Year: 2015

BankServe’s top tips for navigating marine insurance policies

Posted on by World Finance

Peter Mellet, Managing Director of BankServe Insurance Services, explains how to navigate through the paperwork of mortgagee’s interest insurance and innocent owners insurance, and gives his top tips for potential buyers.

World Finance: Insurance can be complicated and getting the right one to fit your company is paramount, especially when it comes to niche industries such as marine, oil and gas.

With me now is Peter Mellet from Bankserve Insurance Services the market leader in a number of insurance markets, to explain how to navigate through the paperwork and various services.

Well Peter I want to start with mortgagee’s interest insurance and innocent owners insurance. What exactly are these?

Peter Mellet: What they are, are contingent covers to protect lenders and investors in the event that owners’ policies don’t pay. When a loan starts, during the life of that loan the owner would buy insurance for hull and war liabilities.

Now sometimes those policies don’t respond and the mortgagee’s interest covers and the innocent owners policies are a second line of defence. And they will step in when the underwriter of the owners policies say: ‘No, we are not going to pay, and we don’t think we have a liability.’ That’s what they do.

World Finance: And are there claims?

Peter Mellet: Yeah, there a lot – people don’t think they are. With any insurance it’s a piece of paper until you make a claim. Maybe it will help you sleep better at nights, but you’ve got to make sure it works. They aren’t as many claims on mortgagee’s interest insurance or innocent owners as there is another forms of cover.

Marine policies get claims all the time. But we have done 80 claims in the last 15 years. Now it doesn’t sound a lot, but that is. And we collected nearly all of the claims in the market during that period of time. Aggregate total is about $160m and we just collected the biggest one ever at just over $64m.

World Finance: What are the differences between the policy forms?

Peter Mellet: I think the differences in the policy forms you can buy are some of the most extreme in the market. Marine policies are fairly concentrated in the middle. But mortgagee’s interest insurance particularly varies. There are two ends of the spectrum: there is a market wording, which is written by underwriters for underwriters. And at the other end of the spectrum, we’ve got a very user-friendly form, which is as wide as we can get it, and also very user-friendly for the borrowers. So it helps everyone during the process.

And it is important to remember that. You are going out, you are not just buying a product from a shelf. You are not buying some hull insurance or war insurance or liability cover. You are buying a product, which has got varieties of form available. And it is important to buy the right one.

World Finance: And policy wording, how has that evolved during the years?

Peter Mellet: It has evolved through claims. I think insurance is a product which does evolve through the claims process. It’s only when you have claims and someone looking at the liability end, lawyers looking at policy wordings and asking themselves: well, does this work? What these words say? What does this do? Is this what we intended the policy to cover? And by people examining those issues you get to a position where suddenly you says: ‘Right, well maybe this is a problem now.’ And you settle and you compromise but next time you look at the wording and you change it to make sure that problem doesn’t come up again. And that is the way it evolves through the claims process.

And mortgagee’s interest insurance hasn’t evolved as quickly because there haven’t been a lot of claims. I said 80. That isn’t many compared to other types of cover. But at the same time, each claim we’ve learned from, and changed the wording to make it more user-friendly the next time.

World Finance: Why should financiers and investors use their own broker to arrange cover rather than let the owner buy it for them?

Peter Mellet: Privity, basically. If they use the owner or the owner’s broker, they will be fixed with the knowledge that the owner or the broker has. And the whole idea of these policies is to protect an innocent mortgagee or investor.

Now they go and buy their own cover, the have to disclose things to underwriters and the covers will work provided they are not aware of the problem which is invalidating the owner’s policy.

Now the owner will know what he is doing wrong – his broker will have information about the owner. Now if the bank doesn’t have that and they place their own cover – they are clean – their policy is untainted. If they use the owner, then they have problems. And I think if they use the owner or the owner’s broker the policy is devalued in its effectiveness by more than 50 percent.

World Finance: Well finally, are there things that people should look out for when they are buying mortgagee’s interest insurance or innocent owners insurance cover?

Peter Mellet: The main thing, one of the main words, is disclosure. You’ve got to tell people the right things; you’ve got to disclose to underwriters any information you have.

Now I know that sounds simple but I think in mortgagee’s interest insurance, it becomes more complicated. And, as soon as you have a claim, the first thing that happens is the underwriters will instruct a lawyer. He will ask for the loan repayment history. If underwriters haven’t been told that maybe the loan is in default; the owner’s missed payments: they will scream non-disclosure.

They’ll say we should have hard worn liability been told this, this is information we should have been provided. And non-disclosure is one of the hardest defences to overcome, to marine claims; it is a very subjective issue.

What would have influenced an underwriter’s decision-making process and that is something which immediately put you into compromise territory. So I think disclosure – and then I think; look at the policy forms. And going back to one of your previous questions, to look at who’s doing it.

Make sure the bank is buying their own cover. The owner buys his cover, the bank should buy theirs; and if you keep the two separate, then you should give yourself the best chance of making policies work when you need them.

World Finance: Peter, thank you.

Peter Mellet: A pleasure.

Bill Gross sues Pimco for $200m

Posted on by Ashton Wenborn

Bill Gross, known often as the ‘Bond King’, has sued Pimco – the company he helped found in 1971 – for its part in driving him out the firm last September. The suit, filed on October 8 in Orange County, alleges that younger executives at the firm ousted him in order to cash in on his 20 percent stake in a $1.3bn bonus pool.

Since his departure, investors have pulled billions of dollars out of Pimco funds

According to the lawsuit, Pimco “wrongly and illegally” withheld hundreds of millions of dollars in compensation owed to Gross. “Driven by a lust for power, greed, and a desire to improve their own financial position and reputation at the expense of investors and decency,” the document goes on, “a cabal” of “managing directors plotted to drive founder Bill Gross out of Pimco,” according to documents seen by The Wall Street Journal.

Since his departure, investors have pulled billions of dollars out of Pimco funds – although the scale of the outflows has diminished in recent months. Assets held by the firm’s flagship fund have slumped to $100bn, down from a 2013 high of $300bn.

Gross’ case marks an attempt on his part to restore his damaged reputation. In the time since his departure, the former executive has been portrayed as a disruptive influence on the firm he helped create, although the lawsuit, if successful, could clear some of the marks against his name.

Gross’ version of events are that Mohamed El-Erian, chief executive at the time of his departure, and he were at odds over the direction of the firm – with Gross opposed to El-Erian’s intentions to pursue riskier investments, away from its core bonds business. The suit also claims Gross was set to receive $250m in bonus payments last year, adding that the firm denied him an $80m bonus for the third quarter, despite him leaving a matter of days before the quarter’s end.

Iran seeks international oil partners

Posted on by Ashton Wenborn

The softening of relations between Iran and western governments over the last six months could allow some of the world’s leading oil companies access to the country’s vast and untapped reserves, according to a senior Iranian official.

Mehdi Hosseini, the head of the Oil Ministry’s Oil Contracts Revision Committee, told a conference in London this week that government-linked Iranian oil companies could partner with international firms to fully develop the country’s reserves; something that has been banned since the 1979 revolution by the Revolutionary Guard.

