2014 | World Finance

US unemployment ‘result of people giving up’; emerging markets ‘little’ exposed, says economist

Posted on July 16, 2014July 16, 2014 by Ashton Wenborn

It’s only a matter of time before US interest rates, which have been at a historical low, rise. But with unemployment figures better than expected, the government will raise rates sooner. So what does this mean for emerging economies? World Finance speaks to Jerome Booth, economist and leading expert on emerging markets, to hear his views.

World Finance: Well Jerome, unemployment’s link to rates rises: how useful a mechanism is this for stimulating economies?

Jerome Booth: There’s a lot of misunderstanding about what’s going on in the US! There are still about 45 million people in the US on food stamps, and that hasn’t gone down significantly since the height of the crisis.

So the unemployment numbers are actually a result of people giving up and not being part of those numbers.

[T]he unemployment numbers are actually a result of people giving up and not being part of
those numbers

The actual underemployment in the US is pretty much as high as it was. It’s improved slightly, but it’s still very high.

I think there’s also a misconception about the objective of quantitative easing, and the trajectory of interest rates, and the separation of those issues and tapering.

Quantitative easing was a policy in the absence of the fiscal authority seizing banks, whereby the central bank wanted to avoid depression. To avoid that, you have to have the banks healthy. So quantitative easing was a way – emergency measures if you like, by the central bank – to pump liquidity into the banks in order to build up the balance sheets of those banks, enable them to access capital markets themselves, and push up asset prices so that the assets on their books improved.

A lot of that money went straight around in a circle, and was deposited right back at the central bank in the form of excess reserves. So the economy was never stimulated by quantitative easing! So that’s the first point. If you then reverse that through tapering, arguably it doesn’t make any impact either.

World Finance: And in reality, how exposed are emerging markets to US rate rises?

Jerome Booth: Very little. And you have to remember that emerging markets are the bulk of savers now. They are the next savers in the world. Their central banks own 80 percent of international central bank reserves.

What I call ‘core-periphery disease’ is this idea that the core affects the periphery, but we can ignore the effect of the periphery on the core. So one of the aspects of that is when people constantly ask the question, ‘How much money might leave emerging markets IF something happens in the US?’ And not asking the question the reverse way around. In other words, ‘How much money which is in the developed world, which is owned by emerging markets, might leave the developed world?’

So: maybe $15bn – that was one estimate a few years back, by the IMF – might leave the emerging markets if there was another, you know, big problem in Europe or the US. But the central banks and sovereign wealth funds in emerging markets own about $11trn – that’s nearly two orders of magnitude more – in just the sovereign, so-called liquid bonds, of Europe and the US.

So it gives you a much better picture of where the real bargaining power is.

If there’s another problem in the US – if there’s a bond crash, as is quite likely in a couple of years time – then you may well see a huge rush of savings out of the developed world, back into emerging markets, and those currencies appreciate.

[T]he economy was never stimulated by quantitative easing!

And the precedent for this is not something recent; it’s the last time we had huge great global imbalances, which was in 1971.

World Finance: Well a couple of weeks ago when the US announced their unemployment figures, the Indian currency for example dropped quite considerably. So what is the effect on emerging markets when rates rise?

Jerome Booth: If you have Indian central bankers, and Brazilian central bankers doing nothing when there’s weakness in their currency – because it’s actually convenient and it can help them export more – that doesn’t give you a good clue as to what might happen, and the overall trend of what will happen, given the state of global imbalances.

We have seen weakness, and it’s very easy and common for people to then extrapolate from that. And then say, ‘Oh well that’s the trend, and therefore that’s going to continue.’ And that would be a large error. Because what we’re talking about here is big structural shifts.

World Finance: Well the FT reported that analysts at Morgan Stanley pointed out that the central banks in developing countries have been struggling to accumulate foreign currency reserves for the best part of two years. But some countries and emerging markets such as China, for example, have huge forex reserves. So who will be the winners and the losers if rates rise?

Jerome Booth: I would actually argue against the comment that you quoted there! In many cases emerging markets have too many reserves.

One of the indications of this is they are often still fixated about current account surpluses. They shouldn’t be. When you’ve got big reserves it means you should have the confidence to be able to import capital, and manage the fluctuation in your currencies through active intervention.

What’s yet to happen is for them to be more active in their use of reserves, to reduce short-term fluctuations, and more confident that this gives them if you like, the self-assurance to be able to import capital. Which they should be doing! These are capital-scarce countries.

Now, they’re generating their own savings so the real issue is not that they should import more, but that they should stop exporting so much. But importing capital is also important at the margin, because foreign capital can help with transparency and governance and gives competition of ideas. So it should be welcome, and it still is.

That was always a problem back in the 90s, because things overshot. Now that you’ve got these big reserves, they need to change their policy stance and stop fixating all the time about ‘have we got enough reserves?’

What I call ‘core-periphery disease’ is this idea that the core affects the periphery, but we can ignore the effect of the periphery on the core

That doesn’t change your other point, which is that there are still some countries which don’t have enough reserves. But to be honest, all the major emerging markets have huge reserves.

World Finance: Unemployment figures have been largely disregarded as a tool for measuring economies, but the US is doing exactly that. So what would you say are the far-reaching effects, and what would be a better tool to do this?

Jerome Booth: I’m not saying that unemployment is not a useful statistic. I’m saying that unemployment typically has an impact at the margin on inflation. We have the NAIRU, we have the Phillips Curve, there’s a huge great history about this.

That doesn’t really work when you’ve got people who are simply not in the numbers, but are unemployed. That’s what I’m saying. And you know, that’s the reality in the US.

World Finance: Jerome, thank you.

Jerome Booth: My pleasure.

Private banking embraces mobile technology, but developments are slow

Posted on July 16, 2014July 15, 2014 by Ashton Wenborn

The wealth management and private banking sectors have long been known for their highly personalised services. Now there’s a new trend in these old-school sectors, as more and more managers roll out advanced mobile banking and wealth management apps. These allow investors to not only check accounts as they would with ‘regular’ retail banking, but also handle investments, keep an eye on market developments, and hold video conferences with their advisors.

Mobile banking is revolutionising emerging markets as it ensures financial management and swift transactions for millions of previously unbanked peoples. In developed markets, apps are quickly changing the face of traditional banking, eliminating branches and personal service centres one at a time. In the UK alone, mobile banking app use for customers at the five major banking groups almost doubled in the past year. According to the BBA, UK customers now make 5.7 million transactions a day using smartphones and other mobile devices.

So far, the revolution has been driven by retail, allowing people to use mobile banking for day-to-day transactions such as checking their balance, paying bills, and taking out loans, whenever they want. However, private banks are now launching specific apps for wealthier clients, who usually receive a more personalised, advised service.

Clients want mobile
“The world today is becoming more mobile in its use of technology and it’s an accelerating trend,” says Andy Mattocks, Head of Corporate Development at the private banking group Arbuthnot Latham. “Within financial services, retail banking clients almost take online and mobile banking for granted, and whilst we don’t want to compete with that, we wanted to give our clients a choice of ways to interact with us. It supports the private banking relationship and service from our perspective.”

Wealth managers and private bankers have a long way to go to realise the full potential of mobile apps

The firm launched its mobile banking app for private clients in January, after consulting clients on the design and delivery of the application.

“Its been received incredibly well,” says Mattocks. “We deliberately took the opportunity to speak to existing and prospective clients on their needs before launching the mobile app, which happened in conjunction with a new online banking platform. About 25 percent of our online banking users use the app. Considering that this is since January alone, we believe that clients have taken it up because they are actively using it and value it.”

The industry has now reached a stage where it is the norm for a wealth manager or private bank to have at least one mobile app for client use. Some of the world’s leading universal banks already have impressive portfolios of mobile apps for wealthy clients. The trend is largely driven by the clients themselves who want to access their wealth and investments at all hours of the day.

“It is very noticeable that this is a consumer-led revolution,” says Robert Watts, Media Relations Director at the British Bankers’ Association (BBA). “Mobile banking is tremendously convenient, straightforward to use and, crucially, it’s extremely popular with the clients. Banks have been surprised at how intense the take-up of mobile banking has been – it’s happened a lot faster than expected. We’ve actually found that the amount of users on mobile banking has doubled from 2012 to 2013, and from what we can understand from our members, we’ll be seeing similar growth in 2014.”

Major players such as Credit Suisse, Société Générale, ABN AMRO, JP Morgan and Deutsche Bank have some of the most popular apps, having invested heavily. According to research from MyPrivateBanking, it is possible to characterise a general mobile approach for wealth managers, but it is clear wealthy clients need to be treated as a separate and privileged client segment when developing this technology. Core features must help them evaluate, analyse and understand their investments, the report says, in addition to providing a lot of specific content for HNW clients (including product information, and client magazines or publications for sub-segments such as women or entrepreneurs). These apps need to be integrated with other online and offline media and prompt live interactions with the user’s personal advisor.

Mobile private banking apps differ from retail banking apps in that they don’t only provide access to accounts and enable transfers, but also portfolio analysis, brokerage services and real-time market data – on top of wealth management advice. The private banking apps are more complex and cater to consumer needs in a way unseen until now, says the BBA.

“Mobile banking is a tangible and strong example of banks innovating for their customers,” says Watts. “Banks are competing with each other like never before, in order to have the best banking app out there and gain customers. Essentially, the innovation we’re seeing when it comes to mobile banking is driven by a hardy competition for customers.”

Targeted apps for the wealthy
However, only a handful of banks already have apps in place that are targeted at wealthy clients. There is a lack of integration between the apps and banks’ social media presence, which would give the apps a broader relevance. According to several reports on the mobile banking industry, this lack of integration prevents customers understanding the app better and gives an overall sense of lacking customer service.

Wealth managers and private bankers have a long way to go to realise the full potential of mobile apps. Improvements are most needed when it comes to coverage for Android devices, as most firms have focused on iPhone and iPad applications. Considering that app downloads for Android amounted to 58 percent of smartphone app downloads in 2013, and iOS only accounted for 33 percent, this represents a serious under-allocation of resources.

In addition, MyPrivateBanking says too many wealth managers and private banks are failing to provide the full range of core functions that wealthy clients could reasonably expect to find in their financial apps. When it comes to support and communication features, the average firm is meeting some basic requirements but is failing to provide a level of functionality or service that matches the needs or desires of their customers.

However, there’s a good reason private banking apps shouldn’t offer all the services normally provided by their adviser, says Mattocks: “The functionality of retail and private banking apps is really similar, but the way we do banking, whether online or mobile, is about positioning that service as part of the overall core relationship. There are many banks out there that only want to be technology, but we’re relationship-led.”

Consequently, Arbuthnot Latham’s private banking app offers a suite of account and transactions services, but is considered a supplement for advice, which, in the firm’s words, requires the intellectual capital of people. The firm primarily uses the app as a mechanism for communication – something other private banks are grossly lacking.

Notably, only half of financial institutions have taken the time to explain security measures enabled within a mobile private banking app. With a lot of money to lose, this is a cause for concern for many high-net-worth individuals, who have been sceptical of using apps that may not present a stringent security policy.

The private banking industry needs to focus on communication and marketing when it comes to its technological endeavours. That way, they will ensure clients know they’re getting the same personalised, secure and high-priority service they’ve grown accustomed to. And in this respect, it can’t hurt to ask those all-important clients: what it is they expect from their bank in a mobile age.

Client-centricity at the core of MAML’s business

Posted on July 16, 2014July 9, 2014 by Ashton Wenborn

At Mediolanum Asset Management Limited (MAML), the Dublin-based asset management arm of the Italian Mediolanum Banking Group, we like to think we are unusual in the pre-eminence we give to embedding client-centricity into our culture, and in developing the human capital and innovation processes on which our future successes will depend.

We put a great deal of effort into the development of behaviours, processes, investment solutions and tools of superior quality that are useful to clients. The best litmus test that we are meeting our objectives is the trust of our clients. We have attracted positive net inflows every month since our inception in 1998, with net inflows of €3.1bn in 2013. This represented an increase of approximately 15 percent in total AUM for our Dublin-based mutual fund business.

We focus on designing products that meet the needs of our typically-European retail clients, using a proprietary product development process – MedInSynC – to develop, support and evolve client solutions. It embeds our core brand values of client-centricity, investment quality and execution excellence at the heart of all our services. MedInSync – combined with our investment management process, Med3, and our open innovation research and development centre, MedLab, with its innovation network – powers new product delivery and superior client outcomes.

Active investment
While MedInSynC develops, supports and evolves product solutions, our proprietary investment process, Med3, is the means by which we ensure they actually deliver against client needs and commercial promise. It is based on active investment and the understanding that, at times, assets and instruments will be inefficiently priced. We identify opportunities by using both fundamental and technical analysis combined with an appreciation of investor sentiment and behavioural biases. The fruits of these internal processes are to be found in our core retail offering, Mediolanum Best Brands Umbrella, a fund-of-funds/multi-manager offering in which each individual sub-fund targets a specific client need and each solution is carefully crafted from layered value drivers in asset allocation, risk management, manager selection and security selection.

Building a culture that supports client-centricity
is what creates
real sustainable
competitive advantage

A paper by PWC, Asset Management 2020 – A New World, gives a flavour of why innovation will be so important to financial services companies in the future. Combined with rising life expectancy, assets under management in developing economies are set to grow dramatically, with the global middle class projected to grow by 180 percent between 2010 and 2040. Between 2010 and 2020 alone, more than one billion middle-class consumers are expected to emerge globally, representing the largest single decade increase in potential customers in history. In this new world of rising costs and flat or decreasing margins, investment in technology and data management will be core to identifying and meeting client needs, maximising distribution opportunities, and coping with the rigours of increasing regulation and reporting.

