Author: Helen

Could carbon pricing incentivise governments to reduce emissions?

Posted on by Helen

“The carbon market is the centrepiece of Québec’s strategy for fighting climate change”, said David Heurtel, Minister of Sustainable Development, Environment and the Fight Against Climate Change, who in February spoke about the province’s latest whip-round. In keeping with ambitions to slash greenhouse gas (GHG) emissions by 20 percent and launch a raft of sustainability projects in the coming years, Heurtel plans to invest CAD 3.3bn in low-carbon development for Québec’s businesses, municipalities and private citizens. Three years and nine credit auctions in, the scheme has so far raised CAD 1bn and should raise a further CAD 2bn by 2020.

Quebec’s government is an advocate of the cap-and-trade system and party to the continent’s largest carbon market. The province’s achievements are proof discussions on these points are finally making ground. Complex though they are, experiments like this are laying the foundations for systems that will reflect the price of climate change.

“Together, we can fight climate change in order to ensure a better quality of life for our children”, Heurtel said. “Let’s do it for them.”

A carbon-pricing scheme – done well – creates a financial incentive for participating governments to reduce emissions, and supporters have been keen to present it as the most efficient – and surely the most attractive – means of doing so. “Carbon”, according to Paula DiPerna, who works as a carbon pricing expert and a special advisor to CDP, will “become the most important commodity in the history of the world”.

Almost 40 countries and many more, smaller, jurisdictions have already adopted carbon pricing. Implemented as either a direct tax on emissions or an emissions cap, the policy is finding favour in some unlikely places: it seems even corporations are beginning to recognise its advantages.

If there’s money to be made, people will try to make it

According to a spokesperson for the UN Global Compact, a leadership platform for the development, implementation and disclosure of responsible corporate practices, a growing recognition among governments of the threats posed by climate change has established a market price for emissions. Carbon pricing, according to DiPerna, “will be mandatory on almost every large emitting company within the next year or two”, and we’ll likely see the essentials of a global cap-and-trade system within the year.

Corporate support
Six of Europe’s leading oil firms penned a joint letter to the UN last year, asking for support to devise a global carbon pricing system. “We owe it to future generations to seek realistic, workable solutions to the challenge of providing more energy while tackling climate change”, the letter read. Irrespective of its costs, the six were clear that a pricing framework could provide them with a roadmap for future investment, a level playing field for all energy sources, and a clear role in securing a more sustainable future.

BP, Eni, Shell, Statoil and Total are among a growing band of companies for which policies that reflect the price of carbon are becoming an attractive – and in some cases unavoidable – proposition. A recent CDP report found over 1,000 companies are now disclosing to their stakeholders that they price their carbon emissions, or intend to do so in the next two years. This number has tripled in the space of a year and is in keeping with the “ongoing mainstreaming of carbon pricing”. According to the report, the idea is now seen as an essential component of the corporate strategy toolkit.

Support for carbon pricing around the world

64%

Of companies are in Europe

59%

Of companies are in emerging markets

18%

Of companies are in the US

The UN Global Compact said businesses see carbon pricing as a cost-effective means of driving operating efficiencies and reducing emissions. Many already operate in countries with active carbon pricing schemes and use an internal price in their planning and investments, as shown by a number of recent studies.

“If there’s money to be made, people will try to make it”, said DiPerna. “The world has been dithering around for the last 20 years on climate change. An entire generation of knowledge, institutional capacity and belief has been lost.”

Of a 377-company GreenBiz Intelligence Panel sample, 75 percent felt a mandatory price on carbon would either help their business or at least not harm it. And although GreenBiz’s finding is more environmentally minded than most, it’s worth mentioning 40 percent of Fortune 2000 companies said a carbon price would create new opportunities in differentiating their products. Climate change is now part of mainstream business decision-making and represents “a bona-fide line item in the standard budget assumptions of successful companies”, according to the CDP report.

Until now, corporations have been largely absent from the carbon pricing debate, but they have been surprisingly strong in taking voluntary action to manage and mitigate carbon risk. What’s different this time around is that, rather than develop specific emissions targets, corporations are looking to pre-empt carbon regulation by using an internal ‘shadow price’. Having expanded outside the confines of government policy discussion, the carbon-pricing question is circulating in boardrooms around the globe.

Threefold benefits
An internal price on carbon, according to the UN Global Compact, helps translate carbon into business-relevant terms, increases support and investment for energy efficiency projects, and helps companies achieve ambitious GHG reduction targets.

The biggest benefits, according to Thomas Kerr (leader of the International Finance Corporation’s private sector climate policy engagement), are threefold. The first is strategic, in that companies can use an internal carbon price to alert their CFO to potential climate risks. The second, he said, is more tactical. “Companies are using creative fee/fund schemes to charge higher-emitting activities so that they subsidise energy efficiency, clean energy or other activities that were having trouble getting internal attention and funding.” Third, an internal price on carbon means a company can position itself as a progressive leader in climate action, and perhaps inspire governments to be more proactive supporters of carbon pricing policy themselves.

Microsoft’s carbon pricing success

60

Sustainability projects paid for

$10m

Saved on company’s annual energy spend

Microsoft made headlines last year when it published results for the first three years of its internal pricing scheme and carbon fee investment fund. In all, the fund paid for 60 sustainability projects across 23 countries, and the scheme itself sliced $10m off the top of Microsoft’s annual energy spend.

Barring these few exceptions, however, US companies, according to Kerr, are not speaking out due to misconceptions about the effectiveness of carbon pricing in delivering a strong environmental and cost-effective outcome. Spain’s Inditex, for example, abides by a $30-a-tonne internal price on top of an existing EU benchmark price, whereas Exxon Mobil and Chevron publically opposed the aforementioned European campaign to secure a global carbon pricing agreement.

Lack of consistency
Corporate carbon reporting is by no means a faultless enterprise, and it’s safe to say there are major issues – certainly in terms of consistency – standing in the way of implementation and performance. A KPMG study found carbon reporting lacked uniform standards, which made it problematic for stakeholders to compare one company’s performance against another’s.

Any company that chooses to implement a price on carbon should align itself with the UN Global Compact’s Business Leadership Criteria on Carbon Pricing. Doing so means: setting a price high enough to materially impact investment decisions; publicly advocating the importance of carbon pricing through policy mechanisms that take into account specific economic and political contexts; and communicating progress on the above criteria in public corporate reports.

So far, only 65 companies – albeit ones that represent $2trn in market capitalisation – have pledged to meet these standards. Beyond the UN criteria, two-thirds provided no rationale to explain why those targets were selected. Some 84 percent reported on emissions from their own operations, while 79 percent reported on purchased power and only half on emissions in their supply chain.

“The term ‘carbon pricing’ can mean very different things to different people, so yes, consistency and clarity is extremely important”, said the UN Global Compact. “Companies are pricing carbon for many different reasons and in many different ways. Some put a price on carbon to ensure they are competitive in future markets. Others are pricing carbon to pursue ambitious clean energy or greenhouse gas reduction goals. Still others are doing it to test new business models and engage new customers.”

According to Kerr, the challenge lies in making sure announced internal carbon price levels are actually administered. “Despite the uptick in companies reporting the use of an internal carbon price”, he said, “the actual use of the price in internal decision-making is still quite opaque.” Too often, it’s unclear whether the price is charged as a fee against emitting activities and the monies used to fund cleaner operations, or as a simple risk screen that is only one of many inputs to a company’s decision whether to invest.

On the other hand, DiPerna argued the central issue of consistency was grossly overstated. “It is not a challenge”, she said. “Carbon can trade at different prices worldwide, as long as the physics line up and a tonne is a tonne, and the protocols to accurately measure emissions are all very well known.”

Kerr said there was a need to develop more transparency and case studies so different sectors could compare notes on the different price levels needed to shift investment. And, while there would be a disparity in prices used by different sectors, this wasn’t to say a solution could not be found.

The end goal of carbon pricing is to alter investment decisions

Businesses, on the whole, are rational creatures, and understand that rising emissions, if left unchecked, could inflict major and lasting consequences on their bottom lines. The great unanswered question is what constitutes a ‘correct’ price for carbon and how it should be used differently, if at all, for certain investments. The end goal of carbon pricing after all is to alter investment decisions in favour of low or zero carbon options, so it stands to reason any carbon price should span the length and breadth of the value chain.

“Carbon markets tomorrow could be global, they could function and they would change the world”, said DiPerna. “You use mathematical models to smooth out what you call the ‘trajectory misalignment’. But you can get regional differences in price just like any other market. So carbon can trade just like any kind of currency. It might be high in China and low in the US, like the pound is high relative to the euro. All these things we somehow manage with money we can certainly manage with carbon.”

Different risk models
Issues of consistency and misalignment, while important, form part of a much broader debate about the creation of models to accurately identify and manage the risks posed by climate change, not just on corporate balance sheets but in government budgeting and economic modelling.

On a fundamental basis, schemes to factor in the hidden – or not – costs of climate change will prepare organisations for the strains of a low carbon transition. Mechanisms such as carbon pricing allow organisations to factor emissions-related externalities into their risk management strategies, and a willingness among corporates to do just that is proof the message is catching on.

“I think the world is lacking in leadership at the moment in general”, said DiPerna. “Climate change is a hard problem on top of many other social problems, and it’s a tomorrow problem for the most part. So, we need to incentivise organisations to see it as a today opportunity, and I think that is where the carbon market comes in. The incentive to reduce is built into the system if every carbon tonne is visible and there’s a price tag on it.”

Those with their finger on the pulse would be wise to make concessions for climate-related risks, although the responsibility does not rest solely with companies: governments, regulators and stakeholders must do their bit too. “If I were getting into business today, I would jump into carbon markets”, said DiPerna. A global system “is just a matter of time”.

Once the champion of free trade, the US is now taking a protectionist stance

Posted on by Helen

For the past half century, the US has been the world champion of free trade. There has been a prevailing consensus among the big wigs of both major US political parties that free trade is broadly beneficial, with trade barriers an obstacle that must be removed. This prevailing convention, however, now seems shaky at best. The two leading nominees for the US presidency, Hillary Clinton and Donald Trump, both openly oppose the Trans-Pacific Partnership (TPP). Such unified, cross-party opposition to a piece of free trade legalisation is representative of a growing dissatisfaction among US citizens with the free trade consensus in general.

The 2016 campaign trail has made it apparent that vast swaths of US citizens have not been convinced by the case for free trade. Now more than ever, the voices of those uneasy about free trade are being heard. And this sentiment has made its way to the main contenders for the highest office in the US. The free trade consensus in US politics appears to be dead.

The end of this consensus has potentially huge implications not just for the US, but for the world economy as a whole. If the US were to abandon its role as the world leader on free trade, it would have ramifications for more or less every other country on the planet. Future efforts to liberalise trade may become either paralysed or abandoned, threatening global prosperity as a whole.

It was in the 1990s that global trade – and its facilitation through free trade – picked up the most steam

Liberal leadership
Since the end of the Second World War, the US has taken the lead on advocating for free trade across borders. Seeing the damage done by protectionism in the 1930s, the freer movement of goods across economies to be the correct course of action. According to Iwan Morgan, Professor of US Studies and Head of US Programmes at University College London’s Institute of the Americas, the US had seen the “depressing effects on global trade set off by the US Smoot-Hawley tariff of 1930, and other nations’ protectionist response to this”.

At the same time, the need to assist in post-war reconstruction and ward off the growing threat of communist ideology forced the US’ hand. As Alan Wooldridge of The Economist told World Finance: “Support for free trade was part of a wider support for global institutions such as the United Nations and NATO, and global strategies such as the Marshall Plan.”

While there had long been recognition that the free flow of goods and services across borders was broadly a good thing, it was in the 1990s that global trade – and its facilitation through free trade – picked up the most steam. Most of the communist world had collapsed, Eurasia replaced its closed economies with economic liberalism, while China – though still under Communist Party rule – was increasingly open to the world.

Many of the vestiges of protectionism that had remained in the non-communist world were also washed away, and social democrats and socialists steadily embraced a new consensus of open markets. Free trade was the order of the day. It was in this decade, with not insignificant opposition, that President Bill Clinton came to sign the North American Free Trade Agreement (NAFTA), breaking down trade barriers between the US and, most importantly, Mexico.

While mainstream politicians of both left and right came to embrace free trade with vigour, the US electorate was less enthusiastic. This opposition translated into significant electoral gains for anti-trade politicians. Ross Perot, noted Morgan, “won 19 percent of the popular vote running as an independent in the 1992 presidential election, and was the most public voice of opposition to NAFTA ratification”. What’s more, the Democratic Party has not been entirely in support of free trade, as much of its supporter base consisted of unionised workers. With their jobs threatened by international competition, such workers drove a strong protectionist wing within the party. “The Democrats have traditionally had a protectionist wing closely allied to the AFL-CIO [the US’ largest trade union federation]”, Morgan noted. Congressman Dick Gephardt, unsuccessful candidate for the presidential nomination in 1988 and 2004, was a key opponent of free trade agreements within the party.

Trade 1At the same time, certain figures on the right also rallied against the free trade consensus, based primarily on concerns over national interest. As Wooldridge noted: “Patrick Buchanan ran a campaign against George HW Bush on a protectionist ticket, and achieved a famous victory in New Hampshire.”

Despite this opposition, however, free trade did indeed prevail. In 2001, China was admitted to the World Trade Organisation, while other countries around the world increasingly opened up their borders to US goods, and the US did the same in kind. Often, noise was made over the unfair nature of China’s export strategy and the impact it was having on jobs, with US politicians from both sides alleging the country was unfairly undervaluing its currency.