Companies looking to enter the Iranian market in the coming months include Royal Dutch Shell, Total, and BP

The Revolutionary Guard – the military wing of the Iranian regime – has influenced many of the country’s industries for many years. It has been vehemently opposed to relations with the west, but that stance seems to be relaxing now that a deal has been struck over Iran’s nuclear capabilities.

Hosseini told reporters that the Revolutionary Guards had considerable experience in Iran’s engineering markets, and so it made sense for international oil companies to seek partnerships with them. “It depends on the quality and selection of the IOCs [international oil companies]. If the IOCs want to work with them, we have no problem. We are not going to interfere in the private negotiations between private companies and the IOCs on what kind of arrangement they have,” he told the FT.

Companies looking to enter the Iranian market in the coming months include Royal Dutch Shell, Total, and BP. With the country having huge resources of oil and gas, but comparatively outdated equipment to extract them, the time seems right for a partnership between western petroleum giants and Iran’s domestic players.

It also comes at a time when the global oil price has sunk to insustainably low levels, alongside difficult geopolitical troubles in traditional markets. The low price has led to Shell scrapping its drilling efforts in the Arctic as it was seen as not financial viable. However, Iran’s resources appear to be far easier to access, and once sanctions are lifted, Hosseini believes that production could increase by 500,000 barrels a day.

India’s Rajan calls for IMF and World Bank reform

Posted on by Ashton Wenborn

Policymakers from the Group of 20 are meeting in Lima as part of the IMF and World Bank’s annual spring meeting. On the eve of the event, the governor of India’s Central Bank, Raghuram Rajan, has called upon the two Bretton Woods institutions to commit themselves to a number of reforms.

There is often a perception among the developing world that the IMF and World Bank are biased

Rajan, himself a former chief economist at the IMF, has repeated his previous calls for a “global safety net,” to assist economies deal with liquidity dry ups and sudden outflows of capital, backed by the IMF. In September, the IMF, in its Financial Stability report, did warn of a growing threat to liquidity levels in the global economy, while the Institute of International Finance estimates that emerging market economies will see an outflow of $540bn worth of capital in 2015, which would be the first net outflow since the late 1980s.

The recent call by the president of the World Bank, Jim Yong Kim, for the capital base of the bank to be increased was also endorsed by Rajan. It is argued that the bank’s chief arm, the International Bank for Reconstruction and Development should see its $253bn capital base increased, partially as a response to slowdown in emerging markets.

There is often a perception among the developing world that the IMF and World Bank are biased towards the advanced economies of North America and Europe, which has resulted in growing emerging market support for the Chinese-led Asian Infrastructure Investment Bank. To counter this bias in both perception and practice, the governor called for further reforms to both institutions.

“There is no substitute to reforming the global multilateral institutions and making them work more broadly for the membership,” said Rajan, reports The Financial Times.

Emerging markets on for a five-year slump, says IMF

Posted on by Ashton Wenborn

The IMF has, in its latest World Economic Outlook (WEO) Update, set out reduced expectations for global growth, with the organisation warning the economy this year will expand at its slowest pace since the financial crisis struck. The report points to a continued slump in emerging markets and weaker prospects all-round for oil-exporting countries.

The hysteria surrounding the Greek debt negotiations and a spike in volatility this August have bred uncertainty among investors

“Global growth remains moderate – and once again more so than predicted a few months earlier,” according to the report. “In an environment of declining commodity prices, reduced capital flows to emerging markets and pressure on their currencies, and increasing financial market volatility, downside risks to the outlook have risen, particularly for emerging market and developing economies.”

The hysteria surrounding the Greek debt negotiations and a spike in volatility this August have bred uncertainty among investors. “Emerging market and developing economies face a difficult trade-off between supporting demand amid slowing growth – actual and potential – and reducing vulnerabilities in a more difficult external environment.”

This year, should the IMF findings prove accurate, could mark a fifth consecutive year of declining growth for emerging economies. Falling commodity prices, depreciating emerging market currencies and on-going financial volatility have each hampered growth in this area and will continue to do so late into the year. Brazil, Nigeria and Russia are among the worst affected, and the Chinese slowdown has done much to dampen spirits among major exporters.

According to the IMF, global growth for this year is projected at 3.1 percent, 0.3 percent shy of 2014 and 0.2 percentage points less than predicted in July. The outlook is not all doom and gloom, however, and, relative to last year at least, the recovery in advanced economies is expected to gather steam, and global activity is forecast to pick up in the coming year.

Japan dangerously close to recession

Posted on by Ashton Wenborn

After recently seeing its predicted GDP growth figures revised downwards by the Asian Development Bank in its latest report, Japan’s economy faces further woes, as new figures show a continued decline in the East Asian nation’s industrial output. Industrial production unexpectedly slid by 0.5 percent in August, following a decline by 0.6 percent in July.

The fear now is that this fall in production will tilt Japan to negative growth

The fear now is that this fall in production will tilt Japan to negative growth. With industrial output forming a large component of GDP, the recent disappointing figures may result in a contraction of growth for Japan’s third quarter, which, following the country’s negative growth in its second quarter, would amount to Japan entering a recession. As The Wall Street Journal notes, there is a “possibility that the world’s third-largest economy will fall into a recession for the second time in as many years and adding to fears about global growth.”

The poor showing is the result of both weak domestic and external demand, although exporting industries led the decline – with the slowdown in China playing a large role. “Japan’s recovery has ground to a halt,” said economist at Capital Economics Marcel Thieliant, reports Market Watch. As a result of the shrinking, “additional easing by the Bank of Japan next month looks all but inevitable,” he added.

Further, Japan’s quarterly business attitudes survey shows many firms are pessimistic about the short term economic prospects of the country. Large firms in particular were most pessimistic, lower their profit forecasts. As Charles Nishikawa, a management consultant in London and lecturer at Mejiro University, tells World Finance, “recent result shows some concern in manufacturing industry particularly with companies exporting to international markets (mainly large corporates). It is surely due to the slowdown of China economy.” The picture, however, is not all gloom. As Nishikawa continues, “businesses mainly serving domestic markets (i.e. service and Small-medium size manufacturers) are still optimistic and they believe in the solid fundamentals of the Japanese economy and future recovery.”

IMF warns of liquidity declines and corporate debt

Posted on by Ashton Wenborn

The IMF has released its latest Financial Stability Report, in which it warns of the potential for falls in market liquidity, as well as rising corporate debt – as well as the implication that the inevitable rise in central bank interest rates – particularly that of the US Federal Reserve – would have.

“Market participants in advanced and emerging market economies,” the report warns, “have become worried that both the level of market liquidity and its resilience may be declining, especially for bonds, and that as a result the risks associated with a liquidity shock may be rising.” Liquidity in markets is vital to financial stability in order to make the market less susceptible to large fluctuations in price.