To achieve effective R&D and to keep abreast of market competition, we have embraced an open innovation business model, developing an external network of industry collaboration partners to complement existing internal skills and expertise. Our R&D expertise and capability is driven by one inter-departmental working group, MedLab, which brings together expertise and ideas from a wide range of sources.

However, such a model can only be a source of competitive advantage if supported by investments in enabling technologies, such as our internally developed ideas management system (IMS) for product development which forms part of a customised knowledge network platform to facilitate knowledge transfer. We recognise that not every idea will work, but in rapidly evolving markets, a constant flow of new ideas, and the dynamism to bring them to fruition if they are workable or close them down if not, is critical to business sustainability. MedLab provides the brokering and knowledge transfer required to tap skills and ideas from both internal and external parties in geographically dispersed locations, and supports the development process from feasibility analysis to implementation.

Our open innovation business model and centralised development process saves time spent trying to galvanise competencies in different locations, which tends to require projects run on a one-to-one basis involving a select number of predetermined participants.

It is particularly effective for complex projects, where experience is not immediately to hand and expanding the reach of inputs can make all the difference. Research shows it also opens up the potential for first-mover advantage because groundbreaking developments are, in practice, rarely conceived by potential users or firms with similar backgrounds.

In fact, a survey of business leaders by Cognizant looking into ‘innovation outside the four walls’ revealed that 42 percent of those questioned have set up a centralised R&D centre, and 58 percent use external resources to implement ideas. The respondents value the open model’s scalability and many have expanded their collaboration to clients, partners and external expert networks, with 60 percent encouraging customer input, 54 percent harnessing various types of social media and 47 percent using crowdsourcing.

Talent and attitude
The other fundamental tenet of MAML’s operations is the recognition that investing in people is essential to growing the business for the benefit of all stakeholders. In the most traditional sense, this includes the 8,100 hours of training enjoyed by staff last year, but it involves so much more: engendering a culture of creativity, self-discipline, flexibility and responsibility is written into everything we do. It would be easy to pay lip service to this ambition, but we know that the best companies in the world, and particularly those that excel at innovation, are recognised above all by their talent and the attitude of their people. You need only to run though the companies you most admire in your mind’s eye, and you will find this is true. To work, however, this kind of culture must be embraced by behaviours and processes throughout the organisation and properly supported by an HR department with the same set of beliefs and targets. For example, a flat hierarchical structure based on empowerment and trust helps to ensure ownership of tasks is effective at all levels.

In recent years there has been a growing realisation that intellectual capital is a major contributor to a company’s capacity to secure sustainable competitive advantage. Getting the best out of that intellectual capital, however, is a key challenge for management. One strand of this has been to develop digital tools that enable us to bank the company’s knowledge and, which is crucial to enabling and sustaining core processes.

When a staff member leaves, they should not in theory take with them part of the corporate memory. Substantial investments are therefore made into information systems, equipment and software with a view towards embedding flexibility in processes, providing transparency and real time information while also enhancing the risk and control environment. We have set up an in-house virtual library which is key to easing and disseminating internal knowledge flows, and MedCred, a virtual inter-employee reward tool to promote collaboration and teamwork in addition to the IMS and knowledge network platform mentioned above.

Trust in the service
Altogether, our culture and tools ensure we have the very highest quality investment management approach based on transparency and innovation, and that over time we execute it with a constant focus on adapting our investment solutions to changing client needs or changing market conditions. Trust is key in any business, but particularly one where the product is a service.

We strive to build trust with our distributors and customers by explaining our investment views in a user-friendly fashion on an ongoing basis. It is core to our distributor and client support model, as well as an effective means of receiving feedback critical to evolving existing products. We provide ongoing ex-ante updates on products throughout their lifespans, and are always prepared to discuss what did or did not happen as expected. Transparency is so much less effective if offered ex-post. Supporting this commitment to transparency have been significant investments in ‘big data’ analytics to enable us to capture different perspectives in relation to product performances, first for our portfolio managers versus their own objectives; secondly for our distributors versus their commercial promise; and finally at the level of individual clients.

Although forward-looking models for product innovation depend on broad interactivity across diverse locations that are both real and virtual, most companies will want to centralise their R&D centres in a location that can support dynamic practices, as success in financial services also depends on advances in technology linked to digital media, analytics and big data, as well as cognitive computing. Ireland’s technological knowhow, well-educated workforce, access to multiple time zones and well-regulated environment have attracted companies such as Fidelity, Citigroup, AON, Deutsche Bank and many others to establish R&D centres in the capital.

Tech hub
For us, Ireland has provided an invaluable ecosystem of global intelligence through its special mix of leading IT companies and financial services organisations. Dublin is the internet capital of Europe, with a giant cluster of blue chip technology names that includes Microsoft, IBM and Google, as well as social media firms Facebook, Twitter and LinkedIn.

In fact, Ireland has become the cloud capital of Europe and while globally the nation was ranked 10th overall of 142 countries in Cornell’s Global Innovation Index 2013, it was voted fourth in the ‘knowledge and technology’ category, behind only Switzerland, China and Israel. These attributes are great accelerators to businesses located in Dublin, especially those that have the systems and culture in place to tap everything the capital has to offer. MAML contributes to this growing pool of interconnected skills and knowledge, having supported the launch of the Diploma in Innovation offered by the Institute of Banking, a recognised college of UCD, as well as becoming a co-sponsor, alongside the State Agency Enterprise Ireland and others, of the FinTech pre-accelerator run by the National Digital Research Centre (NDRC), which aims to identify, support and grow innovators with early stage ideas which have the potential to grow into viable businesses.

At MAML, we have striven to design an open networked, knowledge-based organisational structure and to instil an innovation-driven culture supported by investment in enabling technologies that is able to generate sustainable competitive advantage. These are secondary objectives, however, to the real prize, which is to embed our client interests and needs in everything we do. Building a culture that supports client-centricity is what creates real sustainable competitive advantage, is something companies can control, and in the future will make all the difference between growing market share and simply surviving.

Alaskan Way Viaduct replacement to reshape Seattle’s future

Posted on July 16, 2014July 16, 2014 by Ashton Wenborn

At 10:54 on February 28, 2001 the Nisqually earthquake – otherwise referred to as ‘The Ash Wednesday Quake’ – hit Washington. Peaking at 6.8 on the moment magnitude scale, the 45-second-long tremor inflicted $2bn in damages and injured close to 400 people. Roads were split in two, buildings were torn from their foundations, and the affected area was declared a national disaster zone by then-president George W Bush.

Among the worst hit sites was Seattle’s Alaskan Way Viaduct: a two-tiered, elevated roadway. Following the earthquake, repairs initially cost the Washington State Department of Transportation (WSDOT) $14.5m, but the Viaduct has more recently been the subject of a multi-billion-dollar replacement programme. In the immediate aftermath of the quake, engineers found that the viaduct had sunk several inches and concluded that if the tremor had lasted for another few seconds the structure would almost certainly have collapsed. Fast-forward to the present day and the Alaskan Way Viaduct replacement programme ranks among the most impressive projects of its kind, and amounts to a crucial fix for the region’s long-standing infrastructural deficiencies.

The topmost priorities for the project moving forwards are stability and protection against seismic activity. The original viaduct was believed by some to be in desperate need of construction work, which was made clear over the five years prior to the 2001 quake, when the Washington State Transportation Centre released a summary report entitled Seismic Vulnerability of the Alaskan Way Viaduct. The document, co-authored by University of Washington Professors SL Kramer and MO Eberhard, found that the highway was ‘clearly vulnerable to severe damage and possible collapse in a design-level earthquake’ and in need of vital repair work.

[T]he Alaskan Way Viaduct replacement programme ranks among the most impressive projects of
its kind

Nonetheless, the ageing viaduct somehow escaped the necessary updates, and safety concerns dissipated as the years progressed. Today, the repercussions for having ignored the warning signs have been picked up by the WSDOT and various agency partners, whose aim it is to deliver a seismically safe and fiscally responsible roadway in place of the original.

“The purpose of the project is to improve public safety by replacing the existing Alaskan Way Viaduct with transportation systems and facilities with improved earthquake resistance and provide efficient movement of people and goods in and through downtown Seattle,” said a spokesperson for the project.

Traffic jam
For over half a century, the Alaskan Way Viaduct has stood fast as the major north-south thoroughfare through Seattle. However, since the viaduct’s construction, congestion has steadily crept up, to the extent that the 60,000-vehicle capacity roadway accommodates close to 110,000 vehicles every day. Due to its proximity to the waterfront and central location in Seattle, the north-south passageway carries 20 to 25 percent of the traffic through downtown Seattle and is crucial for transit and freight operations to and from the surrounding industrial sites and nearby port.

“The Alaskan Way Viaduct portion of State Route 99 is critically important to local and regional transportation,” said one spokesperson for the Alaskan Way Viaduct replacement programme. “Because of its age (more than 60 years), design, and location, a decision was made to replace the roadway with a bored tunnel. This project will also replace the existing Alaskan Way with a new road and is a key component to the redesign of Seattle’s central waterfront.”

Once the Alaskan Way programme is completed two years from now, a two-mile-long tunnel and a number of related developments will fundamentally reshape the way in which traffic runs through Seattle. In short, the replacement tunnel and waterfront improvements will make for a vastly improved roadway through the city and create better economic and social prospects for those living in the vicinity.

Arriving at the replacement tunnel proposal, however, was a process littered with debate and disagreement, as opposing parties argued on the many specificities of an alternative thoroughfare. One proposal aimed to simply replace the existing viaduct with a more stable, larger alternative and to entirely reconstruct the sea wall. However, critics were quick to make clear that deconstructing the viaduct presented an opportunity to better connect the city and the waterfront, and so, after state and local agencies evaluated over 90 proposals, the WSDOT decided on a tunnel option.

“Replacing the viaduct opens up enormous opportunities to improve quality of life in Seattle by increasing mobility through the downtown while making the waterfront more accessible to the public,” said the WSDOT’s programme administrator for the Alaskan Way Viaduct and Seawall Replacement Programme, Ron Paananen. “We need to clearly communicate our design proposals to the project stakeholders and the public – helping them understand and visualise how they can reclaim their waterfront.”

Even so, parties opposed to the tunnel plans continued to put forward the benefits of an alternative solution. And after a lengthy period of debate, the majority finally agreed that, all things considered, the tunnel option was by far the best solution.

“In January 2009, leaders from the state, county, city and port recommended a bored tunnel – along with a host of other improvements – to replace the waterfront section of the viaduct,” says the WSDOT. “It was the only alternative that would allow SR 99 to remain open during construction, maintaining a vital stretch of state highway.”

Digging in
Since construction work on the project began in 2008, just over half of the original viaduct has been demolished and replaced towards the southern end of downtown Seattle. And while some of the lesser tasks, such as column safety repairs and electrical line repositioning, have been completed in full, the biggest development thus far is the tunnelling work, which began in earnest at the mid-point of last year.

Boring a tunnel beneath Seattle, however, is an expensive and technically challenging process, and one that requires highly capable digging tools. Christened ‘Bertha’ by the WSDOT, the resulting custom-built, tube-shaped tunnelling machine is the largest worldwide and now sits 60 feet below downtown Seattle, 1,023 feet along its 9,270-foot journey.

Manufactured in Osaka by Hitachi Zosen Corporation, the machine was ferried in on the Jumbo Fairpartner on April 2, 2013 and reassembled west of Seattle’s stadiums in an 80-foot-deep trench. Beginning July 30, 2013, the 7,000 tonne behemoth set off on its two-mile journey beneath downtown Seattle, only for it to be halted in December, due to seal system issues. Nonetheless, Bertha is scheduled to come back online by late March 2015 pending repair work and upgrades, during which time building work will begin on the one-kilometre-plus of tunnel that has been burrowed so far.

One issue that has taken centre stage since talk of the replacement programme began is financing. The state’s viaduct replacement project will cost an estimated $3.15bn, with funding coming from a combination of state, federal and local sources, together with the Port of Seattle and tolls. Of the estimated $3.15bn, over $2bn has been allocated to the SR 99 tunnel project, and the rest to viaduct removal and replacement projects, alongside various other smaller repair works, management fees and environmental impact studies.

As far as funding is concerned, a little over $1.8bn has been derived from tax, and the rest, tolls excluded, has come from other state, federal and local sources. One major amendment, made in August of last year, relates to the issue of toll funding. Whereas the original 2009 legislature read that the finance plan would include no more than $400m in toll funding, the amount was later revised in 2012 to $200m, and an additional $200m in federal funds were donated to the project to offset the shortfall. Also in August of last year, the Port of Seattle pledged $300m to the project, primarily for programme-related items on the waterfront.

The related street, transit and waterfront improvements are being led by the Alaskan Way Viaduct programme, King County, the City of Seattle, and the Port of Seattle to ensure the project’s social and economic benefits extend to those in the community. The Alaskan Way Viaduct replacement project is more than simply a solution to local congestion issues, but a means of boosting the region as a whole. From new parks and pathways to a new pedestrian promenade and a two-way cycle track, a string of regeneration projects will follow the old viaduct’s demolition in 2017.

The new road is scheduled for completion in 2016, and once opened will remedy long-held safety concerns, ease congestion issues and fundamentally reshape the way in which traffic is carried through downtown Seattle.