Whether or not China was manipulating currency unfairly is open to debate. However, the concern reflected a widening anxiety about US jobs being lost due to competition from manufacturers abroad, unburdened by trade barriers. In spite of these concerns, the consensus went unchallenged – save some targeted anti-dumping tariffs on steel. When running for presidential office, Barack Obama said he hoped to renegotiate the US’ position in NAFTA, although that amounted to nothing upon his assuming the presidency. While in office, Obama continued with the consensus on trade, most notably through his efforts to complete the TPP deal. While it has been sold to voters as a key piece of trade legislation for US prosperity and an effort to combat China’s growing dominance, it has still raised anxieties over the potentially destructive impact free trade is having on domestic industries. As Morgan noted, among many the “fear is that it will open the door to even greater imports from China, with whom the US currently operates by far its largest bilateral trade deficit”.

Consensus cut
In 2016, however, the consensus on the wisdom of ever-freer trade seems to have finally broken. While US citizens’ dissatisfaction with free trade is nothing new, the 2016 presidential nomination process has brought it to the forefront. On the Democratic side, outsider candidate Bernie Sanders was able to present a serious challenge to Hillary Clinton in the race for the democratic nomination. By singling out the US’ trade agreements as a core reason for low wages and job insecurity, Sanders was able to tap into a deep resentment felt among workers in the US, pushing Clinton on the defensive. In response, reversing her previous support for TPP, Clinton has come to oppose it – at least in certain regards. Speaking of this reversal, Wooldridge told World Finance: “Her views have changed because Bernie Sanders has proved to be such a powerful candidate. Her initial plan was simply to recycle the Clinton playbook and the Clinton machine; she is now being forced to recalibrate her positions to deal with the growing revolt against the Washington consensus.”

On the right, there has also been a drift away from the free trade consensus. The Republican nominee Donald Trump has openly embraced protectionism, and railed against facing unfair competition from Chinese and other foreign manufacturers. This has brought him a lot of support from working-class Republicans, particularly in Rust Belt states, concerned over low wages and job insecurity.

The US withdrawing from the world economy – even partially – under a reinvigorated protectionist movement would be immensely harmful

Trump has effectively been tapping into a growing anti-free trade sentiment in the Republican Party. According to Wooldridge, the party “has been moving in a protectionist direction in recent years”. The reason behind this is that the party “has brought in a new cohort of working-class voters who haven’t done particularly well out of free trade”. As a result there is “now a civil war within the party between its business wing, which supports free trade, and its populist wing, which opposes it, but the populist wing is winning”.

At both ends of the political spectrum, at the heart of this protectionist revolt are working-class concerns. “Working-class voters are the core of the protectionist turn”, Wooldridge said. “This is because their wages have remained stagnant during the era of the Washington consensus.” The free trade regime has lowered consumer prices for US citizens, but at the same time it has resulted in the stagnation of earnings. Free trade is often a trade-off between lower prices and secure, well-paying jobs.

While workers have never been happy with that trade-off, in the wake of the 2008 financial crisis, lower prices for some goods have come to be seen as less important than countering increasing job insecurity and shrivelling pay packets. Resentment has intensified, reinvigorating anti-trade activists in both parties and forcing the elites to pay attention.

As Morgan noted: “It is certainly the case that both parties are having to pay heed to the anxieties of blue-collar America in the wake of the Great Recession. Aggregate recovery may have taken place, but the sense of insecurity among ordinary Americans is very evident – as is the longstanding stagnation of average household income.”

“The political elite is finally being forced to reflect public anger”, said Wooldridge. “Many people understand intellectually that it is good for the overall economy. But a striking number of politically engaged people are opposed to free trade: trade unionists regard it as a threat to their jobs; liberal activists regard it as a race to the bottom; Republican populists regard it as a threat to national interests. These angry and engaged activists are now setting the agenda in both parties. There is no voice for the silent majority of free traders.”

At the same time, even key defenders of free trade appear to be in retreat. The economist Paul Krugman has been one of the most effective free trade champions of the 21st century. As an economist with a knack for clear and concise communication, his books and widely read opinion columns have often provided lucid and informed defences of why opening up the US economy to trade with the rest of the world has been the correct decision.

Yet now, even this stalwart defender seems to be having his doubts, recently writing in The New York Times: “Much of the elite defence of globalisation is basically dishonest: false claims of inevitability, scare tactics (protectionism causes depressions!), vastly exaggerated claims for the benefits of trade liberalisation and the costs of protection, hand-waving away the large distributional effects that are what standard models actually predict.”

Treade 2“The free trade consensus in America is collapsing”, said Wooldridge. “Those who believe in it are muted, those who oppose it are emboldened. America is reverting to its pre-Second World War protectionist instincts.”

Peak globalisation
The US’ potential pivot from free trade comes at a time when the global tide in general is moving in the same direction. World trade growth in 2013 stood at 2.4 percent, down from the 6.8 percent recorded in 2011. At the same time, world trade growth rates following the 2007 crisis are on average below the rate of world GDP growth. Much of this slowdown is cyclical, stemming from remaining headwinds in the global economy from the financial crisis and later emerging market slowdown. However, this has provoked speculation that the era of free trade has plateaued – that we have reached peak globalisation. Whether or not this has been the case is open to debate, but the US abandoning its role as the driving force of free trade will certainly strengthen that feeling.

For the world’s largest economy, a move to a more protectionist bent is likely to have a profound impact on the global economy. The US has been at the forefront of breaking down barriers that impede trade over the past few decades. While it has often done so in a slower manner than it has allowed other economies, it has pushed for the reduction of fetters to trade while opening itself up to outside competition. According to Uri Dadush, writing in Foreign Affairs: “International trade has doubled as a share of world GDP over the last 50 years. Without it, the global economy would grind to a halt. The highways of trade are much freer today than they were decades ago.”

The US withdrawing from the world economy – even partially – under a reinvigorated protectionist movement would be immensely harmful. A large pool of US citizens have lost out from free trade – and those citizens’ concerns over job security and pay are valid and have to be addressed. But, at the same time, free trade has also bought unprecedented prosperity to the world. “[Trade] liberalisation has opened the way to the rise of emerging markets, and the huge reduction in global poverty. We are now witnessing the end of that era”, said Wooldridge. If the US does go down a protectionist path, the prospects do not look good. “At best, we will see paralysis, with no forward movement” in pushing for greater economic openness, “but no backward movement either”, said Wooldridge. While “at worst, we will see the world divided into regional trading blocks”. As Morgan underlined: “If the US abandons leadership of global free trade, the global economy could be in for a very rough ride.”

Turkey prepares to welcome its largest health complex

Posted on by Helen

With a new project finance agreement having been signed off recently, the Ankara Bilkent Integrated Healthcare Campus is set to push forward. The deal was signed under the auspices of the Turkish Ministry of Health, which has been charged with overseeing the design, finance, construction, and operation phases through a Public Private Partnership (PPP) model. Signed on March 27 2015, the initial agreement qualifies as the largest project to be signed in Turkey’s healthcare field under a PPP model, and is to be implemented by DiA Holding.

Upon completion, the project will hold the title of being the largest hospital in Europe, as well as the largest hospital constructed under a single contract in the world, with a total cost of €1.2bn. The credit extended for the project amounts to €890m over a 15 to 18 year term, and will be used to partially finance the project, provided by the companies listed in the project details. UniCredit Bank Austria will also act as the financial advisor for the project, among its other financing organisations. At the same time, Siemens Financial Services has provided the largest credit tranche to date in Turkey’s healthcare sector.

Building a strong partnership
The PPP model is a new investment and operation model in the healthcare industry in Turkey. Such models have already seen widespread application throughout the world, offering Turkey many examplars. The project is to be implemented in collaboration with the private sector, and is intended to offer services at contemporary standards to citizens by lifting a significant load from the public, in terms of investment, finance and the quality of services.

In this model, it is intended that healthcare services will be completely provided by the public, as has been the case so far. At the same time, the finance, construction and operation of the hospital campus is undertaken by the private sector. Accordingly, it is planned for the public to make significant savings, accommodating the healthcare services to an increased population, and at the same time, see an increase in the quality and efficiency of services.

It is planned for the public to make significant savings, accommodating the healthcare services to an increased population, and at the same time see an increase in the quality and efficiency of services

The Bilkent Integrated Healthcare Campus, with an indoor area of 1.3 million sq metres, will be the largest hospital complex in Europe, and also the largest built under a single contract in the world. At the campus there will be the capacity for a total of 50,000 patients, 5,000 of whom will be in the emergency department.

It is foreseen that patients will be served on a daily basis, with the hospital having a capacity of 3,804 beds. Employment will be provided for more than 8,000 sanitary and non-sanitary personnel. It is estimated that up to 100,000 people will visit the Bilkent Healthcare Campus daily, including patients, visitors and personnel working in the hospital complex.

It is expected the Bilkent Integrated Healthcare Campus will not only serve Ankara, the capital of Turkey and the surrounding provinces, but will also evolve into a regional medical centre; it is hoped the hospital will place Turkey at the forefront of international healthcare tourism, and offer services to the surrounding countries (Turkey is already a major destination for healthcare tourists from the Middle East).

With the opening of the Bilkent Healthcare Campus, 14 hospitals within the border of Ankara will be closed. All personnel, including doctors, nurses and existing patients, will be transferred to Bilkent Healthcare Campus.

The project will take place under the authority of DiA Holding. The firm was founded in 2007 and has focused beyond traditional contracting activities. The first works that introduced DiA Holding on a world-scale were prestigious projects realised in Baku, the capital of Azerbaijan.

It has shown itself to be a leading investment and operation organisation. Within this scope, it operates in the Middle East region, primarily in Turkey and Azerbaijan.

In safe hands
DiA has a proven track record, meaning the project is in safe hands. It has, in particular, experience in the area of healthcare. DiA Holding, in addition to the Bilkent Integrated Healthcare Campus Project, also signed the credit agreements for the Mersin Integrated Healthcare Campus Project, totalling €272m in November 2014. The 1,294-bed capacity hospital is also developing rapidly, at present.

In the annually published list of ENR – one of the world’s most prominent engineering publications – it was included among the world’s top largest 200 contractors and international designers in 2012 to 2014, and has won numerous awards with the symbolic projects that have been undertaken so far, by publications such as Time, Wallpaper and the international real estate show MIPIM.

Its previous Azerbaijani projects have been led by the Heydar Aliyev Center, while the world-renowned architect, the late Zaha Hadid, provided the architectural design. DiA has signed many other works in Azerbaijan, led by the Shahdag Summer-Winter Tourism Complex, which is the only ski centre in the country.

DiA Holding, in line with its goal of becoming a new generation investment and operation company, has started to expand its fields of activity to include the healthcare sector. The push towards increased focus on healthcare costs is born of a belief that it will be one of the most important sectors in the 21st century. In addition to the Bilkent Integrated Healthcare Campus, the Mersin Integrated Healthcare Campus will also be one of the largest healthcare complexes in Turkey, with its indoor area of 355,000 sq metres. When the campus is taken into service, it will offer employment to 2,850 employees in total, 1,350 of which will be sanitary personnel and 1,500 non-sanitary personnel. It will have a capacity of 1,294 beds and will serve an average of 10,000 patients on a daily basis, 900 of whom are expected to be emergency patients.

Project data

Project
Bilkent Ankara Integrated Healthcare Campus

Company
Bilkent Ankara Entegre Saglık Hizmetleri Yatırım ve lsletme

Total bed capacity
3,804

Total construction area
1,285,000 m²

Total credit
€890m

Creditor banks
Türkiye Garanti Bankası
DenizBank
Türkiye ls Bankası
Finansbank
Siemens Financial Services
Garanti Banka
Yapı ve Kredi Bankası
UniCredit Bank Austria

Financial advisor
UniCredit Bank Austria

Contractor
DiA Altyapı Yatırımları ve lnsaat

Sponsor
DiA Holding FZCO

Shareholders of the sponsor
Murat Çeçen and Hassan Gozal

Which is the smarter choice – passive or active investing?

Posted on by Helen

The debate over the relative merits of passive and active investing rages on. Proponents of passive investing rightly point out that most active investors lag their benchmarks and that index funds provide easy access to financial markets for a lower fee. Besieged defenders of active investing argue that disciplined research is a necessary component of long-term investment success, but the drag of active fees weighs heavy in an environment of modest returns. Investors are voting with their wallets, withdrawing $259bn out of active equity funds over the past year, while investing $185bn in passive approaches.

Neither of these opposing camps is likely to yield, but thoughtful investors can benefit from the debate by considering how and why passive strategies outperform most active funds. Rather than rehearse the details of the argument, I will explore why passive investing has succeeded and consider the insights that active investors can derive from that success.

Lethargy bordering on sloth
Much of the benefit of passive investing can be attributed to low turnover. Active managers take positions that differ from the index, and buy and sell as opinions change. Passive managers only buy and sell as the composition of the index changes – and that doesn’t happen very often. The turnover of active managers is therefore almost always higher than passive managers. Herein lies an important contributor to the relative success of passive investing.

Buying and selling stocks costs money and therefore acts as a drag on performance. In addition to per-trade commission charges, investors ‘pay’ the invisible cost of the spread between the asking and offering price of a security. A recent Morningstar study concluded that trading costs reduce the performance of the average active equity fund by between 10 and 20 basis points per year. That’s not a huge burden, but those small costs compound over time and rise with the frequency of trading.

Investors pay commissions on the day of a trade but often pay again much later – and much higher – when they receive the tax bill for capital gains incurred through trading. Lower turnover reduces trading costs, but the far more valuable benefit is that it allows more of your money to keep working for you by not trading, realising gains and paying taxes on those realised gains.