The growth of corporate debt has largely been the result of an accommodating monetary policy from advanced economies for the
past decade

Whether or not declines in market liquidity are the result of new post-2008 financial crisis regulation, the IMF states, is unclear. On the one hand, restrictions on derivatives trading, with the example of the European Union in 2012 given, have weakened liquidity in underlying assets. On the other hand, “regulations to increase transparency have improved market liquidity by facilitating the matching of buyers and sellers and reducing uncertainty about asset values.”

However, with the regime of loose monetary policy soon coming to an end, there are worries over the impact of this on liquidity. As the report puts it, there are “concerns about the resilience of market liquidity to larger shocks, such as a “bumpy” normalization of monetary policy in advanced economies.”

The IMF also outlines its fears for the impact of the expected tightening of US monetary policy on corporate debt in emerging markets. As the report outlines, “The corporate debt of nonfinancial firms across major emerging market economies increased from about $4 trillion in 2004 to well over $18 trillion in 2014. The average emerging market corporate debt-to-GDP ratio has also grown by 26 percentage points in the same period.”

This rise in corporate debt can be beneficial, through allowing for productive investment, spurring on growth. However, there are concerns that the level of corporate leverage could lead to unwanted consequences, particularly because, as the IMF economists note, “many emerging market financial crises have been preceded by rapid leverage growth.”

The growth of corporate debt has largely been the result of an accommodating monetary policy from advanced economies for the past decade. Low interest rates in the West have resulted in emerging market corporate debt build up through emerging economy banks setting their own rates lower to match that of the advanced economies – easing up credit in emerging markets, and greater capital flows into emerging markets from advanced economies in search of higher yields.

This steady build up on corporate debt under the auspices of low interest rates will result in trouble for firms that have binged on corporate debt, once the various central banks of the world start to raise interest rates, as is soon to be expected. Emerging markets should be “prepared for the eventuality of corporate failures,” once rates rise. “Where needed,” the report argues “insolvency regimes should be reformed to enable rapid resolution of both failed and salvageable firms”.

India surprises analysts by cutting rates again

Posted on by Ashton Wenborn

The Reserve Bank of India took analysts by surprise with the announcement that it had cut interest rates for the fourth time this year.

Inflation this August clocked in at a record low 3.6 percent

Of a 52-strong sample of economists polled by Bloomberg, only one correctly predicted the move – whereas 42 expected a quarter of a percentage point cut and the remaining nine forecast no change. The 50 bps reduction follows reductions in January, February and June of this year and means that the bank’s repo rate stands at 6.75 percent currently, its lowest in four and half years.

“Since the third bi-monthly statement of August 2015, global growth has moderated, especially in emerging market economies (EMEs), global trade has deteriorated further and downside risks to growth have increased,” according to the bank’s latest assessment. “In India, a tentative economic recovery is underway, but is still far from robust.”

Global growth is less than it was this this time last year and falling commodity prices mean that India must look to domestic growth and investment if it is to keep inflation close to its expectations. Inflation this August clocked in at a record low 3.6 percent, and sources at the bank are hoping that the cuts will boost investment and domestic spending both.

The emphasis on the repo rate suggests that the Reserve Bank of India feels commercial banks will be of vital importance in kick-starting the country’s economic performance. Looking at the period through April to June, India’s annual rate of economic growth slowed to seven percent, significantly less than the 7.5 percent rate posted in the quarter previous.

Iran to issue short-term bonds

Posted on by Ashton Wenborn

For the first time, Iran has started to issue sovereign debt to international investors. On September 29, the Islamic Republic began to offer short-term, one-year bonds, under the name Islamic Treasury Bills. The bonds will be issued by Fara Bourse, Iran’s small over-the-counter market.

Around $300m worth of the Sharia-compliant bonds will be issued

Around $300m worth of the Sharia-compliant bonds will be issued, with an attractive interest rate of 20 percent. The offering of Islamic T-Bills comes in the wake of Iran and the P5+1 group reaching an agreement over the country’s nuclear project earlier in the year. As a result of successful negotiations, Iran saw the lifting of sanctions on its financial and economic activities.

Iran sorely needs the money that the bonds will supply, as it struggles under high amounts of debt accumulated by former president Mahmoud Ahmadinejad, the strain of years of sanctions, and more recently, the decline in world oil prices. According to the Financial Times, the Iranian economy is “hampered by large levels of bad debts, punitively high interest rates and double-digit rates of inflation.”

“There is a credit crunch in Iran and the solution is to increase the money supply,” Majid Zamani, chief executive of Kardan Investment Bank, which is acting as market maker on the Iranian bonds, tells the FT. According to the Iranian Financial Tribune, “Iran prides itself on not having defaulted once in its 35-year history on its debts. Moreover, the country has one of the most advanced Islamic markets in the region and issues a wide range of sukuks, or non-interest debt securities.”

World Bank-IMF offer guidance on carbon pricing

Posted on by Ashton Wenborn

Working in partnership, the IMF and World Bank have looked at different carbon pricing initiatives from around the world and carried out research of their own in order to help governments and businesses develop successful, cost-effective schemes of their own.

The two international financial organisations contend that well-designed carbon pricing initiatives offer a “flexible tool” for cutting green gas emissions.

The World Bank and IMF recommended that those looking to design and implement carbon pricing follow their six
core principles

“Carbon pricing is effective in reducing emissions that cause climate change, is straightforward to administer, can raise valuable revenues for broader fiscal reforms, and can help address local pollution as well as global climate change,” said Christine Lagarde, managing director of the IMF. “We welcome the opportunity to continue collaborating with the World Bank, OECD, and others on this critical policy tool.”

The World Bank and IMF recommended that those looking to design and implement carbon pricing follow their six core principles, called the FASTER principles:

They contend that all schemes be “fair; aligned with other policies to ensure a level playing field for low carbon alternatives; stable and predictable, transparent, efficient and cost-effective and reliable to achieve a measurable reduction in greenhouse gas emissions”.

“The world needs to find effective ways to reduce carbon pollution,” said World Bank Group President, Jim Yong Kim. “We must design the best ways to price carbon in order to help cut pollution, improve people’s health, and provide governments with a pool of funds to drive investment in a cleaner future and to protect poor people.”

The US and China are looking to implement carbon pricing initiatives, with both countries leading the way in terms of sheer volume of emissions. Currently, the scheme China is developing aims to cover roughly one billion tons CO2, while the US just 0.5 billion.

The international financial organisations argue that more cooperation in this area is required between countries, and that by applying a price on carbon emissions, it will encourage business leaders to make investment decisions that will help stabilise the planet’s climate.

According to the World Bank’s State and Trends of Carbon Pricing 2015 report, increased international cooperation on carbon pricing could raise $2.2tn by 2050 in net annual flows of financial resources. All of which can be used to develop better solutions for tackling climate change.

Asian economies see growth slowdown

Posted on by Ashton Wenborn

The Asian economy faced “strong headwinds” in early 2015, according to the Asian Development Bank’s September Asian Economic Outlook report. Growth figures for the region are predicted to slow from 6.2 percent in 2014, down to 5.8 percent in 2015 before seeing a slight rebound to six percent in 2016.