Standing in the way of capitalism

Posted on July 16, 2014December 21, 2017 by Ashton Wenborn

The saga of the recent attempted takeover of British AstraZeneca by American rival Pfizer kept industry participants glued to their seats with each twist and turn. Over the course of a month, Pfizer tried again and again and ultimately failed to secure a deal, despite its final offer valuing AstraZeneca at £69bn. After this final bid failed, international rules for the takeover of public companies came into effect, dictating that Pfizer must wait at least another six months before attempting to rekindle negotiations.

Pfizer’s pursuit of AstraZeneca was significant for more than just the stratospheric financial values involved; it was a high-profile sign of an important shift in the market. This was a so-called inversion deal, in which Pfizer would acquire AstraZeneca in order to move its operations to a more competitive tax environment on the other side of the Atlantic. Over the past two years, a number of American pharmaceutical companies have secured inversion deals with European drug manufacturers, particularly in Ireland, as they seek more favourable tax rates (see Fig. 1). The result has been that, as with the attempted AstraZeneca deal, premiums for companies residing in these coveted tax environments have gone through the roof.

Inversion deals are fast becoming a stalwart of the mergers and acquisitions market, highlighting the important role governments play in the establishment of tax environments.

Since the huge amount of publicity generated by the Pfizer bid, US lawmakers are taking aim at this kind of merger in order to protect the country’s corporate tax revenues. But this is precisely the sort of deal that the UK Government has been hankering for: a repatriation of funds that would boost tax receipts. In fact, UK Chancellor of the Exchequer, George Osborne, devised the current tax scheme and policies with this specific sort of deal in mind.

As the world becomes more globalised, it is natural that companies will seek out better deals abroad. The risk governments face is that of a race to the bottom when it comes to corporate tax rates.

Pfizer’s bid for AstraZeneca has brought into the spotlight a number of important questions about the role governments play in attracting foreign companies to their shores, but also to what extent they should intervene when a takeover might not be in the public interest, irrespective of, for example, tax revenue.

In the UK, the coalition government was reluctant to get involved, despite significant political pressure from the opposition, but in France that would not have been the case. In fact, only weeks before the AstraZeneca/Pfizer ordeal hit the papers, the French Government enthusiastically threw itself into negotiations for the takeover of Alstom’s energy arm as General Electric, from the US, and Siemens, from Germany, went head-to-head in an attempt to takeover the company. Despite Alstom’s board clearly favouring General Electric’s bid, the government actually changed legislation in order to tilt the scales in favour of Siemens.

The role governments play in cross-border mergers and acquisitions is often downplayed as the spotlight shines on the more titillating aspects of a deal. But over the past few years a significant number of deals have been boosted or scrapped after officials got involved – for better or for worse.

In 2014 alone, $300.5bn worth of acquisition bids have been rejected or pulled, close to double the figure for the same period in 2013, and the highest since 2008, according to research by Dealogic (see Fig. 2), suggesting perhaps that industry leaders need to reassess their approach to cross-border mergers and acquisitions.

Pfizer tries to take over AstraZeneca
Though the attempted deal dominated headlines in the business pages for most of May, it had been in the works since late 2013. As early as January 2014, AstraZeneca had already refused to enter talks on the back of a proposed sale at £58bn. At the end of April, however, Pfizer’s interest had not waned and it went public with its interest in the British counterpart, and made no secret of the fact that it was looking to shield its non-US earnings from US taxes.

Because the British government had been very public in its campaign to attract foreign companies by creating a more welcoming tax environment, Pfizer’s CEO Ian Read wrote a letter to Prime Minister David Cameron assuring him Pfizer would base its operations in the UK, and guaranteeing 20 percent of the merged company’s research and development capabilities would be based in AstraZeneca’s Cambridge facility for at least five years.

By including the prime minister in negotiations, Pfizer was hoping for a spot of governmental pressure to ensure the deal went through. It might have got more than it bargained for when the leader of the opposition Labour Party, Ed Miliband, waded into the debate by accusing Cameron of “cheerleading” for a foreign company, at the expense of British jobs and the wellbeing of British industry. Suddenly the deal was being debated on the front page of every newspaper, and Pfizer was losing support. The heads of both companies ended up being hauled in front of a parliamentary committee to thrash out the deal, which by now was being presented as the pinnacle of British national interest.

In the end, despite raising bids and many reassurances, the public backlash against the deal provided the AstraZeneca board the confidence it needed to hold its ground, and demand a better deal or no deal. Pfizer lost out as the deadline for an agreement expired, but AstraZeneca shares plummeted in the weeks following the collapse of the deal. According to industry researcher Dealogic, the Pfizer/AstraZeneca deal was the second-largest bid ever to fail, after BH Billiton’s attempted takeover of Rio Tinto in 2008.

Horizon Pharma takes over Vidara Therapeutics
Horizon Pharma has grown into one of the most productive independent pharma companies in the US, but once its deal with Vidara Therapeutics is finalised over the summer, it will no longer bear an American postcode. The arrangement is curious. The new Horizon Pharma PLC will primarily market its four products in the US, but it will be based – and taxed – in Ireland, home of the soon-to-be defunct Vidara.

Though Vidara’s portfolio consists only of Actimmune, a bioengineered protein used to treat granulomatous disease and osteopetrosis, Horizon has shelled out around $660m to incorporate it, $200m of which will be paid in cash. For Vidara, a single-product privately held company, it is a good deal. However, it has since become clear that Horizon’s takeover was more of an inversion deal than anything else. By acquiring Vidara, Horizon has secured the right to base its operations in the extremely favourable tax climate of Ireland. Horizon has maintained that its interest in Vidara was purely motivated by Actimmune.

The Wall Street Journal has quoted an anonymous person close to the deal as saying that should Vidara have been based in the US, it’s price tag would have read something between $300m and $400m. Few countries are as welcoming of foreign takeovers as Ireland, which has carefully crafted generous tax provisions corporations looking to settle on its shores. The savings Horizon will make in tax payments by relocating to Ireland more than make up for the additional $260m it is paying for Vidara to begin with.

As well as Horizon, a number of other medium-sized American pharma companies have made the move across the Atlantic to the Emerald Isle. Actavis bought out Warner Chilcott last year for a 34 percent premium to the value of the stock, but revealed soon afterwards that its effective tax rate would drop from the 28 percent paid in New Jersey to around 17 percent in Ireland.

Deutsche Boerse fails to merge with NYSE Euronext
Plans were well advanced between NYSE Euronext and Deutsche Boerse to merge into the world’s biggest exchange in 2012, before EU governing bodies intervened to put a stop to it. Deutsche Boerse was set to take over NYSE Euronext for $9.5bn, and the new merged company would have had an outright monopoly in European exchange-traded derivatives.

In the final moments, the European Commission intervened and stopped the takeover, claiming that the benefits would not be enough to outweigh the “harm caused to customers by the merger,” according to an EC statement on the matter. The two companies had appealed directly to EC president Jose Manuel Barroso in a last-ditch attempt to salvage the deal, but to no avail.

“This is a black day for Europe and its future competitiveness on global financial markets,” said Deutsche Boerse in a statement. “The decision is based on an unrealistically narrow definition of the market that does no justice to the global nature of competition in a market for derivatives. We therefore regard this decision as wrong.” Though both companies considered an appeal with the EU courts, in the end, they parted ways and pursued individual strategies.

The decision to disallow the merger was momentous at the time, as EU markets were failing and market participants had long been calling for a consolidation of the industry. Though the NYSE Euronext and the Deutsche Boerse are based on opposite sides of the Atlantic, they remain each other’s closest competitors, so it seems unlikely that the EU would ever have permitted such a merger. Joaquin Almunia, the EU’s Antitrust Chief, and Barroso have a long history of ruling against mergers like this one, which would clearly create what they perceive as straightforward monopolies.

Almunia said the deal was blocked “to protect the European economy from the perverse effect of a combination that would have practically eliminated effective competition in the market.” However, it could just as easily be argued that Almunia and Barroso’s trigger happy response to shooting down potential cross border take-overs may actually do more harm to the European markets, which have been stale and sluggish since the financial crisis broke half a decade ago.

£69bn

Pfizer’s failed bid for AstraZeneca

£9.5bn

Deutsche Boerse’s blocked bid for NYSE Euronext

Attempted takeover of Alstom Energy by General Electric
Though Schenectady, New York-based General Electric has not been entirely excluded from negotiations with Alstom’s energy arm in France yet, the local government has taken aggressive steps to prevent any takeover by GE from happening. In yet another act of unabashed protectionism, François Hollande’s government has given itself the power to veto or block foreign investment in key industries such as energy. Though it is an extension of a previous piece of legislation passed in 2005, few doubt the motives behind the timely amendment and the vital powers it gives Hollande.

The French government has made no secret of its distaste for GE’s proposed takeover of Alstom’s energy operations, and has openly favoured Germany-based Siemens’ proposed bid, in an attempt to keep control of the company within the EU. Alstom’s board has openly backed GE’s proposed takeover, but Hollande himself has deemed the terms of the agreement “unacceptable” as they fail to provide sufficient protection for French workers. “It is for the government to ensure that its legitimate objectives are fully taken into account by foreign investors, whether from within the European Union or other countries,” Minister for the Economy and Industry Arnaud Montebourg said in a statement. “This new power will naturally be applied in a selective and proportionate manner.”

GE has openly stated that it will protect French jobs and open new sites in the country but there are fears that the rail section of Alstom’s business might not be able to stand alone after the energy business is sold off. Alstom is one of France’s most traditional companies, and as well as its more profitable energy arm, it runs the country’s iconic TGV rail service. Alstom and TGV were bailed out by the government only 10 years ago, and might not be strong enough independently.

France is also a powerhouse in the global energy market, and the government is fearful that a takeover by a foreign company could harm its standing in the industry. It is understood that Siemens’ proposal would ring-fence Alstom’s steam turbine used in nuclear plants, thus protecting France’s exports in the atomic power market.

The power grab by the French government could be setting a dangerous precedent for cross-border takeovers in France, and Europe as a whole, and it is especially troubling when taken alongside the European Commission’s tough stance on antitrust legislation. It could put the future of cross border takeovers into Europe is in jeopardy.

3D printing cannot completely replace traditional manufacturing, say experts

Posted on July 16, 2014July 16, 2014 by Ashton Wenborn

Cited by some as ‘the next industrial revolution’, 3D printing is slowly reshaping the traditional supply chain, and could conceivably be the single most disruptive breakthrough since progressive assembly. “The fundamental economics of manufacturing changes with additive manufacturing,” says Terry Harrison of the Supply Chain and Information Systems Department at Pennsylvania State University.

Additive manufacturing has only recently come into mainstream use, and companies are beginning to question how the technology could factor into their processes and improve backward integration. Provided the technology addresses a number of areas still in need of improvement, where once the onset of globalisation gave rise to globe-spanning supply chains, additive manufacturing could spark a return to highly localised manufacturing environments.

Some analysts have pointed out, however, that 3D printing won’t replace traditional manufacturing in its entirety; it will only improve upon a select few components of the traditional supply chain

The traditional supply chain, though it has been much improved over the years, still carries with it a number of glaring inefficiencies, namely: long lead times, high transport costs, complex distribution networks and a dependency on economies of scale. However, a 3D printing alternative represents quite the opposite, in that goods can be locally printed and distributed, with low transport costs to match, leading some commentators to speculate overly enthusiastically about the changing dynamics of traditional supply chains.

Changing supply chains
Additive manufacturing, according to a Goldman Sachs report entitled The Search for Creative Destruction, is one of eight major technologies that will drive companies and business models in the future to either adapt or die. However, 3D printing is still very much in its infancy, and fails to match the requirements of big businesses aiming to improve upon existing products and processes. Should some of the technology’s creases be ironed out, however, the process could well emerge as a viable alternative for organisations seeking to streamline and localise their supply chains.

“Many articles in the popular press lead one to conclude that these large impacts are very near term,” says Harrison. “Our view is that there is significant work ahead before additive manufacturing will realise the kind of potential that is forecast.”

Beginning in the late 1980s and early 1990s, early iterations of 3D printing – or rapid prototyping – were used to create prototypes within a relatively short amount of time. However, the high costs associated with doing so meant the process was off-limits to most, and it is only in the past five years or so that the technology has become affordable for SMEs and even consumers.

Since the technology’s migration to the mainstream – and in particular since 2010 – industries have introduced additive manufacturing to various day-to-day processes. For instance, those working in architecture, construction and industrial design enterprises often utilise 3D printing for prototyping, as do those in the fashion, food and medical industry, to a much lesser extent.

The area in which additive manufacturing will have the biggest influence in the near-term, as has been the case for the past 30 years, is in prototyping. “The biggest advantage of 3D printing is the ability, as I put it, ‘to move from design for manufacturing to manufacturing the design,’” says Pete Basiliere, Research Director at Gartner. “‘Design for manufacturing’ leads to compromises that enable highly efficient and cost-effective mass production, but does not always result in what the consumer or marketer originally requested. ‘Manufacturing the design’ means the ideal design can now be produced, even in lots of one unit, just as the buyer wanted.”

However, some analysts believe 3D printing will have more fundamental consequences for manufacturing. “We are seeing more and more manufacturers extend beyond product development to using 3D printed parts to augment their manufacturing lines and processes,” says Basiliere. “While not a ‘self-replicating printer’, Stratasys’ subsidiaries MakerBot and Solidscape use their parent’s Fortus 3D printers to make the jigs and fixtures used to assemble their own 3D printers. And certainly there are manufacturers who are making finished goods, ranging from Asda’s 3D printed figurines to BMW’s valve stems for its high-end, limited production engines.”

