last two years our government has improved a lot of laws for residential and fiscal opportunities for foreign investors in San Marino.

Just to give you another idea, San Marino is involved as a smaller state – a European small state – in an agreement with the European Union for association, when enables exchange of capital and people inside Europe. So when this process has been handled, there should be the possibility to invest through our country directly in Europe and also using our double taxation agreement network to have fiscal advantages for investors in Europe.

World Finance: Well finally, what’s Banca CIS’ strategy for future growth?

Daniele Guidi: To offer for our local customers a number of products and services under our technology; mobile phone and mobile opportunity.

Secondly, there is an opportunity reserved with this agreement with the European Union. We would like to develop corporate finance, because corporate finance should be very interesting for this kind of investor.

Thirdly, our know-how is also important in private banking and wealth management, and as a family office. We are opening new branches outside Italy, outside Europe in this sector, so we would like to develop private banking and wealth management opportunities in Europe.

World Finance: Daniele, Massimo, thank you.

Daniele Guidi: Thank you.

Massimo Merlino: Thank you.

Pakistani anti-terrorism measures not good enough to attract FDI | Video

Posted on July 22, 2014July 23, 2014 by World Finance

Pakistan continues to face a sluggish economy partly due to recent terrorist attacks in the nation’s financial capital, Karachi. These events, in addition to other local threats from militant groups, have resulted in a limited number of foreign direct investment opportunities. World Finance speaks to Michael Kugelman on how the government and the emerging middle class can improve the country’s economic prospects.

World Finance: Pakistan is currently engaged in its most ambitious attempt to control the Taliban and Islamist fighters in the mountains of Waziristan; what are the costs of losing this region?

Michael Kugelman: You hear very often the phrase that Pakistan is essentially the supermarket for global terrorism, just because there are militants of all walks of life. Some Pakistani, some from elsewhere around the world. Al-Qaeda has a large, or had a large presence, in this region. There are a lot of foreign fighters there. And of course Pakistan is a country with nuclear weapons, so that all adds to the picture, and makes it a really unpleasant stew of militancy.

So there’s really a lot at stake here.

World Finance: Now do you think the perception that Pakistan has been harbouring terrorists, the likes of Osama bin Laden, will be obscured by this current military campaign?

Michael Kugelman: Unfortunately no. I think that on the surface level, this military campaign in north Waziristan seems to be a good thing. Because for the very first time in recent memory, the Pakistani government has agreed to launch a military offensive in this locus of terrorist activity in north Waziristan.

The problem though is that the Pakistani military’s going to be very selective in who it goes after. It’s going to go after certain militants, like the Pakistani Taliban, that target the Pakistani state. But there are many militants in north Waziristan that target Afghanistan, that target international troops in Afghanistan, that target India; I’m talking about groups like the Afghan Taliban, the Haqqani network.

There are a lot of groups that are threats, and they really are not going to be dealt with. In fact many of them have actually just left north Waziristan and slipped into Afghanistan or other tribal areas.

World Finance: And all of this being considered, how is it going to affect investor confidence in the region?

Michael Kugelman: There really is not much interest at all in terms of foreign investment in Pakistan, and particularly since a terrorist attack on the Karachi airport not too long ago, which I think really hit home.

If the major airport in the financial capital of Pakistan is attacked… you know, it can’t really get much worse than that.

And it’s a shame! Because there is a lot of potential in Pakistan. A lot of growing industries. In my view there is the architecture for there to be significant foreign investment in Pakistan. But the security situation just does not allow for it.

World Finance: So what is this all going to do for the country’s international economic curb appeal?

Michael Kugelman: If the security situation calms down, then I think we could see it change. Unfortunately I tend to be a pessimist. I really fear that the security situation will get worse before it gets better. I fear that a lot of the militants that are being targeted by the military will essentially launch a new campaign of revenge attacks, which will make the security situation even more troubling. And that of course bodes very ill, bodes very poorly, for foreign investment.

World Finance: Now let’s consider the role of the military. The military complex of course is one of the strongest in the world in Pakistan; who really controls the country? Is it the government, or is it the military?

Michael Kugelman: The military has a say in everything, including the economy. Every year, despite promises to the contrary from the government, defence spending always constitutes a significant component of the national budget. And this hasn’t changed this most recent year. And so I think until the military is willing to relinquish its tight hold on the budget; until more money is made available to cover other key areas – from energy to education – there are going to be a lot of problems.

Others will argue however that the military, when it’s been in power, the military was actually very effective. It actually managed the economy very well. There wasn’t as much corruption and so forth.

But the key issue is that the military still hogs the national budget, and that’s not going to help the economy.

World Finance: But there have been some demographic changes, including the role of the middle class; can you tell me how important are they to the future of Pakistan?

Michael Kugelman: Pakistan is not the type of country that lends itself to large protests. It’s a very divided country, fractured along ethnic lines, provincial lines, sectarian lines. It’s hard to get these large movements, even within the middle class.

I’m glad you mentioned that, it’s a very significant component of the demographic; it’s relatively large and rising.

I just don’t see it as realistic. I don’t see there being these protests, trying to get the military to change the role it plays in the politics of the country.

World Finance: Now let’s look at the government’s overall game-plan. They’ve been involved in fiscal consolidation to deal with high deficits, but do you think that this is even the most effective economic strategy?

Michael Kugelman: No, unfortunately I think there’s much to be concerned about the Pakistan’s economic policy. I’ve said before, I’ve said many times that Pakistan does have the potential to get its house in order. But I just see repeatedly that despite what the government’s saying about belt-tightening moves and austerity measures, that it essentially is settling for hand-outs.

Not too long ago, the Saudi Arabian government, which is very close to the Pakistani government, provided a lot of money to Pakistan to try to deal with some of its economic problems. It’s a good short-term measure, but it certainly is not sustainable in the long-term.

Similarly Pakistan has tried to address its very large amount of debt in its energy sector. Not by creating more efficient industries, or dealing with pricing and subsidies, but simply printing more money to bring the debt down! That’s what it did a few months back. And of course, completely predictably, that debt has come right back.