The benefit of passive investing is that it more or less does the job for us by reducing the opportunity for error

A final and far more subjective benefit of low portfolio turnover is psychological. Behavioural psychologists have compiled a long list of repeatable and predictable ways in which human beings act contrary to their own interests. Among other tendencies, we have too much confidence in our own opinions, naturally seek confirmation of our beliefs while ignoring contrary evidence, place too much importance on available information, see patterns where none exist and generally believe that we have far more control over our future than we actually do.

This isn’t to say that we are stupid, but that we are normal. Seneca the Younger had it right when he observed errare humanum est – to err is human. Put differently, the fewer decisions you make, the fewer mistakes you make. A low-turnover approach simply reduces the opportunity for error.

Rigorous discipline is a vaccine against behavioural bias. It enables us to avoid being misled by the instinctive, emotional and reactive part of our nature and to replace it with patient, analytical and deliberative thought. This is not easy, and the benefit of passive investing is that it more or less does the job for us by reducing the opportunity for error.

A passive investment approach based on a stable underlying index provides an investor with the benefits of lower trading costs, more efficient tax treatment, better opportunities to compound returns and less risk of emotional interference. These advantages are also available to active investors who avoid the temptation of frequent trading in favour of a more patient and disciplined approach. To quote from a letter to the shareholders of Berkshire Hathaway, Warren Buffett memorably and poetically affirmed in 1990: “Lethargy bordering on sloth remains the cornerstone of our investment style.”

Daring to be different
The inability of most active managers to consistently beat an index reflects yet another behavioural bias: regret avoidance. In an attempt to avoid significant, and perhaps career-ending, underperformance, many active managers are reluctant to stray too far from the index against which they are being measured. Conventional success in money management leads to job security and raises. Even failure, if conventional enough, leads to job retention.

An old Wall Street adage holds that it is far better for a professional investor to succeed unconventionally than conventionally. Unconventional success leads to fame and glory. Yet unconventional success requires one to assume the risk of unconventional failure, and unconventional failure leads to getting fired. Most managers prefer to fail conventionally and keep their jobs rather than assume the risks required to succeed unconventionally. The poor track records of most actively managed funds reflect this desire to avoid the regret of being unconventionally wrong. Job preservation trumps wealth preservation.

The degree of a portfolio’s unconventionality can be measured through a concept called active share, calculated as the sum of the absolute differences between the weights of each stock in an index versus a portfolio, divided by two. An index fund that perfectly replicates the index has an active share of zero percent, whereas a portfolio that owns no names in common with its relevant index would have an active share of 100 percent. Mimicking an index, as reflected by a low active share, magnifies the performance drag associated with turnover, making it difficult for managers to beat an index even before a higher level of fees is taken into account.

Conventional wisdom holds that portfolios with higher active shares are riskier, yet this conclusion implies that risk is defined by deviation from a benchmark. This definition of risk lies at the foundation of modern portfolio theory, stretching all the way back to Harry Markowitz’s seminal paper on portfolio selection published in 1952. Is it any wonder that many portfolio managers address both portfolio and career risk by sticking close to the index against which they are measured?

True active managers define risk as a permanent loss of capital and manage it by willingly deviating from the benchmark. In many cases, this results in a concentrated portfolio of companies and high active share, which increases the potential for superior returns. It is important to note that high active share does not guarantee superior returns; it simply magnifies the impact of investment insight, either for better or worse. Concentrated portfolios furthermore offer additional protection against the behavioural biases outlined earlier. The temptation to sell a company into weakness diminishes when you know its underlying value so well that price volatility doesn’t shake your conviction.

Superior active managers embrace the benefits of low turnover. They appreciate the power of compounding and have the discipline to hold stocks that are performing poorly – or even take advantage of price volatility by adding to those positions. They tend to have a substantial portion of their own wealth invested alongside their clients. They are not interested in launching new mutual funds and attracting billions of dollars of assets because the performance of their portfolio over the long run is a more important driver of their own wealth. Finally, they tend to be privately owned firms that care more about the sustainability and growth of their business than job security. The peculiar incentive to fail conventionally and keep your job doesn’t apply when you are your own boss.

These managers don’t aggressively market their track records, and those records are, therefore, largely absent from the databases that analysts rely on to argue for the superiority of passive over active investing. If those databases were expanded to include less conventional managers who assume a higher active share, we wonder if the returns of passive investing would look as competitive.

Having your cake and eating it too
Investors can have everything they want as well. Many benefits of passive investing, such as low turnover, tax efficiency, compounding returns and resistance to behavioural biases, can be obtained through active approaches. Concentration and high active shares are ingredients for investment success, although it takes the right combination of discipline, skin in the game and independence to encourage a manager to stray from the herd in pursuit of superior returns. Investors should always gauge the skill of an investment manager based on after-fee returns, and we conclude that managers who share these characteristics of success warrant the fees they charge, while admitting that there simply aren’t that many of them out there.

While this article won’t settle the debate between active and passive investing, proponents on both sides cling to their arguments as if they were articles of faith. Active investors should acknowledge the challenges associated with providing superior returns, and borrow from the success of passive approaches in pursuing those returns.

For more information visit www.bbh.com

The importance of active asset management amid market volatility

Posted on by Helen

We live in a volatile world characterised by a bombardment of data. Economic releases and market updates are continuously being streamed to our TVs, PCs, tablets and even to our cars, smartphones and smart watches. We seem to move from one crisis to the next, some of which are potentially so severe they threaten to demolish the financial world as we know it. Most of it is just noise, exacerbating market volatility (see Fig. 1).

At Argon Asset Management, we think volatility is here to stay. This creates opportunities for disciplined long-term investors, and particularly for bottom-up stock pickers.

Bottom-up stock pickers generally base investment decisions on their estimation of the intrinsic value of a share. They focus on the fundamentals of the underlying company, industry dynamics, cash flows and so on in order to arrive at a fair value – or intrinsic value – for the company. Share prices (what the market is willing to buy or sell the share at) tend to fluctuate around the intrinsic value of shares, with the market swinging between overvaluing shares (when share prices trade above their intrinsic values) and undervaluing shares (when share prices trade below their intrinsic values). Volatility tends to exaggerate the mispricing (over and undervaluation) of securities. This creates opportunities for bottom-up stock pickers, as share prices tend to deviate further away from their intrinsic values, and more frequently.

Beating the market
According to the efficient market hypothesis, it is impossible to ‘beat the market’ because stock market efficiency causes existing share prices to reflect all relevant information. But surely the fundamental long-term intrinsic values of proper businesses cannot change as frequently as market volatility suggests? This invalidates the efficient market hypothesis.

Some new information may temporarily impair or improve the outlook for a company or industry, but well-run companies with long-term sustainable competitive advantages have proven track records of surviving tough economic down cycles. They continue to reinvent themselves over the long term. These temporary changes, therefore, should not significantly affect their intrinsic values. Volatility often results in great businesses being undervalued, creating attractive long-term investment opportunities for the patient, disciplined investor.

Well-run companies with long-term sustainable competitive advantages have proven track records of surviving tough economic down cycles

Since the global financial crisis, central banks around the world have implemented unprecedented accommodative monetary policy tools, such as quantitative easing and negative interest rates. Time will tell whether these unconventional monetary policy tools (or as the cynics would refer to them, ‘experiments’) are effective or not, as it is currently unclear whether they will merely cause unforeseen consequences and their own set of problems.

What is clear, however, is that these unconventional monetary policy tools have resulted in unconventional market distortions and increased volatility. The US ended its quantitative easing programme and has attempted to ‘normalise’ monetary policy, which has resulted in an increase in market volatility. Uncertainty about the timing of interest rate hikes and its effects continue to sway markets.

Distorted valuations
The environment of low interest rates has created a search for yield, which has distorted sector valuations as investors have been prepared to pay up for stocks with bond-like characteristics, which are defensive and pay stable dividends.

This effect can be seen by the inflated valuations among global consumer staples, which trade at significant premiums relative to their histories. At the other end of this spectrum, global financials appear to trade at significant discounts to their respective histories. Adopting a passive investment strategy would result in counterintuitive behaviour, given the divergent valuations among sectors. Investors would effectively be buying high and selling low, in that they would be buying the index with relatively larger weights in expensive sectors, while being relatively underweight in the more attractively valued sectors.

Divergence among sector valuations is a common theme in markets, usually exaggerated at the peaks and troughs of cycles. During the Chinese economic boom, as China’s ferocious appetite for commodities elevated prices, resources stocks traded at significant premiums, while during the IT boom, tech stocks traded at excessive valuations. In the more recent past, investors have been willing to pay up for consumer staples stocks. Financials, on the other hand, have fallen out of favour since the financial crisis, and trade at cheap valuations relative to their history.

It is understandable that an enhanced perception of risk in financials should result in cheaper valuations, but the banks in particular are much stronger and better capitalised than they were prior to the financial crisis. Insurers have also proved to be more resilient than expected. These are all factors that belie the current valuations.

The bottom line is that sectors tend to move in and out of favour, as reflected by their valuations. Simple passive investing would not protect investors from irrational ‘cyclical’ peaks in valuations. Investors would be relatively overexposed to overvalued sectors, given their relatively larger weights in indices at their peaks, while being relatively underexposed to undervalued sectors given their relatively smaller weights at cyclical troughs.

ArgonAnother benefit of bottom-up stock picking is that stock pickers are able to sift through the market and screen for mispriced securities. This allows bottom-up stock pickers to identify mispriced securities within broad sectors. In other words, bottom-up stock pickers may be able to identify attractive, relatively undervalued companies within expensive sectors or markets. Passive investment strategies would not (by definition) be able to identify these undervalued gems.

Opportunities to outperform
Another effect of the great quantitative easing experiment has been the excess global liquidity that has propped up global markets. The current bull market, which began in March 2009, is the second longest going back to data from 1929. The average bull market has lasted 32 months: as of April 2016, we are 87 months into the current bull market. This does not necessarily mean the bull market should end, or that we will enter a bear market any time soon. However, given the stellar market returns for the better part of the last decade, it would be unrealistic to expect similar returns over the next few years.

Given that the returns of the current bull market were supercharged by the tailwind of unprecedented monetary stimulus and liquidity injection, it would be fair to assume that we can expect lower returns over the next few years. Passive investing during strong bull markets may yield great returns driven by the rising tide of the market. However, during periods of lower overall market returns, stock picking should yield superior results to passive investing.

Algorithm-based and passive investing products have become increasingly popular. This applies to simple market capitalisation-weighted passive index tracking products like exchange-traded funds, and the more complicated ones that enable investors to access specific sources of risk and return (‘smart beta’ products). The growth of these investment products has seen the proportion of fundamental investor participants in the market decline, resulting in relatively fewer fundamental investors ‘pricing’ news into stocks. This is expected to result in an increase in mispriced securities, which we anticipate would provide more opportunities for bottom-up stock picking.

The rise of online trading software, day trading and algorithmic trading programs has resulted in increased volatility and shorter investor holding periods. Many investors claiming to be long-term investors in reality have shorter investment horizons than traditional long-term investors. This creates more opportunities for disciplined, true long-term investors who are willing to look beyond the short-term noise.

China attempts to shake its dependence on coal by turning to shale gas

Posted on by Helen

Prior to its use with oil, the technique of fracking was actually pioneered for use in shale gas extraction; Mitchell Energy produced the first shale gas in the north of Texas in 2000. The technological process behind fracking involves extracting gas from sedimentary rocks, through a mixture of horizontal drilling and hydraulically fracturing rocks – hence the name ‘fracking’. Since 2000, natural gas production has surged, lowering the cost of the energy source around the world. Increasingly, it is now favoured over other cheap sources of energy such as coal. However, despite a crash in prices – as happened with the fracking revolution in petroleum oil – production has not fallen in a major way. Rather, shale gas is set for a continued boom.

As any observer of energy markets will know, the US has stormed ahead in the extraction and use of shale gas, becoming by the far the world’s largest producer. However, while it has a technological and commercial lead for now, it is far away from a monopoly on accessible reserves of shale gas. According to Advanced Resources International’s World Shale Gas and Shale Oil Resource Assessment report, prepared for the Energy Information Administration (EIA) in 2013: “Two-thirds of the assessed, technically recoverable shale gas resource is concentrated in six countries: the US, China, Argentina, Algeria, Canada and Mexico.” Canada and Argentina have since commenced large-scale extraction of their shale gas reserves.

China, meanwhile, has only steadily increased its ability to extract shale gas in recent years. And yet, although China only produces a small amount of shale gas now, its reserves are estimated to be 1.7 times larger than those of the US. This means China has the largest reserves in the world, as well as a growing population and economy that will require their use. Currently heavily reliant on coal for its huge and growing needs, natural gas is seen in China as a cheap and clean alternative.

The Chinese state relies on the steady performance of the economy to legitimise, in the eyes of its citizens, Communist Party rule. At the same time, tied to this is the guarantee of improving living standards. While coal has definitely boosted living standards in some regards, air quality has become an increasing concern for Chinese citizens. Transitioning from coal to liquid natural gas promises to provide a practical solution, mitigating the effects on air quality without forsaking the cheapness and abundance required for China’s economy and growing prosperity. However, since 2015, China’s shale gas development has stalled. International firms, essential for its development, have been pulling out of agreements and partnerships, raising the question of whether China’s purported shale gas boom is just a paper tiger.

