Author: Max Tomlin

Coming of age in Asia’s growing insurance sector

Posted on by Max Tomlin

In the past few decades, Hong Kong has become a major hub for insurance. By the end of June 2016, 161 insurers – including 14 of the world’s top 20 – were authorised to conduct business in Hong Kong. The insurance market in the region has come a long way since 1981, when HSBC Insurance (Asia) was first founded. Hong Kong is a mature insurance market, with talented professionals and a well-established legal structure. As of the end of 2015, the industry’s gross premium amounted to HKD 374.1bn ($48bn).

As part of the Pearl River Delta, Hong Kong is in a good position to be an important insurance and risk management centre for investments under the Chinese Government’s Belt and Road Initiative. Furthermore, as mainland enterprises are seeking to ‘go global’, they will favourably consider the advantages in establishing captive insurance companies in Hong Kong for insurance arrangements and risks management of their overseas businesses.

World Finance spoke to Candy Yuen, Chief Executive Officer of HSBC Insurance (Asia), to discuss Hong Kong’s insurance sector, HSBC’s position within it, and the challenges the industry is currently facing.

How has HSBC managed to become such a strong contender in Hong Kong’s insurance market?
We are well positioned with regards to the nature of Hong Kong’s insurance market for a number of reasons. First, we have a strong heritage and a strong brand both globally and locally, where we as a bank have been serving customers for 150 years. Second, we are a global and universal bank. The group serves customers worldwide from over 6,100 offices in 73 countries, in territories both in Asia and around the globe. This gives us, the insurance business in Hong Kong, the advantages of leveraging and synergising the strength, experience and learning from other markets.

Third, we already have a leading presence in the Hong Kong insurance and Mandatory Provident Fund markets; we ranked first in the Mandatory Provident Fund market as of June 2016 in terms of total assets under management, and we are a leading insurance company in terms of both in force and new business premiums. Finally, we have been enjoying a long and strong relationship with our customers built from our customer-centric services, offerings and extensive customer touch points, including in-branch and digital. Doing the right thing for our customers is paramount to the maintenance and deepening of this bond, and is accomplished by knowing our customers.

Hong Kong remains a high-growth sector in the region as those in the city look to fill their protection gap with insurance products

At HSBC, we excel at consumer insights, where we dedicate ourselves to producing consumer surveys, reports and tools, such as The Future of Retirement, The Value of Education, The Power of Protection and the HSBC Retirement Monitor, among others.

How has the recent economic slowdown in Asia impacted Hong Kong?
Recently, impacts from an economic slowdown in Asia are a very real concern for those in Hong Kong. Hong Kongers are now more vulnerable than ever to the protection gap created upon the loss of a breadwinner. According to Swiss Re’s Asia-Pacific 2015 Mortality Protection Gap report, Hong Kong’s mortality protection gap in 2014 was approximately HKD 4.2trn ($538bn), up from HKD 3trn ($391bn) in 2010.

According to a HSBC customer survey, 70 percent of our customers have a protection gap and require on average around three times their current coverage to achieve adequate protection. One can imagine the breadth of coverage needed to protect their loved ones in the event of an unfortunate incident.

However, Hong Kong remains a high-growth sector in the region, as those in the city look to fill their protection gap and fulfil their goals, hopes and dreams with insurance products. The continuous low interest rate environment has spurred high net worth individuals to see universal life insurance products as an attractive savings option, while enjoying life protection. The life insurance industry is recording historic growth, primarily driven by demand for Hong Kong insurance products by non-resident customers.

What is the most important issue affecting the insurance industry in Asia today?
hsbc-fig-1Like many parts of the world, demographic change is a prominent issue affecting the insurance industry, with far-reaching social implications. It is forecast Asia will account for 62 percent of the aged population globally by 2050, and so the need for pensions and old-age protection will stimulate demand for insurance coverage.

Healthcare reform is also on the agenda of several Asia-Pacific countries. This will create incentives for insurers to develop a wider variety of medical and health insurance products and better position themselves in formulating their marketing and pricing strategies.

In particular, society is currently experiencing an increased exposure to ‘longevity risk’. What this means is people are living longer than expected (see Fig 1), and hence run a higher risk of outliving their savings in light of increased healthcare costs as they live longer. According to the latest Power of Protection report by HSBC, 69 percent of Hong Kong residents worry most about their health, with healthcare costs posing the biggest health-related concern. As such, besides life protection products, HSBC Insurance has been addressing this concern through launching new health products, such as critical illness insurance plans, in 2016.

What sort of challenges does this present to the insurance sector and how can they be resolved?
Hong Kong has the highest average lifespan in the world (81.2 years for men and 87.3 years for women), according to recent Hong Kong and Japanese Government censuses. In a world of extending lifespans, it has become increasingly difficult for traditional pension plans to be the sole source of retirement funds. In Hong Kong, the burden to support the elderly has increasingly shifted to the younger generation, with mounting pressure as the number of senior citizens grows.

This will also result in increased stress on age-related spending for governments, as the population aged 60 or over will outweigh young citizens by 2050, resulting in a smaller tax base. This will mean defined benefit pension plans will be more likely to become underfunded, and this will be exacerbated by a low interest rate environment. Our survey also shows more than 63 percent of people with self-paid life cover do not know what the pay-outs from their policies would be, or do not think they are enough. The survey results also identify 53 percent of Hong Kongers think someone else should take responsibility for funding the cost of their personal healthcare, and 60 percent of people believe someone else should be responsible for ensuring their family’s financial stability.

To cope with this challenge, insurers will need to deploy a holistic retirement strategy and a new business model to address retirement needs. We will also need to be aware of the limitations of protection plans offered by employers, as they usually only provide a basic level of protection.

Our survey also shows that people who plan most actively are more confident in their future than those who do not. It is important to conduct personal planning and hold a regular financial ‘check-up’ with a trusted financial advisor. To help society further plan for their life after work, HSBC launched the Retirement Monitor, becoming the first and only firm to release retirement spend indicators using real statistics in the market. This information is publicly available and updated quarterly to reflect the latest changes in prices and consumer behaviours. We aim to help our customers achieve their ambitions, hopes and dreams, including their retirement aspirations.

Where do you see the Hong Kong insurance sector going in the next few years?
Insurers will be deploying digital as an enabler to improve customer engagement and experience, and as a key distribution channel. Fintech and digitalisation have become the main focuses among governments, regulators and insurance companies. These present ample opportunities for the industry to leverage new technologies to improve customer offerings and enhance its omni-channel experience.

Traditional insurers are expected to face much competition within the industry, while smart deployment of technology can capture the tremendous opportunities in this rapidly growing insurance space. Both regulators and industry players have been striving to catch up with the latest technology in order to serve the best interest of our customers in Hong Kong, as well as to ensure a healthy industry growth. As an example, we have also launched a simple term product, sold online, which has been well received by our customers.

We expect the industry to introduce more lifestyle-centric offers to relate insurance to the daily lives of customers. Insurers strive to use lifestyle offerings to build long-standing, meaningful relationships with customers. New ecosystems will be evolved. Lastly, there will be changes in the regulatory landscape in Hong Kong, as the Office of the Commissioner of Insurance transits to the Independent Insurance Authority. We look forward to continuing to work closely with the Insurance Authority for the future and the betterment of the community.