So I see a lot of encouraging nice talk, and the right things are being said. But in terms of actual action on economic policy, I’m not seeing much to be encouraged about.

World Finance: Michael, how long is it going to take for us to see Pakistan really turn a corner?

Michael Kugelman: So I think it’s going to really take a paradigm shift in how the state and its practitioners, and the people in government, think about the country as a whole.

Maybe one could argue that we have to wait for a new generation of younger, more open-minded Pakistanis to bring about this change. But unfortunately, given what I’m seeing about demographics in young people in Pakistan, they tend to be much more conservative, in many cases much more hard-line, than their parents’ generation. More supportive on the military.

So I fear… it’s hard to put a date on when things could change. And I really worry that Pakistan could really… it…

Probably what will happen is that it will muddle along. It’s not going to collapse, it’s not going to fail – contrary to what a lot of people, including in Washington DC here, say. But I think it’s really going to plod along, muddle along, and it’ll reach a point where you have to wonder – how long can it continue to survive on that level? And I don’t know.

World Finance: Michael Kugelman, thank you so much for joining me.

Michael Kugelman: Thank you.

The threat of secular stagnation

Posted on July 21, 2014July 23, 2014 by Ashton Wenborn

Former US Secretary of the Treasury Larry Summers has been doing the publicity rounds lately – talk shows, radio interviews and op-ed columns all over the world. Summers is a man on a mission. Not fighting crime or ending world hunger, the former Secretary of the Treasury wants to warn the world of the risk global economies are of becoming entrapped in a cycle of secular stagnation.

Outside of an undergraduate economics course, secular stagnation was last considered a newsworthy subject shortly after the Great Depression, but once recovery was assured, the concept was promptly forgotten by the mainstream. Since the global economic downturn, many parallels have been drawn with that grim period in the 1930s, so it was only a matter of time before secular stagnation was brought up again. However, as far as parallels go this one appears to be fairly pertinent – and it might be threatening the meagre economic recovery the US and Europe have experienced over the past year.

“Secular stagnation refers to the idea that the normal, self-restorative properties of the economy might not be sufficient to allow sustained full employment along with financial stability without extraordinary expansionary policies,” Summers told Ezra Klein of The Washington Post in January. “The idea was put forth first by Alvin Hansen in the late 1930s. Given the Second World War and the tremendous pent-up demand for consumer and investment goods after the war, it did not prove relevant. But the difficulty our economy has had for many years now in maintaining simultaneously full employment, strong growth and financial stability makes me wonder about its current relevance. So does the rather dismal growth performance in recent years of the remainder of the industrial world.”

Former US Secretary of the Treasury Larry Summers has been touring the world, warning leaders that global economies face the threat of secular stagnation

In a nutshell, Summers argues, rather pessimistically, that this recovery is not a recovery at all, but yet another sign of the chronic underuse of potential resources in the economy. Over the past two decades, economies have been kept afloat not by new investments or innovations, but by asset bubbles based on ever-mounting levels of leveraging. Meanwhile, interest rates were falling, as were rates of expected profitability of investments. Crucially, however, expected profitability was sliding much faster than interest rates.

Not new, yet still prolific
Most experts agree that stagnation was indeed a risk during the worst of the slump, which is why many governments opted to inject money into economies through quantitative easing or other methods. What is unique to Summers’ argument, though, is that he suggests modern western economies have been in this slump for the past 15 to 20 years. If correct, that would mean major economies might never return to full employment and robust growth without policy support.

“While things are looking up now, it is only because the economy was performing so poorly before,” explains David Orrell, an economist and principal at Systems Forecasting. “Summers has a plot showing that GDP for the US, Euro area, Japan, and UK only recently recovered the ground lost following the crisis in 2007. The growth rate remains relatively slow, leading him to suggest that the potential economic output has been permanently lowered. Structural stagnation provides a narrative that explains the build-up to the crisis [a savings glut], the slow recovery, and the existence of asset bubbles.”

According to Summers, one of the main causes for concern is that even before the crash in 2008 the US economy was being propped up by an enormous housing bubble. But even that was “not enough to produce any kind of overheating as measured by wage and price inflation, or as measured by unemployment relative to traditional low points,” he told Klein. Were it not for the housing bubble and irresponsible credit, not much was left to drive the US economy between 2003 and 2007. “Housing investment would have been two to three percent lower than GDP, and consumption expenditure would have been considerably lower as well, resulting in very inadequate performance,” explains Summers.

In 1938 Hansen suggested that due to a slowdown in population growth, demand for capital would lower and the world would face an enduring issue of “secular, or structural, unemployment… in the decades before us.” Of course Hansen was wrong – the 1950s and 1960s saw some of the most robust employment rates on record, and growth was solid. However, it would be foolish to completely disregard Hansen’s predictions. A lot of the progress of this period was off the back of World War II, and growth was driven by the rebuilding efforts in Europe, and Cold War investments in the military in the US.

“Population growth was boosted by a war-induced baby boom and mass immigration into the US and Western Europe. New export markets and private investment opportunities opened up in developing countries,” Robert Skidelsky, a Warwick University professor and peer in the British House of Lords, writes in the Social Europe Journal. “Most Western governments pursued large-scale civilian investment programmes. Think of the US interstate highway system built under President Eisenhower in the 1950s.”

It is therefore not far-fetched to argue that these unusual circumstances merely postponed the falling demand and employment that Hansen had foretold. It is possible that when circumstances normalised and when birth rates started falling again, the global economy once again began to move towards the slump we are experiencing today.

Bending the rules
Summers is not alone in reviving Hansen’s idea of secular stagnation to explain growth patterns in the world today. Brown University economists Gauti Eggertsson and Neil Mehrotra have recently published a paper suggesting the US economy will not recover any time soon. Despite close to zero short-term interest rates, the Federal Reserve will be “unable to generate a sufficient monetary stimulus”, which they say will lead to a “permanent slump in output”. “It’s not a baseline scenario, but I think people should at least be starting to consider the possibility that this could go on for a while,” Eggertsson went on to tell CNBC.