Even so, the technology is still seen as the remit of high-end manufacturing and tech-savvy entities targeting very specific segments of consumers, and with a high price tag to boot. While some predict that the technology will change the way in which certain products are manufactured, most stop short of the opinion that 3D printing will fundamentally reshape global supply chains on a universal basis. “3D printing is ‘a’ new tool ‘in’ manufacture, but not ‘the’ new tool ‘for’ manufacture. 3D printing is great as it requires no tooling, but it is inherently a more expensive, lower quality way of making a part,” says Nick Allen, founder of 3D Print UK. “3D printing will help a lot in the prototyping market, meaning that products can get to market quicker and can be updated faster… so what is being supplied might change quicker, but how it is being supplied probably won’t change much in the near future.”

Opportunity for change
Proponents of the technology argue that 3D printing will play a major part for a much broader base of consumers and could potentially reshape supply chains in the not-too-distant future. Admittedly, 3D printing for certain applications, such as circuit boards and similarly intricate components, is some way off the quality of existing processes, but it could, in theory, play a significant part should accuracy improve and costs fall.

Alongside technological breakthroughs such as advanced robotics and open source electronics, 3D printing is making its way onto the agendas of business leaders seeking to optimise manufacturing and distribution processes. “To compete in this fast-approaching future, companies and governments must understand and prepare for this new software-defined supply chain,” says one IBM report, entitled The New Software-defined Supply Chain.

What’s key in the adoption of 3D printing is that the technology eliminates the need for high-volume production and reduces the waste product that comes with it. Whereas the traditional supply chain relies on the efficiencies of mass production and requires a high volume of assembly workers, additive manufacturing needs little more than the necessary raw material to fulfil any one order and the necessary blueprint to produce it.

As the technology develops, the impact in terms of inventory and manufacturing could be vast, in that a product could be printed immediately on demand and need no longer be stacked on store shelves prior to an order. “These effects are likely to be different for different firms. For some, the effects will be large and for others, not nearly so much,” says Harrison. Clearly there is an opportunity here for SMEs with small order quotas to fill, ridding enterprises of the pressures that come with maintaining a suitably sized inventory at any given point.

The potential for small-scale production runs also means that SMEs will no longer have to pay for expensive moulds, and that smaller orders will not necessarily prove more costly per unit than larger ones.

On the other hand
Some analysts have pointed out, however, that 3D printing won’t replace traditional manufacturing in its entirety; it will only improve upon a select few components of the traditional supply chain.

“Complete replacement will never happen because there are too many items that are made in such high volumes, without any changes from item to item, that traditional, highly efficient, long run manufacturing technologies will always be more efficient and cost-effective than 3D printing,” said Basiliere. “On the other hand, 3D printing revolutionises certain industries, as well as short run and custom production in almost all industries.”

Eliminating the need for mass production also means that companies needn’t look to emerging markets for a more cost competitive workforce. This development marks perhaps the biggest game changer for 3D printing in that it could reshape the global supply chain of today into a new hyper localised model. A tighter supply chain and reduced transportation costs will also limit carbon emissions, meaning that companies looking to improve upon their CSR offerings will be eyeing 3D printing as an attractive alternative.

“3D printing’s impact on supply chains will be evolutionary, not revolutionary,” says Basiliere. “Supply chains consist of multiple functions (plan, source, make, deliver, service) so 3D printing’s application will vary across those functions as well as by the different supply chain types and the segments in which a company operates.”

Although it’s easy to speculate how 3D printing could radically reshape the traditional supply chain, the benefits of the process will only really reap major rewards for smaller companies with a design focus and manageable order base. As far as larger, manufacturing intensive firms are concerned, the technology is some way yet from replacing global supply chains.

Pension funding gaps cause turmoil throughout America

Posted on July 16, 2014 by Ashton Wenborn

Once an economic powerhouse of American industry, the city of Detroit is today little more than a hulking shell of its former self. This is a city that, in its heyday, was America’s fifth-largest, home to 1.8 million citizens and the birthplace of the American auto industry. Six decades on, however, one in five residents were without a job. The once prosperous auto industry – fresh from a 2009 bailout – was struggling for a solid footing, and an estimated 78,000 buildings stood unoccupied.

Having accumulated $18.5bn of debt over 60 years of steady decline, the city’s mayor, at the mid-point of 2013, said that without reverting to extreme measures, spiralling bills would claim 65 cents of every dollar earned. And so, on July 18, 2013, Detroit filed for chapter nine bankruptcy, becoming the largest urban administrative division to do so in US history, and another name on the long list of states and cities to have fallen foul of insurmountable pensions liabilities (see Fig. 1).

The circumstances have brought to light the consequences that pension funding gaps can bring if left unchecked, and have called into question America’s ability – or lack thereof – to protect state pensions in the event of a collapse. “It is a scandal in government management that should be addressed,” says John Turner, Director of the Pension Policy Centre. “However, I am sceptical that it will be, at least within the next year.”

Broken promises
According to data published this year by the Pew Charitable Trusts, American state and local government pension obligations – as of fiscal year 2012 – surpassed $1trn. Beginning in 2008 at a humble $452bn, unfunded state liabilities grew to $757bn by 2010, and bulged by another $158bn over the next couple of years, despite a string of strong investment returns. As a consequence, almost every state in America has fallen short of its predictions, and, as of 2012, only 17 states managed to better the 80 percent fulfilment quota. Jagadeesh Gokhale, Senior Fellow at the Cato Institute, is critical of a long-standing failure to address the crisis, and believes the principal reasons for the state’s runaway finances to be twofold.

Total pension assets and liabilities across all 50 states

$2.6trn

Actuarial assets

$3.6trn

Actuarial liability

$6.7trn

Market valued liability

Source: Business Insider

“The first has to do with what’s permissible under the Government Accountability Standards Board (GASB) accounting rules,” he says. “Those rules allow valuing pension liabilities by discounting future pension payments at the rate of return expected on fund assets – at least, until existing funds are not depleted.”

Leslie Papke, Professor and Director of Graduate Studies at Michigan State University, echoes Gokhale’s concerns, and questions the integrity of those promising lofty payouts, irrespective of the costs. “This is misguided from an economic perspective,” she says. “The size of the pension liability should be valued independently of how assets are invested. The pension liability should be discounted at a rate that reflects its risk – in this case, risk comes from any uncertainty that the payments will actually be paid. Generally a risk-free rate would be around three or maybe higher at four percent, if we think there is some likelihood, as in Detroit’s case, that the entire promised benefit won’t be paid.”

The funding gap that exists for many US states and cities is due largely to irresponsible politicians in years past who have chosen not to fulfil their pension promises, but to pass the buck on to later incumbents. By assuming that investments will yield sky-high returns in the future, states and cities have been allowed to effectively write off any shortfalls for the immediate term, and avert disaster at the expense of future generations. Fast-forward to today and yesteryear’s overly rosy assumptions have landed some states with gaping holes in their public finances.

“The other major contributing factor is political,” says Gokhale. “Reducing the discount rate to correctly reflect the certainty and high protections accorded to benefits would increase unfunded liabilities and increase pressure to make annual pension fund contributions. Politicians want rather to spend on their constituents’ wishes for public services rather than salt funds away for future pension payments. So fund rates are set high by investing in riskier assets. These incentives ensure that liabilities are ‘safe’ but investments are risky – a perfect recipe for [the unfolding] disaster!”

Whereas the worst of the financial crisis subsided some time ago, the funding gap that opened in the immediate aftermath has continued to rise – albeit by a lesser degree – since. “State and city pension funds have invested a higher percentage of their portfolios in the stock market than have private sector funds. This appears to be fine when the stock market is going up, but many people think they have taken on excessive risk,” says Turner. “Furthermore, they have used unrealistic assumptions for determining the value of their liabilities, causing a considerable understatement.”

Buoyed by a stint of better-than-expected returns, some states were too eager to anticipate similarly impressive returns in the years to come. Once the crisis awoke, however, many proceeded to skirt their responsibilities and allowed the gap to widen, sometimes to unmanageable degrees.

Passing the buck
At the end of 2013, Illinois had the highest unfunded pensions liabilities in America at $100bn. Due to unrealistic expectations and years of legislative inactivity; the state has been landed with the lowest credit rating in all of America, pushing borrowing costs to unprecedented heights. As a result, and to the dismay of the public sector, at the tail end of 2013 Illinois proposed a number of radical reforms to overturn the state’s runaway fiscal problems.

By cutting retirement benefits for state workers and forcing the state to make good on its pension promises, Illinois authorities estimated that it would save approximately $160bn over the next three decades. While the proposed cuts would trim Illinois’ unfunded liabilities by 21 percent to $79bn, many believed that by passing the bill on to state employees, the financial implications were grossly unfair for public employees.

Whereas most business groups backed the legislation, public workers were less than enthusiastic about the proposal. “This is no victory for Illinois, but a dark day for its citizens and public servants,” wrote one coalition of union workers acting under the name of We Are One Illinois. “Teachers, caregivers, police, and others stand to lose huge portions of their life savings because politicians chose to threaten their retirement security.”

Source: The Washington Post 2014 figures

As such, the plans to stabilise the state’s pension system have come undone after unions challenged the constitutionality of the proposed legislation.

The central fact still remains, however, that taking the necessary funds from any one party will come up against stiff opposition. Illinois’ proposed reform package highlights one of the more important considerations when tackling state pension-funding gaps; that is, who will foot the bill? Opinions differ dependent on the individual questioned, but the vast majority believes the gap will be plugged by a combination of tax increases and broken pension promises.

“The bill for the funding gap will be borne in part at least by workers and retirees through reduced benefits and reduced wages,” says Turner. “Taxpayers may be affected through higher taxes, or more likely by reduced services. Bond ratings will be affected, which increases the cost of borrowing, which is borne by taxpayers.”

One report by the Centre for State and Local Government Excellence entitled State and Local Government Workforce: 2014 Trends reveals the extent by which retirement plans have changed over the past year. The report found that 27 percent of respondents had increased employee contributions, 18 percent had decreased pension benefits, 16 percent increased eligibility requirements and eight percent had reduced or eliminated cost of living adjustments.

What’s arguably more important for the debate moving forwards, however, is whether or not state pensions will enjoy the same protection rights they historically have done. Detroit, therefore, is an especially important case in that anything less than a guarantee could have huge ramifications for the way in which state pension promises are managed. “It could go either way as the crisis unfolds,” says Gokhale. “Shortfalls may lead to stripping existing protections in some cases. But, given recent experience with poor pension fund management and plan conversions in so many places, public pension beneficiaries may begin lobbying for even stronger protections in the future.”

The worst affected states have so far chosen to focus on making adjustments to existing retirement plans as opposed to changing state legal protections, and some believe that the central problem is not necessarily the guarantee, but the fact that obligations were allowed to go on unpaid for so long. “The real lesson is a need for greater transparency,” says Dean Baker, Co-Director of the Centre for Economic and Policy Research. “If politicians had made required contributions year by year, then no pension would be in any trouble. The problem was that it became a sport to skip these contributions in places like Chicago and New Jersey.

Cause for optimism
Although the funding gap in certain instances has strained public finances close to breaking point, many are in agreement that the worst of the crisis is now over. Provided that taxpayers and employees accept the resulting concessions, most states and cities should see their funding gap steadily decrease over time. “If pension plans meet their investment return targets and government sponsors make recommended contributions to their retirement systems, states can expect to see funding levels start to rise in future years,” reads a Pew Charitable Trusts report.

“There will be little or no funding gap to pick up in the vast majority of cases,” says Baker. “Most of the gap came about because the market plunged in 2008 to 2009. Because of averaging, the 2009 valuations still appear in most state and local pension funds’ measure of assets. Assuming there is no collapse in the market this year, funds will look considerably better when we have next year’s valuations [2014 valuations replace 2009 valuations]. Instances of serious shortfalls have come about almost entirely because states have gone years without paying required contributions. If the parties approach this problem in good faith, in most cases the gap will be manageable.”

In New Mexico, for example, state legislators and unions agreed on a plan to plug one of the country’s largest funding gaps, which in fiscal year 2012 came to $12.5bn. However, beginning last year, certain plan members are required to make larger contributions, and the minimum retirement age for young workers and new hires has been raised. Together, the reforms have offset the vast majority of the state’s projected funding gap, and significantly reduced the strain on public finances.

“If other states follow this sort of model, it is likely that the gaps can be filled in even seriously troubled systems without too much pain. However if you have politicians who want to score political points by inflicting pain of public sector workers then we see serious problems,” says Baker.

US states hit by the pension reforms

Illinois

Owing to years of unpaid pensions promises, Illinois’ liability was close to $160bn in 2012. Only 40 percent of the state’s fulfilment quota was met that same year, and a series of stop-start reforms since have inspired little in the way of confidence that the state will return to fiscal stability anytime soon.

Kentucky

Kentucky’s funded ratio (as of 2012) came to 47 percent, amounting to the second highest in America. Funding for the state’s principal government worker pension system is currently under one quarter funded, and a number of filed bankruptcy cases of late have seen various parties exit the system altogether.

Connecticut

With liabilities of $48.2m and an unfunded gap of $24.5m as of 2012, Connecticut’s public finances have been severely strained by years of unpaid promises. Stemming back to the mid-1990s, the state has by-and-large failed to meet its obligations, leaving it with a funded ratio of 49 percent in 2012.