Brazilian laws need to match economic order

Posted on by Max Tomlin

Insolvency procedures are among the most complex and challenging in today’s business environment. In most cases there has been a breach of contract, bringing together a series of collateral effects that should be addressed. However, when it comes to the insolvency processes, the question is: should the laws meet the demands of the economic environment, or should the economy follow the dictates of the laws? Maybe the most appropriate answer is to establish a balance between the two points.

In the case of the laws that govern insolvency processes, for those that are dissociated from the reality of the economic environment, the market will find ways to correct such distortions. Other important points include the application of laws, the understanding of their principles, the establishment of jurisprudence, and their correct application. Nevertheless, talking only about the application of the law by the judicial branch may not be sufficient for a balanced analysis of its efficiency.

In light of a series of recent macro and microeconomic events, Brazil is at a moment of great reflection with regards to the insolvency processes and laws that were implemented 11 years ago. Many initiatives to introduce changes in the law are currently in progress from a variety of sectors in the economy. Part of these proposals is aimed at creating an environment with a greater balance of power in the relationship between the debtor and its creditors. Another part suggests the submission of all debtors’ creditors to the insolvency procedures, since the current laws provide for credits that are not subject to the recovery process. For example, the fiduciary liens and tax debts, which may hamper the finding of a global and integrated solution.

Moving forward
On the part of entrepreneurs in the industry, the greatest challenge to be faced is the cultural change that occurs with the postponement of corrective measures – the so-called ‘denial period’, when it is expected that a fact will suddenly arise and reverse a company’s decline process. Unfortunately, we still see some companies resorting to formal insolvency processes when they are undercapitalised and have few alternatives for their reorganisation. This can even happen when they have already missed the required deadlines.

Contrary to what we assume, a modest number of successful reorganisations are largely due to such mistimings, rather than the structure of the law itself or its application. Nevertheless, in my view, there is room for improvement in both.

In light of a series of recent macro and microeconomic events, Brazil is at a moment of great reflection with regards to its insolvency processes

Taking bad timing into consideration, aligned with the cash crisis of most of the companies that are submitted to the reorganisation process, the creation of stimulus to the entry of liquidity becomes an essential factor for us to achieve more success. A simple solution would be to qualify credits granted to the entities under reorganisation as a priority, including in bankruptcy.

Regarding the need for cultural change among entrepreneurs, we still frequently see inadequate levels of transparency and symmetry of information. In recent years we have already seen good progress, but there is still much to move forward with in order to create greater efficiency.

Local law
Another point that still needs to be addressed is the organisation of creditors and creditor committees, the latter of which remain underused. Better organisation by creditors could substantially help the process, since creditor committees have greater supervisory and bargaining powers compared with individual creditors.

With regards to the application of the law, the creation of specialised courts with regional operations may be an alternative of great relevance. Through this, we could prepare and apply specific training to the involved parties, exercise better control and have a more consolidated jurisprudence that would result in the legal certainty and predictability that is necessary to the economic environment.

It is clear that in Brazil we have seen complex processes in terms of the reorganisation of companies, recovery of credits and all related social benefits. Fortunately, we have achieved much success in these last 11 years, but we must push on further still for the continued improvement of the culture and procedures involved in reorganisation.

Click here for more from Deloitte Brazil

Brazilian trade regulations ‘too complex’

Posted on by Max Tomlin

Approximately 20 years ago, in order to discourage tax evasion, the Brazilian Government introduced a series of rules aimed at avoiding the undue transfer of profits through transactions conducted between multinational companies and their parents or associates abroad. Since then, all movements of goods, services and rights between entities belonging to the same group have been subject to transfer pricing rules.

Naturally, there are many countries in the world that also have transfer pricing regulations and guidelines. However, the Brazilian laws are unique and are considered by specialists to be too complex, especially given their clearly revenue collection-oriented nature.

Introduced by Law 9430/1996, these rules became effective in 1997. Although they were significantly revised in 2012 with the enactment of Law 12715, there are still numerous challenges for taxpayers, including with regard to foreign exchange fluctuations, which occur mainly during severe economic instability.

One of the assumptions underlying transfer pricing calculations by Brazilian entities is that such calculations must be made in Brazilian reals. At the same time, the methods that are most used both by Brazilian importers and exporters are those that require minimum profitability margins in import and export transactions. These methods are the resale price less mark-up (PRL) method and the acquisition or production cost plus taxes and income (CAP) method respectively.

Differing methods
The PRL method – which is applicable to imports – requires that a local entity reports a statutorily predetermined gross profit generated by goods, services or rights imported from related parties when resold to third parties. This can range from 20 to 40 percent, depending on the industry. However, these profits can vary significantly since they are directly linked to how foreign exchange fluctuation affects the import prices and, consequently, the cost of sales. In other words, every time the local currency depreciates, the import price in the Brazilian real increases and, as result, profit margins drop, thus leveraging potential taxable adjustments.

The Brazilian transfer pricing laws are unique and are considered by specialists to be too complex

On the other hand – and based on the same reasoning – there can be an adverse impact on exports in the case of an appreciation of the Brazilian real. This impact occurs when the CAP method is applied, since this method requires that the Brazilian taxpayer adds a fixed gross mark-up of at least 15 percent to the cost of all the goods, services or rights exported to its related parties.

However, specifically with regard to the CAP method – as well as one of the waivers of proof criteria applicable to export transactions – the federal government allowed exporting taxpayers to use the adjustment mechanism applicable to transfer pricing under administrative rules, so as to mitigate the impacts arising on the appreciation of the Brazilian real against foreign currencies. Therefore, in conformity with said administrative rules, taxpayers have been able to apply foreign exchange adjustment factors on revenue generated by exports to related parties in different calendar years.

In summary, the Brazilian Government has allowed exporters to add targeted percentages, which vary depending on the year, to the prices actually charged in order to increase the sales prices. As a result of this, an exporter can decrease or even eliminate a possible gap between the price charged on exports and the benchmark price, whether by applying the CAP method or the waiver of proof criterion.

We must highlight that the administrative rule currently in force does not provide for the use of the same mechanism when other transfer pricing methods – such as PVEx (export sales price), PVA (wholesale price in the country of destination, less profit) and PVV (retail price in the country of destination, less profit) – are applied. This is because, if the goal is to mitigate the impact of foreign exchange fluctuations, it does not make sense to apply this adjustment in methods that already use foreign currency-denominated amounts as a pricing basis and, consequently, somehow already contemplate some type of adjustment in light of the foreign exchange rates used. This is not the case, however, for CAP, which uses the costs incurred in Brazil for pricing purposes.

From an economic standpoint, the federal government’s approach of seeking to eliminate – or at least alleviate – the distortions caused by foreign exchange fluctuations to avoid making unreal adjustments to exports price is quite reasonable, not to say commendable. We emphasise, however, that the government does not allow the same type of flexibility in the case of imports, which often exposes the taxpayers who conduct import transactions to economic hardships that are beyond their control and cannot be mitigated with good management or a sound transfer pricing policy. Even though foreign exchange is a variable that escapes taxpayers’ control, there are some alternatives and procedures that could be adopted to mitigate or even eliminate the possible transfer pricing tax adjustments, even in a foreign exchange fluctuation scenario.