Source: International Monetary Fund. Notes: Figures post-2013 are IMF estimates

Neither Eggertsson, Mehrotra or Summers use the term ‘liquidity trap’, as it is understood that the current state of the economy means monetary policy is effectively being held back by the ‘zero bound’. Paul Krugman has discussed Summers’ secular stagnation theory as “a situation in which the “natural” rate of interest – the rate at which desired savings and desired investment would be equal at full employment – “is negative.” He describes a de facto liquidity trap, in which “normal rules of economic policy don’t apply. As I like to put it, virtue becomes vice and prudence becomes folly. Saving hurts the economy – it even hurts investment, thanks to the paradox of thrift. Fixating on debt and deficits deepens the depression.”

Though the argument has been mainly about the US economy, secular stagnation is certainly a global phenomenon and is best observed through the development of industry. All over the world, from Europe to Japan, industrial output has cooled off and Summers argues there is virtually no chance of the industrial world recovering within the next five to 10 years, relative to potential and employment.

Since the onset of the crisis in 2008, a number of countries have been in the habit of accumulating huge amounts of foreign reserve in an effort to maintain steady exchange rates that will benefit trade; but this practice has a knock-on effect on demand globally. As a result central banks have been left with few choices to stoke demand, so interest rates have come sliding down. “Central banks have tried to boost the economy by lowering interest rates, but instead of stimulating investment and employment the money seems to have been channelled into asset price inflation, for example, house prices in the UK or here in Canada,” explains Orrell. “The problem is that monetary policy is an indirect, top-down way of stimulating economic activity. So lowering interest rates might not have the effect that the central bank is aiming for.”

Creating demand with demand
Summers suggests the only way to tackle the long-term economic slump looming on the horizon is for countries to engage in a period of expansionary investment policy by governments. “I am convinced it would still be better to raise demand in the economy in ways that do not work through reduced interest rates but operate at any given level of rates,” he told Klein. “Consider my favourite example: debt-financed infrastructure spending. Notice several things: first, when your growth rate exceeds your interest rate – which is surely going to be true for a long time for short-term debt – then you can issue debt, roll over the debt to cover interest and still have a declining debt-to-GDP ratio. Further, debt-financed infrastructure increases GDP (see Fig. 1) by increasing productivity, which makes us wealthier and stimulates demand in an economy that is demand-constrained.

“Finally, if we fix Kennedy airport today, we don’t need to fix it tomorrow. If the concern is the obligation placed on future generations, then our accounting leads us seriously astray if it teaches us to fret over the treasury debt that will be left behind but not the deferred maintenance liability that will be left behind.”

Concerned: Gauti Eggertsson, Senior Economist of the Federal Reserve Bank of New York, has co-authored a report that raises concerns over how quickly the US economy can recover

Not everyone agrees with Summers though, and many have seen his suggestions as a pot-shot at austerity policies. He has written extensively on the subject in a series of columns for The Financial Times, suggesting that though growth in Britain is picking up, it is only because of the extent of the problem Britain has created for itself with its harsh austerity measures. The argument is that the only way to avoid a prolonged period of economic stagnation is to invest in real assets that increase an economy’s capacity. “A main problem with this thesis is that it does not fully take into account the fact that money is created by private banks whose incentives are not perfectly aligned with the needs of the economy,” says Orrell. “The central bank therefore has limited influence on the way in which money is invested (which is one reason so much ends up in unproductive things like real estate). So one way to tackle this problem at source is to go to 100 percent reserve banking, and prioritise business investment.”

One of the main arguments in Summers’ theory of secular stagnation is that central bank policy is fuelling the creation of bubbles, but if it were succeeding in creating adequate demand, it is also likely the fiscal stimulus necessary would lead to huge increases in nominal interest rates. “I would argue that central bank policy, plus the fact that most money creation is private, is creating bubbles; and this has an indirect effect on employment,” says Orrell. “We need investment in green projects which don’t necessarily boost economic growth as measured by GDP. So I would say that he has put his finger on a central problem of the economy, but for solutions we need to look more critically at the way money is created and invested in the first place.” Secular stagnation need not be a threat, and should instead be an opportunity to re-evaluate economic models that pursue indiscriminate growth ahead of a healthy and sustainable economy.

Mexico’s reforms make the country increasingly attractive to investors

Posted on July 18, 2014 by Ashton Wenborn

At a time when money is flowing out of emerging markets, particularly those in Latin America, Mexico stands as a bastion for investment, pulling in record flows as its growth continues to excel. Key reforms and trade agreements have helped make it the 11th-largest economy in the world, with $1.845trn in purchasing power, according to the World Bank. Its exports and manufacturing far exceed that of its Latin American neighbours, and despite erratic growth in recent years, Mexico is currently attracting unprecedented investor attention. With the Mexican Stock Exchange growing (see Fig. 1) and currently valued at some $451bn – second to only Brazil in Latin America and fifth in all of the Americas – banks and investment firms are heralding this as an economy to watch.

Now, a deregulation of major sectors such as energy and telecoms could finally boost the economy once and for all, making Mexico one of the brightest growth stories out there. Financial firms are currently seeing a second wind as key reforms are ensuring more open and regulated markets. With Mexico already racking up a track record for incredible manufacturing booms, as witnessed by its auto industry following the implementation of NAFTA in the 1990s, the economy is quickly becoming a favourite recommendation of major firms like HSBC and Scotiabank. With emerging economies in the region experiencing poor growth following the global deceleration in commodities, as well as a slowdown in manufacturing, Mexico is currently the only LATAM economy which investors can assuredly invest their money in. Mexico’s economy is the happy product of trade deals, as well as broad and effective deregulation, which has transformed the economy.

International trade
The main driver for Mexico’s growth was its adoption of NAFTA in 1994, which nearly tripled its trade with the US and Canada and made it the largest trading nation in Latin America. At the time, Mexico, similar to many current Latin American economies, was developing and had a somewhat protectionist economic stance. NAFTA helped create a more open, value-added and focused Mexican economy, led by an outward-focused manufacturing sector rather than by commodities, or in some cases inward-looking manufacturing, which dominates the rest of the region. This is highlighted by the fact that Mexico exports 1.8 times more manufactured products than the rest of Latin America combined, despite its economy being only 32 percent of the size of the rest of the region. What’s more, data proves that this divergence coincides with Mexico’s entry into GATT and NAFTA, as manufacturing exports grew from eight percent of GDP in 1980 to 18 percent in 1995, and 23 percent by the end of 2012. By way of comparison, South American manufacturing exports as a share of GDP have mostly hovered in a three-to-six percent range.