Alaska

Even through a period of surplus, Alaska has succeeded only in paying a fraction of what it has promised, leaving it with a mountain of unfunded liability to make up. As a consequence, the state now looks to take on a raft of legislative changes in a last ditch attempt to
plug the gap.

Louisiana

Although major pension reforms were enacted in 2009 and 2010, the state still has one of the biggest funding gaps in America. The government proposed yet another legislative change in 2012, however, unions have blocked its passage and many appear unwilling to pick up the bill for years of missed payments.

Legg Mason Asset Management on Asia’s investment opportunities

Posted on July 15, 2014October 17, 2014 by Ashton Wenborn

Asset management is a multi-billion dollar industry, but navigating the market can be tricky – especially in emerging economies. One institution that has successfully established itself in the region is Legg Mason Asset Management. World Finance speaks to Lennie Lim and Freemason Tsang from the firm to find out about the challenges of working in Asia, and the opportunities open to investors.

World Finance: Now Lennie, Legg Mason has over $700bn of assets under management worldwide, so how well positioned would you say Asia is to drive the company’s growth forward?

Lennie Lim: It is quite rare for a firm of our size and given our history, to be so new in the market. We first carried the brand of Legg Mason into Asia when we acquired Citibank Asset Management in 2006. Since then we have weathered the global financial crisis very well, and now we are in the growth stage. We are firmly establishing our business throughout Asia.

For mutual funds, Asia is the fastest growing region in the world, relative to the US and relative to Europe

World Finance: How would you say asset management is developing in Asia, and what challenges do you face in that region?

Lennie Lim: For mutual funds, Asia is the fastest growing region in the world, relative to the US and relative to Europe. What’s driving this growth is very strong economic growth from various Asian countries, at the same time as a strong culture within Asia in terms of savings, and the sheer size of the population.

It can be seen in the amount of wealth that is being created in Asia, but it is also important to keep in mind that many of the Asian countries are still very young in terms of its mutual fund history.

Take China for example; there is less than 15 years of history in mutual funds. As such, in terms of challenges, you will see that Asia is very dynamic in its changes. New regulations are coming in all the time, as the industry goes through its growing pains.

This market is therefore very fast paced, the environment changes frequently and it is rather complex, with so many countries at different stages of growth, and each with their own regulations. But in Asia we always say; in every adversity lies opportunity. And that is how we see Asia right now.

World Finance: Freeman, in a competitive market such as asset management in Hong Kong, what differentiates you from other asset managers in the region?

Freeman Tsang: Hong Kong is one of the mature markets within Asia in terms of mutual fund.

The size of our firm offers a global platform to provide a range of products. And of course, we have to have the local people, to have the local touch, with the local distributors.

We often visit local distributors to talk to them, to see what they need. And then we find the best solution, and consistently and precisely deliver this solution to the bankers, the trainers, and the product people.

World Finance: How do you identify investment opportunities for your clients and what are the main investment opportunities in Hong Kong and China?

Freeman Tsang: The beauty of Legg Mason is that it represents six individual asset management companies.

They provide the investment view to us and we provide the solution to the bankers. So when we go to an individual affiliate they can provide us with the individual asset class investment view and the product idea.

This market is therefore very fast paced, the environment changes frequently and it is rather complex, with so many countries at different stages of growth

Alongside this we also have a small cap dedicated manager, a large cap dedicated manager, and one of our largest affiliated fix income managers. In order to provide the best investment opportunities, we are committed to delivering the message from the investment professionals of Legg Mason, to all the bankers around the world.

World Finance: Lennie, from a regional perspective now, is there any notable difference in how your team meets clients’ needs across Asia?

Lennie Lim: We are unique in the sense that we are able to bring our multi-affiliate model to our Asian clients, and with this some of the best-of-breed managers that we have within the Legg Mason fold. My clients deal with a single point of contact on client service, and that’s true of all of us. And therefore my responsibility to ensure we bring a high level of client service to our clients, that’s able to deliver the investment objectives of our clients.

World Finance: Freeman, what trends do you see arising in Hong Kong and China, and how do you think this is going to affect the industry in the coming years?

Freeman Tsang: I would say there is going to be more integration between country and country, like the ASEAN Passport in Southeast Asia, and in north Asia between Hong Kong and China we will see more mutual recognition. This will mean that more funds can be brought forward to China from the Hong Kong registration perspective, or vice versa.

For us, more integration means more opportunity, and when we deal with that, we do see more opportunity, if we can provide a solution. In terms of trends in product development, it’s one of the key trends for Asia, because Asia is a low interest rate, high inflation environment.

Investors are looking for high-income products. Previously, during the crisis, they were looking for stable income. But after the crisis, they’re looking for high-yield fixed income.

Nowadays, we are seeing that they are more willing to take more risks, but they still want that income. So as a service provider when we talk to our bankers or distributors, they do need some kind of income theme but with the equity theme. So we do see a trend developing of people looking for more income but with a higher risk element.

World Finance: Freeman, Lennie, thank you.

Brazil hangs up its boots to prepare for the sixth BRICS summit

Posted on July 15, 2014August 7, 2014 by Ashton Wenborn

The World Cup is over but Brazil will now turn its attention to banking as it hosts the sixth BRICS summit. The leaders of Brazil, Russia, India, China and South Africa will meet in the north-eastern city of Fortalez in their sixth meeting without western powers.

The summit is an annual diplomatic meeting with emerging economies around the world. In the past, little progress has been made, leading many to question if the BRICS can deliver anything better than a catchy acronym – but real progress is on the agenda this time around. The economic powerhouses hope to get the ball rolling on their long-awaited development bank and emergency fund – with initial capital of $50bn.

The development of the BRICS is seen as crucial for Russia as it struggles with visa bans and asset freezes after its annexation
of Crimea

This will be the emerging markets version of the World Bank and the IMF. It sets an implicit philosophical statement that the BRICS are dissatisfied with their role in global political and economic debate. Russian President Vladimir Putin told Russian news service ITAR-TASS that he wants the emerging markets to have a stronger voice on the world stage and provide opposition to US influence on foreign policy. He said: “Any attempts to create a model of international relations where all decisions are made within a single ‘pole’ are ineffective, malfunction regularly, and are ultimately set to fail.”

The development of the BRICS is seen as crucial for Russia as it struggles with visa bans and asset freezes after its annexation of Crimea. For President Xi Jinping of China, the summit is an opportunity to gain more responsibility on the global stage. As the most prominent superpower present, China will want to demonstrate it can promote the rights of the developing world.

Speaking on BBC Radio 4, economist Jim O’Neill – who coined the term “BRIC” – described the three-day summit as a “statement of intent” from nations that feel left out of global democratic discourse. He summarised their attitude as: “If you don’t include us, we’ll do our own thing.”

There is plenty to iron out before plans for a new world bank can be put in motion. Most pressing is the fact that the nations are at loggerheads over where the bank’s headquarters will be. Shanghai, New Deli and Moscow are tipped as the most likely candidates.

Banks take inspiration from retailers to attract consumers

Posted on July 15, 2014July 10, 2014 by Ashton Wenborn

Traditional retailers are the envy of retail banks. Here is a sector adored by the consumer, whose weekends are happily spent wandering the aisles of Wal-Mart, perusing the store shelves of Apple, or seeking a bargain at Target. Contrast this with the way in which consumers see banking, and it’s clear why those in the industry are under threat, as they take pains to absorb some of the retail sector’s more desirable qualities.

Not unlike banking, the emphasis for retailers today is on customer experience. See Apple or Tesla, for example, both of which have opted not for shop space chock full of products, but something closer to a showroom, in order that they may better convey their brand identity and commitment to customer centricity. The ultimate ambition for retailers today is to make each store a ‘destination’ – a far cry from the transaction centres of old, which were designed simply to maximise efficiency and productivity, often to the detriment of customer experience.

It is this so-called ‘destination shopping’ that has seen enterprising retailers turn what many consider a chore into an experience. The internet has destabilised the all-conquering force that bricks-and-mortar sales used to represent, and shifted the focus from customer convenience to experience. Ultimately, traditional retailers have found themselves forced to contend with all manner of alternatives, and in doing so have happened upon a new era for retail, as well as a host of new opportunities for financial services.

While the circumstances for retail at first glance seem disconnected from the issues facing retail banking, many financial institutions are now beginning to consult traditional retailers as part of the process of rethinking the world-weary foundations on which the sector is built. Retail banks, to all intents and purposes, are retailers, with the biggest difference between the two being a long history of unrealised potential and an often narrow-minded means of interfacing with customers.

[M]any financial institutions are now beginning to consult traditional retailers as part of the process of rethinking the world-weary foundations on which the sector is built

Remaining competitive
The introduction of non-traditional business models such as peer-to-peer lending and e-banking has spooked the industry, and ramped up the emphasis on technology and convenience in order to remain competitive. One often overlooked obstacle, however, is customer experience, and if retail banks are truly to emerge from the post-crisis world utterly transformed, they must first take heed of sectors outside financial services.

Although the ramifications of the financial crisis have been far-reaching for banking, it has allowed onlookers a rare glimpse into the innermost dealings of financial services, shining a light on the extent to which the industry has been allowed to act irrespective of changes in consumer attitudes. Long-held values have slipped, margins have narrowed and “incumbent banks have just been so awful at serving their customers,” says Tony Greenham, Head of Finance and Business at New Economics Foundation.

As such, banks are increasingly looking to their not-too-distant retail counterparts for an example in how best to adapt to ever changing consumer trends, and are in some instances going so far as to combine the two sectors as a means to that end. Granted, product innovation, good governance and greater quality of service are all crucial facets of the transformation, but some firms need to look outside the traditional banking space in order to streamline operations, cut costs, and improve their offerings.

“Digital innovation does not mean the end of branches (see Fig.1), but a different kind of branch network. Good local lending needs a local presence and face-to-face meeting,” says Greenham. “However, the current number of branches is uneconomic. Branch sharing is the answer.”

New banks on the block
One example of this method in practice is M&S Bank. British fashion and food retailer Marks & Spencer and London-based bank HSBC came together in mid-2012 and set out with an ambitious plan to open up 50 branches across the UK. The bank has joined the likes of Halifax, First Direct and Tesco Bank, who likewise hope to challenge the already established group of British high street banks. Almost two years on from its establishment, M&S Bank has launched a current account with no monthly fees, cheap overdrafts and small overseas charges – along with a complimentary £100 M&S gift card – in an effort to test the mettle of the high street’s existing players. Crucially, the alternative banking solution marks an attempt on the part of HSBC to utilise M&S’ branch infrastructure. Here lies a radically alternative method of not only cutting branch-associated costs, but emphasising customer centricity by aligning brand values with those of another firm whose primary focus is on matching the ever-changing demands of the consumer.

“M&S Bank brings the trusted M&S brand values to banking, delivering a new choice on the high street,” said an M&S Bank spokesperson. “We’re already seeing new entrants in the market, such as M&S Bank, and this is something we’ll continue to see. This is bringing more competition to the industry, and more choice can only be a good thing for the consumer.”

Another benefit of note is that, contrary to the traditional nine-to-five opening hours of most high street banks, retail hours are more flexible and guarantee a greater stream of potential customers. For every store is another bank branch that need not necessarily be kept open. And in a time where margins are tight and efficiency key, the option is seen as a significant opportunity for retail banks and retailers alike moving forwards.

US retailers have also launched new financial services opportunities for consumers who might be disillusioned with or else excluded from traditional banking channels. For example, American Express and Wal-Mar launched the Bluebird service in 2012 to target low-income customers who were unable to contend with the high fees associated with traditional retail banking.

“The financial services landscape is changing,” said Dan Schulman, Group President of Enterprise Growth at American Express, in a press statement. “In an era where it is increasingly ‘expensive to be poor’, we have worked with Wal-Mart to create a financial services product that rights many of the wrongs that plague the market today.”

banking-activities — Source: Deloitte Centre for Banking Solutions/ Harris Interactive Study

21st-century banking
These partnerships also bear a certain resemblance to correspondent banking, which has for some time now been employed by financial institutions, and more recently emerged as a vital component of retail banking in emerging markets. Whereas correspondent banking has historically been used as a means of conducting transactions abroad, the method is today being used to cut branch-related costs and reshape the retail banking environment.

Increasingly, regulated financial institutions are partnering with commercial entities to create an extensive and cost effective branch network, and in doing so they are able to access individuals they otherwise would not be able to with no added expenditure.

The changes in this space are again closely in keeping with a much wider shift in retail banking, as delivery channels quietly, though rapidly, expand far and above what they once were. ‘Customers are demanding seamless, multi-channel sales and service experiences and not consistently receiving them,’ reads a Deloitte report entitled Reinventing Retail Banking.

‘Simultaneously, other financial institutions and non-traditional players are looking for opportunities to invade this space or to redefine it through disruptive innovation. The result is forcing banks to examine a more balanced, integrated approach to the customer experience and growth.’

Most in the financial services industry have improved customer data, services and customisability. However, what the sector needs is not incremental improvement, but a wholesale shift in the way banking services are delivered to customers. In short, retail banks must cement partnerships with commercial entities and develop an entirely new set of tools, as well as dramatically rethinking the way in which they accomplish strategic goals.

Alternate distribution channels
Crucially, young, affluent consumers are coming to the counter with greater expectations than before, and expecting in-branch assistance to be personable and intelligent, given that the vast majority of simple tasks and transactions can just as easily be done online. The task for retail banking moving forwards is a complex one: it must at once simplify distribution and develop a more comprehensive branch network. In order for banks to come to terms with these new heights of expectation, they must surely look to entities whose primary business is not banking.