New alternatives
One of these alternatives is for the Brazilian entity’s management to negotiate the possibility of conducting import and/or export transactions in Brazilian reals. This way, the foreign exchange risk would remain overseas and the profit margins could be negotiated in advance in order to comply with the prevailing laws and regulations, while being maintained without any interference from economic drivers.

The use of simple price benchmarking methods – or other methods that size the maximum profit margin earned by related companies abroad – could also constitute an option for organisations that seek to scale down their own taxable adjustments. Since there is no benchmark for a price charged in a foreign currency with a benchmark price calculated on costs incurred or revenue recognised in Brazilian reals, as is the case with the CAP and PRL methods respectively, foreign exchange fluctuations do not tend to have any impact on taxable adjustments.

However, the use of any other method basically requires having access to foreign information, which in practice could be a barrier, especially when the relationship between the Brazilian entity and the related parties that hold such information is not close.

Credit notes
When a taxable adjustment to transfer pricing is identified, it is not uncommon to resort to the use of so-called ‘credit notes’ as an alternative to reduce such taxable adjustment. It is worth noting, however, that Brazilian tax legislation does not acknowledge or address the use of credit notes and, consequently, such use for the purpose of scaling down transfer pricing adjustments could be challenged by the tax authority.

Even though many address the matter rather simplistically, there are numerous aspects that should be taken into consideration when assessing the use of a credit note to ensure the intended outcome is achieved, with a high level of certainty that it will be accepted. The most relevant of these aspects include: the note issue timing; supporting documentation for the imported goods to which the note will make reference; the technical treatment used to calculate the price charged and the benchmark price; and customs and other impacts.

Even though, as mentioned above, the use of a credit note requires care, discretion and moderation, this alternative should be considered, especially when the primary goal is to reduce or eliminate the impact of the double taxation commonly produced by transfer pricing adjustments.

Price watching
Without disregarding the possibilities described above as alternatives to soften the impact of transfer pricing, the periodic monitoring of import and export prices is key for any taxpayer subject to these rules.

Even though there is an annual obligation to file transfer pricing calculations, adopting price monitoring as a recurring practice on a monthly basis, or at least every quarter, coupled with price renegotiation is still one of the most efficient ways of avoiding transfer pricing adjustments.

As the calculations are made using average prices charged per item, theoretically these could be renegotiated, adjusted or previously offset against each other, according to the outcomes of the partial adjustments determined for each calculated period.

Obviously, in order for this to happen it is necessary to monitor impacts from a customs standpoint and, essentially, make sure the foreign related companies are flexible enough to engage in such price renegotiations throughout the year. Based on this quick, skimming approach of the impacts of foreign exchange fluctuations, we can see how important it is for a taxpayer to have a detailed knowledge of the Brazilian transfer pricing rules and be aware of the paths that can be treaded to soften its impacts.

Finally, we emphasise that the foreign exchange impact is but one of the numerous aspects to be observed, and that there are many other equally or even more complex issues that, if not appropriately grasped, handled and addressed, could result in a high tax burden or severe penalties.

 

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China set to grind down its salt monopoly in market shake-up

Posted on by Max Tomlin

China’s state control of the salt sector – thought to date back to the seventh century BC – was officially dismantled on January 1 as salt producers were exposed to market forces.

The monopolistic system was previously under full state control, with producers required to operate under a national quota. Under the new reforms, licensed companies will now be permitted to set their own production rates and distribution patterns, as well as being able to run their own marketing campaigns. Companies will also be permitted to operate outside their previously designated areas for the first time. Additionally, the reforms will allow new openings for private capital to be invested in the sector.

The salt monopoly… once provid[ed] the funds for emperors to built parts of the Great Wall of China

The industry will remain heavily regulated, however, with no new licenses being issued for table salt producers. The government will also retain some level of supervision over pricing, in order to “prevent abnormal fluctuations”, according to the official plan published last year. Furthermore, regulations will ensure that distributors provide good quality salt – which must be supplemented with iodine – to 90 percent of the market. The addition of iodine to table salt has been part of a health drive to reduce iodine deficiency in the Chinese population.

Shortly after the reforms were announced, Zou Jialai, a Shanghai-based lawyer, told The Wall Street Journal: “It’s a milestone for China’s salt reform. The removal of state controls over price and distribution is big progress for the industry.”

The move is part of a much broader effort to move away from central planning in the Chinese economy, and the ruling party has pledged to carve out a “decisive” role for the market over the coming years. Given the history and former financial significance of the monopoly, the decision certainly has symbolic value. The salt monopoly has witnessed a rich history while in state hands, once providing the funds for emperors to built parts of the Great Wall of China.

However, despite this symbolism, the industry has less financial clout than other, more lucrative state-controlled industries. Larger state dominated sectors like tobacco, energy and banking are yet to experience a substantial overhaul, which would mark a more convincing shift towards market forces in the slowly transitioning economy.

Scaling the wall of Trump’s doctrine

Posted on by Max Tomlin

“As democracy is perfected, the office of president represents more and more closely the inner soul of the people. On some great and glorious day, the plain folks of the land will reach their heart’s desire at last, and the White House will be adorned
by a downright moron.”

HL Mencken

As President-elect Donald Trump approaches his inauguration on January 20, world leaders are no doubt wondering with some apprehension how an America led by a property developer and reality television star will act on the world stage.

After all, there’s no precedent in modern times for a political novice with little international experience occupying the White House at such an unusually complex and tense period. And yet organisations such as the G20 will expect the new president to have effective ideas for a delicately poised world with much of the Middle East and North Africa in turmoil, an Asia-Pacific region concerned about China’s claim to most of the South China Sea, a shaky eurozone, international terrorism on the rise, a muscle-flexing Russia, and the urgencies of global warming.

Overall, most commentators declare themselves perplexed and confused by Trump’s views of the world beyond the Statue of Liberty

In short, will a Trump administration have an international or xenophobic perspective on these and other pressing issues that, by definition, require the full engagement of the US? Based on the candidate’s campaign speeches, here’s what we know.

Taking the terrorism threat first – if only because Trump hammered it to death while on the campaign trail – the fight against jihadists would go up several notches. “Containing the spread of radical Islam must be a major foreign policy goal of the United States”, he announced at frequent intervals.

This would occur on several fronts. Assuming the president-elect means what he says, ISIS would be bombed out of its various strongholds and “extreme Muslims” would be expelled from the US. Co-operation with countries that have produced radical Muslims would cease forthwith. By implication, these would include Belgium, the UK, France, most of North Africa, much of sub-Saharan Africa, and parts of the Asia-Pacific, among other regions and countries that, deliberately or inadvertently, have harboured jihadists in the past. However, provided they cooperate fully, Trump’s America would also work with “our allies in the Muslim world”.

Second, America would re-arm rapidly. Impatient with what he decries as President Barack Obama’s “gutting” of the US’ nuclear arsenal and running down of the armed forces, the incoming president said: “Our ultimate deterrent… is in need of modernisation and renewal.” In terms of firepower, Trump clearly sees his mission as restoring the US to the status of the world’s greatest military force: “The Russians and Chinese have rapidly expanded their military capability, but look what’s happened to us.”