[T]he economy is considered a strong bet for growth from 2015 onwards as the effects of fiscal and industry reforms start to take effect

In addition to this, Mexico is also party to a number of free trade agreements including deals with the EU, the new Latin American trade bloc, Pacific Alliance, and the proposed Trans-Pacific Partnership, which would include the US, Singapore and Australia in addition to various other Pacific nations.

“International and bilateral trade deals have made Mexico more competitive by changing production costs, rolling back protectionist trade stances and making the economy more open. Because Mexico keeps pursuing competitiveness, we look at the economy favourably and believe we will see a trend of growing GDP bringing growth over 3.5 percent from 2015 and onwards,” explained Andre Loes, HSBC’s Chief Economist for Latin America.

Opening up energy
International trade deals aside, the Mexican government has also worked hard to reform its economy by opening up key sectors such as automobile production, energy and telecoms. This has helped bolster Mexico’s economy, the GDP of which plunged 6.5 percent in 2009 as exports dropped during the financial crisis.

The most important recent reforms have opened up Mexico’s energy sector. So far, one player has dominated the energy market for the last 75 years: government-run Petróleos Mexicanos, otherwise known as Pemex. However, this will soon be in the past, as President Nieto surprised global investors last year by gaining support for a constitutional change to open up one of the most closed energy sectors in the world to foreign investment and refashion Pemex into a for-profit company within two years. Analysts from consulting firm McKinsey expect the move to attract $20bn of investment by 2016 alone.

“The energy reform will allow for private company intervention in a notoriously closed market,” said Loes. “Given the size and perspectives of Mexico’s oil fields and shale oil and gas, energy will be a very important sector to invest in”.

There are big opportunities for the domestic economy and foreign oil companies as Mexico is estimated to have 54.6 billion barrels of oil in conventional resources, and 60.2 billion in unconventional, according to Pemex figures. Lower energy costs would help Mexican consumers and boost domestic demand. With electricity and gas prices higher than any other North American country, Mexico is keen to invest in its energy sector and bring down grid prices. This is also why the government is pushing for private companies to produce shale gas in northern regions, in addition to promoting partnerships on deep-water drilling projects in the Gulf of Mexico.

Financial sector stability
In addition to the convergence in manufacturing and energy development, Mexico’s financial system has also become more integrated with the rest of the world, making its financial services some of the most stable and regulated institutions in the region. Reforms opened the country’s financial system to foreign players in the late 1990s and recent changes have contributed to the country ranking 30th globally for its ‘soundness’ according to the World Economic Forum.

Analysts suggest that engagement with foreign institutions through NAFTA led to strong financial standards being set up by local regulators, plus the supervision of parent companies from various countries. In addition, the presence of major banks also helped Mexico import institutions from mature financial markets, and has contributed to a banking system with an average tier-1 capital ratio of 15.7 percent. “As part of the efforts to make the economy more competitive, there has been a continued push to reform institutions (with different levels of success over time), but which has over the past 20 years resulted in an independent and credible central bank, relatively liquid financial markets (one of the most liquid forex and fixed income markets in all emerging markets, and in some metrics, even a rival to lower tier developed markets), as well as a stronger balance sheet and solid institutions,” explained Eduardo Suárez, an analyst at Scotiabank, in a recent report on the Mexican economy and the impact of NAFTA.

Source: World Bank. Notes: Figures are for domestic listed companies

By allowing for capital market integration, the domination of foreign banks and eliminating restrictions on trading, Mexico has managed to successfully link domestic incentives with those of foreign players, and this again is opening the economy to much needed foreign investment.

Balancing China and the US
That said, the Mexican administration continues to face many economic challenges, including improving the public education system, upgrading infrastructure, modernising labour laws, and fostering more private investment in the energy sector. To this end, the president has stated that his top economic priorities remain reducing poverty and creating jobs.

Dealing with labour issues is especially important as Mexico continues to compete with China when it comes to low-cost manufacturing. Although its auto-industry reigns supreme as the top North American producer, China has already caused several shocks to the Mexican economy since its entrance into the WTO in 2001, which led the Latin American economy to adjust its wages and increase trade through more reforms in order to remain competitive. Despite Mexican exports taking a slight dive in the early 2000s, there seems to be a clear lesson that developing economies can compete with the Chinese if non-protectionist policies are encouraged.

Mexico has made itself extremely dependent on trade, and as with any open economy, this makes the country especially subject to structural changes in the global economy and particularly the US, which currently absorbs about 80 percent of Mexico’s exports. Consequently, analysts at Scotiabank suggest that education reform will be crucial for the country to step up productivity and become less reliant on the US.

Finally, what’s really key for Mexico is to boost its levels of foreign direct investment (FDI). As of now, the economy is considered a strong bet for growth from 2015 onwards as the effects of fiscal and industry reforms start to take effect. According to HSBC, this will boost investment flows into the Mexican auto, energy and electronics industries, and FDI is sure to pick up as the energy market continues to develop in line with ongoing global demand. As a result, Mexico is poised to become the fifth-largest economy in the world by 2050, making it one to watch among emerging markets.

Emirates could buy 80 superjumbos from Airbus by 2020

Posted on July 17, 2014 by Ashton Wenborn

French aircraft manufacturer Airbus has been called on by its biggest customer, Emirates, to fit its four-engine A380 superjumbo with new Rolls Royce motors to boost poor sales. Emirates Airline has said it will buy 60 to 80 A380 aircrafts if the planes are revamped to include fuel-efficient engines, weight reductions and improved aerodynamics.

President of Emirates Airline Tim Clarke said his company was willing to purchase additional aircraft on top of the 140 that have already been acquired from Airbus. The fast-growing Gulf carrier has publicly called on Airbus to start work on the new planes in order for them to ready for service in six years time.