As a consequence, various industry experts predict that commercial entities, technology companies and traditional retailers in particular, could well prove crucial to the banking shake up moving forwards. And provided the rate of change – technological or otherwise – continues at the same pace it has been going in recent years, alternative retail distribution channels could come to constitute a large part of the industry and a saving grace for the profitability of retail banking moving forwards.

“Retailers have brand and distribution but have tended to rely on existing banks to operate their own retail banking operations. I guess they are not as important in changing the industry as the new disruptive business models from new entrants,” says Greenham. The solution does not lie solely with retailers, however; and in a more general sense banks must ensure they broaden delivery channels for customers if they are to remain competitive.

Therefore, retailers should be seen not as a fix-all solution, but as one part of a much larger solution for traditional banking moving forwards. As low-cost business models such as peer-to-peer lending and internet banking squeeze margins further still, existing players must take pains to ensure they’re engaging with customers in every way they can.

A new era of African banking

Posted on July 15, 2014May 11, 2017 by Ashton Wenborn

Guaranty Trust Bank (GTBank) has long established itself as a top-tier bank in its native Nigeria, having dominated the market through strong corporate banking. With a solid footing in West and East Africa already, the firm is keen to expand into countries with high growth potential, such as Angola and Mozambique.

Surprisingly, the bank is not pursuing equity-generating areas such as wealth management, which has been a popular choice for banks of late. Rather, GTBank is going all-in on retail, pursuing new customers across a plethora of alternative channels, as well as drawing in lucrative SMEs through a brand new platform. All of this could put the bank among the top three banks in Africa by 2016 based on profits, believes Managing Director and CEO Segun Agbaje.

“Right now we’re daring to dream,” Agbaje told World Finance in an exclusive interview. “In 2011, we were number 15 in Africa in terms of profit, today we’re number six, and our objective is to be number three… within the next two years. Once we’ve done that, it will give us some scale to develop across different economies, so we’ll be relevant in West Africa, East Africa and obviously be looking into Central Africa.”

Assets

54.5%

corporate

12%

retail

22.2%

commercial

3%

SME

8.4%

public sector

The firm currently has offices and subsidiaries in Nigeria, Ghana, Liberia, Gambia, Cote d’Ivoire, Sierra Leone, Rwanda, Kenya, Uganda and the UK. The Kenyan, Rwandan and Ugandan businesses – the firm’s East African subsidiaries – were all purchased when Guaranty Trust Bank took over Fina Bank in late 2013. The bank currently earns six percent of its total profits abroad, and Agbaje expects to generate one tenth of the group’s profit from outside of Nigeria by 2016.

“We’re trying to build a strongly African franchise and we started in Anglophone West Africa because we believe that ultimately there will be a West African economic zone. We went into Francophone Africa for that same reason. The three East African countries we’re in right now give us a client base of 87 million, and they’ve also discovered oil in a lot of these places. So in order to be a very profitable African institution we’re hoping to go into Mozambique and Angola next for the same reasons – reaching natural resources as well as a population size where we think we can help,” says Agbaje.

Going where the growth is
With this regional expansion in mind, GTBank is not on the cusp of entering Africa’s only developed economy, South Africa. Instead, Agbaje wants to focus on economies with a much higher growth trajectory than the matured South African economy. The hope is that the focus on countries experiencing explosive growth will bring in a surge of customers, as the bank hones in on the lower end of the retail segment through alternative approaches to capturing customers.

“In growing our retail [segment] we’re trying to use all other platforms, which is why we’re using mobile and social banking on Facebook as well as looking into using other social networks. Recently, we’ve also launched a virtual SME market hub, where we put SME-type companies on the platform, creating our own little marketplace for them,” says Agbaje.

GTBank’s social banking service offering on Facebook includes balance enquiries, mobile » airtime purchases, third-party money transfers and access to 24/7 real-time customer service. The service was introduced in 2013 as part of several new value-adding channels designed to give customers a high degree of flexibility and allow people to bank safely, quickly and conveniently at all hours of the day.

Non-traditional banking
The bank currently has over two million followers on Facebook: the largest for any African bank. It also offers a mobile money transfer application similar to Vodafone’s popular M-Pesa service, which allows customers and non-GTBank customers to perform transfers and payments from their mobile phones to any mobile phone subscriber within the country, in addition to online banking.

“We’re not planning on making major business acquisitions, so one way for us to grow our retail base is through mobile phones. Five years ago we had a retail base of about 300,000. Today it’s 5.4 million and we’d like to get to about 10 million in the next two years,” says Agbaje. “In Nigeria, you have more than 100 million mobile subscribers today and even with people having two or three mobile phones, we’re still looking at 70-80 million potential customers so there really is a huge upside.”

Another alternative customer channel is GTBank’s ‘Express’ service: an agent banking offering that provides customers with access to financial services at convenient locations such as supermarkets, schools, cinemas, markets and restaurants. It is an initiative to reach out to the unbanked segments of the population through the use of non-banking retail outlets.

“Financial inclusion has many facets to it – it’s not just for the poor and downtrodden,” says Agbaje. “When we’re talking about a number like 10 million, you’d have to drive this type of financial inclusion by banking in non-traditional banking outlets. We piloted it with a supermarket and right now we’re in a joint partnership with a petrol station. After that we’ll be working with fast food restaurants.”

Profit before tax

58.8%

corporate

11.8%

retail

18.5%

commercial

4.7%

SME

6.3%

public sector

Catering to SMEs
To this end, GTBank has made it a key point to embrace digital technology in its search for strong business growth. The firm’s most recent venture is its SME MarketHub, which offers the resources entrepreneurs need to grow their businesses, in addition to enabling online trade and market visibility.

Customers on the MarketHub get a unique website address, a personalised online storefront, a shopping cart with no consignment fees, an online payment gateway, inventory management tools, messaging services and membership in the hub’s directory. More importantly, the hub provides access to millions of customers – as long as the SME is a new or current GT Bank customer.

The aim is to help customers promote their business online to a broad audience, buy and sell a wide range of products online and find potential business partners, suppliers etc. through the global directory. Agbaje believes this venture is set to be the key driver of profit growth in the coming years – despite the known volatility associated with SMEs. “No matter the economy, SMEs constitute the largest part of the business population,” he says. “From a banking perspective it is also one of the riskiest places to put loans. With an equity focus, we’re trying to work backwards for them. Creating a business platform, generating cash flows, growing their businesses so they will have a better chance of acquiring the services and loans that we will ultimately give them. So we’re not going to start by agreeing to loans – we’re going to help them create businesses, give them capacity in the form of accounting, corporate governance etc., and then we’ll later help grant them loans.

Tech-driven profit
By building a robust technology infrastructure to drive its mobile and electronic banking channels, GTBank could be looking at enormous growth prospects in the retail space. What’s more, following the announcement of its 2013 annual results, the firm is looking to grow its loan book by 15 to 20 percent. SMEs currently account for 10 percent of the loan portfolio.

GTBank’s audited annual results revealed that its loan book amounted to $6.3bn at the end of 2013, up 25.48 percent from $5bn the previous year. The bank’s profit before tax rose 3.9 percent to $671m in 2013, while return on average equity was up 29.3 percent. Agbaje attributes the positive results to the many technological and retail initiatives implemented by the bank in recent years.

“If you want to stay profitable, continue to grow and support efficiency then you have to develop new markets,” says Agbaje. “You can’t continue to grow only the corporate end of the business or the high end of retail, because if you do, you’ll get to a point where you can’t grow anymore. So in order to sustain growth you have to open new markets – whether it’s retail or SME.”

To this end, the CEO maintains that GTBank will continue to strengthen its core business areas such as oil and gas, maritime, manufacturing and corporate business. By not giving up market share in traditionally strong areas and moving into new regions, the firm is looking to gradually extract more profit.

Keeping costs down
However, as most people know, plans for expansion across regions and offerings tend to come with additional costs. With an aim to achieve a 40 percent cost-to-income ratio by 2016, the bank is hard-pressed to make its growth strategy as efficient as possible. According to Agbaje, this involves ensuring economies of scale across suppliers, hiring at entry-level to keep staffing expenses down, as well as focusing less on a sizeable branch network and more on alternative, cheaper delivery channels such as online and mobile banking. “It’s all about being aware that everything you do is relevant to capital expenditure. Whether it’s people or bricks-and-mortar, always go for the cheaper, more efficient options,” he says.

With a brand hinged on professionalism, ethics, integrity, and the concept that the ‘customer is king’, it is worth asking whether efficiency to that level is compatible with the bank’s high standards of customer service.

“You have to segment your business properly so nobody suffers,” says Agbaje. “For instance, in retail you have human beings servicing your high-net-worth and personal banking clients, while your mass retail clients will be serviced through other channels that are less expensive – like the contact centre we’re about to complete in Nigeria with about 1,000 call-centre agents. Straight-through processing like mobile and online banking and our ATM network ensures that we are able to keep our service standards up as we expand.”

Choosing a customer-friendly outlook was never a hard choice for GTBank, which took advantage of a gap in the market when launching in Nigeria 23 years ago. “When we came into the banking industry, all the colonial banks were not known for service, so there was a good niche for us to pick in order to attract customers,” says Agbaje.

Guaranty trust bank profit after tax

550m

USD, 2012

564m

USD, 2013

This is also why corporate social responsibility (CSR) is a major focus for the bank, which, as opposed to its competitors, is not focusing its marketing or philanthropic efforts on attracting a wealthy or mature clientele. Rather, GTBank has made the young African population its main focus – a group that is large and generally underbanked. The bank’s CSR strategy includes adopting non-fee-paying schools by helping to teach, run labs, refurbish and improve facilities. Other key areas include sponsoring sports, arts and music initiatives for young people, in addition to a programme for children with autism.

“Banking is a service-driven business and all the money we make comes from our customers. CSR should be important to any corporate organisation – even for selfish reasons, because if you take care of people in an economy where you are trying to grow, a natural love comes with it,” says Agbaje.

Whether it’s GTBank’s dedication to its customers or the alternative approaches to retail growth that it supports, one thing is for sure: it has been the most profitable bank in Nigeria consecutively for the last three years, and 2014 could prove just as positive.

Foreign direct investment flows into China despite slowing economy

Posted on July 15, 2014 by Ashton Wenborn

China’s foreign direct investment inflows rose at an annual pace of 2.2 percent in the first six months of 2014, indicating investors are still cautiously optimistic about the world’s second-largest economy. New data from the Commerce Ministry says China attracted $63.3bn in FDI over the period and that June inflows rose 0.2 percent from a year earlier to $14.4bn – its 16^th straight month of gains.

FDI inflows in China have maintained steady growth every year since the country joined the World Trade Organization in 2001, with inflows reaching a record high of $118bn in 2013. Foreign investment is an important way of measuring the health of the external economy, which China’s vast production and manufacturing sector is largely dependent upon. The continued growth in flows is considered proof of faith in the Asian economy, despite FDI being a small contributor to overall capital flows when compared with exports (which were worth about $2trn in 2013).

[T]here’s evidence of continued weakness as China’s economy struggles to regain momentum

Problematically, Chinese exports and manufacturing have generally slumped since the beginning of the year. Despite a small improvement in output in June, there’s evidence of continued weakness as China’s economy struggles to regain momentum.

Hongbin Qu, Chief Economist for China & Co-Head of Asian Economic Research at HSBC said in a recent investment note that the Chinese “economy continues to show more signs of recovery, and this momentum will likely continue over the next few months, supported by stronger infrastructure investments. However there are still downside risks from a slowdown in the property market, which will continue to put pressure on growth in the second half of the year.”

Second quarter GDP figures, which are due soon, are expected to be roughly in line with first quarter results, when the economy grew by 7.4 percent year on year. That was its weakest pace in 18 months – it grew by 7.7 percent in the last quarter of 2013.

What’s more, despite FDI flows growing, foreign investors have lost some of their enthusiasm. China’s May FDI figures accounted for $8.6bn in flows, which were a significant 6.7 percent drop from a year earlier. That is a weak showing for one of the world’s fastest-growing major economies.

China’s property slowdown could have a domino effect on global commodities

Posted on July 15, 2014July 15, 2014 by Ashton Wenborn

When Bill Gates tweeted that China had consumed more cement in the three years leading to 2013 than the US had in the whole of the 20th century, Twitter went into overdrive. Some speculated that he was misusing statistics; others assumed that he was just wrong. But not only was Gates entirely correct, the statistics tell a very alarming story.

Between 2011 and 2013, China used 6.6 gigatonnes of cement; 1.1 gigatonnes more than what the US used between 1901 and 2000, according to Vaclav Smil in Making the Modern World. “Concrete is the foundation (literally) for the massive expansion of urban areas of the past several decades, which has been a big factor in cutting the rate of extreme poverty in half since 1990,” Gates wrote about Smil’s findings on GatesNotes.com. “In 1950, the world made roughly as much steel as cement; by 2010, steel production had grown by a factor of eight but cement had gone up by a factor of 25.”

The sharp increase in the global consumption of cement over the latter half of the 20th century was driven by the vast improvements in quality of life experienced in the West but also by unprecedented levels of rural-urban migration in industrialised nations. This is an ongoing trend globally, as more people join the middle classes. Over the past three decades, China has experienced phenomenal growth – much faster than anywhere else in the world.