Furthermore, America’s allies would be expected to foot a greater share of the bill. Claiming the US has borne the brunt of defence spending that’s now protecting Asia and Europe, Trump would require other countries to boost their defence budgets if they ever want help from America. For instance, he has argued only four of NATO’s 28 member countries are spending the obligatory two percent of gross domestic product on their armed forces. If they don’t take more responsibility, he warned, “the US must let these countries defend themselves”. On the same subject, he warned that America would take a long, hard look at its defence treaties with Japan and South Korea, among others.

A bad deal for America
In matters of trade, Trump has foreshadowed a modern version of isolationism, in spite of the overwhelming evidence of the benefits of the free global exchange of goods. He has already repudiated the Trans-Pacific Partnership (calling it “a terrible deal”), which had just been agreed between 12 Pacific Rim countries, excluding China. He has also slammed the 22-year-old North American Free Trade Agreement (NAFTA) between the US, Canada and Mexico for “emptying” the US of jobs. He also appears to hold the World Trade Organisation (WTO) in scorn.

The incoming president’s rationale for setting up import duties against other countries’ goods is that President Obama’s “open borders” policy has created a $1trn trade deficit in manufacturing, with the rest of the world having stolen countless jobs from Americans. This statistic is questionable, to say the least. “We’re rebuilding other countries while weakening our own”, he argued.

276

seats were gained by Trump in the Electoral College vote

0.7%

The dollar’s rise in the ICE US Dollar Index following Trump’s victory

1,900

miles – the length of the US-Mexico border

$25bn

The Washington Post’s estimate for the cost of Trump’s infamous wall

But, as the respected independent Washington-based think tank Cato Institute warned: “His threat to dismantle NAFTA and to use import duties to force our trading partners to bend to his will would tank any economic recovery and have severe constitutional implications.”
In trade, as in its wider relationships with the outside world, America hasn’t been tough enough for Trump’s liking. As he put it: “In negotiation you must be willing to walk. The Iran [nuclear] deal, like so many of our worst agreements, is the result of not being willing to leave the table. When the other side knows you’re not going to walk, it becomes absolutely impossible to win.”

On the positive side, he added: “At the same time, your friends need to know that you will stick by the agreements that you have with them.”

Third, in all his administration’s decisions, the interests of America will come first, second and last. “I will view the world through the clear lens of American interests”, he promised to thunderous cheers on the campaign trail. “I will be America’s greatest defender and most loyal champion.”

Trump’s repeated references to “America first” concerned other world leaders, as it amounts to a complete reversal of Obama’s US foreign policy, which has engaged much more fully and openly with the outside world than that of the Bush administration. The subtext behind “America first” is Trump’s conviction that the interests of the nation state should triumph over transnational organisations – never mind that these bodies have been created to harmonise the efforts of individual countries in the achievement of mutually beneficial goals.

As we’ve seen, Trump has little respect for the WTO. But many commentators believe his low regard for transnational bodies may extend to NATO, financial organisations such as the World Bank and the IMF (both of which rely greatly on US support), and perhaps even to political organisations such as the UN and EU. “I am sceptical of international unions that tie us up and bring America down”, he said. “I will never enter America into any agreement that reduces our ability to control our own affairs.”

To many, that sounds very much as though he’s got no patience with the UN – an organisation which, it is claimed, frequently ties American hands.

Taking down the bogey states
In Trump’s worldview, there are ‘bogey’ nation states: China, for one, cropped up frequently during his campaign. He virtually blamed the entirety of America’s purported haemorrhage of jobs on the nation, accusing it of supporting North Korea (roughly 90 percent of the latter’s trade is with China). Indulging in some additional Obama-bashing, Trump also blamed the president for “allowing China to continue its economic assault on American jobs and wealth, refusing to enforce trade rules or apply the leverage on China necessary to rein in North Korea”. As a result, Trump told voters, China had lost all respect for America.

On safer ground, he also faults the Obama administration for allowing China to “steal government secrets with cyber attacks and engage in industrial espionage against the United States and its companies”. Although that’s generally true – as experts on cyber attacks unanimously agree – it’s also true that the Pentagon and other similar agencies run active worldwide espionage campaigns that are considered to be at least as effective as those of China.

Iran is another enemy of Trump’s America (he would immediately dismantle its nuclear capability, for instance) – and so, of course, is Mexico, because so many of its citizens live illegally across the border.

To Russia, by contrast, he has handed an olive branch. During his election campaign, Trump expressed admiration for Vladimir Putin and said he was looking forward to meeting Russia’s sanctions-hit president. This has worried some commentators, who cite the Russian leader’s guile and cunning. “Does [this mutual admiration] mean US-Russia relations will suddenly be repaired, giving Putin a free hand in Europe and a proxy in the White House?” international lawyer and political commentator Robert Amsterdam asked in November. “Not so fast.”

But we might find out all too soon: Amsterdam fears Putin could move quickly to test the boundaries of his relationship with the Trump White House by invading, for example, the Baltic countries, thereby drawing Trump into a trap “in which confrontation with Russia is unavoidable”. As financial and other sanctions over the invasion of Ukraine bite deeper into the Kremlin, the fear is Putin could strike in the early weeks of the Trump presidency, before the incumbent has his feet firmly under the table.

Until – or if – that happens, the new president believes he could strike a rapport with Putin. “Some say the Russians won’t be reasonable”, he said. “I intend to find out. If we can’t make a good deal for America, then we will quickly walk from the table.”

But despite his aggressive rhetoric, Trump insists he’s not spoiling for a fight with nations he doesn’t count as friends: “We desire to live peacefully and in friendship with Russia and China. We have serious differences with these two nations, and must regard them with open eyes, but we are not bound to be adversaries.” He cited common ground with Russia, for instance, based on shared interests including the fight against Islamic terrorism.
But if he openly dislikes some countries, Trump has a soft spot for others. Israel – “one of our greatest allies” – would certainly qualify, and so would Scotland, the birthplace of his mother and the home of the Trump golf course near Aberdeen.

But so far, at least, his worldview does not encompass Europe or the Asia-Pacific. And it certainly doesn’t embrace Latin America, for which he has not articulated a coherent policy – if you exclude the running battle with Mexico over the infamous wall that would be built (by Mexico, insists Trump) to keep “illegals” out. It is a strategy that contributed to the rapid drop in the Mexican peso’s value during election night in November (see Fig 1).

True or false?
In any examination of the entrails of what has euphemistically been described as the ‘Trump doctrine’, the problem is whether the president-elect meant what he said in the run-up to his stunning election victory – or whether he was simply saying what he wanted voters to hear. Certainly, the soon-to-be 45th president’s various expositions of foreign policy were riddled with errors. The question is whether these were deliberate or not.

As several news organisations hastened to point out, he was plain wrong in some assumptions, half-right in others, and on the mark in very few. For example, he promised the US will put a stop to the “era of nation-building” – that is, attempts to install democracies in Iraq and Afghanistan – that Obama had allegedly practised. In fact, as ABC News noted, the statement was “mostly false”, because Obama had actually phased out most of the large-scale nation-building efforts that originated with the Bush administration.