Known in the industry as the A380 Neo, Airbus is yet to commit to manufacturing the new plane, despite Emirates saying it will buy them. Instead, Airbus will assess the reengineering of the A380 to ascertain if it is possible to have the aircraft ready sometime in the 2020s.

Clarke has stressed that Airbus should treat the matter with urgency

Clarke has stressed that Airbus should treat the matter with urgency and talk to other airlines soon to find out if there is suitable demand for the revamped carrier. In an interview with the FT, the Emirates president said:“Airbus need to get on with the job and say ‘this is how [an A380 Neo] will look and this is what [the aircraft] will do and this is the price we will charge in 2020’ and go out and test the market.”

Airbus does not agree. Chief Executive Fabrice Brégier has stressed there is “no urgency” to drop its current plans and press ahead with manufacturing the untested airbus. The French company, which posted profits of €21.1bn in May, said its main priority is to continue growing the sales of the existing superjumbo, dubbed the new “Queen of the Skies”.

The A380 can carry 500 passengers, making it the largest airborne people carrier in the world. The catalogue price for one is $414m, so the purchase of 80 would cost Emirates billions. With Emirates and Airbus at loggerheads, however, it looks unlikely that sale will happen before 2020.

Alex Brummer: banking system is ‘still living on crack cocaine’

Posted on July 17, 2014 by Ashton Wenborn

Six years on from the financial crisis, and the banks are still seen as villains. But is the reputation fair? One man who has been deeply critical of the ways in which banks have conducted themselves is Alex Brummer, financial journalist and author of Bad Banks: Greed, Incompetence and the Next Global Crisis. World Finance speaks to the writer to hear this views on why we need – in his words – a return to “plain vanilla utility banking”.

World Finance: Well Alex, everyone’s pointing fingers at banks, but are they as bad as people make out?

Alex Brummer: The record is pretty bad, and hasn’t got any better. You’d have thought that, you know, six years after the crisis, things would have calmed down, but there’s scarcely a day when there’s not some sort of regulatory action against the banks, and some new problem that we find.

Most recently we found a problem in the area of stock market trading, in a mysterious area called dark pools. And so there’s always a new area where intervention is taking place.

World Finance: As regulators and governments have tried to stabilise the industry, skeletons have come out of the closet. But surely that was inevitable?

Alex Brummer: I don’t think it was inevitable! I think that what’s interesting is that a lot of this behaviour took place since the financial crisis.

So we had the crash, which was 2007-8-9, that was a huge shock to the financial system; many of the banks had to be bailed out by governments. But many of these new actions which we’re finding – problems in the foreign exchange markets, problems in dark pools, problems of selling products to consumers which they shouldn’t really be buying – have come up since the crisis.

So that suggests that none of the lessons that they learned in the period leading up to the crisis have been learned!

World Finance: Well regulators have been working very hard to get rid of bad habits, so, have banks now cleaned up their act?

Alex Brummer: A lot of this is a kind of wash, an attempt to sort of, look better than they are, that the culture is changing and so on.

[T]here’s scarcely a day when there’s not some sort of regulatory action against the banks, and some new problem that we find

I also think that the regulators have changed their attitude too. I always regard it a bit like a football match, where the referee didn’t give a penalty in the first half, but now he’s giving out lots of penalties because he realised he was too soft in the first period of the problem.

And so that’s why a lot of these things, these skeletons, as you referred to them, are tumbling out of the cupboard.

World Finance: So which banks would you say are the worst? In your opinion?

Alex Brummer: I don’t know, I mean – a case for measuring that. But you could look at some of the fines which have been levied.

So one of the banks which came out of the crisis most strongly – JPMorgan Chase in the US – has actually now had the biggest fines on mortgage securities. It paid fines of $17bn. BNP in Paris, that paid a fine of $9bn.

Here in the UK, Barclays have been involved in almost every scandal you can think of: interest rate fixing, foreign exchange market fixing, a problem in the gold market, a problem in the dark pools which we referred to before – that’s the shared dealing markets in the US. Almost every area of activity that they’re involved in, they’ve had some disciplinary action.

World Finance: Well you talk about interest rate fixing, mis-selling, dark pools for example; some of these practices aren’t illegal, and there’s definitely a grey area there. So what’s the problem?

Alex Brummer: We have to be very careful here, because many of these cases now are actually being looked at by prosecutors. In particular the activities in the foreign exchange market, in the activities in the Libor market. A number of people have been arrested, a number of people have been charged. And we’re waiting for some of these cases to come to court as we speak now.

So in fact, that does suggest that there was some measure of illegality that went on. Although it’s only allegations at the moment.

World Finance: So where did it all go wrong? Do you think it was a case of bankers just thinking they were invincible?

Alex Brummer: I think that they live in a world of their own. I think that they feel that there is a kind of sense of entitlement in the banking world, and the bonuses in the banking sector drives a very bad culture. So the profit motive is far too strong. People are incentivised to push the boundaries as far as they can to try and improve performance and improve their bonuses.

I think if we controlled the bonus culture, made it much more long-term, that would be a big start in cleaning up the whole process.

World Finance: Well there were other industries that exposed economies on a large scale: insurance or other brokers. Are they equally to blame?

Alex Brummer: In the past they too have been involved in big mis-selling scandals. They were involved in the wrongful selling of endowment policies, the wrongful selling of private pensions to people in the public sector. So they’ve made big mistakes in the past.

I actually do think that they have cleaned up their act quite a bit. We’re seeing much fewer complaints. But you do get complaints about the way insurance is sold and so on. But it’s on a much lesser scale. And I think the banking system is where it’s really gone badly wrong.

World Finance: Now do you think there’s a case that maybe banks have had a little bit of unfair publicity? Because they were after all working under the remit of governments? So surely they should be to blame?

[T]hese skeletons, as you referred to them, are tumbling out of
the cupboard

Alex Brummer: I just think that they got out of control. While the profits were flowing in, nobody complained. When the public had to pick up the pieces? After the financial crisis, here in Britain we had to pump a trillion pounds into the banking system. A lot of that we haven’t got back.