China has the largest shale gas reserves in the world, as well as a growing population and economy that will require its utilisation

Energy needs
China is the world’s second-largest economy and the world’s biggest consumer of energy. Its consumption outstrips that of the US – the world’s largest economy – by 30 percent. Collectively, the nations that make up the EU also have a larger GDP than China, yet China consumes twice as much energy. Being the workshop of the world, it could be no other way – China’s economy is incredibly energy intensive. According to Arthur Kroeber, in his book China’s Economy: What Everyone Needs to Know, China “needs to burn the equivalent of 2,000 barrels of oil to generate a million dollars’ worth of economic output”. To put this into perspective, it is more than twice the figure of the US and three times the collective total of EU member states.

To service this huge energy demand, as mentioned previously, China currently relies on coal (see Fig. 1). Since embarking on its rapid industrialisation – primarily spurred by energy-intensive heavy industry – China has found coal to be both cheap and abundant. The country now consumes nearly the same amount of coal as the rest of the world combined, according to the EIA, accounting for 49 percent of total global coal consumption. Roughly three quarters of China’s gigantic energy demand is met with coal, half of which goes into power plants to generate electricity, with the rest being used to directly fuel industrial activity.

China’s coal-fuelled economic boom has done wonders for the country. Millions have, since the 1990s, been lifted out of extreme poverty. Across both city and countryside, incomes have risen, and China has gone from being crushingly poor, technologically deprived and isolated, to a modern industrial economy in just a few decades. As the country enjoys cheap and abundant reserves, coal has played a key role in this – such development would scarcely be imaginable without it. The country’s demand for coal grew at an average of 10 percent per year in the 2000s. In recent more recent times, however, as China has become richer, it has started to pay more attention to some of the concerns over the heavy use of coal.

Shale 1Down the shaft
Coal is a dirtier alternative to other fossil fuels, releasing more pollution into the atmosphere than other hydrocarbons such as gas or oil. The results of large-scale pollution are being felt across China, with cities becoming blanketed periodically by thick smog. Most significantly, in late 2015, Beijing issued a red alert over air pollution for the capital city for the first time. School classes were cancelled and traffic numbers reduced. As The New York Times reported at the time: “Chinese cities, especially northern ones, have some of the world’s worst air pollution…most of it comes from industrial coal burning.” For an industrialising country, smog is, however, par for the course. London in the late 19th and early 20th centuries suffered similar issues, alongside other great economic powers in their early years, from Tokyo to Pittsburgh. Increasingly, however, Chinese citizens are becoming dissatisfied with both the smog itself, and the disruption to everyday life that it can bring.

As a result, China has come to focus its attention on creating what it terms an ‘ecological civilisation’. This policy is not some attempt to do away with China’s much-needed ongoing industrialisation, but rather, according to leaders, is a move to factor in some environmental concerns while maintaining economic growth. In the west, environmentalism and meaningful economic growth are often portrayed as opposing concerns, with a trade-off required to favour one over the other. China, however, seems to view it otherwise. The ecological civilisation policy, according to China Dialogue, “is set alongside the other high-level political slogans that are emerging as the signature of Xi Jinping’s leadership, notably the Chinese Dream” of doubling GDP and per capita income by 2020.

Therefore, China is opting for a transition from using coal to service its energy needs, moving to the much cleaner liquid natural gas. According to Smithsonian: “Burning natural gas…produces nearly half as much carbon dioxide per unit of energy compared with coal.” According to Kroeber, China’s leaders are now committed to changing their “energy mix to rely less on coal and more on cleaner fossil fuels”.

Related to this is another issue with coal. As mentioned above, China is uniquely energy intensive. This stems from the fact that coal is less efficient than other fossil fuels; to produce a single unit of electricity, it takes 25 percent more coal than natural gas. Using gas as a source of electricity not only allows for a better environmental outcome (without sacrificing economic advancement), it also allows for more efficient energy use.

China has, since the early 2000s, increasingly looked to natural gas as a source of energy. According to Kroeber, in China natural gas imports from around the world “rose from almost nothing in 2002 to about 30 percent of demand in 2014”, with much of this coming from nearby producers in the Asia-Pacific and central Asian regions. China’s reliance on coal was, for many years, a matter of common sense: it was abundant in easy-to-reach reserves, while gas had to be imported at higher costs. Now, however, China is looking to make use of its own vast shale gas reserves.

Collectively, the nations that make up the EU have a larger GDP than China, yet China consumes twice as much energy

Frack attack
As noted, China has seen a steady growth in its demand for natural gas imports. Between 2012 and 2013 alone, China’s demand grew 15 times faster than the rest of the world’s. Yet, if this demand is to be sustained – and the evidence suggests it will be – domestic production must step in. With the world’s largest shale gas reserves, China must look to meet its needs with its own production.

Shale gas was first discovered in China in the mid-1990s. However, with coal still king, little was done to utilise it. Small efforts were made to develop production – in 2014, 1.3 billion cubic metres of shale gas were produced – but overall, the numbers remained negligible when compared to China’s overall energy use. This was also the case when compared to the size of its conventional natural gas use, of which shale accounted for a mere 0.2 percent in 2013. Of the shale gas that was produced, nearly all of it came from a single field, operated solely by the firm Sinopec.

The Government of China has been attempting to change this, announcing bold targets and making deals with international firms. The key site of China’s shale gas revolution was supposed to be the Sichuan Basin, in the east of Sichuan. It is here that much of China’s large reserves of shale gas can be found and this province has often served as the scene of development in communist-run China. Following Deng Xiaoping’s ascent to power and the start of economic liberalisation, Sichuan has been at the forefront of reform. It was one the first regions in the country to start to experiment with market-based economic reforms.

International firms have been courted to develop wells on the site. Gary Locke, the United States Ambassador to China between 2011 and 2014, said at the 2013 US-China Oil and Gas Industry Forum: “From Sichuan to Eagle Ford, Texas, from Bohai Bay to the Marcellus Shale in Pennsylvania and Ohio, US and Chinese companies are investing and working together to increase energy production in both countries.” China and the US have since signed various agreements, most notably in 2009 when President Obama and President Jintao signed a deal for mutual cooperation in developing China’s resources, with shale gas at the forefront. Shortly after this, state-owned PetroChina signed an agreement for cooperative exploration and development of shale gas with Shell for the Fushun-Yongchuan block in Sichuan Province. Soon, many of the world’s top energy firms started to take an interest. AirChina even started offering direct flights from Texas to Beijing, facilitating the transport of any Texan energy executives with an interest in investing.

Coal is still China’s dominant and most important energy source
Coal is still China’s dominant and most important energy source

Since 2015, however, the country’s shale boom has looked in doubt. Many international firms have pulled out. After a two-year study, ConocoPhillips ended its talks with PetroChina, following the conclusion of a two-year study questioning shale gas production’s commercial viability in the country. Shell was also set to be one of the biggest investors and partners in China’s shale industry, pledging billions of dollars. As Shale Gas International reported: “As recently as March 2013, Shell pledged to spend as much as $1bn a year to explore shale and other resources in China. At the time the company bet hard on shale exploration in the Sichuan basin in cooperation with PetroChina.” However, in 2015 the company announced it would be pulling back much of that investment, before announcing it was completely quitting Chinese shale earlier this year. At the same time, China’s shale gas production targets have been slashed. As Bloomberg reported: “China missed its annual shale gas target of 6.5 billion cubic meters last year, and earlier reduced its 2020 production goal to about a third of its original estimate.”

Tough times
Many of the international energy firms quitting Chinese shale exploration have done so due to a general tightening of spending, following the onset of the 2014 oil slump (see Fig. 2). However, any decision as to where to cut spending depends upon the specifics of a certain project. And shale gas in China, while abundant and promising for the future of China, is, according to Shale Gas International, “a thankless job” for those exploring and developing it.

The geological formations of China’s shale sites are rather different to those of the US. This means that any firm with US experience will face new challenges, rather than merely being able to replicate their US approach and apply existing technologies wholesale. This inevitably increases the cost. Added to this is the fact that, beyond just being different to US, the geology is difficult to work with, while there is also a severe lack of data regarding the geology of many sites – again, increasing or making uncertain extraction costs. All of this – compounded by the pressure of soft oil prices – has led many international energy firms to disengage from what seemed to be a promising prospect.

Shale 2However, this should not be seen as the end of China’s shale gas boom: rather, it is a delay. China has clear and valid reasons for developing its shale gas industry. Right now, energy firms – owing to the global oil glut – are being cautious, and are therefore scaling back. But the current climate is not necessarily set to continue. Oil prices may never reach the $100 highs again, but concerns from energy firms about investing in shale gas exploration are predicated not on the price of oil itself, but the uncertainty it is currently bringing. Large, speculative projects are being cut across the board in response to such uncertain times, in an effort to recalibrate in an era of low prices. Once the market has stabilised, we can expect renewed interest from energy producers in Chinese shale gas. Until then, the gas will remain underground, and China’s need for it will only grow. The vast shale fields in the Sichuan basin will not go anywhere and nor will China’s desire to develop them. Indeed, the size of shale gas reserves seems to be growing and Chinese state-owned firms are still exploring too: in August last year, PetroChina reported it had discovered an additional 63 billion cubic meters of proven shale gas in Sichuan.

China has always been a tough environment in which to invest: Hank Paulson, the former US Treasury Secretary, recounted in his recent book Dealing with China the complex processes he and other officials from Goldman Sachs (where he was working in the 1990s) had to navigate to make many of China’s large IPOs. Yet, despite the complex Communist Party hoops that had to be jumped through, and the bureaucratic intricacies that had to be navigated, firms such as Goldman Sachs persisted, and eventually they successfully took Chinese state-owned firms to their IPO and the returns justified the entire process.

Likewise, for international energy firms, the potential returns for investing in Chinese shale gas will be worthwhile in the long run. China has the largest shale gas fields in the world and is the largest energy consumer. Once distantly related issues such as low oil prices ease, investing in Chinese shale gas development will once again seem not only commercially viable, but vital. China may not have quite managed to set its shale gas boom in motion yet, but it is only a matter of time until it does.

Increased transparency in offshore centres will benefit the global economy

Posted on by Helen

There is a debate in the wealth management industry as to whether wealth owners and the businesses they have interests in still have a need for corporate and fiduciary structures. These structures are designed with a view to achieving holistic objectives that include asset protection and legitimate, transparent tax minimisation, among others. Yet a question now in play is whether there are ways to maintain privacy, while also being fully compliant with tax and other reporting requirements.

Philip Marcovici, a taxation law expert and board member at wealth management firm Kaiser Partner, asked: “Is it always the case that setting things up ‘onshore’ in the country of the wealth owner or of an investment is the best option, or even a possible one?”

With this question in mind, there is talk of a shift to reliable and reputable mid-shore financial centres that can offer what today’s wealth owners and businesses really need. Perhaps mid-shore financial centres, which often have a long history in planning and relationship building with other countries, are the ideal locations from which corporate and family holding structures can be maintained.

Moving mid-shore
Marcovici told World Finance: “After years of secrecy within the offshore corporate services industry, we are now witnessing a regime change. This transition is largely driven by the onshore governments whose tax and legal systems have been compromised on an industrial scale. Had the offshore world shown leadership in relation to the global problem of undeclared money and of the other regulatory failings of the industry, things would be very different than they are today.”

Wealth owners and businesses are now facing a tsunami of initiatives that are designed to ensure tax compliance and transparency. Many of these new reporting measures are complex, duplicative and raise numerous issues in and around the legitimate privacy needs of tax-compliant wealth owners and businesses.

The tax laws of mid-shore financial centres make them highly attractive as places in which to establish corporate structures, trusts and other financial vehicles

“In my opinion, the offshore world and the wealth management industry have largely failed to help ensure a balance between the legitimate rights of countries to enforce their own financial laws and the needs of wealth owners and businesses to protect their interests”, Marcovici said. “Rather than taking leadership, most offshore financial centres have had reactive strategies, which focus on preserving the past and neglecting to plan for the future.”

An alternative does exist, however: Liechtenstein, where Kaiser Partner is based, was one of the first financial centres to embrace change and recognise that good strategy involves taking into account the needs of all stakeholders. This entailed protecting the needs of wealth-owning families and their businesses, while respecting the legislation of home countries and fulfilling the requirements of Liechtenstein’s financial centre.

On this basis, Liechtenstein began to take steps much earlier than other countries to establish itself as a compliant and strategic mid-shore financial centre; a process that involved investing in education, and gaining a deep and comprehensive understanding of the real needs of the clients that its businesses serve.

The tax laws of mid-shore financial centres make them highly attractive as places in which to establish corporate structures, trusts and other financial vehicles. At the same time, they offer safety, sophisticated infrastructure and human resources in a broad range of areas, effectively offering the same advantages that come with onshore locations. Mid-shore financial centres also benefit from having long embraced information exchanges and effective tax treaties that reduce or eliminate withholding taxes, while also addressing other tax issues in a clear and often beneficial way.

“Mid-shore jurisdictions are part of our world, not outside of it”, said Marcovici. “We offer users bilateral and multilateral investment protection agreements and more. This has been achieved because Liechtenstein began its journey towards establishing itself as a forward-looking financial centre very early on, and is now well ahead of its competitors given its recognition as a ‘first-mover’ in a number of key areas.”

Hub of choice
“Through the work of our Chairman, Fritz Kaiser, and board member Otmar Hasler, the former prime minister of Liechtenstein, as well as myself, we believe we have helped Liechtenstein move in the right direction”, said Marcovici. For instance, during Otmar Hasler’s tenure as prime minister, Fritz Kaiser led a working group that developed the Liechtenstein Declaration of 2009. In this declaration, Liechtenstein committed itself to acting as a responsible member of the global community by contributing to the global effort to help foster long-term economic prosperity and to ensure the social wellbeing of the international community.