Trump also repeatedly misrepresented his own position on some big issues, such as the war in Iraq. He insisted throughout the campaign he had opposed the invasion from the beginning, despite the fact, as ABC News reminded him, that he’d sat on the fence. Other news organisations proved he had supported the invasion of Libya, even though he repeatedly lambasted Hillary Clinton for allegedly prosecuting the war that toppled Gadaffi. They also cited several falsehoods about the role of the Obama administration in the coup in Egypt in 2013, and other upheavals in North Africa during the ‘Arab Spring’ of 2010.

Overall, most commentators declare themselves perplexed and confused by Trump’s views of the world beyond the Statue of Liberty. Describing one speech, popular current affairs site Vox Media fulminated: “The bulk of it was dedicated to demagoguery, xenophobia and bizarre lies about status quo immigration policy in the United States and Hilary Clinton’s proposals for gun regulation.”

However, according to his audience, Trump can change tack. When, for instance, the Prime Minister of Pakistan, Muhammad Nawiz Sharif, called to congratulate him on his election victory, Trump was pleasantly effusive, despite Pakistan being one of the countries that would be on his banned list for harbouring terrorists. According to the Pakistani Government’s transcript of the conversation, the incoming president told the prime minister he was “a terrific guy” who was “doing amazing work” in “an amazing country with tremendous opportunities”. Further, “all Pakistanis I have known are exceptional people”.

And, far from informing his caller that he regarded Pakistan as a rogue nation, Trump told the probably-startled prime minister that he was “ready and willing to play any role that you want me to play” to address his nation’s problems.

The global superpower
If Donald Trump is true to his rhetoric, world leaders should expect him to behave as though America is the world’s superpower with the dominant role in global politics. Indeed, his “America first” motto has led him to make exaggerated claims about his country’s role in world affairs. For instance, he appears to believe America won the Second World War single-handed: “We have a lot to be proud of. In the 1940s, we saved the world”, he insisted in April last year. “The Greatest Generation [a description he borrowed from a 1998 book about Depression-era soldiers] beat back the Nazis and the Japanese imperialists.” Though, as countless war historians have pointed out, this statement completely ignores the contribution of the other Allied powers.

The subtext behind “America first” is Trump’s conviction that the interests of the nation state should triumph over transnational organisations

Trump also stated as fact that Mikhail Gorbachev acted under instructions from Ronald Reagan when the Soviet Union was dismantled. “Then we saved the world again, this time from totalitarian Communism”, he declared. “The Cold War lasted for decades, but we won.”

Because of sweeping and frequently inaccurate statements such as these, foreign policy specialists are nervous of how the new president will act and behave in the future. “It’s impossible to tell from his stated agenda what his foreign policy would actually look like”, noted Vox Media. “But it’s easy to see that it’s going to be a muddle driven by impulse and catch phrases, unguided by actual understanding or reliance on the support of anyone who has it.”

Others are slightly more sanguine, suggesting Trump will be more pragmatic once he takes office. “Trump’s foreign policy will be much more fluid than anticipated, but we are still potentially looking at some fundamental, tectonic shifts in the post-Second World War international system”, predicted Amsterdam.

Surprisingly, business and finance professionals in Shanghai and Hong Kong are also optimistic. According to a poll conducted by the deVere fund management group two weeks after Trump’s election victory, a healthy majority of 650 top executives believed the new president will have “a positive effect on the world economy”, citing Trump’s expected dismantling of some of the regulations imposed on Wall Street and his softer attitude to global warming, which, they expect, will boost the extractive industries. There’s also talk that he may emasculate the FATCA tax evasion laws that are widely resented in several regions, including the Asia-Pacific.

trump-fig-2They could also have mentioned Trump’s promise of individual and corporate tax cuts. Along with regulatory reform, these “hold great promise”, according to the Cato Institute. But whatever Trump’s foreign policy turns out to be, it will certainly be diametrically different from that of the Obama administration. “Our foreign policy is a complete and total disaster”, Trump said of the current regime. “[It has] no vision, no purpose, no direction, no strategy.” The big question is what it will be replaced with.

Part-term president
Hovering over the 45th president is the possibility he may not last a full term. Even as he prepares to take office, a powerful groundswell of opposition is building against his policies, his personality and his lack of the popular vote (see Fig 2). In late November, the left-wing magazine The Nation began organising a full-scale, America-wide, volunteer-led campaign with the sole purpose of destroying a Trump presidency. The Nation sees this as nothing more nor less than a mission to save the country. It said: “Passionate, moral and urgent opposition to Trumpism could represent the greatest opportunity for mass participation in politics since the anti-war movement of a half-century ago.”

There’s also serious opposition in government circles, even from within Trump’s own party. Insiders report a powerful bloc within the Grand Old Party is so concerned about the damage a loose-cannon president – if, indeed, that is what Trump turns into – will do to the Republicans that they feel they cannot support him, or the party will be tainted by association and lose all chance of winning the election in another four years’ time.

One thing is for certain: if President Trump lasts the distance, it will undoubtedly be a turbulent four years.

Growing infrastructure: the international agenda

Posted on by Max Tomlin

As the world meets in Davos to survey the economic situation around the globe, a fairly consistent view emerges: countries have generally high levels of public debt, lower-than-desired rates of economic growth and job creation, and historically low interest rates providing little incentive to save. Added to this, many also have acute problems of youth unemployment as the world has moved to globalised, automated and streamlined production and services alike.

Looking at Europe, these issues are compounded by social and economic pressures, due to unfavourable demographic trends and high migration levels produced by conflict and economic distress in neighbouring countries. Viewed through the lens of emerging market countries, the imperative to achieve economic growth – while encouraging quality investment that raises living standards and competiveness – is a real-world issue that, if left unfulfilled, will negatively affect political and social stability.

And yet, while many emerging market countries do appear to be stuck in transition at present, these same countries currently have opportunities to attract investment due to a unique set of circumstances.

The infrastructure gap
New infrastructure is undoubtedly necessary in emerging markets to enable economic growth, but it is well established that the difference between the infrastructure needed and the current level of actual investment is very sizeable. The emerging market ‘infrastructure gap’ is estimated by the OECD, WEF, IMF, World Bank and various academic institutions to be somewhere between $2trn and $3trn per annum, when taking into account the dual need to modernise and expand infrastructure, as well as the need to make green investments called for by the UN Sustainable Development Goals (SDGs).

The difference between the infrastructure needed in developing economies and the current level of actual investment is very sizeable

Today, around 20 multilateral development banks (MDBs) are active, including the newly created Asian Infrastructure Investment Bank and the New Development Bank. According to recent G20 estimates, the operational commitments of major regional MDBs and the World Bank Group total around $80bn to $90bn annually. But despite this substantial balance sheet potential, MDB operations cover less than five percent of the total infrastructure gap for emerging markets.

The gap between the ability of MDBs to provide direct funding and the latent and real demand in emerging markets has focused international debate on how MDBs can catalyse more third-party financing – particularly private finance from commercial banks and non-bank financial institutions – to cover more of the financing needs. Given constrained fiscal balance sheets, it is clear much of this new investment will need to come from the private sector.