People forget that we still own, all these years afterwards, 80 percent of the Royal Bank of Scotland. We still don’t know the story of what happened to HBOS. So you feel we’re part of a kind of conspiracy, in which the taxpayer is picking up the bill. The bankers walk off with the profits, and the taxpayer picks up the bill every time.

World Finance: So who would you say are the major players today, and are we just waiting for more scandals to hit?

Alex Brummer: We just don’t know; the regulators are looking at a whole series of things which they’ve never looked at before. So one of the things that has tumbled out of the cupboard most recently is the breaking of financial sanctions.

So, governments throughout the world, through the UN, have taken steps to prevent the flow of finance to countries like Iran, to Sudan, to Al-Qaeda and so on; and it now looks like a number of banks – BNP Paribas and HSBC are allegedly involved in this, Standard Charter here in the UK are allegedly involved in this – a number of banks have set up whole, complete systems to circumvent laws which have been put in place by governments, by the UN, by the European Union, in order to go around that to make money.

And those particular cases are now coming up now very strongly.

World Finance: Well you have suggested that we haven’t resolved the problems that led to the credit crisis six years ago, and in fact we could be headed for another one. How can we avoid this?

Alex Brummer: Probably the way we’re going, which is to try and change the culture of the banks, change the behaviour of the banks, and change the focus of the banks.
What we really need to focus on is what banks are there for. They’re there to take deposits; they’re there to make loans to companies, corporations, small businesses and individuals.

What we’ve seen is, the banks have found these other activities in financial markets, speculation of one kind or another, to be much more profitable. And so the rollback of trading on your own behalf, principal trading by banks – that’s a very important development.

And what I would like to see is a return to plain, vanilla, utility banking. Where banks do what they’re meant to do.

World Finance: Well finally your book says that the failings of the world banking system are threatening to undermine the future security of economies. How exposed are we?

Alex Brummer: We’re still living on – I suppose you’d call it crack cocaine. The US Federal Reserve has been pumping trillions into the market. It’s still doing so, and it will be doing so for most of this year, until the autumn of this year.

The problem is, when that stimulus is removed, we may see some more cracks in the system. In the emerging markets, some of the weaker banks in Europe which have still to address their serious problems. And so I think we may feel we’re getting better – prosperity is returning, the financial system is becoming normalised again – but I feel that when that artificial stimulation is taken away and the interest rates return to a proper level, we may have another series of problems. Particularly in the emerging markets.

World Finance: Alex, thank you.

Alex Brummer: Thank you.

LEI promotes transparency across financial markets

Posted on July 17, 2014July 10, 2014 by Ashton Wenborn

The LEI is well on its way to establishing more transparency around financial transactions and markets. Its implementation will highlight some specific data management challenges, but its benefits for financial institutions and firms are wider reaching than simply reporting to regulators.

The problems financial institutions had to deal with in 2008 included the understanding that they faced full exposure to one another. Underscoring the need for additional transparency and regulation in the financial markets is the ability to uniquely identify financial interconnectedness. When the Lehman Brothers collapsed, both financial regulators and the private sector were unable to assess quickly the extent of market participants’ exposure to Lehman, or to fully trace how the vast network of participants were connected to one another.

Subsequently, regulators identified the failure of risk management processes and controls as a significant contributory factor, and focused on developing the macroeconomic tools required to monitor systemic risk. As a result, the demands for transparency on firms and understanding exposure across the business have increased.

The LEI provides the glue that will allow firms to uniquely identify and map business entity data to the many public, proprietary and internal identifiers utilised by the
industry today

Over the years, industry bodies such as the International Standards Organisation attempted to establish a global entity identification system, but efforts could not achieve the level of coordination needed to launch a single global solution. Neither was there the regulatory impetus in place required to drive broader adoption. While there are currently many ways to identify entities in financial transactions, there is lack of a unified global system to identify and link data to enable financial regulators and firms to better understand the true nature of risk exposures across companies, markets and jurisdictions.

Initiating a LEI
Post 2008, the G20 nations tasked the Financial Stability Board (FSB) – a supra-national regulatory coordination body – to prepare recommendations for a global LEI governance and implementation framework. Coordinated worldwide commitment has helped overcome previous impediments to developing a global LEI system, which is expected to be a significant achievement in responding to the vulnerabilities of the financial system, and provide meaningful long-term benefits for regulators and market participants alike.

The LEI is designed to be a unique and persistent entity identifier enabling risk managers and regulators to consistently determine parties to financial transactions instantly and precisely on a global basis. It will be a common pervasive code to supersede the many proprietary vendor and internal codes already in existence. Aside from an initial registration fee and an annual maintenance fee paid by the firm requiring a LEI, it will be free of licensing conditions to encourage adoption.

Within scope are legal entities, subsidiaries and fund structures, banks, fund managers, corporates, partnerships, trusts, municipal corporations, government departments and charities which all require LEI. Individual persons, branches and operating divisions, however, are out of scope and therefore do not.

When industry adoption of the global LEI reaches critical mass, data reported both externally to supervisors and internally for risk management purposes will be more reliable. The global LEI will enhance the ability of regulators to monitor and analyse threats to financial stability and the ability of risk managers to evaluate their companies’ risks. It promises to facilitate improved risk analysis, supervision and regulation, reduce cost for industry in collecting, cleaning, and aggregating data, and in reporting data to government regulators. It also mitigates operational risks of private firms and improves their internal risk processes, and enhances the industry’s market discipline.

The LEI system is an alphanumeric code and associated set of reference data items to uniquely identify a legally distinct entity that engages in financial market activities. Following a robust International Organization for Standardization (ISO) process, ISO Standard 17442 was created as the new LEI standard, and made publicly available in May 2012. This global standard is endorsed by the G20 as a 20-digit code with associated ‘business card’ information.

Successful operation of the Global Legal Entity Identification System (GLEIS) – which was officially launched in March of last year – will require support from the global regulatory community, private sector firms, and industry associations. The endorsed recommendations define clear roles for public and private sectors. The system is based on two components, a governance model and an operational model.