88%

of Mongolia’s exports go to China

73%

of Turkmenistan’s exports go to China

68%

of Gambia’s exports go to China

The emergence of the Chinese middle class over the past couple of decades has impacted more than anything else in history the world’s building and commodities market. Suddenly, rural workers were moving in droves to industrial centres; factories, railways, highways, energy infrastructure and entire towns had to be built where previously there was nothing. In part, it was this huge investment that kept the Chinese economy ticking upwards so fast; increased demand fuelled increased investment.

Building for growth
Since the onset of the financial crisis in 2007/08, though, the story behind China’s rapid investment in the property sector and infrastructure completely changed. Investment in infrastructure became a way to keep the economy growing, as foreign demand plummeted. In addition, the Chinese Government relaxed its attitudes toward credit in a bid to fuel domestic demand. So, as the rest of the world contracted, China continued to build skyscrapers, mansions, high-speed rail lines, theme parks, and anything else it could shape concrete into – with little or no regard for commercial viability.

In 2013, this cycle of investment started to unwind. The Chinese economy grew at its slowest rate since the end of the 20th century: 7.7 percent. Shockwaves were felt globally. A slowdown in China directly impacts a lot of other countries, and can have a domino effect on global growth. China imports 88 percent of all Mongolia’s exports, 20 percent of all Brazil’s exports, and 10 percent of the US’, to name a but a few.

Though the slowdown was driven at least in part by weak global demand, the domestic repercussions have been monumental; and growth is unlikely to pick up significantly any time soon. One of the hardest-hit industries in China has been the real estate and property sector, once responsible for driving growth. In the first four months of 2014, real-estate sales were down 7.8 percent compared with the same period a year earlier. If that wasn’t bad enough, construction on new projects was down 22.1 percent during the same period, compared to a year earlier, according to official government figures.

The figures are bad enough when taken at face value, but Gate’s tweet reminds us exactly how catastrophic this 22.1 percent decline actually is. The sheer scale of the Chinese construction industry means that any decline, however small, can have consequences globally. According to Moody’s, the residential property sector in China accounts for 24 percent of the country’s steel consumption, and as the sale and outfitting of apartments has plummeted 23 percent, it has taken with the it the price of iron ore. The consequences have been dire for Australia, which relies on the its copious iron ore exports, and has suffered tremendously as prices dropped 23.3 percent in 2014.

Bringing down the house
Australia has also experienced robust growth over the past decade, and most of that success is inextricably linked to China. Around 80 percent of Australia’s exports are commodities; 30 percent of the country’s total exports are bound for China (see Fig. 1). The slowdown in the Chinese economy has already had severe implications for Australia. “If you had a serious slowdown in Chinese property, which we are sort of seeing at the moment, you could easily shave off a percent or so from the real GDP numbers [for Australia],” Damien Boey, a Credit Suisse analyst, told The Sydney Morning Herald.

In early June, shares in Australian mining companies dropped to their lowest since 2012, as the price of commodities exported to China continued to drop. Australia has been investing heavily in infrastructure to support its mining sector, including building new ports approving controversial new mines. A lot of these developments depend on strong demand from China to be economically viable. It is likely that Australian commodities exports will eventually find another home, and the country will be less exposed to China, but in the meantime it’s not looking good.

It might seem like Australia is stuck between a rock and a hard place, but other countries are even more dependent on China. Mongolia, Turkmenistan and Gambia, for instance, rely on China to pick up 88, 73 and 68 percent of their exports respectively – and these countries have much less diversified economies than Australia. For Mongolia, in particular, the slowdown of the Chinese property market is nothing short of catastrophic.

Historically, when times have gotten tough for Mongolia economically, it has looked to China for support and trade, but as China slows down, it will inevitably drag down its neighbours too. Mongolia’s chief advantage is that its main exports are actually coal briquettes, widely used in China as fuel for home cookers and heaters. Up to 70 percent of China’s primary energy supply comes from coal, and though the country produces much of it internally, the briquettes imported from Mongolia are a vital source of energy for Chinese households, particularly in rural or poorer areas, where it has replaced firewood.

Source: Australian Department of Foreign Affairs and Trade

Though the Mongolian economy has been performing very strongly over the past few years – as it begins to explore its rich copper and iron ore deposits – the sheer volume of exports into China means the country could run into some trouble. Because of its location, nestled between China and Russia, Mongolia can certainly expand its trading horizons, but so far it has failed to do so. Only 2.1 percent of its exports make it to Russia.

Over-reliance on real estate
China’s overreliance on real estate to fuel its economy is not news, but the scale at which this had been occurring was unprecedented. The sale and outfitting of apartments accounts for almost a quarter of the country’s GDP, a worrying statistic; at the peak of their respective housing bubbles the US, Spain and Ireland did not rely on the property sector as heavily as China does today. This overexposure to the property market is also having problematic repercussions on the local financial services sector, as would be expected. Lenders, in both the conventional and shadow banking sectors, have been left terribly exposed as house prices fall and construction stalls on new projects. Debt levels in China have been increasing rapidly, and in 2013 there was more corporate debt issued there than anywhere else in the world. A large portion of those loans will inevitably have gone to the many property developers who are now watching their investments fail.

The images of ‘ghost’ cities, peppered about the Chinese countryside, have made the rounds online for the last couple of years. The deserted skyscrapers and unkempt gardens, though really quite shocking, only tell part of the story. According to analysts at Gavekal Dragonomics, it is actually the coastal cities like Beijing, Shanghai, Guangzhou and Shenzhen, which are driving the price decline: Rosealea Yao and Thomas Gatley have noted that house prices in these overheated markets have increased by 20-30 percent per year over the past few years; the decline in house prices is in part driven by the market correcting itself from these previous gains.

“And when sales growth slowed in late 2013,” Yao and Gatley wrote in their analysis, “developers starting cutting prices in some cities to boost sales and cash flow. The price cuts were focused in cities with high prices, because that’s where they had the best chance of boosting sales. Unfortunately, those large, high-profile cities serve as bellwethers for the national market, and as word of falling prices spread, sales and sentiment were hurt across the country.”

According to research by the Nomura Group from Japan, the downturn is actually a sign that a property bubble that has already burst. “To us, it is no longer a question of ‘if’ but rather ‘how severe’ the property market correction will be,” three Nomura analysts wrote in a report released in May, and for them there is little the Chinese government can do to halt the crash: “There is no policy that is universally right.”

According to the Nomura analysts, property investment in China began to slump in four of the 26 provinces in early 2014, and in two of these provinces, the decline was greater than 25 percent. The analysts predict that the fallout could be so severe that GDP growth will be pushed below six percent this year, for the first time in decades. For Nomura, China might even be heading for a hard landing, with growth dropping below five percent for four consecutive quarters.

So far, the Chinese Government has not taken significant steps towards mitigating the effects of the property market slowdown, even as other industries are beginning to be dragged down as well.

Industrial production, which is heavily correlated with the property sector, has already started slowing down. Retail growth sales have also been weak, dropping from 12.2 percent in March to 11.9 percent in April. A significant number of international companies are exposed to these industries in China, and if output continues to drop, it could trigger another global downturn. The clock is certainly ticking for the Chinese Government to make a move, but so far it has been curiously reluctant to intervene. Meanwhile, all the rest of us can do is wait with baited breath as the dominos topple.

Manufacturing capital

Posted on July 14, 2014July 14, 2014 by Ashton Wenborn

Following a prolonged stint of explosive growth, GCC policymakers have been landed with the task of stabilising and diversifying the region’s economy. Having accumulated a vast pool of wealth in recent years, leaders must now identify economic drivers that are separate from oil, and put their funds to use in laying the foundations for sustainable growth. Here we take a look at some of the region’s biggest challenges and opportunities, and highlight the companies that have played an instrumental part in the GCC’s path to prosperity in the World Finance GCC Awards 2014.

“Higher world oil prices have raised the revenues of Gulf oil producers to unprecedented heights,” says Atif Kubursi, Professor of Economics at McMaster University in Canada. “Unfortunately the oil fortunes have not led to diversified and productive economic structures, as could and should have been realised given their enormous wealth. The GCC countries are more rich than they are developed.” The GCC boasts the largest proven oil reserves of any region worldwide, representing little over 35 percent of the world’s total at approximately 486.8 billion barrels. Discussions of the area’s prosperity, therefore, are often intertwined with developments in oil and gas, or fluctuations in the commodity’s price.

Oil prices reached an all-time-high of $147.27 a barrel in July 2008, and GDP in the GCC region increased threefold in the period from 2002 to 2008, throughout which demand for oil was strong and geopolitical stability much improved. However, growth in the region’s oil sector slowed to a crawl in 2013, finishing the year at 0.4 percent. While the sector is expected to post closer to 1.5 percent growth in 2014, the unimpressive figures serve as a sobering reminder of the GCC’s unsustainable economic makeup. “The Gulf countries remain today, as they were decades ago, principally undiversified and heavily dependent on the core oil sector,” says Kubursi.

WF-GCC-Investment-&-Development
World Finance GCC Awards 2014

Time for new revisions
Although the model has served the region well so far, evidence suggests that the commodity’s prospects are growing increasingly uncertain, and the region’s production rate could level out by 2025, contract by 2055, and go into sharp decline before the turn of the century. For instance, demand for oil plummeted soon after the financial crisis took hold, exposing the weaknesses of the region’s overreliance on hydrocarbons, and prompting policymakers and investors alike to rethink the GCC’s economic makeup.

“Were oil supplies everlasting, and the demand for oil strong and continuous, economic diversification would be pointless,” wrote Kubursi in his 1984 text, Oil, Industrialisation and Development in the Arab Gulf States. Unfortunately for the Arab Gulf states, hydrocarbon reserves are not, and the region’s huge oil and gas industry, while prosperous, has long starved the economy of the diversity it so needs.

What’s more, the shale revolution and the increasing viability of unconventional hydrocarbons is squeezing prices further still, as the geographical domination of oil production steadily moves away from the Middle East. While GCC producers – particularly Saudi Arabia – are keeping consumers well stocked in the event of supply disruptions, the wealth has so far failed to translate into jobs and domestic gains.

Consequently, economic diversification has come to be seen as one of the most important considerations for the Gulf states in cementing a more sustainable means of economic growth, as the region – for the first time in a while – looks beyond oil.

For all of the GCC countries, oil revenues as a share of total budget revenues stand above 80 percent, according to research led by BNP Paribas, representing a dangerously high dependence whichever way you look at it. The downturn in the global oil market, however, saw investments wane and development slow, and governments in the six Gulf states have since taken pains to transform their national development strategies and look to sectors aside from hydrocarbons.

Underpinned by budget surpluses and rising oil prices, spending and private sector conditions have improved in the non-oil sector of late and lifted the region’s outlook ahead of what it was. Qatar National Bank, for one, estimates that economic growth for 2014 will come to 4.7 percent, up from 3.7 the year previous and backed primarily by advances in the non-oil sector and accommodative fiscal and monetary policies.

UAE storms ahead
One country where non-oil sectors are far outperforming oil and gas related developments is the UAE, where manufacturing and hospitality have emerged this year as key growth drivers. With easy transport links to Africa, India and Central Asia, the UAE and Dubai in particular, is an attractive destination for manufacturers looking to tap opportunities in any number of emerging markets. These manufacturing opportunities, combined with record high hotel occupancy rates and air passenger traffic figures, mean that the country is no longer dependent on oil in quite the same way it has been.

Another sector exhibiting growth in the Gulf is banking, which has posted a loan growth average of 10.6 percent for this year. Led most notably by Saudi Arabia, Qatar and the UAE, the region’s banking sector is currently in the midst of adapting for a new competitive landscape and enjoying the benefits that come with solid economic fundamentals. “The pre-crisis heyday of growth for all GCC countries is gone, leaving behind a more diverse banking landscape. Triggered primarily by macroeconomics, demographics, and regulation, the new landscape is here to stay, and it is having far-reaching consequences on both strategic and operational levels,” according to an AT Kerney report entitled The New Reality of GCC Banking.

The GCC’s non-oil sector is forecast to hit six percent for this year, far and above comparative oil-related growth and a percentage point higher than previously anticipated, according to KFH Research. This growth is due largely to the on-going expansionary fiscal policy in the region, with government spending for the region having risen approximately six to seven percent through 2013 and 2014. What’s more, inflation throughout the GCC remains relatively low, which in many cases is approximately a little over two percent (see Fig. 1). Monetary policy is also healthy, with key lending rates in the GCC standing at two percent or lower.

Figure-2-gross-domestic-product — Source: International Monetary Fund. Notes: Figures post-2014 are IMF estimates

The business environment in the GCC countries is also much improved on years passed, and, according to the World Bank’s 2014 Doing Business report, the region boasts the most hospitable climate in the Middle East and North Africa. Most of the Gulf countries ranked highly in this year’s report, with the UAE and Saudi Arabia coming in at 23 and 26 respectively. Nonetheless, other sources have been quick to point out that there exists a fair few challenges to first overcome before the GCC cements its status as a fertile ground for SMEs and investors.

“The overall picture is one of uneven progress. On one level, investors are welcomed: the countries are open to foreign ownership and red tape on things like construction permits has been cut. But on another level, there are policies restricting foreign labour and widely varying business regulations, which can stall projects and growth. These two contrasting messages from GCC countries present a conundrum for investors,” writes Aviva Freudmann, Editor of the Merck Serono-sponsored report entitled The business environment in Gulf Co-operation Council countries.