Growing interest
Following the global financial crisis, a downward trend in interest rates set in across most developed countries, a situation that persists to this day. Given the duration of such low rates, even naturally risk-averse investors, such as pension funds and insurance companies, have become increasingly interested in diversifying a portion of their portfolios into higher-yielding investments in emerging markets.

Due to the unique nature of infrastructure projects – very long-lived assets with relatively stable revenues – such investors have woken up to emerging market infrastructure as a type of investment where they would like to increase their share, which currently stands at just 1.1 percent. A 2016 survey by EDHEC and the G20 Global Infrastructure Hub (GIH) revealed that 70 percent of institutional investors want greater portfolio exposure to emerging markets infrastructure. With some $50trn of assets under management belonging to institutional investors, a two percent asset allocation by this massive pool of capital would account for $1trn.

In 2015, Moody’s published an influential report reviewing the performance of some 1,400 PPP projects from the mid-1980s to 2014. The report showed they have a comparatively low default rate of three percent – lower indeed than the default rates of some 6,000 general project finance loans (six percent) during the same period. Furthermore, it was shown there is no statistically significant difference between the default rates of infrastructure in emerging market countries versus developed countries. This conclusion should help close the gap between ‘perceived risk’ and ‘real risk’ for investors.
The passage of SDGs in 2015 has focused the need for cleaner investment that deals with both climate change mitigation and adaptation. Donors, international financial institutions (IFIs), international banks and industrial players have all committed to ambitious investment targets, where resource efficiency and sustainable infrastructure will be central to the action plan over the next 15-20 years.

Supporting the infrastructure agenda
If there is such need for clean, high-quality investment with higher yields, and the emerging market infrastructure sector offers a place for capital to be attracted, why isn’t more happening? The answer is simple to identify, yet complex to solve: due to weak institutional capacity in the public sector, there are not enough investible projects available.

This deficiency leads to projects that are too often presented to the market with unacceptable structures and unpalatable risks. Multiple barriers curtail investment in emerging market infrastructure: major risks are related to local currency and convertibility, political and regulatory uncertainty, and a lack of certainty surrounding revenues, tariffs and project-based cash flows. The result is too many failed tenders leading to, ultimately, underinvestment in infrastructure.

The response that has formed over the past four years, led by IFIs, the G20, OECD, WEF, key bilateral donors and other key development finance organisations (DFIs), has coalesced around a multifaceted joint agenda for infrastructure support. There are four primary areas of support for this agenda: first, a number of project preparation facilities (PPFs), with some $300m committed in total, have been formed to create a deeper pipeline of well-prepared, investible projects for the benefit of emerging market countries. In addition, many of these countries have created national-level PPFs to boost pipeline development.

The external support for deeper and better prepared pipelines can only be sustained if emerging market governments invest in the institutional capacity to select, plan, prepare, tender and monitor quality infrastructure. As a complement, the International Infrastructure Support System (IISS) is a platform for project pipeline dissemination led by the local country managers and supported by all major IFIs, using standardised templates for each subsector project type.

Second, there is an acute need to disseminate leading practices and build capacity. The PPP Knowledge Lab is an online space that consolidates all major policy outputs across IFIs, and features outputs by the PPP Infrastructure Resource Centre, the Public-Private Infrastructure Advisory Facility and regional IFIs. OECD’s extensive programme of research and policy advice has focused on infrastructure in emerging market countries. The PPP Certification Programme, supported by the IFIs, provides for the first time a standardised body of knowledge emerging market governments can use to train their key staff on PPPs.

Third, policy initiatives are critical to sustaining the lessons learned across countries and regions, while also stimulating innovation. Building on the successful ‘PPP days’ organised by IFIs since 2004, the Global Infrastructure Forum, which held its inaugural meeting in 2016, is set to annually bring together the heads of all IFIs with the UN Secretary General to provide high-level direction.

The G20’s GIH, created under the Australian G20 presidency in 2014, is producing a suite of knowledge products, ranging from the PPP guide to the capability framework to boost private sector investment in particular. The WEF’s Strategic Infrastructure Series, meanwhile, provides insights informed by its Global Agenda Council on Infrastructure. Finally, the Global Infrastructure Connectivity Alliance, created by the G20 in summer 2016, was established to disseminate lessons learned on critical cross-border corridor development that facilitate global trade and inform major new efforts, such as the Belt and Road Initiative.

Finally, risk mitigation, credit enhancement and blended finance are particularly active agendas for IFIs. The World Bank’s Multilateral Investment Guarantee Agency’s panoply of risk insurance products is now complemented by new credit enhancements, such as the Managed Co-Lending Portfolio Programme, where the Swedish International Development Cooperation Agency provides first-loss coverage at scale for IFC loans which are offered on an automatic pari-passu basis to institutional investors, such as major insurers.

The Sustainable Development Investment Partnership includes some 50 entities (donors, IFIs, DFIs, global banks and other international organisations) that seek to provide coordinated credit enhancement and other means of support to accelerate investment in emerging market countries. Convergence, which has been backed by the Government of Canada, WEF, OECD and the Ford Foundation, also provides risk mitigation for particular project finance deals, especially in lower income countries.

Local expertise
With over $300m available, there are enough resources in IFIs’ PPFs to prepare and tender out more than 150 complex infrastructure projects over the next 24 to 30 months across emerging market countries. If successful, the global project capex result would be approximately $30bn, assuming a $200m-per-project capex value. But for this to happen, the PPFs need to become fully operational by getting the mechanics right.

They need to be selective by subjecting each project request to a vetting process, so as to understand the basic business case, verify the readiness of the legal framework, analyse affordability, and do an initial assessment of the main risks to identify potential deal-breakers. Once this ‘phase zero’ vetting is done, high-quality advisors are needed. The European Bank for Reconstruction and Development’s (EBRD’s) IPPF, for example, has a roster of four internationally experienced and pre-selected external ‘framework consultant’ consortia which are able to be called off and mobilised in eight weeks. Part of this accelerated delivery is about such basic mechanics.

Another key aspect is knowledge transfer: the PPFs should make a conscious effort to work closely with clients using local experts. As countries like Chile, Korea, Singapore and Taiwan know from their respective development pathways, capacity building takes a dedicated long-term investment in your own people. There is no shortcut.

The PPFs should also seek to collaborate wherever possible, including joint funding and joint preparation of complex deals. Finally, IISS holds great promise, with a minimum target of 500 projects to be uploaded onto its cloud-based platform by 2020, in an effort to make IISS the go-to place for project pipeline information.

Knowledge that sticks
Knowledge platforms, such as the innovative PPP Knowledge Lab, have great potential to become primary destinations for public sector officials seeking to understand leading practices and lessons learned. However, IFIs, DFIs, donors and other international organisations need to follow up this offer with frequent regionally specialised ‘policy seminars’ that focus on real-world cases: what works, why and how.

The PPP Certification Programme offers the potential for a critical mass of emerging market and developing economy officials to learn the same set of PPP basics that the private PPP industry knows and employs when entering into contracts.

Due to the unique nature of infrastructure projects, investors have woken up
to emerging market infrastructure

The programme should help reduce the level of knowledge asymmetry that exists today, which can lead to unbalanced PPP contracts that are prone to restructuring. The aim should be to have 50 countries with 20 people each – 1,000 key figures in emerging market countries – PPP-certified by the end of 2018.