Southeast Asian economies also saw their
recovery delayed

The estimate for 2015 is a revision downwards of the bank’s March Asian Economic Outlook figures, which forecasts growth at 6.3 percent for the year. The reasons for this slowdown are numerous. A delayed recovery in the major industrial economies such as the US and Japan has played a role, with the former facing a particularly harsh winter at the start of the year along with labour disputes at the ports of the West Coast – while the latter saw an unexpectedly weak recovery of consumption and investment. At the same time the large economies of the region underperformed. China saw export growth falter, while India saw investors defer their decisions pending government action on structural reforms.

In China, “growth is forecast to slow from 7.3 percent in 2014 to 6.8 percent in 2015,” and expected to fall further to 6.7 percent by in 2016. East Asia as a whole is expected to expand by only six percent in both 2015 and 2016, a considerable slowdown from 6.5 percent in 2014

However, while Indian growth has been more moderate than expected, the South Asian region itself is set to see reasonable levels of growth. As the report notes: “Growth in South Asia is now projected at 6.9% in 2015, below the 7.2 percent March forecast but up from 6.7% in 2014. Growth is forecast to rise further to 7.3 percent in 2016.”

Southeast Asian economies also saw their recovery delayed. Although growth in Vietnam has been particularly strong, other Southeast Asian economies has held the regions collective growth back, with export demand dampened by subdued demand in the major industrial economies and China. At the same time, the report notes, “planned infrastructure investment has fallen behind schedule in Indonesia and the Philippines, and Thailand’s recovery to date has been sluggish.” The region’s growth is expected to be 4.4 percent in 2015, the same pace as in 2014.

Despite a moderation in growth figures for much of the Asian economy, the region itself is still one of the main contributors to global economic growth.

Reviving Germany’s banking giant

Posted on by Ashton Wenborn

Since the onset of the 2008 crisis, many banks have come under increasing scrutiny by financial watchdogs. On both sides of the Atlantic, newly beefed-up regulators have launched increasing numbers of investigations into the conduct of financial institutions.

Pieces of legislation such as the Frank-Dodd act have placed banks under tighter regulatory control, while regulators have stepped up action pursuing banks that have transgressed rules. For instance, the UK regulator the Financial Conduct Authority carried out just four dawn raids in 2007, before this number spiked to nearly 40 by 2009 to 2010.

“Since 2008, regulators have devoted more time and energy to ensuring that a) financial institutions pose less of a systemic risk to the financial system and b) financial institutions are more aware that they must not only pay lip service to complying with regulations and ethical expectations but that they will be sanctioned for misdemeanours or lapses”, Dr Michael Flanagan, of the Accounting, Finance and Economics Department at Manchester Metropolitan University Business School told Word Finance.

According to research carried out by Roger McCormick of the CCP Research Foundation, the financial industry’s 10 largest banks racked up fines worth £166.63bn ($260.7bn) between 2009 and 2013. A number of high-profile incidents have also seen institutions slapped with large fines subjected to criminal investigations.

Large fines have been handed out to a number of banks for their role in the Libor scandal in recent years, often very publically so. According to Flanagan, particularly since the crash, “Country regulators who might in the past have preferred to handle ‘situations’ [such as the] Libor scandal in a discrete and private manner are now forced to actively cooperate and intrude more forcefully on how banks govern their businesses and appoint their senior managers.”

Over its long history, Deutsche Bank has seen a number of crises and each time it was able to survive… although not always unscathed

No stranger to scandal
Deutsche Bank in particular has been subject to much criticism from both the press and regulators for its role in rigging Libor rates. As the FT reported at the time, “Deutsche Bank has paid a record $2.5bn to authorities in the US and UK to settle allegations that it manipulated the Libor benchmark rate, a key interbank borrowing rate that underpins as much as $350trn of debt worldwide, from student loans to complex financial instruments.”

A number of employees were also dismissed, as well as DB Group Services, a subsidiary group, admitting to US criminal wire fraud charges. The fines levied on the bank were so high partially as a result of the bank misleading regulators during their investigation. This, according to one journalist at Forbes, “Shows the rottenness of Deutsche Bank’s culture.” Likewise, a confidential BaFin report criticised the bank for “keeping quiet about attempted Libor manipulation”, The Wall Street Journal reported. The bank has also been fined for its practices in US mortgage selling and is to be investigated for violating Iran sanctions as well as for alleged bribery in its Russian operations. As Flanagan noted, while it is “fairly plain that corporate governance and control was also at fault in many other financial institutions ranging from credit rating agencies, to regulators to banks… Deutsche was left standing when the musical chairs game ended”.

However, if the bank itself has a “rotten heart”, so too does it have a long legacy. Being a bank at the heart of Europe – and in Germany no less – it has played a key role in the economic development of the continent at various points in its history. Over its long history, Deutsche Bank has seen a number of crises and each time it was able to survive, often through overhauling its practices, although not always unscathed.

Early pioneer
Created just before its national namesake in the 1870, Deutsche Bank was the last financial institution to be authorised a licence as a joint-stock bank in Prussia, with such license requirements being abolished in the same year.

At a time that can be described as the first round of world economic globalisation, from the outset the bank was tasked with an international mission, with the bank’s statute stating that the “object of the company is to transact banking business of all kinds, in particular to promote and facilitate trade relations between Germany, other European countries and overseas markets”. At the time British finance dominated the financing of German foreign trade. Deutsche Bank hoped to challenge this hegemony of British banks, and between 1871 and 1873 branches were opened in the financially dominant cities of Bremen, Yokohama, Shanghai, Hamburg and London.

Financing international trade, however, soon proved to not be adequate in the long run and the bank looked to expand its operations. During its first year of business, the bank had taken the unusual step of accepting cash deposits. As normal – expected even – as that may be now for a major bank, as a Deutsche Bank outline of its own history reads, “for the German banking world it was little short of revolutionary”. These deposits gave the bank a broad capital base and also pioneered the deposit-taking business in the newly formed German Empire.

According to Deutsche Bank, the financial institution went on to see great success in its first few decades due to an “eye for good commercial prospects [that] was combined with a sound feeling for risk”. Early 20th century economists such as Nikolai Bukharin and JA Hobson saw the last two decades of 19th century capitalism as one where financial institutions and industry became increasingly intertwined; Deutsche Bank was archetypal bank in this regard.

In the 1880s and 1890s it increasingly began issuing to business and, according to the bank itself, “played a major part in the development of Germany’s electrical-engineering industry, but it also gained a strong foothold in iron and steel. A solid base in Germany permitted the financing of business abroad, which in some cases kept the bank occupied for years, the best-known example being the Baghdad Railway.” Other ventures included the in the Shantung Railway Company and Shantung Mining Company in Northern China, as well as the continued opening of new branches as far away as Istanbul. By 1914 one newspaper was able to confidently label it the biggest bank in the world.

Tragedy of the 20th century
From here on, however, the fortunes of the bank declined. In the chaotic, post-First World War era in Germany, the bank was forced to sell many of its holdings, as well as seeing its overseas assets taken over. The 1920s in Germany saw a tendency towards banks merging and consolidating. Being no exception, Deutsche Bank merged with its largest competitor Disconto-Gesellschaft in 1929. This consolidation helped it weather the impending financial crisis that hit Germany especially hard.