Remaining challenges
Regardless of the impressive rate at which the non-oil sector is expanding and the improved climate for doing business, the challenges of fiscal reform and job creation remain for many in the region. Although the oil sector has contributed vast sums to the region’s GDP and oil exports, this has largely failed to translate into well-paying jobs and is affecting the regions’ current account balance (see Fig. 2). Therefore, structural reforms are necessary to target inefficient bureaucracy and corruption, alongside uncompetitive tax systems, and subsidised energy that serves only to handicap the non-oil economy.

The IMF has warned that without more private sector jobs there could be a one million-job gap shared between the Gulf Arab states before 2018. Owing to an overreliance on the oil sector, the region’s public sector is growing increasingly crowded, and private companies are expected to generate only 600,000 jobs in the next five years, far short of the 1.6 million required. Another issue is that 88 percent of government jobs go to nationals, whereas just shy of 70 percent of private sector jobs go to expatriates, starving nationals of the employment they so need.

“The massive expatriate labour imported remains heavily biased toward cheap Asian workers. There is little incentive to source knowledgeable workers or create new production clusters outside oil and the high consumption economy it engenders,” says Kubursi. However, governments in the six member states are beginning to introduce laws that encourage private entities to employ nationals ahead of expatriates.

The abundance of foreign workers is symptomatic of the region’s failure to develop critical skills and inspire a strong work ethic among its citizens, according to one Booz&Co report entitled Meeting the employment challenge in the GCC: the need for a holistic strategy. Educational deficiencies alongside a lack of vocational training, and a lack of opportunities for nationals are also compounding the problem.

“Overall growth prospects in the region remain considerably below what is needed to make a dent in the high unemployment, particularly among youth,” said the IMF’s Middle East Department Director Masood Ahmed. “Many of the necessary reforms are difficult to implement during political transitions. Yet some can be pursued immediately and would help improve confidence. For example, streamlining business regulations (to start a business, register property, or obtain permits and electricity), training the unemployed and unskilled, improving customs procedures, and deepening trade integration.”

Irrespective of the challenges that remain for GCC governments and private enterprises, the region’s impressive growth rate has attracted foreign investment in abundance. Playing host to some of the world’s largest hydrocarbon reserves (see Fig. 3), international investors see the region’s oil sector as an assured return on investment, considering the rate at which oil prices have risen in years passed.

“Beyond oil, however, the complex and vitally important trade and investment relationship the GCC has with the world is less well known. New markets are being sought around the world for a growing range of non-oil goods and services, while, on the investment side, both the well-capitalised sovereign wealth funds and an increasing range of private investors have built up wide-ranging investment portfolios. Emerging markets, especially in Asia, are becoming increasingly important economic partners for the GCC,” reads one report by the Economist Intelligence Unit.

Central to the GCC’s improved investment landscape is the increasing economic clout of India, China and Sub-Saharan Africa on the world stage. To put the rise of emerging markets into perspective, findings presented by the Economist Intelligence Unit show that non-OECD global nominal GDP accounted for 16 percent of the total, whereas in 2015 the amount is projected to reach 41 percent. As emerging markets continue to gain in stature, many will be looking to the GCC as an accommodating environment in which to work and a crucial trading partner.

Provided that the six GCC states expand upon their economic make up and take advantage of their proximity to rapidly emerging markets, the region will stand at the forefront of global economic affairs. To celebrate the GCC’s transformation, World Finance pays tribute to the companies leading the region’s most impressive advances in the GCC Awards 2014.

Mongolia looks to end mining purgatory

Posted on July 14, 2014July 14, 2014 by Ashton Wenborn

Just two years ago, economic observers around the world were enthusiastically trumpeting one Asian economy as the next great investment opportunity. While much has been said about China and India over the last decade, it was the more sparsely populated Mongolia that had got global investors so excited.

Here was a country that had been experiencing staggering GDP growth since 2008, as high as 17 percent in 2011 – as predicted by the IMF – and during a period of global economic strife to boot (see Fig. 1). Fuelled by the discoveries of vast quantities of coal, copper, gold and other minerals, and a subsequent mining boom, Mongolia’s economy was set to take off. According to the IMF, mining accounts for a colossal 71 percent of the country’s income, emphasising just how important it is to the economy, especially for a country of just three million people.

However, by the beginning of 2013, enthusiasm had taken a serious hit. A parliamentary election that was more about short-term populism and less about long-term strategy saw a series of rules brought in that seriously hampered investment opportunities and deterred many potential overseas investors. Slight amendments subsequently have suggested an acceptance of the need to get the country back on track, but Mongolia’s government still has much to do if it is to persuade the world that it really is the great investment opportunity it had promised to be.

Untapped frontier
For many mining explorers, Mongolia represents the largest and last untapped frontier in the world. Kincora, a Canadian-listed copper exploration firm, has been developing a number of projects in the country. CEO Sam Spring told World Finance that there is clearly vast potential in the country, but turning that potential into a commercially viable proposition is challenging. “It is one of those last untapped frontiers. When you have a look at its geology, it’s extremely prospective. When you look at places like Chile or Peru, with similar geological belts as down in the south Gobi, there are probably commercial operations found every 30 or 40 kilometres. That potential is very much unknown still in Mongolia, because you haven’t had the stability or the exploration to make those discoveries in the copper space. In the coal space the potential is well known – a bit like iron ore in Western Australia, you can kick your toe on it. It doesn’t need much exploration to find it. With that underground copper there are more of those advanced techniques that need to take place.”

Mongolia’s government still has much to do if it is to persuade the world that it really is the great investment opportunity it had promised to be

Largely dominated by coal and copper deposits, Mongolia has a plethora of other valuable minerals deep within the ground. The largest deposits of coal and copper can be found in the Ömnögovi Province to the south of the country, with the Tavan Tolgoi coal mine and the Oyu Tolhgi (OT) copper mine being the most important sources.

While many investors talk passionately of gold, uranium and other valuable deposits, coal and copper are in such huge quantity that they are the cornerstones of the country’s economy, according to IHS’ Asia-Pacific analyst Neil Ashdown. Speaking to World Finance he said: “When we talk about copper and coal, it’s important to stress just how much there is. There are huge deposits and they’re right on the doorstep to China. I think sometimes people forget just how important these deposits are strategically in terms of Southeast Asia. In terms of other minerals, there’s uranium in the east of Mongolia, and that was mined by the Soviets.”

The leading firms exploring these deposits include partnerships between the government and other countries, such as the Chinese-Mongolian company Mongolia Energy Corporation and the Russian-Mongolian Erdent Mining Corporation. Private firms like Rio Tinto are also active, as well as a number of smaller explorers.

Stunted potential
Mongolia’s staggering potential and need for foreign investment is recognised by the government, says Ashdown: “There’s no doubt that the opportunity is there, in terms of minerals in the ground. I think also, if you look at things very broadly, in terms of the government’s attitude [it] is very aware of the need for foreign participation, particularly in the mining sector and especially some of the more technically advanced projects that it’s thinking of working on.”

Yet, investor sentiment was badly hit by the uncertainty that resulted from the election campaigns of 2012 and 2013. According to Ashdown: “There are a couple of countervailing points. Firstly, we had the election cycle in 2012 and 2013. That really was very disruptive for Mongolia’s mining industry and… foreign investment, and the perception that it was a good place for foreign investment. The parliamentary election in 2012 was particularly bad, because… the outgoing parliament rushed through the Strategic Entity Foreign Investment Law (SEFIL), which did a lot of damage to the country’s investment environment and [the] perception [of it] as a good place to invest.”

Shortly before the 2012 parliamentary election, the outgoing government hastily passed a bill that was designed to assuage local fears over the rampant exploitation of Mongolia’s natural resources. SEFIL was rushed through before the election in May and proved deeply unpopular among foreign investors. The law made it much harder for foreign firms to obtain approval for mining, in particular the Aluminium Corporation of China’s (CHALCO) bid to seize control of a large coal deposit. As a result, analysts believe that the law culminated in a massive slump of 43 percent in overseas investment over the course of the following year.

Coupled with a halt to new exploration licences, 2012 proved to be a difficult period for the mining industry in Mongolia. “It’s been quite a difficult recent history,” says Spring. “The Chalco dispute over the south Gobi, [which] came just ahead of the 2012 election, led to a new foreign investment law that shut things down. Before that, there was a moratorium on exploration licences. If you look at the exploration sector, per se, you’ve gone from about 50 percent of Mongolia’s territory that was covered by exploration licences, to a number that I think is less than eight percent.”

In response to the negative sentiment from investors and subsequent downturn, Mongolia’s government swiftly axed SEFIL. “The 2013 presidential elections were less disruptive because people had realised what had happened and since then the Mongolian government has been working very conscientiously to portray itself as supportive of foreign investment. [It] passed in November 2013 [a] new investment law, which set out a level playing field for foreign and local investors, and addressed many of the concerns that were raised by SEFIL,” says Spring.

Source: International Monetary Fund. Notes: Post-2011 figures are IMF estimates

Despite these changes, Mongolia is still trapped in an election cycle that has done little to soothe the concerns of the mining industry, which requires around 10 years to get its projects up and running. “It’s going to come up again at the start of the next election cycle in 2016, which in terms of putting money into a major mining or infrastructure project is not very far away at all,” says Spring. “The concern is that if we see a repeat of the disruption that we saw in 2012 and 2013, then it will further exacerbate the damage that’s been done.”

Licensing disputes
Another issue that has deterred investors is the concern over the lack of new exploration licences being offered, as well as the disputes that are occurring over existing ones. Spring says that many of the existing licences are starting to get old and need to be renewed, and the uncertainty is harming investor sentiment. “Within the exploration space, despite all this huge potential, there hasn’t been a lot of work done. A lot of the licences out there are getting a bit old, and if you’re a major company and you know that it generally takes over 10 years to go from discovery to production, then you’re probably a bit hesitant coming in, as opposed to other jurisdictions.”

Disputes over licences are also causing uncertainty and concern that the government will try and renegotiate deals to assuage local anger. Ashdown says that disputes like the one involving the government and Rio Tinto over the second phase of the OT project have eroded the cautious optimism of last year. “The problem is that there have been a number of high profile issues, most notably the OT second phase expansion project, where there’s an ongoing dispute between the government and Rio Tinto,” says Spring. “The attention on that has taken the wind out of the sales [of] those positive regulatory developments.”

Kincora is currently involved in a licensing dispute, and Spring believes that such situations benefit nobody. “This licence dispute that we’re caught up with is not in anyone’s interest. It’s causing less investment and less employment. Any groups looking at Mongolia and doing their due diligence will get spooked by it, because security of tender and a transparent legal process are the cornerstones of foreign investment.”

He adds that lifting the restrictions on new licences also needs to happen if the industry is going to get investment back on track. “The exploration sector as a whole has come into somewhat of a natural death, unless they lift this moratorium. A lot of the licences are coming to the end of their term, and when that happens there is a security of tender issue. You look at all the other disputes that are taking place in Mongolia, and you can understand why people are getting a little bit nervous.”

China-Russia balancing act
Another issue that Mongolia’s government faces is its relationships with its neighbours. Previously controlled by both China and Russia, Mongolians are wary of being overly tied to either country. Its history as a Soviet satellite state is still an unwelcome memory for many Mongolians. And with China’s economic dominance, demand for natural resources and location just next to Mongolia, it is exerting increasing influence in the country.

71%

of Mongolia’s GDP comes from mining

The government is therefore engaged in a careful balancing act between the two nations. “In China, there is an appreciation that as Mongolia struggles economically then [it] will be more willing to accept the kind of Chinese investment that [it was] previously more hesitant about,” says Ashdown. “The Mongolian Government’s strategy has always been to lean towards Russia. They are very much aware that they’re engaged in a balancing act between these two countries. China is the country that perhaps has the most natural tendency to exert disproportionate influence over Mongolia, because it is the dominant trading partner by a long way, particularly in terms of exports.”

How Mongolia gets back on track will depend on what strategy the government takes in the future. It has two very enthusiastic customers right on its borders in the shape of China and Russia, but a relatively small workforce that is concerned about the impact of foreign investment and rampant resource exploration. One way to balance these demands is to use the profits from its mining industry to provide services to its people.

If it wants to provide a balanced economy in the future, the government must invest the profits from the mining industry towards building new infrastructure, while also training its workforce, says Ashdown. “The only way in which you’re going to make Mongolia’s economic growth sustainable is if you have an engine driving the economy – mining – and you funnel all that money into developing infrastructure or making a city like Ulaanbaatar a more liveable place. It’s not just about the mining industry, but you need it there if you’re going to make the economy sustainable in the long term.”

While the government obviously has a major role to play in educating the population, companies working within the mining industry are doing their bit, and education should remain the core focus for the country. “In a country like Mongolia that is a relatively young democracy, where the state took care of everything during the Soviet era, there still needs to be a very educational approach by the whole industry,” says Spring. “OT has done a great job in terms of educating and taking that lead, but it does need to come from junior firms like Kincora, all the way to bigger firms, in terms of lobbying for good policy to trying to employ local people, good training, and [having] best-in-class legislation that’s in the interest of all stakeholders.”

While the promise of 2012 has been replaced with a sense of disappointment, investors should still realise the vast potential that there is in Mongolia. Its GDP is still expected to rise at rates far greater than most other countries, and its many resources will always be in demand. “We’re talking about a country that’s had growth rates that have been world leading, and so when we talk of a downturn it’s about those figures not being quite so incredible,” says Ashdown.

What Mongolia must do is to assure foreign investors that it is a business-thinking country where their money is welcome and secure, and will be used for long-term growth, rather than short-term populism.