Taking a leadership role on tax compliance and transparency, in 2009 Liechtenstein positioned itself as a financial centre of the future with the support and guidance of the OECD. One measure the state introduced to ensure its positive influence across the entire industry was the Liechtenstein Disclosure Facility (LDF) and the accompanying Taxpayer Assistance and Compliance Programme (TACP). These two mechanisms were established between the governments of both the UK and Liechtenstein.

“We designed and implemented these actions with the help of the OECD, and shortly afterwards a team of advisors to Liechtenstein and the UK”, Marcovici said. “The LDF and TACP provided the means for a sympathetic approach to ensuring that all UK-connected users of the Liechtenstein financial centre are tax compliant. Consequently, they were able to provide a safe, private and efficient approach to regularising historical tax issues.”

This approach attracted thousands to make use of the LDF, and its existence helped many more companies and individuals learn of the numerous advantages that come with holding investments in Liechtenstein structures. Essentially, the TACP provided a simple and reliable way for the UK to ensure any taxpayers who employ the services of the Liechtenstein financial centre are compliant.

“Interestingly, this is a much cheaper and less intrusive approach than the Common Reporting Standard and the other transparency initiatives now being introduced around the world”, said Marcovici. “These ground-breaking arrangements with the UK proved to be a huge success for clients of Liechtenstein’s financial centre, as well as for both countries. These arrangements, which did not in any way compromise Liechtenstein’s focus on the legitimate privacy rights of the clients of its financial centre, recognised that countries whose tax and legal systems respect the human right to privacy are entitled to ensure that the integrity of their tax systems also remains intact.”

Improving relations
Since the agreement was introduced, the relationship between Liechtenstein and the UK has gone from strength to strength on the basis of their cooperation and foresight, and has even included a full tax treaty between the two countries. The tax treaty offers a number of important planning opportunities for UK-connected wealth owners and businesses that make use of Liechtenstein as a financial centre.

“For the UK, the LDF was a real success – it was so much of a success that the UK extended the time that the LDF was originally set to run for”, Marcovici said. “The UK also went on to use the LDF as a template for additional disclosure facilities that it has since put in place.

“As an industry leader, Liechtenstein has achieved its aims in that no subsequent disclosure facility implemented by the UK has offered as sympathetic an approach to tax regularisation as the LDF. Eventually, the extension of the LDF was cut short due to, among other reasons, the political repercussions of the disclosure of widespread bank secrecy abuses by HSBC in Switzerland. The LDF stands, however, as an example of what can be achieved when governments are strategic, cooperative and look towards solving problems in ways that benefit all stakeholders”.

As a member state of the European Economic Area and the European single market for financial services, Liechtenstein, with its solid and modern bank secrecy laws, was uniquely placed to go beyond existing standards of information exchange and approaches designed to address tax fraud, tax evasion and double taxation, without compromising its commitment to privacy. The relationship developed with the UK in negotiating the LDF and TACP allowed Liechtenstein to focus strategically on positioning itself as a jurisdiction of choice for businesses and wealth owners connected to the UK.

Marcovici said: “Among others, Liechtenstein was able to work with the UK to ensure that Liechtenstein vehicles, such as foundations, trusts and companies, are clearly recognised by the UK with the application of its tax laws being clear, even though the structures involved are outside the UK.”

Myanmar’s economy opens up to the rest of the world

Posted on by Helen

Myanmar has been referred to as the last frontier in the Association of South-East Asian Nations (ASEAN). The McKinsey Global Institute predicted Myanmar’s economy will double in 10 years, and more than quadruple by 2030 to reach over $200bn. This is a positive indicator for Myanmar, as its banking sector has started to gain momentum. The sector has seen great interest due to the lack of exposure it had during the five decades the country’s economy was closed. There are now 29 local banks, of which four are state-owned and nine are semi state-owned. There are also nine foreign banks, and another four have received their licenses recently. The latest four are expected to commence operation before Q3 2016.

Myanmar has a population of 53 million people, of whom fewer than 10 percent have bank accounts, which offers great potential for the sector. At present, people are underserved in terms of banking facilities. While the branch network (totalling less than 1,500) has been expanded aggressively over the last three years, its outreach is still considered low, with less than two bank branches per 100,000 people. This represents the lowest outreach in the region. With a young population, of which more than 70 percent are between the ages of 16 and 55, Myanmar’s banking sector will likely to see a rapid upward trajectory.

Challenges and opportunities
Myanmar‘s new financial institutions law (MFIL), enacted in January, will strengthen the banking system, in line with international requirements. The framework traditionally adopted by central banks in monitoring banks’ health will likely see greater control and stringent policy changes. The law will require that banks adopt proper credit risk management policies, enhance asset liability management policies to enable longer-term lending, improve funding frameworks to support growth, and strengthen management capabilities. The MFIL will see banks arming themselves with innovative products and services, as well as enhancing customer service and deliveries. Banks that will be able to operate efficiently, effectively and deliver higher customer satisfaction will reap the opportunities ahead.

Another big issue on the agenda is the ASEAN Economic Community (AEC), due to be implemented within the next 12 months. The AEC will help create a more competitive landscape, as well as opportunities for banks seeking expansion in regional markets. But, even though Myanmar has opened its banking sector, foreign banks are prohibited from operating in the domestic retail space. Domestic banks must, therefore, be ready to face the new competitive landscape, as well as seize the opportunity to enter new markets within the AEC.

Myanmar has a population of 53 million people, of whom fewer than 10 percent have bank accounts, which offers great potential for
the sector

The first wave
Over the last five years, under the new democratic government, Myanmar has witnessed drastic political and economic reforms in an effort to adhere to transparent governance and sustainable development. KBZ Bank has been fortunate to take advantage of this trend. KBZ started its first-wave transformation journey in 2012. This will be implemented within the next five years.

Working towards this transformation, KBZ Bank has remodelled its business strategy to focus on four strategy pillars: capacity building; innovation and leveraging cutting-edge technology; business realignment; and strengthening governance and risk management functions.

Firstly, in light of banking sector expansion in terms of size, complexity and the entry of foreign players, KBZ Bank considers its people-centric initiative a cornerstone of its success and sustainability. Acquiring the right skillset, personal development and knowledge could be a game-changer. This initiative started in 2012 and has continued to inspire us to invest in and enhance our human resources capability. New recruitment from abroad, as well as domestic talent, is actively sought.

In 2013, a new human resources planning initiative was implemented to enhance productivity and operational efficiency. A comprehensive staff reward scheme and performance-related incentives were introduced. Staff welfare benefits were reviewed to ensure a positive culture. Investment in leadership programmes and talent management is a continuing process, and a ‘right fit’ approach was thus adopted to continually enhance effectiveness and productivity through hiring.

KBZ Bank was first among Myanmar banks to introduce an internship programme, delivered in association with the University of Yangon’s Institute of Economics, to provide final-year undergraduates an opportunity to pursue a career in the banking industry. This internship programme has been well received, and KBZ Bank is proud to be a leader in the industry for homegrown talent.

Secondly, customer satisfaction and service quality is vital for any service industry. The ability to meet and delight the customer is a key differentiator. KBZ Bank’s strategy for innovation and leveraging cutting-edge technology is based on delivering customer-centric services, operational excellence and innovation. KBZ Bank has invested substantially in state-of-the-art technology since 2012.

Arising from this, KBZ Bank has successfully streamlined and rationalised its processes, products and systems capability to create a simpler, smoother and more affordable experience for its clients and customers. KBZ Bank is in a commanding position to grow aggressively and successfully, and has launched numerous successful initiatives aimed at stimulating the creation of new products and businesses, promoting innovation and sustaining growth.

$50bn

Myanmar economic value 2016

$100bn

Predicted Myanmar economic value 2026

$200bn

Predicted Myanmar economic value 2030

Thirdly, Myanmar is heading towards the adoption of international best practices, while simultaneously increasing competition. As seen in many emerging markets, the changing banking landscape puts great demand on domestic banks. KBZ Bank has realigned itself and is ready to face the challenges. The business realignment transformation initiated in 2014 is a continuous process that will shape the bank according to the changing environment.

Lastly, KBZ Bank’s paradigm shift from a family-orientated business to an institutionalised business has gained the bank international recognition and acknowledgement. KBZ Bank’s clear understanding of strengthening corporate governance and risk management capabilities is a key contributor to its performance. This builds confidence for all stakeholders, chiefly regulators, customers, business partners, employees and shareholders. Presently, Myanmar companies are not fully in compliance with International Financial Reporting Standards (IFRS). To prepare itself for international recognition, KBZ initiated its journey towards IFRS compliance in 2015. KBZ recognises the importance of IFRS compliance, given the need to position itself for international engagement. The bank has targeted the financial year 2017/18 to be in full IFRS compliance.

Besides this, KBZ is also reviewing its reporting capability in budgeting and control, statistical and data monitoring tools, performance measurement and risk portfolio management processes. This strategic initiative pillar will enhance KBZ Bank’s position in terms of engaging with international investors, collaborating with global companies and facilitating overseas expansion. With the first-wave transformation journey in place, KBZ Bank is now ideally positioned to adapt effectively to changes in both the regional and the national market. KBZ Bank clearly understands the market, is ready to meet and anticipate customer needs, and is capable of delivering services in a manner that results in the highest customer satisfaction. This careful approach has so far seen KBZ Bank command about 40 percent in terms of domestic market share, as well as a prominent brand presence throughout Myanmar.

Embracing opportunities in fixed income and credit markets

Posted on by Helen

As any observer of finance and economics knows, present market conditions are both challenging and often illogical. These conditions are presenting a challenge for asset management firms and private investors the world over. Global growth is still weak, while increasing regulation is affecting the structure of global financial markets. Market-moving political flashpoints – from Brexit to the Middle East – persist. Polices such as quantitative easing and ultra loose monetary policy have made even decent returns harder to deliver, while liquidity remains weak.

World Finance spoke to Christos Kassianides, Investment Manager of the K&B Global Total Return Fund at Byron Capital Partners, to explore these challenges facing markets and his own firm. Kassianides also explained some of the challenges that have presented themselves under these new conditions, and his opinion on the outlook for fixed income and credit markets going forward. In a climate that is increasingly volatile and hard to make sense of, Kassianides sheds some much-needed light on the opportunities.

How have you seen the market for asset management change recently?
There have been complaints from investors that asset managers promise the world and, in reality, deliver little. Not just in terms of performance and returns – for example according to research by Bank of America, just 19 percent of funds outperformed the S&P 500 in the first quarter of 2016 (the worst performance in 18 years) – but in terms of client service and personal relationships. Global growth is still and will most likely continue to be weak. That continues to put pressure on expected rates of return for risk assets, and with negative interest rates, it is even harder for asset managers to find acceptable returns today.

Regulation is also a game changer. Asset managers are facing year-on-year higher regulatory and compliance costs, and this trend alone is forcing consolidation in the asset management and private banking industry. Banks are also cutting costs and are no longer either able or willing to absorb and transfer liquidity risk as a result of regulatory changes, including the Volcker rule and Basel III regulations. This has affected market liquidity, particularly in global bond markets.

We feel that today many banks have moved too much of their operations to e-commerce and have lost the relationship with the clients

How have some of these changes influenced the way we invest in global bond markets?
Liquidity is definitely a concern, and market makers are changing their business models accordingly. It is difficult to trade corporate credit these days without incurring liquidity and transaction costs. The evaporation of liquidity manifested itself particularly severely at the start of the year, when global financial markets experienced a spike in volatility and a sell off materialised.

As a result, you have to be cautious when you invest in the global bond markets, but on the positive side for unconstrained investors, this brings opportunities provided you do your homework – particularly for smaller asset managers, who are more nimble.

What other factors have influenced global bond markets?
Many macro factors have recently influenced global bond markets, and the net result is that we have experienced higher volatility, and we expect that trend to continue in the future. We have seen political factors such as the bailout of Greece, sequential conflicts in the Middle East, and terrorism is on the rise again.

Negative interest rates in developed economies – together with the quantitative easing programmes implemented by central banks – are having an impact on bond market pricing. The collapse of commodity prices has also had a major impact on high yield bond markets, but personally I think the real influence is the concern regarding global growth, and where that growth will come from going forward.

What differentiates K&B Global Total Return Fund from other funds?
As a boutique fund house, we treat each euro into any fund we manage as irreplaceable. These days, we believe capital preservation is equally as important as capital gains, so we focus first and foremost on risk management rather than ‘swinging the bat’ to achieve the highest possible returns.

As opposed to product offerings from some fund houses where the investors often end up just owning an index the K&B Global Total Return Fund is not constrained by an index, and takes positions in ‘off the run’ names where we believe alpha generation is possible. The smaller size of the fund also makes this strategy more effective. It is UCITS-compliant and offers investors weekly liquidity, and we actually have investors who view the fund as an alternative to cash, given the punitive returns offered by most bank accounts in the era of a zero interest rate policy, or even negative interest rate policy in some countries.

As a boutique fund house, we are obliged to deliver full transparency and visibility on the portfolios to our investors, and we regularly have one-to-one meetings with all our investors, always involving the fund managers, to ensure they are fully briefed on the current themes and positions in the portfolios.

We feel that today, many banks have moved too much of their operations to e-commerce and have lost the relationship with the clients. We strive to maintain a close relationship with our clients, as we truly believe this is the best way to earn and maintain the clients’ trust. After all, investing is ultimately about trust.

What are some of the biggest challenges the company has faced recently?
Low economic growth and the corresponding structural shift to lower returns remains a challenge for everyone in the industry. Negative rates have also complicated an already difficult investing backdrop.

While performance problems have been the main issue facing asset managers in recent months – with the first quarter of 2016 being a very difficult quarter for the vast majority of the asset management community as outlined above – the K&B Global Total Return Fund actually had a very good first quarter of the year, returning +1.94 percent net of fees.