Following the Second World War, the bank saw its largest crises to date. In the eastern zones of Germany, controlled by Soviet forces, all banks were nationalised. Some banks under Allied control in Western areas were also nationalised or broken up to operate regionally. Deutsche Bank was subject to the latter policy, being divided in 10 different banks with the name Deutsche Bank forbidden to be used as the name of any banking operation. Deutsche Bank, it seemed, was dead.

However, under the initiative of Hermann Josef Abs, a long-time leader at Deutsche Bank, an agreement was reached in 1952 whereby 10 of the former Deutsche Bank successor institutions gradually merged into three separate new joint-stock banks, and in 1957, all three merged to form Deutsche Bank AG.

The bank slowly rebuilt its operations, creating a strong domestic network. Issuing business also picked up in the 1950s after Germany’s debt was eventually settled, leading the nation to become a creditor rather than a debtor. In 1958 the German bond market reopened when Deutsche Bank floated a “foreign-currency bond for the Anglo American Corporation of South Africa”.

Deutsche Bank once again recovered its international position in the 1970s, opening a number of branches abroad and acquiring other banks across the world in countries such as Italy, Spain, the UK and the US. This regaining of its international position it had held a century earlier continued, with the takeover of the British Morgan Grenfell Group in 1989 and in 1991 all of the bank’s American business was brought under the control of the holding company Deutsche Bank North America Holding.

With the reunification of Germany and the fall of Communism across the Eastern Europe, the bank further expanded its operations, opening up branches in once-closed off markets, with representations in Budapest and Prague starting in 1990 and Deutsche Bank Polska opening in Warsaw in 1995. A number of other international banks were acquired throughout the 1990s, culminating in the investment bank Bankers Trust in the US in 1999 and eventual listing on the New York Stock Exchange in 2001. By the 2000s the bank could boast that it was “the leader in its German home market” and “enjoys an outstanding position in Europe”.

Reorganisation, once again
Deutsche bank has been through a number of troubles and reorganisations and due to its most recent troubles may be facing another, with the new stating that the banks current performance is not good enough. John Cryan, a former UBS banker who took over from Anshu Jain as co-chief executive of Deutsche on July 1 said: “Our challenges are… evident in the unacceptably high level of our costs, our continuing burden of heavy litigation charges, a balance sheet that must be more efficient, and the poor overall returns to our shareholders.”

While many banks were caught up in the Libor scandal, Deutsche Bank’s attempt to mislead regulators perhaps suggests a specific lack of integrity and transparency at some levels of the bank. Acknowledging this, the bank has set up a review panel to ensure more ethical behaviour at the bank. Likewise, as part of its settlement, the bank will also have, according to Transparency International, as “independent monitor on Deutsche Bank to ensure the bank implements changes to prevent similar wrongdoing from occurring in the future”.

The ability to pull the bank back from the troubled place it is in today – and exculpate any alleged rotten core – of course will depend on the how well Cryan and other high-ranking employees carry out the task at hand. “Ultimately these events are a symptom of how top management govern and set objectives for its employees. High ethical standards start at the top and are adopted more or less willingly by employees through (corporate) culture, training and recruitment control mechanisms”, said Flanagan. Deutsche Bank as an institution has many times been able to overcome crises and seems adept at evolving to survive.

Can you put a price on pollution?

Posted on by Ashton Wenborn

In May this year, six of Europe’s leading energy firms, BP and Royal Dutch Shell among them, joined in a bid to bring the UN on board and devise an agreed-upon carbon pricing system. Proposed on the grounds that doing so would discourage high-carbon options and boost investment in low-carbon technologies, the six took a stand that ran contrary to their reputation as thorns in the side of the fight against climate change. Often criticised for their contributions, or lack thereof, to curbing emissions, the agreement has seen the fossil fuels business stand up and be counted as a force for progressive change.

Consumers – for whom inaction on climate change has become an all-too-familiar occurrence – have welcomed joint action on carbon pricing, though American opposition, notably from ExxonMobil and Chevron, doused any hint of positivity and highlighted the biggest obstacle standing in its way. Whereas studies show that greater numbers are warming to the policy, a failure to agree on a solution has inhibited progress, and governments, not to mention fossil fuels companies, are at a loss when it comes to taking a joint stance on the issue.

“Drastically cutting power emissions has proved easier than expected, with the astonishing growth of renewables, and energy use has fallen across the developed world even as economies continue to grow. However, energy-intensive industry has been relatively ignored, and has thus represented the largest block to further emissions reductions”, according to Phil MacDonald of the Sandbag Climate Campaign. “Carbon pricing schemes must recognise this, and must go hand-in-hand with policies to dramatically decarbonise industry.”

$50bn

Estimated value of the carbon pricing market as of April 2015

Growing carbon markets
“In the past few years, the use of markets to reduce greenhouse gas (GHG) emissions has grown rapidly; in its 2015 status report, the International Carbon Action Partnership found that jurisdictions with emissions trading in place account for 40 percent of global GDP”, added the IETA’s Director of International Policy Jeff Swartz. “We are in a time now where the conversation is less about whether climate change is real or not but rather what should we do to respond, which is an important step forward in the debate. And with more and more regions introducing carbon pricing policies, the overall risk to competitiveness is decreasing.”

The World Bank’s annual review of carbon markets shows that schemes designed to ensure polluters either pay for or reduce their emissions were at play in 39 nations and 23 subnational jurisdictions, as of April 2015. “There has been a rapid acceleration in both the support for carbon pricing and the adoption of carbon pricing policies in countries and regions around the world”, said Noah Kaufman, a Climate Economist for the World Resources Institute. “It is now far more difficult for countries to delay climate change action by pointing at the inaction of others.”

Looking only at the financial value of carbon pricing, the progress is significant, and, as of April 2015, the market was worth an estimated $50bn. The increase is made to seem even more significant considering that Australia last year repealed its carbon pricing mechanism and made a quite sizeable dent in the market. Buoyed by South Korea’s newly introduced emissions trading system (ETS) and Portugal’s $5 per tonne of CO2 tax, the market enjoyed a modest pick-me-up last year; compounded further by the expansion of schemes such as those in California and Quebec.

Impressive as the numbers are, the coverage extends to only 12 percent of global emissions, and progress on the issue has been wildly inconsistent. Sure, there is cause for optimism insofar as carbon pricing is finding its way onto the frontlines of global policy discussion, but participants are yet to arrive at a workable solution. Introduced or expanded on the basis that carbon pricing raises revenue and reduces budget deficits, while curbing emissions, the system is seen by many as a costly and sometimes-oppressive policy stance.

Finding the right solution
Australia, for example, abolished its carbon tax last year after only two years on the basis that it was inhibiting businesses and exerting undue financial pressures on households. Capping an eight-year stint in which climate policy has featured front and centre in three election campaigns, the government finally succumbed to those-against and, in eliminating the tax, handed businesses a $7bn pick-me-up.