As noted in a report by the WEF, IFIs have developed a wide array of formal risk mitigation instruments to crowd in institutional investors. However, the uptake of those products seems to be limited, with risk mitigation instruments accounting for a mere 4.5 percent of total financing operations undertaken by major IFIs in 2013.

What is striking is there seems to be little standardisation across the formal MDB risk products offered. What is also apparent is the annual mobilisation contribution of these instruments has been extremely limited, making at best a marginal contribution to crowding in
private sector finance.

As a key enabler of global economic growth and jobs creation, achieving accelerated infrastructure investment in emerging market countries will require a deeper pipeline of bankable projects coming to market, supported by a suite of streamlined, standardised and comprehensive risk mitigation products to credit enhance projects. These efforts will need to be reinforced by policy dialogue and sustained capacity building, focusing on local expert networks and officials committed to the agenda.

And let us remember: the wall of institutional money waiting and wishing to move into emerging market infrastructure will only do so if the project opportunities to do so are clear, transparent and backed by enduring public policies and regulations.

This leads to a final consideration: governments must summon the political will to create the institutional and market conditions that in turn provide fertile ground for infrastructure investment. EBRD’s more than 25 years of experience of development banking has proven there is no substitute for a strong and committed local counterpart on the other end of international development projects – and infrastructure
investment is no different.

US strikes oil export deals

Posted on by Max Tomlin

In February 2016, the US completed its first major export of natural gas, with an American ship setting sail for Brazil. Cheniere Energy, the US firm that orchestrated the shipment, said the occasion represented a significant turning point in US global trade, with the energy company predicting “the US will be one of the biggest three suppliers of LNG by 2020”. In July, two further cargoes left Cheniere’s Sabine Pass plant in Louisiana, venturing to the Middle East – with Kuwait and Dubai the destinations. These shipments were symbolic of a major change underway in the world economy; they signalled the US’ increasing importance in the export of hydrocarbon fuels.

Better out than in
According to US Energy Information Administration (EIA) figures, February 2016 saw the country export 884,000 barrels of propane and propylene gas per day. At the time, this was the highest figure on record. The US has seen an almost constant year-on-year increase in its export of gas. Exports took a slight dip in the months following February’s record figure, down to 673,000 per day in March, before rising again to 700,000 in April. Data for May showed this number rising again, taking it to 894,000 per day, and beating February’s record figure. These numbers are a long way from the humble 127,000 barrels per day exported by the US in January 2011.

The world’s current top exporters of oil tend to be ranked poorly in terms of corruption and transparency

The trend is clear: the US is becoming an ever more significant exporter of propane and propylene gas. According to analytics provider IHS, cited in The Wall Street Journal, US oil and gas producers are “on track this year to export more propane than the next four largest exporting countries combined – OPEC members Qatar, Saudi Arabia, Algeria and Nigeria, which have long dominated the trade”.

The same is true for crude oil exports. As noted by the EIA: “Since the removal of restrictions on exporting US crude oil in December 2015, the number of countries receiving exported US crude has risen sharply. In 2010, the US was exporting 42,000 barrels of crude a day. By 2013 this surged to 134,000, and in 2015 it totalled a massive 458,000 barrels per day. In the first five months of 2016, US crude oil exports averaged 501,000 barrels per day, 43,000 barrels per day (nine percent) more than the full-year 2015 average.” The destination of these exports has also changed notably; prior to the December 2015 restrictions being lifted, the majority of exported US crude oil went to Canada. However, as the EIA noted: “In March, total crude oil exports to countries other than Canada exceeded those to Canada for the first time since April 2000.”

Shale trail
The bulk of this growth has come from the monumental increase in shale oil and gas extraction in the US. Technological advancements took off in 2008, quietly seeing US production of both natural gas and oil surge. A cocktail of high energy prices and cheap credit (due to a loose federal monetary policy) caused a flurry of investment in shale production. While softened oil prices have since seen many of the less cost-effective shale projects shut down, the US’ capacity to produce – and therefore export – hydrocarbons has seen rapid growth in the past eight years.

US oil exports in 2016 (barrels per day)

884,000

February

673,000

March

700,000

April

894,000

May

According to some commentators, the US’ newfound position as a major energy exporter will come with major geopolitical benefits for the country. For one thing, the country’s growing ability to export gas and oil to Europe will seriously dent Russia’s sway over the continent. Many European nations have been beholden to Russian natural gas – but with the US’ renewed ability to export this commodity to Europe, Russia’s influence will likely dwindle. The same is true for oil. According to a Manhattan Institute report by Mark Mills, entitled Expanding America’s Petroleum Power, more than “60 percent of Russian oil exports currently go to Europe”.

Europe currently imports roughly 90 percent of its oil needs, and European governments are keen to increase the amount sourced from the US. “During the 2014 EU-US trade negotiations”, noted Mills, “a leaked memo revealed European eagerness for access to American oil.” Becoming a major exporter of oil will also give the US leverage over an increasingly assertive China. The latter is both the world’s second-largest economy and the world’s biggest importer of oil. If the US were to increase its exports to China, it would further wed the countries economically, and provide the US with a powerful bargaining chip to counter any sway held by China’s ownership of US debt.

Good for the goose
The US becoming a major oil exporter not only puts it in a stronger geopolitical position, but also brings benefits to the global economy. Its increased role in oil deals should bring greater transparency and stability to markets. The world’s current top exporters of oil tend to be ranked poorly in terms of corruption and transparency. As Mills noted: “Because America scores well in these categories, as well as in rule-of-law metrics, an expanded role for the US in oil trade would add confidence and stability to global commerce.”

Oil prices will also, in theory, become more stable. Some of the world’s largest oil producers, such as Iran and Iraq, are global political hotspots. Political crises within countries in volatile political regions – be it war, revolutions or sanctions – will, with increased US global supply, be somewhat muted. OPEC’s power to manipulate and force price changes will also further be diminished. In fact, this is already happening, with the ability of the cartel to hold the world economy to ransom, as it did in the 1970s, now long gone.

Although not his obvious intention, under President Barack Obama’s two terms of leadership, the US changed from a major importer of energy to a major exporter. Although Obama’s legacy on energy is often spoken of in terms of his commitment to renewables and reduction in coal use, the shale boom over which he presided is much more significant. The transition will have, and indeed already has had, massive consequences for the wider world.

Navigating Turkey’s project finance industry

Posted on by Max Tomlin

Turkey is a key market for global investors, and continues to offer growth and investment opportunities. Erdem&Erdem is a full service independent law firm with offices in both Istanbul and Îzmir, Turkey. The company’s project finance team regularly advises clients on developing innovative financial structures that support infrastructure investment, and can address the specialised needs of lenders and developers in financing both public and private infrastructure projects, including acquisition finance, project finance and debt capital markets.

The highly skilled cross-disciplinary team of lawyers at Erdem&Erdem is one of the company’s major strengths. Each member provides integrated legal advice required for the development and financing of successful infrastructure projects. These include the negotiation and preparation of concession agreements, leases, direct agreements, construction contracts, operation and maintenance agreements, joint bidding agreements, joint venture arrangements, letters of intent, term sheets and other financing documentation.