Having a footprint in south east Europe has created distribution challenges following capital controls implemented by Cyprus and then Greece, meaning inflows into funds have been constrained following policy measures implemented as a result of unprecedented macro events in southern Europe. As a result, we have shifted our distribution focus to other geographies.

And what opportunities have you encountered?
The volatility in the market has created some trading opportunities, which the fund has capitalised on as noted in the performance numbers above. In terms of sector-driven opportunities, when everyone was selling commodity-focused companies at the beginning of this year, this created some interesting opportunities provided you did your homework correctly.

As an example, one year the Anglo American paper was yielding seven percent, and we were comfortable in taking a small position, as their balance sheet in the short term remains strong in our view, with ample liquidity to repay this debt. The underperformance of our larger competitors also creates distribution opportunities for products such as the K&B Global Total Return Fund.

For the bond market in the short and long term, what is the company’s global outlook?
The bond market feels like it is running on morphine. The European Central Bank expanded quantitative easing by €20bn per month and decreased interest rates to -0.4 percent. This should support bond prices, but once the ‘morphine’ wears off it will be interesting how the market reacts, especially when German government bond yields are negative out to nine years.

We believe credit spreads should continue to tighten in Europe, but we also acknowledge that the threat of the Brexit referendum has caused material volatility and further political risk in the Euro area where Greece and its creditors are discussing (yet again) a bailout agreement. In the US we think the yields will remain relatively depressed given a dovish Federal Reserve and mixed economic data.

What are Byron Capital Partners’ plans for the future?
As both an Alternative Investment Fund Manager and UCITS Fund Manager, the company is focused on the performance of existing product offerings, but will continue to look to roll out new products (some bespoke in nature) that cater to the current global investing environment and match demand from investors, particularly in niche areas.

While the environment is challenging for independent asset managers like Byron Capital Partners – particularly against an increasingly demanding regulatory backdrop – it creates opportunities to work and cooperate with other independent asset managers to enhance scale, service existing clientele and create new products in order to bring to market value-added product offerings, be it an UCITS or AIF format. Regulation is here to stay, and we have positioned the business accordingly.

Octagon Pension Services is helping Kenyans to prepare for retirement

Posted on by Helen

The value of the Kenyan pension industry is projected to hit $10bn in 2016, according to industry regulator the Retirements Benefits Authority (RBA). The rapid growth of the sector can be attributed to an increased awareness of the need to save for retirement, the bolstered role of the RBA, and trustees’ enhanced awareness of their roles and responsibilities, among other factors.

Despite the industry’s astronomical growth in the past decade, the majority of Kenyan workers are not saving for retirement, especially those in the informal sector. Data from the RBA shows only 20 percent of the workforce is saving for retirement through registered pension providers.

The country’s National Social Security Fund has the highest proportion of membership, at 67 percent, with an estimated membership of 800,000, followed by the civil service pension scheme at 22 percent. The occupational retirement benefits schemes and individual retirement benefits schemes currently have around 1,350 members, accounting for about 11 percent of total scheme membership in the country.

Furthermore, the Savings and Monitor Report, which was conducted by financial services firm Old Mutual on the Kenyan pension industry, showed only 12 percent of Kenyans are financially ready for retirement, while even those who are saving with retirement benefit schemes do not know the value of their savings.

A ticking clock
According to Kenya’s Public Service Commission (PSC), the body responsible for the provision, management and development of human resources in the Kenyan civil service and local authorities, Kenya is facing a pensions time bomb, with nearly a third of the civil service set to retire in the next decade. The PSC says 32 percent of civil servants are above the age of 50, meaning about 60,000 civil servants will retire before 2025.

Kenya is facing a pension time bomb, with nearly a third of the civil service set to retire in the next decade

Leading regional financial services provider Octagon Pension Services has been hailed as an industry leader in repositioning the retirement benefits industry in Kenya. The company has a diversified client base, including individuals, non-profit organisations, and public and private sector organisations.

In 2008, the company incorporated Octagon Trustee Services to meet the needs of organisations or schemes that require independent and professional corporate trustee services and, more importantly, to oversee settlement of trust funds for children who are left behind by deceased members of schemes. In 2010, Octagon acquired the majority shareholding in an insurance brokerage company that was subsequently branded Octagon Insurance Brokers.

The company also provides training and property management services for pension schemes to its clientele. Following its mantra of ‘service with passion’, the firm has used innovation and exemplary service to bolster the inclusion of many Kenyans into the retirement savings sphere.

“Octagon has grown its client base from handling 3,100 scheme members in 2007, with a fund portfolio of $70m, to more than 41,000 members currently, whose combined portfolio stands at $400m in assets”, said Fred Waswa, Managing Director of Octagon Pension Services. “This is a vote of confidence in the innovative product offering, stability and excellent customer service offered by the company.”

Fuelling Octagon’s growth is its experienced team of specialists in the financial services sector. The firm began its operations with three members of staff in 2007, and by 2015 it had grown to 40 staff, whose combined experience in pension management spans over 200 years. According to Waswa: “Octagon Africa’s philosophy is premised on building long-term beneficial relationships with clients, in providing a service beyond expectations that is built on expertise and responsiveness to clients’ needs. We care and respond to clients’ needs.”

Inclusive policies
With its innovative product offering, Octagon has brought into the fold individuals and institutions traditional pension scheme providers tend to ignore. These include SMEs, savings and credit cooperative societies, and small non-profit organisations including self-help groups and community-based organisations.

For corporate organisations, the firm provides corporate scheme administration and scheme accounting, as well as corporate trustee services. Octagon also acts as a corporate principal officer for its clientele while undertaking pension settlement trust services, as well as providing other scheme advisory services.

The firm has an umbrella pension scheme product designed for SMEs that enrol members to a retirement benefit schemes without having to set up a standalone scheme that requires a lot of regulatory compliance. The scheme simultaneously reduces the usual costs for setting up such a system. Octagon Umbrella Retirement Scheme gives these organisations an opportunity to pool together into one scheme, with each organisation having the flexibility to design their trust rules like any occupational scheme, while having shared service providers and being governed by a single trust deed.

The firm’s income drawdown product fund has been designed to provide individuals and members of retirement schemes with the option to access their benefits as a regular income through an investment fund upon retirement. A member simply transfers the benefits into the fund and then withdraws regular payments at an agreed frequency, and the balance is invested to earn extra income.

Octagon believes in sharing knowledge and experience, and has been instrumental in training trustees and members of pension schemes to deliver services in the retirement benefits sector. Having trained over 4,500 clients in the last eight years, it has developed training programmes for trustees, CEOs, CFOs, human resources managers and secretarial staff associated with retirement benefits arrangements. Octagon also runs bespoke programmes to address scheme-specific deficiencies, and open programmes on certain areas where trustees need their skills developing. The firm upgraded its training services department in 2015 to become a functional subsidiary.

Octagon also incorporated Octagon Realtors as a subsidiary in 2015, to offer support to a growing number of pension schemes with property investments, providing professional, independent services on property management and advisory.

Ready for the future
In line with its innovative philosophy, the firm recently launched the Octagon Pension Administration System, which has revolutionised pension administration in Kenya by easing a wide range of functions such as data maintenance, member benefits calculation, online services for members and trustees, reporting and payments – all with maximum flexibility, and at a minimal cost. A number of leading firms in the region have already adopted the system and have rated it highly.

Octagon has a solid management and governance system: its top five managers have a combined global pension experience of over 100 years, and its board of directors is composed of thought leaders in east Africa’s accounting, legal and marketing space. Octagon’s chairman heads up the largest law firm in east Africa, and also one of the oldest in the region.

“Octagon sits on a solid foundation of sound management and governance. We have experienced managers and a board of directors who steer the organisation. We are a stable pension services provider”, said Waswa. “We are true believers in, and practitioners of, good corporate governance – this is critical in the financial services sector, where trust and stability are the sector’s engines.”

Octagon runs a campaign dubbed ‘futuready’, which targets youth and the working class, helping them to be ready for the future. The firm now aims to expand the campaign to target the vibrant African diaspora market across the world.

Furthermore, individual pension schemes have shown potential for growth in Kenya in the last four years. The sector’s asset base has grown by 150 percent over the past four years, reaching $200m after registering 100,000 new savers over that period. This is an area Octagon wants to target, as it promises to deepen its financial inclusion agenda. Individual schemes mostly target Kenyans in the informal sector, including those in SMEs, an area which has previously been sidelined in terms of pension savings.

This year, the firm is also opening the Institute of Pension Management, which will exclusively target pension training in East Africa. Once established, the college will bolster expertise in the region, as it will attract students from as far as east, central and southern Africa.

According to Waswa: “This is our contribution to the manpower revolution in Africa. We want to see many professionals in the region driving innovation in the pension industry in several African countries. This college, once established, will help us realise this dream. As we grow, we are mindful of the environment that we operate in.
“In this regard, we have a number of corporate social responsibility initiatives, as well as sustainable business practices that we have adopted. This way, we can grow without compromising the survival of future generations. Our most satisfying initiative has got to be our university and college outreach programme, where we want young people to start saving for retirement immediately after they get employed.”

In line with its pan-African agenda, Octagon has its sights trained on covering the whole of Africa. The firm has an established presence in Uganda and Zambia, and is targeting Rwanda by 2017 as it seeks to replicate its success in Kenya, especially among the SMEs the big players don’t prioritise.

Although data on the actual size and progression of Africa’s pension industry is lacking, the industry is nonetheless showing strong growth, according to Renaissance Capital. The firm estimates the assets of Africa’s six largest pension fund managers could increase to $622bn by 2020, and then reach a figure of $7.3trn by 2050.

The US’ key infrastructure begins to crumble

Posted on by Helen

Being the world’s hegemon and economic superpower, those outside the US may assume that its nationwide infrastructure is of the highest standard – reliable, safe, efficient and innovative. Or, at the very least, that the state of railways, waterways, subways and bridges in the US are good. Yet as the Failure to Act report from the American Society of Civil Engineers (ASCE) has warned, support systems in the US are in fact far from good – actually, they are in a terrible state of affairs. So bad is the situation across the US, that the organisation calculates a GDP loss of $3.9trn by 2025, with lost business sales at around $7trn and more than 2.5 million jobs under threat.

The underlying problem for the various sectors connected to the broad term ‘infrastructure’ comes down to a severe lack of investment. The ASCE forecasts that about $3.6trn is needed by 2020 in order to raise the country’s infrastructure to acceptable standards. With such large sums in play, many instinctively look to the federal government to fix this all-encompassing issue. The question of funding, however, is actually far more complex than that. State governments, localities and the private sector all have a large role to play; moreover, when it comes to infrastructure, the most successful projects are likely to result from a partnership of the latter.

Escalating problems
According to the ASCE’s report, unless addressed with the urgency and funds required, US infrastructure is on a path to economic disaster. “We did this economic study to try to show people here that if we continue to invest at the current level, we’re taking an economic risk as a nation”, said Casey Dinges, Senior MD at the ASCE. The logic behind this forecast of doom is simply that infrastructure has an impact on absolutely everything – from productivity and prices, to wages and disposable income.

Rising business costs are a huge problem in the US’ deteriorating infrastructure, given the cumulative effects that ensue when they increase. If surface transportation – namely airports, ports, railways and inland waterways – continue to deteriorate or become increasingly congested, the cost of transportation will inevitably increase. This will impact imported goods that are necessary for the manufacture of US-made products, as well as exports. A resulting increase in the price of exports will therefore make US goods less competitive on the international market, and so threaten the country’s position in global trade. With export revenue in decline, GDP will take a hit as well – which in turn can have a series of disconcerting cumulative effects.

Infrastructure has an impact on absolutely everything – from productivity and prices, to wages and disposable income

Ultimately, the rising costs of an increasingly inefficient and expensive delivery of water, energy and goods are passed onto households. With consumers having to spend more on goods and services, disposable income will inevitably fall, which will reduce both spending and saving – a vicious cycle that again sees the economy suffer.

What’s more, as Dinges told World Finance, exacerbating this cycle further is the reduction in wages that is likely to occur if business costs continue to rise and productivity levels continue to fall. “Businesses delay hiring or don’t hire, or keep people at a part-time job instead of moving them up to a full-time job – all these little impacts add up to the kind of numbers that we released in the report”, he said. The ASCE study also predicted that fewer high paying jobs could be created, particularly as the labour market may shift to fulfil the needs that result from the infrastructure deficit.

According to Dinges, the current funding gap for surface transportation is around $100bn a year. “That’s a big number, but when I think of the US GDP of $18trn and the importance of surface transportation to the entire economy and almost everyone’s daily lives, what’s $100bn? We have to be able to figure that out.”

At present, the problem is already costing every household in the US an average of $3,400 per year, or just over $9 a day, according to the report. “If we increase investments, we can avoid these economic losses with a benefit cost ratio of about 3 to 1; if we invest $3 a day per family, we can avoid those losses of $9 a day”, said the organisation. It hopes that, by shedding light on the significant impact of ageing infrastructure in a way that is both relatable and understandable, it is possible that a move towards greater investment will follow – because if it does not, this figure is set to worsen apace with the deterioration of vital support systems across the entire country.

Disrupting the flow
While one automatically thinks of roads, railways and ports when it comes to infrastructure, the term covers a broad range of systems that are crucial to the functionality and expansion of any economy. “A water main will rupture in the US every two minutes, but unless it is happening on someone’s street or outside their business, they won’t think about it”, said Dinges. Additionally, there are the systems that are not used by the public in their daily lives, but still have a sizeable impact on them. For example, the inland waterway system that connects the Mississippi river to the Midwest region is vital to the US’ positioning within the global market.