Whereas recently-axed Prime Minister Tony Abbott, for whom eliminating the tax formed a major part of his election campaign, called the move “great news for Australian families”, those with an eye on the country’s emissions were less than convinced. “With the Senate’s vote today, Australia not only lurches to the back of the pack of countries taking action on climate, but sees the responsibility of emission reductions shift from major polluters to the taxpayer”, said John Connor, CEO of The Climate Institute, in a statement. “Today we lose a credible framework of limiting pollution that was a firm foundation for a fair, dinkum Australian contribution to global climate efforts.”

To date, Australia’s change of heart is perhaps the highest profile setback for the cause, though, more than that, the lesson serves as a sobering reminder of the challenges, economic but mostly political, associated with the endeavour. “Politics is the biggest challenge for any climate change policy because, the benefits are distributed throughout the current and future populations of the world, whereas the costs are concentrated on the regions and countries that must pass legislation”, said Kaufman.

“While many governments not only see carbon pricing as a way to combat climate change, but also to improve public finances, the worry of short-term increases in energy prices and goods persists. Businesses are worried about their competitiveness and consumers about their energy bill”, said Long Lam, Consultant on Climate Strategies and Policies at Ecofys. “Many carbon pricing schemes therefore have measures in place to compensate businesses and low-income households for the additional costs they face. It will remain a challenge to strike a balance between the incentive to reduce GHG emissions and mitigating these worries to gain public acceptance.”

As it stands, carbon pricing takes one of two forms, either a carbon tax, as in the case of Australia, or an ETS, popularised by the EU. Speaking on the challenges, Kaufman said: “Carbon taxes and emissions trading systems are the best way to overcome this political hurdle, because they generate government revenues that can accomplish important and popular policy objectives, such as lowering taxes, reducing deficits, and investing in infrastructure and education.” However, the promise of broad-based and sustainable gains has eluded the majority, and the priority for participating nations in the here-and-now has fallen on learning from the mistakes made in days past and on reaching a political consensus.

European struggles
Perhaps no other region exemplifies the failings of carbon pricing better than the EU, and the bloc’s cap-and-trade system has struggled to make good on its promise of reduced emissions for nigh on 10 years now. Active in 28 EU countries, and three EEA-EFTA states in Iceland, Liechstenstein and Norway, the system covers 45 percent of the bloc’s emissions, and the expectation is that by 2020 emissions will be down 21 percent on 2005 and 43 percent by 2030.

Similar to rival ETS systems in that polluters receive a certain number of emissions allowances to trade as they see fit, companies, at the end of each year, must surrender enough allowances to cover their emissions or suffer fines. Currently in its third phase, running through 2013 to 2020, the previous two iterations were heavily criticised for their failure to appropriately penalise offenders.

Dictated by the market rather than by regulation, the price of the allowances has been on the slide now for some time, and the situation is unlikely to right itself without an interjection on the part of policymakers. However, doing so means turning away from the market-based cap-and-trade system of days past and arriving at an alternative whereby policymakers and not polluters dictate the price of industrial emissions. The price in 2008 stood at €30 per ton, which has since plummeted into single digit territory, and without a price floor, such as that proposed by California recently, or some sort of stability mechanism, the EU ETS will fall short of its intended purpose.

“Back when the EU carbon market launched in 2008, it was the only game in town. Now carbon markets have spread across the world, from the US west-coast and east-coast markets, to China’s pilot schemes, which launch as a national system next year. However, in Europe, the stubbornly low carbon price has failed to drive emissions reductions (emissions have fallen for other reasons)”, said MacDonald. “Until the persistent surplus of spare emissions allowances can be cancelled, the European carbon market will fail to do its job.”

One problem, as cited by Naomi Klein in her book This Changes Everything, is that a carbon pricing system similar to that of the EU ETS will see results only with the assistance of mass public support. The policy, at its core, is an inherently complex matter, and one that is not so easily understood by all, and for as long as public support falls short of industry opposition, the EU is unlikely to institute a far higher – and more effective – carbon price.

Better to try than try not
Despite the less-than-savoury situation facing Europe, made worse recently when politicians voted down measures to boost the carbon price artificially, it appears that enthusiasm for a system of much the same type is gaining momentum in China.

“Carbon pricing has gained a lot of traction globally as a key instrument in reducing GHG emissions and combating climate change in the recent years”, said Lam. “With the slow progress in the international negotiations on climate and a limited international mitigation ambition, carbon pricing developments have shifted from an international level to a national or sub-national level.” This is particularly true in Asia and in the US.

Having experimented with provincial carbon market schemes in each of the past four years, it looks that a national market in China will open up at the mid-point of 2016. “China will be a country to follow in the coming years”, said Lam. Buoyed by a desire to shake off its status as the world’s number one polluter, China’s seven pilot schemes are each very different in scope, though together paint a picture of how the country might best go about creating the world’s largest carbon market. With a carbon price that ranges through CNY 20 to CNY 55 ($3-9) per ton, regional variations have been put in place so the country might more easily avert the oversupply issues facing Europe currently.

What’s important now, not just for China but for any nation intent on curbing emissions, is that past failings, such as those in Australia and the EU, are seen not as reasoning against carbon pricing itself, but as food for thought when arriving at a more appropriate solution. Buoyed by widespread public support and a consensus that climate change merits action, the issues standing in the way of carbon pricing are fewer and the pressure to introduce carbon pricing more pronounced. “All of this has happened absent a strong international enabling framework”, said Swartz. “The Paris Agreement set to be reached at the end of this year could play a significant role in encouraging other jurisdictions to act.”

Are megaprojects worth the money?

Posted on by Ashton Wenborn

It is often said that the defining feature of humans – what separates humanity from the animal kingdom – is our manipulation and mastery over nature. Since the Neolithic revolution and the start of history, humans have, to varying degrees of success, attempted to re-craft the environment to their own ends, rather than be subject to the whims of nature. From the Bible designating the earth as man’s dominion, to Enlightenment authors such as Sir Francis Bacon encouraging humans to “put nature on the rack and extract her secrets”, the drive to control nature and gear it towards humanity’s ends has been a constant impulse.

Around the world, this sentiment seems to remain, with governments and businesses engaging in large construction projects altering the Earth and the way we traverse it, from high-speed rail changing how humans travel, to audacious canals and dams harnessing the power of water.

Let the steppes be trampled
With the start of the 19th century and the inauguration of industrial society, reaching its apogee in the 20th century, this impulse reached dizzying heights, in both theory and practice. To support the needs of emerging mass industrial society, and encouraged by constant technological and scientific development, large infrastructure projects were built.

$6trn

The minimum spent on megaprojects per year

Following the Civil War, America criss-crossed itself with rail tracks – at no small human and financial cost – allowing for the movement of people and goods across its vast expanse. This was soon copied by the Russian Empire, which in the late 19th century completed its own rail network from one end of its sixth of the world to the other. In the 20th century, from the deserts of the American West, to Ghana’s Lake Volta and further east to China’s Yangtze River, huge dams were constructed, manipulating the natural flow of water, with an eye on improving humanity’s lot, be it through regulating water supply or providing electricity.