For the governance model, the GLEIS is overseen through a Regulatory Oversight Committee (ROC), which was established in January 2013. The ROC has a plenary of members and observers from more than 70 authorities as well as a regionally balanced executive committee taking its work forward. Its standing committee and a secretariat in Basel, Switzerland, support it on evaluation and standards.

The Central Operating Unit (COU) will be the principal operational arm of the global LEI system. The private industry will participate and consult on the development and operations of the COU. Established as a not-for-profit foundation, it will also be based in Basel, but is not yet fully functional. In particular, the COU is responsible for ensuring the application of uniform global operational standards and protocols.

It will guarantee that all parties implementing the GLEIS will adhere to governing principles and standards, including reliability, quality, and the uniqueness of the LEI.

Local implementation will be conducted through a federation of Local Operating Units (LOUs), which will benefit from local knowledge of infrastructure, corporate organisational frameworks, and business practices. LOUs will register and validate applications for LEIs, issue LEIs, and maintain the associated reference data.

Progress of the LEI system to-date
Considering the scale of the initiative there has been significant progress since the G20 mandated the FSB in November 2011. Over the last year, there have been several developments towards full operational deployment. The ROCs implementation of a clearly defined governance framework laid the foundations for the use of pre-LEIs allocated by endorsed pre-LOUs in regulatory reporting – until the COU has been established all endorsed LEIs have ‘pre’ status as do the LOUs that allocate them.

The momentum has been further strengthened by the European Banking Authority (EBA), stating that all EU credit and financial institutions apply for pre-LEIs by the end of 2014 for supervisory reporting. Similarly, in the US, the Securities Industry and Financial Markets Association (SIFMA) has called on the Financial Stability Oversight Committee to encourage the adoption of LEI among regulators for financial reporting.

As of April this year, 13 pre-LOUs have endorsed status and this interim system of pre-LOUs and pre-LEIs will continue until the COU is set up and the GLEIS becomes fully operational. At this point, pre-LOUs will convert to LOUs, pre-LEIs will transition to LEIs, and LOUs will begin issuing LEIs. Initial adoption of pre-LEI has predominantly resided among firms that trade OTC Derivatives.

Dodd-Frank in the US and EMIR in Europe both require pre-LEIs in trade reporting, while regulators in Hong Kong (HKMA), Singapore and Australia are also introducing rules to use pre-LEIs. In addition, their use has been mandated for Solvency II reporting by EIOPA, the insurance and pensions regulator in Europe. Looking forward it is expected that the LEI will also become a requirement for AIFMD and Markets in Financial Instrument Directive II (MiFID), which will broaden across asset classes.

As the number of use cases increases, it is safe to assume the number of institutions applying for and utilising LEIs will increase significantly. Eventually it is expected that LEIs will be included in every financial transaction concerning a financial instrument as a
matter of course.

There are challenges however, as the practice of issuing and tracking LEIs becomes more complex once LEI operations have begun. With pre-LEI portals continuing to emerge in several markets, data management professionals will have to cope with the on-boarding and maintenance of LEIs from multiple venues. Without cross reference to alternative identifiers, firms need to manually map pre-LEIs into systems and apply corporate actions on an ongoing basis to maintain data provenance.

As regulatory mandates overlap, firms need to establish a holistic approach to data management to facilitate aggregation of risk exposures. This is done by connecting the disparate data held on counter parties, clients, obligors and issuers. As an identifier with a limited set of reference data, the LEI alone will not resolve all of these challenges.

The full benefits will be realised only when the LEI is packaged with additional content, such as broader entity hierarchies and linkages to the securities master, to provide transparency of organisational structure and risk exposure.

The LEI provides the glue that will allow firms to uniquely identify and map business entity data to the many public, proprietary and internal identifiers utilised by the industry today. It is that mapping and deployment across the enterprise that will yield the true benefits.

Within this model, the LEI could significantly reduce the amount of time to aggregate entity data across different systems, for a view of enterprise-wide risk exposure to a single name issuer or group of issuers by way of the securities held in an investment portfolio or fund.

From the collapse of Lehman Brothers, it is clear how important this structure is to regulators, firms and to the market as a whole. The LEI may primarily be intended to provide regulators with the tools to monitor systemic risk, but in light of its obvious benefits it is worthwhile for all market participants to accept its challenges.

Marc Faber’s financial predictions are the ones we fear, but need to hear

Posted on July 17, 2014July 17, 2014 by Ashton Wenborn

Predicting the highs and lows of the global economy is how fortunes are made and reputations secured, but few people have accurately forecasted major economic shifts with much consistency. However, one man has been doing just that for over three decades. Swiss-born investor Marc Faber has developed notoriety for being a contrarian investor, but despite frequently going against the grain, has successfully warned of impending downturns in markets many months before any of his contemporaries.

Often outspoken, controversial, but more often than not prescient, Faber has cultivated a reputation that’s seen him become a regular commentator on the global economy, touring television studios and conferences the world over. World Finance has taken a look at his career, his biggest predictions, and how he sees the global economy developing in the coming years.

Swiss-born Faber began his career working at financial institutions in New York, Zurich and Hong Kong during the early 1970s. However, he relocated to Hong Kong in 1973, reflecting his enthusiasm for a market that offered intriguing new investment opportunities. In 1990 he launched his own advisory firm, Marc Faber Limited, and is now based in the Thai city of Chiang Mai. He keenly travels the world, advising investors on his differing investment beliefs, while also acting as a fund manager for wealthy private clients.

Faber is such a popular subject for financial journalists because, unlike other economists, he would stick his neck on the line

Gloom, boom and doom
Faber is often labelled a contrarian investor, a strategy that few people are brave enough to pursue. Such investors deliberately take an attitude that is against conventional wisdom, and look to profit from being apart from a herd mentality. While many analysts will be enthusing about a certain stock – therefore driving it up – the likes of Faber will perhaps look at the stocks that were being sold off for value.

The nature of being a contrarian investor is to proclaim ideas that are completely opposite to the consensus, and Faber has certainly succeeded in getting his seemingly outlandish views heard. He has made many of his most notorious predictions about how he sees the global economy developing, alongside his sometimes-colourful way of describing the big issues. He is famed for predicting many of the wild fluctuations to hit global stock markets over the last three decades.