“People don’t even realise the massive movements of products and raw materials that travel by barge down these rivers. One of the numbers I saw is that these barges, [which] are very energy efficient and can carry huge amounts of materials, displace the equivalent of 51 million truck trips per year on our roadways. So it’s actually an important component of the US surface transportation system”, Dinges said. “We already have incredible traffic issues in major metropolitan areas here, just think if another 51 million trips had to happen on our already crowded road system, what kind of impact would that have?”

Maintaining the necessary infrastructure to support drinking water is another huge and pressing challenge that needs to be addressed urgently. While a federal programme was implemented in the 1970s, it ceased to exist some time ago, with the responsibility now resting with utility companies and local government entities. Therefore, a new look is needed to modernise and reinvigorate the maintenance and development of these systems in the long term.

“These modern drinking water systems had more impact on human health than just about anything, including the discovery of many medicines and antibiotics”, Dinges said. “[However], there is a tendency to take this stuff for granted until it is absolutely not working. At ASCE, a civil engineering association with a responsibility to design and manage these facilities, the notion of waiting for an absolute crisis is unacceptable.”

While one automatically thinks of roads, railways and ports when it comes to infrastructure, the term covers a broad range of systems that are crucial to the functionality and expansion of any economy

The solution undoubtedly comes down to encouraging greater investment, but even if and when this is achieved, the allocation of funds is another highly complex issue, particularly in a country as large as the US. As such, the decision of who pays what and of how to prioritise the numerous projects that need investment is a mammoth challenge.

In 2015, public capital investment was at its lowest level in over six decades, at just $611bn and 3.4 percent of GDP. Some promise was shown when Congress passed the Fast Act, a five-year $300bn bill aimed at addressing the long-term funding issue for surface transportation maintenance. Yet, disappointingly, the increases each year are nominal, and by no means do they tackle the gap highlighted by ASCE in its pivotal study.

The shortfalls of the Fast Act highlight that, while the federal government has an important function in resolving the country’s infrastructure problem, that of localities and state entities is far more crucial.

“I think we overemphasise the federal role in a lot of cases”, said Robert Puentes, President and CEO of the Eno Centre for Transportation. “We think about infrastructure in very big abstract terms, we think about the country in very big abstract terms, and it kind of defaults them to a federal role and responsibility, when really the federal role is actually probably more limited than folks think. Even if you take the two sectors of transport and water, federal investments are only about a third of all of the investments that are made in the US; states and localities have the lion’s share.”

States act
Despite the forecasts given by Failure to Act, there is still cause for optimism. The poor state of infrastructure in the US is finally growing in the public dialogue, and was picked up on by several candidates. One-time presidential hopefuls Bernie Sanders and Marco Rubio, along with Democratic nominee Hillary Clinton, each published manifestos for improving the country’s deteriorating infrastructure. Sanders’ proposal involves investing a further $1trn of federal funds, while Clinton really gets into the specifics of how the system should be governed, looking forward. In any case, there is a general consensus that the role of federal government must be reassessed in order to establish a more efficient system that encourages a greater flow of investment.

The US’ waterways are extremely important for the transportation of goods, reducing pressure on the overstretched road network
The US’ waterways are extremely important for the transportation of goods, reducing pressure on the overstretched road network

Moreover, several states are tackling their individual challenges head-on, even in spite of the potential outcry that can accompany tax increases. Los Angeles has been making its own strategic and prioritised investments in its transport systems in order to safeguard its identity as a modern metropolitan area with global goals.
“Denver is another example of a place that is trying to accommodate a lot of the growth that is projected for the region over the next 20, 30 years”, Puentes said. “They are using their transport system as a way to channel and focus that growth in places where they want it to occur.”

As crucial as these initiatives are, the federal government must still take a leadership role where necessary, certainly in terms of multi-state projects and cross-border systems. In regards to intra-state systems, it is imperative that it provides the support needed by local entities.

“They really should be incentivising and encouraging states, localities and metropolitan areas to do their own problem solving”, Puentes said. “They should be supportive of the new innovations that are happening out there, whether it’s new kinds of financing partnerships or new types of regulatory reforms.”

Partnerships may indeed be the key to solving the US infrastructure deficit. While private-public partnerships in infrastructure have existed for some time in other regions – such as Asia and Europe – they have largely remained on the sideline in the US. “There is the belief that these are shared public assets, so that’s a little bit of a political challenge for the US”, Dinges said. Encouragingly, however, this shift is beginning to take place in the US as well. For example, Texas recently struck a partnership with private firm Texas Turnpike Corporation, which is investing and constructing new toll roads in the state, in return for the toll fees collected over an agreed stretch of time.

With more successful projects and partnerships taking place, together with more dialogue in the public space and far greater attention, perhaps Failure to Act came just at the right time to reverse a self-fulfilling prophecy that threatens the not-quite-invincible US economy.

Growing interest in Azerbaijan is helping the country’s banks to thrive

Posted on by Helen

Located in the Caucasus, Azerbaijan has been part of one of the fastest-growing emerging market regions in the world in recent years, with investors seeking riskier asset classes in the era of low interest rates in advanced economies. However, a number of macroeconomic trends, alongside the Federal Reserve tightening monetary policy in the US, have reversed this of late.

World Finance spoke to Taleh Kazimov, CEO and Chairman of PASHA Bank, about this trend. As Azerbaijan’s leading corporate bank, PASHA Bank is well placed to shed light on the financial sector in the region. Established in 2007, the bank offers all standard financial services, including investment banking, trade financing and asset management, to a range of clients, from large corporations to small and medium enterprises. The bank works particularly closely with companies operating in the non-oil sectors of the economy, including agriculture, transportation, construction and retail, which are vital for helping Azerbaijan to diversify its economy.

What has spurred PASHA Bank to take an active role in the securities market?
Besides its core business activity – corporate banking and private banking – PASHA Bank is also known as an investment bank in the regional market. The bank has been named Best Investment Bank, Azerbaijan by International Finance and EMEA Finance several times.

Among the different types of products, securities play a major role. The Azerbaijani Government has been investing a lot to set up the securities market framework and improve legislative requirements to create the necessary market conditions for growth. At PASHA Bank, we also see this as our responsibility as a corporate citizen, and we contribute by initiating underwriting and market-maker opportunities for corporations as well as financial institutions.

PASHA Bank is the major player in the market in terms of offering underwriting and market-making services to clients

This creates the opportunity for them to diversify their funding sources, gain access to cheaper funds (compared to equity) and secure a solid reputation (if the placement is successful). At the same time, PASHA Bank utilises securities as an important diversification tool. We believe that, in an uncertain economic environment, diversification of income sources is important and the securities market is definitely the right one for us.

PASHA Bank is the major player in the market in terms of offering underwriting and market-making services to clients. The impact of this service is immediate liquidity, as well as access to different funding sources and products. PASHA Bank has underwritten over 100 million bonds for both financial institutions and corporations, and has created the opportunity to diversify their funding sources.

PASHA Bank is the only bank in Azerbaijan that hasn’t been downgraded by rating agencies. How was that achieved?
PASHA Bank has been analysing the market and following economic trends closely. We have taken the necessary steps to avoid forex risk, credit risk and operational risk. The bank announced, in 2015, a transformation year in which we created a corporate recovery team which solely manages loan clients that are struggling with their payments, helping them to correctly frame their strategies in order to recover from challenging situations. Another major difference is our approach to the lending process. Thorough analysis of financial statements is a must, and existing cashflow sources have to be matched with lending currency. We believe that these decisions and approaches have helped us to achieve the aforementioned success.

What challenges currently exist in the region’s financial industry?
Economic slowdown generally results in the weakening of asset quality. This period is no exception. Consumer finance banks are experiencing problems with loans nominated in foreign exchange, while corporate and investment banks see problems from large corporations due to weakening macro conditions. We think that those institutions with the best quality of management, systems and procedures will navigate these challenging times, while weak institutions will lose market share.

Developing banking activity inside the Azerbaijan-Turkey-Georgia economic triangle, we are aspiring to contribute to an increase of trade flow between the countries. We are more than confident in the successful future of the region, and we are ready to become one of the engines of its economic development. We plan to lend support both to Azerbaijani entrepreneurs in these countries and local businesses too.

What plans does PASHA Bank have for the future?
Our vision is to be the leading Azerbaijani bank, and we align our operations with our vision and strategic objectives. The bank will continue strengthening its core capabilities and working on efficiency improvements. Corporate banking will remain our focus.

Why struggling SMEs are turning to fintech firms for help

Posted on by Helen

The increasingly important role of technology in the financial sector, together with a new regulatory framework, has forced large institutions around the world to ‘clean house’ and identify new strategies in terms of functionality and client base. But they have also created an environment wherein small and medium sized companies fall through the gaps.

One legacy of the financial crisis is the blockage in liquidity for SMEs, together with obstructive and inefficient processes that prevent access to the working capital they need to thrive. Although this situation imposes a risk for true economic recovery, there is hope in an alternative: fintech companies are now stepping in to enable small start-ups to achieve extraordinary things.

No risk, no gain
“Regulations like Basel III have had an unintended consequence of making it harder for banks to lend to these SMEs, as they look to rebuild capital bases and de-risk lending portfolios”, said Mark Thomas, Director of Client Operations at C2FO, the world’s largest working capital marketplace. “As a result, lending to SMEs is still far lower than pre-financial crash levels in Europe.”

Large companies have also implemented a substantial increase in their cash reserves since 2008, but they are still struggling to generate returns on them in an environment of low or negative interest rates.

“Ultimately, more of this liquidity needs to flow to SMEs to kick-start the economy again”, said Thomas. “Online lending, and in particular P2P lending, often dominates discussions about the changes and disruption associated with fintech. There have certainly been important developments in this area, which have benefited both lenders and investors, but, in reality, the amount of liquidity provided to consumers or businesses via P2P to date is still small and remains dwarfed by traditional lending models.”

There is around $40trn in outstanding invoices at any point in time globally

Invoice discounting is another area that is undergoing a renovation. This form of alternative finance enables suppliers to offer buyers a discount in exchange for early payment of their outstanding invoices. As such, it provides a chance for suppliers to access liquidity that can support their growth and expansion.

“To put this in context, there is [around] $40trn in outstanding invoices at any point in time globally”, said Thomas. “Even if a small amount of this can be made liquid through invoice early payment models, then the benefits to the whole supply chain can be measured in hundreds of billions, or even trillions, of additional global GDP.”

New model
Traditionally, the practice of invoice discounting was carried out manually by large businesses: procurement teams negotiated with suppliers individually, and then sold their invoices to a third party in a process known as factoring. Technology, however, has transformed factoring through digital platforms that enable suppliers and buyers to negotiate early payments en masse.

“The most effective [and] dynamic discounting model uses a real-time marketplace to discover the unique price for early payment that is profitable for both buyers and their suppliers”, said Thomas. “This gives SMEs control over their cash flow and corporates have an opportunity to create a healthier supply chain, while also improving their bottom line.”

Accelerating payments is vital for facilitating the flow of liquidity to suppliers, which can use cheaper rates to invest in their development. “As the invoices are already approved for payment, this is risk-free to the large corporates, and the return they receive on their cash from the discounts is far higher than other options”, Thomas told World Finance. “Technology platforms like C2FO make these early payments straightforward for all parties by automating the process and connecting buyers to their whole supply base, which might be tens of thousands of suppliers, in a single marketplace.”

The financial sector still has a long way to go to iron out all the creases that resulted from the financial crisis, with more likely to appear in the coming years as the true picture continues to emerge. During this interim period in banking, small fintech companies are becoming increasingly competitive, using the edge they have in terms of technology to provide much-needed and workable solutions (such as alternative financing models) to help corporate clients.

With more flexibility and possibilities, companies have a far greater chance of expanding their operations. The outcome in broader terms is a flourish of economic activity that can provide a real impetus to the economies of individual states, as well as the entire global system. Meanwhile, larger traditional financial institutions are now faced with new competition from a rapidly evolving market, meaning they will have no choice but to adopt the mechanisms offered by fintech firms, or else risk being left outdated, outmoded and unwanted.

Zenith Bank works to promote banking accessibility in Ghana

Posted on by Helen

Banking, as a functional part of the daily human routine, is underpinned by strong technology deployment and constant innovation. This did not come about by chance – in fact, like in most endeavours, there were pacesetters that rightly predicted the role of technology and thus embraced it from the outset. Zenith Bank Ghana is clearly in this bracket – banks that invested in the appropriate technology and thus were able to deliver relevant innovations, which defined and continue to define the banking experience for their customers.

Over the years, in line with the Ghanaian Government’s agenda to create a cash-light economy using technology as the backbone, the bank has introduced an array of products and services, which are responsible for the seamless way its customers transact their businesses.

Zenith Bank, which was named Best e-Commerce Bank in Ghana in the 2015 Global Banking and Finance Review Awards, recently launched GlobalPAY, an e-commerce service to enable companies and individuals to sell their products safely online. This allows them to boost sales in an increasingly competitive and global marketplace.

Pay it forward
Recognising the vast opportunity for local companies to expand their businesses online, supported by a digital-savvy bank with robust and state-of-the-art technology, GlobalPAY has been designed as a secure web-based collection gateway that enables merchants to accept real-time card payments from customers worldwide.

The GlobalPAY platform serves as a link between Zenith Bank, merchants and cardholders, as well as payment networks such as MasterCard and Visa. Very soon it will also include the E-zwich card, a local card created by an offshoot of the Bank of Ghana.

The product works in two ways. The first is the website integration element, which sees the bank integrate its payment application programme interface (API) into the merchant’s website. Customers can then make direct payments with their cards through the merchant’s website.