This impulse is perhaps best summed up by the Soviet writer V Zazurbin in 1926, when faith in human’s ability to reforge nature was perhaps at its peak: “Let the fragile green breast of Siberia be dressed in the cement armour of cities, armed with the stone muzzle of factory chimneys, and girded with iron belts of railways. Let the taiga be burned and felled, let the steppes be trampled.” Likewise, Zazurbin’s contemporary, the poet V Mayakovsky, once quipped, “After electricity I lost interest in nature. Too backward!”

The age of megaprojects
While the rhetorical flourish of earlier enthusiasts for such projects may now be absent, government bureaucrats with large plans and larger budgets, however, have not. We are, it seems, living in an age of the megaproject.

First, it is worth outlining what exactly a megaproject is. The word itself seems self-explanatory: some sort of large-scale construction project. The term, however, is a discreet label. The word megaproject first appeared, according to the Merriam-Webster dictionary, in 1976. According to Bent Flyvbjerg in a paper for Oxford University entitled What You Should Know About Megaprojects and Why: An Overview, they can be described as “large-scale, complex ventures that typically cost $1bn or more, take many years to develop and build, involve multiple public and private stakeholders, are transformational, and impact millions of people”.

One of the key characteristics of megaprojects, which the words of Zazurbin seems to have anticipated, is that they are they are transformational. They are ‘trait makers’ of a society or economy. As Flyvbjerg notes, “They are designed to ambitiously change the structure of society, as opposed to smaller and more conventional projects that are ‘trait taking’, that is, they fit into pre-existing structures and do not attempt to modify these.” Such projects are often viewed as infrastructure style projects, but can also include water and energy provision, industrial plants, space exploration, urban regeneration, as well as less material types such as IT systems.

These projects, then, are said to be dominant in our age. Total megaproject spending is assessed at $6trn to $9trn per year, which amounts to eight percent of total world GDP. According to The Economist, we are living through the “biggest investment boom in history”, estimating infrastructure spending in emerging economies at £2.2trn ($3.44trn) annually between 2009 and 2018. Likewise, McKinsey Global Institute claims that global infrastructure spending will be $3.4trn per year between 2013 and 2030, which would amount to roughly four percent of global GDP.

Alongside this, the amount spent is accelerating at break-neck speeds. Despite the rhetoric of industrialisation and modernisation that China’s Communist rulers espoused in the 20th century, “In the five years between 2004 and 2009, China spent more on infrastructure in real terms than during the entire 20th century, which is an increase in spending rate of a factor of 20.” Furthermore, China built as much length of high-speed rail track between 2005 and 2008 as Europe has in the past two decades.

To demonstrate the large scale of megaproject spending, Flyvberg makes a comparison to US debt to China, which is often viewed as an important and potentially destabilising aspect of the world economy. Megaproject spending is “the equivalent of spending five to eight times the accumulated US debt to China, every year”.

Geopolitical influences
Yet despite such a boom in spending for these transformative projects, many look upon them dispiritingly. Opposition to transformational infrastructure projects – what we now call megaprojects – is nothing new. In her Concise History of Germany, Mary Fulbrook notes, in reference to Germany’s massive construction of railways in the 19th century, “The Prussian King’s publicly expressed doubts about whether being able to arrive in Potsdam a couple of hours earlier really constituted a major contribution to human happiness.”

Moreover, according to Nancy Alexander, Director of Economic Governance at the Heinrich Boell Foundation, one major issue with » megaprojects is that the rationale behind these projects is not economic but geopolitical. “These megaprojects are driven largely by geopolitics”, she writes – rather than carefully considered economics. “The United States has begun to worry that its hegemony will be challenged by new players and institutions, such as the China-led Asian Infrastructure Investment Bank”, she continues. “In reaction, the Western-led institutions, such as the World Bank and the Asian Development Bank, are aggressively expanding their infrastructure investment operations, and are openly calling for a paradigm shift.”

The criticism, however, seems to miss the point. If certain megaprojects are indeed intended to make certain countries politically more powerful on the world stage, the questions begs how this is intended to do so. Outside of defence projects, the answer seems to be by increasing the economic power of the country, be it through increased manufacturing, transport or trade capacity, through the construction of large scale ports, industrial zones or plants to meet industry energy requirements, or extensive rail and road networks. Whether a country sees these as part of a plan to strengthen their state or simply create economic growth, the result is the same: more jobs, more trade and faster transport for citizens. For most megaprojects to pay geopolitical dividends, they must surely first present economic dividends.

Top 10 megaproject cost overruns

Defining success
One major problem with megaprojects is that they are notorious for their propensity to overrun in both completion and budgets. As Flyvberg notes, “Nine out of 10 such projects have cost overruns; overruns of up to 50 percent in real terms are common, over 50 percent are not uncommon”. Many famous megaprojects have faced serious overruns (see Fig. 1). However, in a table provided by Flyvberg, nearly exclusively, with the exception of four projects out of 32 listed with the highest overrun costs, all are located in economically developed nations. Once reason for this could be that such countries typically face more stringent regulation, both environmental and social. Tough planning laws, greater legal recourse and denser population mean opposition from those living in areas affected by megaproject construction costlier, resulting in the need for high legal costs. Likewise, more stringent environmental regulations can often slow down construction, as well as adding to legal compliance costs.

This suggests that overrun costs are not necessarily inherent to megaprojects, but rather to do with the political environment. European and North American countries have made a political decision – right or wrong – to enact legislation, which gives people legal recourse against megaproject constructions or various pieces of legislation. All of this amounts to extra costs in both direct terms but also in paying for legal experts to ensure all the rules are followed.

One case of such a project encountering overruns is the Channel Tunnel. The underwater tunnel connecting Britain and France was intended – and expected – to be profitable. The project, however, went 80 percent over budget for construction and 140 percent above for financing, while revenues have been 50 percent lower than expected. “The project has proved non-viable, with an internal rate of return on the investment that is negative, at minus 14.5 percent with a total loss to the British economy of $17.8bn; thus the Channel Tunnel detracts from the economy instead of adding to it”, wrote Flyvberg.

Yet despite being a financial failure in terms of generating a profit, the Channel Tunnel can be seen as a success in other ways. As a piece of technological engineering it is impressive, being one of the largest underwater tunnels in the world. Both symbolically and practically, it connects the UK to the rest of Europe, allowing for passengers to quickly and easily cross the English Channel.

Many major projects have been crippling overrun, yet we could not imagine the world economy without them. The Panama Canal overran by 200 percent, while Suez Canal in Egypt did so by an eye watering 1,900 percent – surely a great loss to all involved at time of construction. Yet these projects – as megaprojects are intended to be – were transformational. Panama, without its canal would surely not be home to one of the continent’s most impressive cities, Panama City, not to mention the obvious benefit of opening up a shipping route that cuts through the American continent. Likewise, by opening up shipping from the Mediterranean to the Indian Ocean, global trade without the Suez Canal seems unimaginable.