Through the 1980s, while markets were notoriously surging upwards, Faber was a rare voice of caution. He advised his clients in the months preceding the October 1987 crash to withdraw their money from the stock market, saving many of them from the colossal losses that others suffered. He would then go on to make a considerable amount of money from seeing the impending bursting of the Japanese economic bubble in 1990, the collapse of US gaming stocks in 1993, the Asia-Pacific financial crisis in 1997 and the ensuing turbulence it caused to global markets.

As a result of these predictions, Faber became – certainly in Asia – the go-to person for those looking for a unique financial voice. His forthright opinions on how the markets will perform have established him as a solid source for journalists, who frequently asked for his predictions. Hong Kong-based journalist and author Nury Vittachi has worked with Faber over the years, and in 1998 published a book, Riding the Millennial Storm: Marc Faber’s Path to Profit in the New Financial Markets. He told World Finance that Faber is such a popular subject for financial journalists because, unlike other economists, he would stick his neck on the line.

“In principle, we [financial journalists] always loved Marc because he would actually make a prediction. Most of the others came out with the market may go up or it may go down or it may go sideways. He actually had an opinion – whether it was wrong or right, it was a solid opinion from a highly intelligent and analytical source, so it had more value than other people’s financial notes.”

Such is his confidence in his opinion that, according to Vittachi, Faber has staked his treasured ponytail against the performance of the stock market: “…he was so sure of his prediction of a turn-down in the market that he bet his ponytail against it. I was writing the daily financial gossip column in the South China Morning Post at the time and we kept a tight watch on market movements and ponytail length. At one point he had to get one cm cut from his ponytail because the market rose a certain amount.”

Unique insight
Faber recently spoke at an event in London to an audience of investment specialists and entrepreneurs. While many of those in attendance would already have clear ideas as to how they saw the world economy, Faber enthralled the room the minute it was his turn to speak. The event, titled ‘Where next for equity markets and entrepreneurial ambition’, was arranged by global investment firm Meridian Equity Partners in order to help those within the industry get a unique perspective on how the global economy will play out in the coming years.

Meridian’s CEO and founder, Anthony Venus, told World Finance how he first encountered Faber. “I first hired Marc in 1998 for an Asia Business Forecast and watched him go toe-to-toe with Paul Krugman on stage, and it was clear that he had a really unique point of view on the markets, beyond traditional economics. Later in 2003 I hired him again to speak to clients, right after he published a book called Tomorrow’s Gold when the gold price was $400 per ounce, he was urging to stock up on gold. I should have listened back then, although I got in around $600 and still did reasonably well.”

Over the last decade, Faber’s predictions have continued to be accurate, while at the same time pessimistic. At the turn of the century, Faber accurately predicted the sharp rise in price for many commodities, including oil and precious metals. He was also an early proponent of the potential of many emerging markets, most significantly China. In his book, Tomorrow’s Gold: Asia’s Age of Discovery, Faber laid out his belief that the world was undergoing a shift as profound as Europe’s late-fifteenth-century golden age of discovery and the nineteenth-century industrial revolution, pointing to Asian economies as those set to dominate the world for decades to come. By contrast, he also was correct in his prediction of a steady decline in the value of the US dollar since 2002.

The onset of 2008’s global financial crisis led to Faber’s pessimism regarding the US economy, especially in light of the Federal Reserve’s policy of sustaining extremely low interest rates. Such a strategy would eventually lead to the US economy experiencing the sort of hyperinflation seen in countries like Zimbabwe, Faber told Bloomberg in 2009.

Indeed, he has become renowned for his negative attitude towards US economic policy. A staunch critic of the US government over the last decade, Faber believes that the country has outsourced many of the industries that once propelled it to super-power status. In one of his Gloom, Boom & Doom newsletters from June 2008, Faber mocked the US governments’ economic strategy, adding that the country no longer had any serious domestic industries.

“The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in the US. I’ve been doing my part.”

Asian ascendance
His enthusiasm for Asia – and in particular China – is not unbridled. He sees a housing bubble emerging in many Asian economies, with an influx of foreign buyers taking up residence in cheaper Asian locations. In May he told business website King World News that he highly recommended buying up Asian real estate. “Over the last 12 months I increased my positions in Vietnamese shares significantly. And I also increased some real estate holdings in Vietnam. I think we have kind of a bubble in real estate in Thailand. But I can see that real estate markets are very fragmented, and I’ve seen that in the US as well. So, yes, prices of real estate in Chiang Mai have gone up substantially, but I see zillions of Chinese now coming to [live in] Chiang Mai.”

As well as excelling in real estate, Asia’s new status as the focus of the global economy meant that foreigners were increasingly travelling to all over the continent on holiday. Faber told Barron’s recently that the global economy will tilt towards eastern economies, and that the newfound affluence within Asian countries was spurring the region’s tourism sector. “From Vietnam, Laos, and Cambodia to Singapore, Malaysia, and India, tourism in the region is on the rise, propelled by the Chinese. This year, Chinese tourism in Thailand is up 90 percent. Twenty and 30 years ago, the largest tourist groups in Asia were Europeans and Americans. Today, the Chinese dominate. This is an example of how the centre of economic gravity is shifting to Asia from the Western countries.”

The coming years are not going to be as smooth as many central banks and finance ministers are suggesting, according to Faber. He believes that as Asia takes a central role in global economics, the older Western economies will have to get used to looking east for their income. Indeed, he has likened Europe to merely a museum for newly enriched Asian travellers eager to see the world, and that tourism will increasingly be a crucial part of the region’s economy.

More immediately, he believes that global stock markets are heading into treacherous waters once again, and within the next year could face a crash of the same magnitude as the one in 1987. He told CNBC’s Futures Now programme in May that things are likely to be particularly bad over the next 12 months. “I think it’s very likely that we’re seeing, in the next 12 months, an ’87-type of crash. And I suspect it will be even worse.” While such a suggestion flies in the face of the relatively upbeat proclamations from finance ministers across Europe and the West, anyone willing to bet against him should know that his track record of predicting a crash is almost incomparable.