Over the years, Zenith Bank has acquired the reputation of providing innovative banking products and services that cater to the needs of numerous customers

The second element, known as the ‘storefront’, is tailored to merchants who wish to utilise the product but do not have websites and the technical capability to use the API. The bank supports these merchants by creating an online store through which they can list their products on the GlobalPAY platform, where customers can make purchases with their cards.

Merchants – which may include supermarkets, shopping malls, stores, large and small corporations, airlines, internet companies, and virtually any entity seeking to do business or receive payments online – stand to benefit from using GlobalPAY, as it increases the global reach of their businesses, grants 24/7 access to their products and services, provides real-time card authentication and payment authorisation, and ensures multiple card acceptance and secure transactions via Verified by Visa
and MasterCard SecureCode.

Corporate institutions and individuals who sign up for this product can be assured of secure transactions, real-time payments, global reach, and increased business channels, among other benefits.

Product diversification
Some of the innovative products that culminated in Zenith Bank becoming a pacesetter in technology and innovation included its pioneering partnership with mobile telephony service operators Airtel and MTN to offer mobile money services to the large unbanked population.

Last year, the Bank of Ghana passed a set of regulations for mobile money operators that, among other things, called for partnerships between operators and banks. A year after the passage of the regulations, the value of transactions recorded on the mobile money platform reached nearly $10bn, representing an increase over the previous year of 216 percent.

With Zenith Bank’s partnership with Airtel and MTN, customers are able to link their mobile wallets to their bank accounts. For instance, customers are able to pay for goods and services using their connected mobile wallets.

Travel and transport
The unmatched efficiency of the bank’s payment services has drawn more airlines, both local and international, onto its E-Ticketing and Travel Solutions platform, bringing the benefits of the bank’s highly convenient payment options to more travellers. Currently, the bank collects payments for nine international airlines and all domestic carriers. The list of international airlines includes KLM, Tap Portugal, Gambia Bird, Kenya Airways, Arik Air, Dana Air and Med View Airline. These airlines fly directly to, or connect to, most cities in the world. The domestic carriers are Africa World Airlines and Starbow, which cover the main Accra-Kumasi, Accra-Takoradi and Accra-Tamale routes.

The convenience Zenith Bank offers is that customers of these airlines can book their flights online and pay at any of the bank’s 32 business locations across Ghana. The airlines receive instant notification of the payments and quickly dispatch customers’ flight tickets to them through the email address they provide when booking.

The service thus eases the booking process for flights to various destinations and the general travel experience, saving customers the time they would otherwise have spent looking for an airline’s specific office location to book and pay for their flights.

Card access
In addition to its technology-driven products and services, Zenith Bank currently offers four different types of cards for people with diverse needs. These include Zenith Eazypay, Visa Classic Debit, Visa Classic Credit and Visa Classic Prepaid.

The Eazypay cards are issued to account holders to carry out cash withdrawal services from any Zenith ATM, any ATM of an eTranzact member bank, or the ATMs of other switches connected to Zenith Bank Ghana. Cardholders can also transact on any Zenith Bank or eTranzact enabled point-of-sale (POS) terminal.

Zenith Bank’s Visa cards allow cardholders to access their funds for withdrawals or payments worldwide. The debit card, which is the most popular, is used to make withdrawals on all Visa branded ATMs and also to make payments locally and internationally at POS terminals and online. Funds are deducted directly from the customer’s account.

Unlike the debit card, the credit card grants access to a monthly line of credit based on a particular credit score.

The last of the cards is the prepaid card. This is a reloadable card loaded with the user’s own funds for purchases or withdrawals. Cardholders get instant value on the cards, and have the option of loading their cards at any Zenith Bank branch or online.

Industry recognition
Currently in its 10th year of operation in Ghana, Zenith Bank has fast become recognised as the tsar of innovation in the Ghanaian banking industry, and continues to distinguish itself through its ability to offer an unrivalled customer experience.

Its dedicated service resulted in the bank being named Best Banking Group, Ghana for 2015 and 2016 by World Finance. According to the magazine: “Zenith Bank Ghana has spurred innovation within the Ghanaian banking industry and has helped to provide an international standard of financial services to the market.” The bank was also named Bank of the Year, Ghana for 2014 and 2015 by The Banker, and won Best Bank in Customer Care at the Ghana Banking Awards in 2014.

Over the years, Zenith Bank has acquired a reputation for providing innovative banking products and services that cater to the needs of numerous customers. Never resting on its laurels, the bank continues to develop and enhance these products and services to satisfy the ever-changing and growing needs of today’s customer, bearing in mind the technologically driven world we live in today.

Behind the story of the Panama Papers

Posted on by Helen

On Monday May 9, 2016, the biggest leak in history went public. With an incredible 11.5 million documents and 2.6 TB of data, the Panama Papers eclipsed 2010’s Wikileaks and Edward Snowden’s secret intelligence documents in 2013 combined. What’s more, the leaked database, in all of its brimming glory, hailed from just one source – the now-infamous Mossack Fonseca, an international law firm based in Panama.

On that historic Monday, a coordinated release of information and articles took place around the globe, the likes of which had never been seen before. From Germany to Washington DC, people woke to the news that a highly secretive and deeply consolidated network of offshore bank accounts was in existence. While holding an offshore account is legal in itself, it was revealed that thousands of shell companies were administrated in Panama in order to cover up the identities of the true owners of funds, some of whom engaged in illegal activities. Despite attempts made in recent years to clamp down on tax avoidance and money laundering, the mechanisms required to do so were actually kept running in the sunny climate of Panama, as well as in the havens of Switzerland, the British Virgin Islands – and elsewhere.

“What came to light through the Panama Papers was that there is a systematic network of secrecy jurisdictions, of which Panama is only one and not the most important one”, said Markus Meinzer at the Tax Justice Network. “These tax havens help individuals and economic and political elites to escape the rules and regulations of the societies in which they reside, and on which they and their wealth depend to a large extent.”

Undercover ops
The process of unveiling the Panama Papers actually started in late 2014, when an unidentified source approached Süddeutsche Zeitung, a leading daily newspaper based in Munich that had reported on a previous leak of Mossack Fonseca documents to German regulators. Communication began via encrypted electronic messages with Bastian Obermayer, an investigative reporter at the paper, who became the source’s sole point of contact. Given the masses of information in question, as well as its highly sensitive nature, the two never met in person. The encrypted channels used varied frequently, from PGP-encrypted emails to cryptographic apps, such as Threema and Signal, while records were deleted after every exchange. What’s more, according to Wired, the pair would use a stipulated question and answer to authenticate their identities before each discussion could begin.

Despite the various initiatives that have been made in recent years to tackle these kinds of abuses, the offshore secrecy world remains very much alive and kicking

Under these precautions, batches of Mossack Fonseca’s decades-old database were delivered periodically to Obermayer. Having realised the enormity of the leak in his hands, Obermayer reached out to the International Consortium of Investigative Journalists (ICIJ), given the group’s experience in organising leaks of a similar nature. A project of Washington DC’s Center for Public Integrity, the ICIJ had recently co-ordinated ‘Swiss Leaks’, the revelation of a series of hidden bank accounts and documents showing that banking giant HSBC had been dealing with international outlaws, traffickers, arms dealers and the bagmen of dictators.

In order to plough through the millions of documents that came in from Obermayer, the consortium built a protected search engine with an encrypted URL. According to Süddeutsche Zeitung, the data was systematically indexed, with a folder for each shell company, which in turn contained all pertinent correspondence, documents, contracts and transcripts. The ICIJ and Süddeutsche Zeitung used optical character recognition to turn all data, including images, into machine-readable, searchable information, while a sophisticated algorithm was used to compare searches by topic and scandal in a matter of seconds.

With these mechanisms in place, mass coordination with 108 media outlets around the world began, including the BBC and The Guardian. The secret site contained a real-time messaging feature so journalists could communicate, exchange tips and share translations from any time zone. Journalists around the globe conducted painstaking research in order to ascertain and link information about each name found, including what role they played in a company and the origins of the money they sheltered.

The fallout
As the news reverberated around the globe, one by one, the names of high-profile individuals with secret accounts were revealed. From celebrities to politically exposed individuals and even state leaders, it began to feel as though anyone who was anyone had their name in the Mossack Fonseca database. Among the most shocking was Icelandic Prime Minister Sigmundur Davíð Gunnlaugsson. Together with his wife, Anna Sigurlaug Pálsdóttir, Gunnlaugsson owned a shell company in the British Virgin Islands called Wintris, which held almost $4m in bonds in Iceland’s three biggest banks – a fact he had failed to declare upon instatement to public office, in contravention of Icelandic law. Instant public outcry forced the Prime Minister to step down from his post and presumably resign from the political game for good.

Vladimir Putin also faced international condemnation when he was linked to a whopping $2bn via his close friend and world-famous cellist Sergei Roldugin. According to the Panama Papers, Roldugin owned three offshore firms, International Media Overseas, Sonette Overseas and Raytar, the first two of which were created by Russian joint stock entity Bank Rossiya. Panama Papers journalists also found connections between Roldugin’s companies and Kamaz and Vi, Russia’s largest truck manufacturer and biggest buyer of television advertising, respectively.

The scandalous details continued in waves, naming the President of the UAE and his 30 offshore companies, the President of Ukraine, the King of Saudi Arabia, and the Former Emir of Qatar among those secretly on Mossack Fonseca’s books. Relations of the world’s most powerful were also exposed, including the children of Pakistan’s Prime Minister, the nephew of South Africa’s President, and China’s so-called ‘Power Queen’, the daughter of former leader Li Peng.

With so many people implicated, the public debate about offshore tax havens rose with vigour. “The Panama Papers underlined that, despite the various initiatives that have been made in recent years to tackle these kinds of abuses, the offshore secrecy world remains very much alive and kicking”, said Meinzer. “It also drives home the point that this network of secretive places and structures can exist and will exist as long as the major economies, such as the US, Europe and others, are willing to tolerate and accept the legal fiction and the secrecy that these places are offering.”

11.5 million

Number of documents leaked

2.6

Terabytes of data available

108

Media organisations involved

Treading a fine line
“The Panama Papers has focused attention on tax havens, but we have to remember that tax havens and offshore structures are entirely legal and often used for inheritance and estate planning. Unfortunately, the glitch in the system is the lack of due diligence performed by organisations operating in these countries”, said Nina Kerkez, a due diligence expert at Accuity. “Organisations should be able to prove to their banks and other counterparties that they have completed the necessary due diligence to avoid any illicit behaviour, regardless of where they are based or established. The fact that an entity is operating offshore does not exempt them from performing due diligence on all parties involved.”

Although many of those who employed the services of Mossack Fonseca did so lawfully, there were also plenty of criminals and traffickers who used the system to conceal ill-gotten funds.

“Knowing who you are doing business with is critical, yet discovering this information can often be a challenge. Many entities have extremely complex ownership structures, and with that comes another challenge – it is really difficult to understand where the money is coming from. Real owners usually hide behind nominees – people who lend their signatures on behalf of the entity but have no real control over it”, Kerkez explained. “We should not only look into ownership of entities, but also look closer into the networks of those owners. As part of due diligence processes, we need to understand what those relationships around them mean, and if that allows for any corrupt individuals to hide funds.”

Managing risk
It could reasonably be argued that, as it stands, the offshore system threatens the stability of the entire global economy. “It is a network that has a debilitating effect on, and is an existential threat to, the principle of free market economics. It undermines the trust and the mutual confidence that trading partners need to have in each other when doing business on cross border levels”, Meinzer said. He also argued the international offshore system is designed for one sole purpose – to “break the chain of accountability” for those who wish to conduct business in democratic societies, yet seek to circumvent the regulations pertinent to their activities. “If we continue to tolerate the system, we will see a spiralling of fraud in all colours and shades, as we have already seen in the financial crisis – it will spread out further to other economic sectors too.” In such a scenario, fraud and money laundering are but one set of outcomes of an endemically corrupt system; others include market manipulation, such as insider trading, market rigging, and short-circuited public procurement processes.

There are some, including the German finance minister, Wolfgang Schäuble, who support the idea of a private register for offshore companies. “What has been promoted can be qualified as a manoeuvre in misdirection, because it would dispense with the single most promising measure, which is a public registry of the true owners of the companies”, Meinzer said. “In reality, we know that the Achilles heel of the entire anti-money-laundering regime is the identification of the true owners behind legal identities.” As evidenced by the recent efforts made by new banking regulations, the true identity of account holders and beneficiaries cannot be compromised or conceded – indeed, this is the ultimate line of defence against fraud of any kind.

However, what Mossack Fonseca’s database revealed, by its sheer size and breadth, is that the means for flouting certain rules are still in existence; the tools for corruption and abuse have, in fact, become systemic and entrenched. “The key to lock down and end this institutional corruption is in the hands of the major economies. [They can] decide to only accept offshore investors as long as they go public and identify themselves in registers throughout the economic zones that they control”, Meinzer said.

There is a general consensus that industry changes will continue to be made, particularly in light of the Panama Papers. As Kerkez noted, there will be a tightening of regulations, which will focus more on personal relationships and the identification of ultimate beneficial owners. What’s more, she added that, although personal privacy may be affected, “transparency is key…[and] if entities are transacting via international financial networks then they should expect to be subject to due diligence procedures”. As shocking and controversial as they are, scandals such as the Panama Papers are instrumental in uncovering the state of the international network as it truly stands. Only from such a basis can a regulatory framework be pushed even further, and in the direction needed. Promisingly, the first steps have been taken – one day perhaps we will finally achieve a global system that is robust, sustainable and genuinely free from corruption.