Megaprojects are transformative for economies. While they often overrun, this seems to be a trend restricted to areas where regulation is stronger – pushing up costs. And overrunning on costs does not indicate a megaproject itself as a failure; trait-making as they are, they can provide long-run foundations for economic growth. Indeed, while the term megaproject is relatively new, any major industrialisation pursued by an economy – the only sure-fire way to address poverty – has either relied on such projects, for instance railway building, or on the creation of large planned industrial zones. In and of themselves megaprojects are vital to both address present poverty and ensure the world’s continued economic prosperity.

Technology companies consider the possibilities of asset management

Posted on by Ashton Wenborn

Results from a recent State Street survey showed that, of a 400-strong sample of asset managers, the overwhelming majority felt that the industry stood on the threshold of a new era. Sure, assets under management were on the up and firms last year posted healthy returns, but 79 percent of respondents believed that they’d soon be forced to confront competition from non-traditional markets (see Fig. 1) – namely those in the technology sector.

“Technology players like Google, Apple and Alibaba Group could mount a serious challenge”, according to the findings. “Asset managers also find themselves competing with their clients’ own investment talent, as large investors bring more asset management in-house.” Put another way, advances in technology promise to shake-up the industry, and, in order to survive, traditional managers must either shape up or ship out.

Assets under management last year, for the third time in three years, reached a record high, at $74trn, and profits improved also, yet there are concerns that the costs of doing business are marginalising clients at the lower end of the spectrum. Not to take away from a string of positive headlines recently, the biggest threat to the sector’s stability stems from rising costs; and closer regulatory ties, combined with a growing pool of tech-savvy investors, who have asked that firms do more to relieve the pressures weighing on their bottom line.

$74trn

Assets under management globally, 2014

Looking at figures compiled by McKinsey, the industry’s cost base is 44 percent greater today than it was in 2007, and while increased profitability points to an asset management business in good health, persistent cost pressures threaten to outpace this growth in the long-term. Worse is that progress on this front has come slowly, and a growing wealthy client base has perhaps obscured some of the issues plaguing the industry’s long-term health.

High entry costs
The ultra-high-net-worth individual (UHNWI) population, for example, has risen 61 percent over the past decade, going by WealthInsight figures, bringing the grand total as of last year to $29.7trn worth, according to the Wealth-X and UBS World Ultra Wealth Report. Owing both to strong economic and equity market performance, the population is greater now than it ever has been, and, looking at the gathering might of the Asia-Pacific region, promises to expand further in the coming years.

An abundance of multi-millionaires means easy pickings for an industry intent on reaping healthy returns, but the rise also means that business at the lower end of the spectrum has suffered. Compounded by a widening wealth gap at the top, a strong conversion rate of millionaires to multi-millionaires and new additions in developing countries, the growing UHNWI population means that firms need no longer rely on lesser investments from lowly millionaires.

Research conducted by the Financial Times this year showed UK consumers now need, on average, £806,000 ($1.26m) to secure the services of a private client wealth manager, 48 percent greater than the year previous. Furthermore, a third of all wealth managers stated that they’d offer advice only to those fronting at least £1m ($1.56m). Prompted by regulatory changes and increased compliance costs both, firms can afford to be picky in a climate wherein costs are rising and so too is the UHNWI population.

“They wanted me to commit to giving them £1m to look after. Their own fee starts at one per cent so that’s like handing them a cheque for £10,000 on the spot”, said one entrepreneur and consultant Holly Mackay, speaking to the FT. “It was basically ‘Hi, here’s a posh coffee and a PowerPoint presentation, now give us a million quid’.” By no means a rare occurrence, the sad truth of the matter is that firms will more-often-than-not choose not to expend the time and expense it takes to serve those with less than a seven-figure sum, and for as long as the market remains as it is, the opportunities for lower end clients will be less. However, where many firms are scrambling to make good on a thriving UHNWI population, just as many are keeping a watchful eye on the wandering bottom half of the market, as well as the technology companies that could profit as a result.

“It is widely believed that the current generation of asset management models and their advisory channels are simply not up to the task of attracting the new generation of clients – especially at the two ends of the age spectrum: those affluent millennials keen on retirement planning and those baby boomers entering their golden years with significant nest eggs”, reads a recent report entitled Why the Internet Titans Will Not Conquer Asset Management. “The asset industry is ripe for a big makeover.”

Technology takes over
Often criticised for inflated charges and a refusal to embrace new technologies, the asset management industry of today is susceptible to any technology-savvy enterprise looking to muscle in on the market. Speaking on the role of technology in asset management, CEO of CREATE-Research Amin Rajan said, “First, it is enabling digitally savvy investors to bypass intermediaries and buy funds directly from asset managers with digital platforms. Second, it’s providing DIY tools to investors that enable them to make asset allocation decisions and undertake follow-up activities.”

With trust in financial services still lacking and an emerging middle class seeking investment advice, the asset management landscape is ripe for change, and it’s in this climate that tech firms, armed with their superior expertise and influence, could support the neglected lower end and even pose a threat to established fund houses.

“We are on the verge of the biggest shake-up the industry has experienced; and the message to asset managers is clear – adapt to change or your business won’t survive”, wrote Tom Brown, Global Head of Investment Management at KPMG in a recent report. “We could see the Apples, Googles, or large retailers of the world becoming the next big powerhouses in investment management.”

As much has happened already in China, where internet giants Alibaba, Tencent, Baidu and even Xiaomi have taken to asset management in the form of money market funds. A relatively minor player in March 2013 managing only $1.9bn in assets, Tianhong Asset Management Co, after teaming with Alibaba and launching a money market fund, reeled in $81bn in the space of only nine months. Christened Yu’e Bao, the fund’s success means that, as of the end of last year, Tianhong controlled a more than 10 percent share of China’s assets under management, with $93bn in assets and 185 million users.

Offering a four to six percent return, rather than the customary three percent offered by banks, China’s budding middle class has ploughed its savings into these money market funds, and the segment has expanded 15-fold in the past four years as a result, controlling $306bn in assets as of the end of 2014. Dangerous on the one hand insofar that a fair share of investors are ill informed about their exposure to risk, the success of internet companies such as Alibaba shows that there are opportunities for non-traditionals not just in China but in mature markets also.

Opportunities vs threats in asset management

Unlikely conquerors
Where traditional fund managers have largely struggled to reel in retail investors, technology companies such as Google for example, which command far more brand loyalty than most in financial services, might find it easier to do so. Regulatory hurdles may well prove too big a hurdle to stomach at the present time, though these same firms may well make a better fist of keeping up with the latest technological developments and, in doing so, keeping to modest operating costs.

Asked whether he thinks more technology companies might enter the asset management space in the future, Rajan said, “Yes, I do. But their disruption is unlikely to conquer the industry. They do not have the risk management DNA that is at the heart of investing. So, they are more likely to form alliances with the incumbents.”

All things considered, the encroaching technology sector is a net positive for the asset management industry overall, and, aside from stoking fears of survival among some fund houses, the development has forced firms to concede that they must do more to accommodate digital consumers. Utilising technology to make wealth management services both more customisable and more cost-effective, firms can ensure also that reporting and engaging with clients is made more transparent.