Over the last 20 years, Erdem&Erdem has been involved in a large number of transactions that represent developers, sponsors, investors and financial institutions seeking to develop, acquire, bid on or sell infrastructure assets privately, under government privatisation, or as part of public-private partnership (PPP) programmes.

The team has developed a significant presence across many sectors with a strong insight into how to structure these transactions, as well as how to conduct efficient, in-depth and useful due diligence on the underlying assets and relevant documents. This is done by offering services across a full breadth of financial infrastructure techniques, and the financial engineering that improves asset value from structured finance within the infrastructure, energy, construction and engineering industries. This should also occur within the corporate, securities and real estate sectors, transportation, ports, airports, hospitals and power plants.

Recognised practice
A number of Erdem&Erdem projects have been recognised as landmark transactions. In Turkey, the company represented YDA Group on the construction and financing of Dalaman Airport’s domestic terminal, and assisted on the Kayseri Integrated Health Campus. Dalaman Airport received the first prize in Bonds & Loans’ Transportation Finance Agreement of the Year category, and second price in the Syndicated Loan of the Year category. The financing of the Kayseri Integrated Health Campus received third prize in Project Finance of the Year, Syndicated Loan of the Year and Structured Finance of the Year categories by Bonds & Loans in 2015.

In Kazakhstan, Erdem&Erdem advised the Yıldırım Group on financing Voskhod Chromium, with $245m of the term loan facility raised through UniCredit and the European Bank of Research and Development (EBRD), as the first chromium mining project financing in the history of EBRD. Voskhod Chromium financing won the Best Project Finance Deal award and the Best Natural Resources Deal award from the EMEA Finance Institution in 2016.

Legal enforcement, compliance and sustainability all play key roles in achieving reliable outcomes for infrastructure financing

In Ecuador last year, Erdem&Erdem represented Yılport Holding for the operating rights transfer of Port Bolívar in Machala for a period of 50 years, conditional for a return investment of $750m by Yılport Holding, sealed in an agreement with Ecuador’s government.

Dalaman Airport’s investment comprised EBRD financing from a senior A/B-loan to YDA Havalimanı Yatırım ve Îs˛letme, a special purpose vehicle company of YDA Construction, part of the YDA Group of Turkey. The financing by EBRD consisted of an A-loan portion of up to €87.5m ($92.3m) and a B-loan portion of up to €87.7m ($92.5m), syndicated to UniCredit Bank Austria. The funds were provided to support the construction of a new domestic terminal at Dalaman Airport, together with auxiliary structures.

Due to its proximity to major tourist resorts in the southern Turkish Riviera, Dalaman Airport is one of the key airports in Turkey. The deal is a benchmark one in the private sector and of airport infrastructure across Turkey. Dalaman Airport’s financing is historic, as it is the first regional airport financed by EBRD, one of the most respected players of infrastructure financing projects.

Erdem&Erdem’s approach has always focused on minimising the subjectivity across financing agreements and planning a development strategy through to procurement. The firm aims to create contracts and the management and operational phases permitted for future investments under the main contractual framework, tailored specifically for airport construction financing.

Prior to the negotiation of financing agreements, Erdem&Erdem’s focus was first and foremost on identifying unique issues facing the public authority, and the sensitivities of commercial considerations of private institutions as developers and operators, which may be particularly complex across different levels (with respect to individual infrastructure projects implemented for the first time), as in the case of Dalaman Airport.

A healthcare focus
PPP projects are officially introduced by an explicit reference to the term itself under the Building and Renewal of Facilities and Procurement of Services law through the PPP model. Historically, Turkey’s first and foremost implementation of PPP projects was targeted at the construction and rehabilitation of hospitals in a structured legal framework introduced by the PPP law in healthcare. However, it opened up the path to future PPP growth in infrastructure investments – particularly transportation – with toll roads, railroads, toll bridges and educational facilities.

Erdem&Erdem advised the YDA Group on project financing that was worth €330m ($347m), which included design, construction and management of the Kayseri Integrated Health Campus project – the first PPP project in Turkey implemented under the requirements of PPP law. The company adopted a coordinated and multidisciplinary approach, with sensitivity to the special issues related to critical infrastructure assets.

One of the main challenges in attracting private sector investment is the difficulty the public institutions encounter arranging a sustainable delivery framework to prepare PPPs effectively. Setting benchmarks for socio-economic and environmental impact, affordability, risk identification, bankability and similar comparative assessments requires project-specific methodologies.

Clearly a greater number of PPPs are structured to be bankable for different levels of investment with comprehensive technical, financial, business and legal assistance. Therefore experts such as Erdem&Erdem are able to advise and present well-structured projects that are indispensable for the effectiveness of projects such as the Kayseri Integrated Health Campus.

Voskhod Chromium, a major chromium mining facility in Aktobe Oblast, north-western Kazakhstan, is an example of a landmark cross-border transaction that includes six different jurisdictions involving both A and B-loans, each making two separate tranches that equal $260m in aggregate. EBRD’s financing as the lender in Voskhod is significant as the company’s first transaction in chromium mining.

Yıldırım Group’s financing provided Turkey with an industrial conglomerate of mining and port operations, which will be used to restructure and rehabilitate the operation of Voskhod Chromium and improve its efficiency and competitiveness, while reinforcing its overall environmental and operational health and safety standards. Voskhod Chromium is expected to have a transformational effect on the mine operations by introducing new technologies into Kazakhstan for the first time.

In contrast to a typical project finance contract based on the assumption that the lenders will have step-in rights, granting security in Voskhod Chromium’s financing was challenging due to a restriction of securities given over minerals in Kazakhstan. From an early stage, Erdem&Erdem’s advisory planning on the securities has been instrumental to the success of Voskhod Chromium’s financing.

PPP opportunities in Turkey
The most significant obstacle to financing infrastructure projects is the difficulty in delivering financial demands through tax revenues. Taking into account Turkey’s past, which is similar to other high-growth markets, the country has strong potential to generate landmark PPP projects with high-level support from its government with an extensive PPP agenda.

Legal enforcement, compliance and sustainability all play key roles in achieving reliable outcomes for infrastructure financing

With a successful track record across other industries, PPP will certainly generate exciting opportunities for both Turkish and foreign investors and lenders – particularly across mega-infrastructure projects where there are great incentives from the Turkish Government. Roads and railways have not yet been revitalised, but there are a number of projects currently underway.

So far, healthcare is the most recent and successful industry where the PPP model has been implemented. The Turkish Government has planned to develop 18 integrated healthcare facilities using the PPP model, with the purpose of promoting a diversified network of medical services and raising standards in healthcare in line with the technological innovations and new trends in medicine.

Regardless of the financing model selected, there are basic considerations required for successful infrastructure investment with project financing. The project finance team’s ability to prepare the project cycle – including preparation, concessions, procurement, contract management and an efficient dispute resolution mechanism – is instrumental in providing strong development, leading to a positive economic return.

Legal enforcement, compliance and sustainability all play key roles in achieving reliable outcomes for infrastructure financing, either from private institutions as lenders or through public sector support. This will also ensure the credibility of public institutions by selecting sustainable PPPs. Another key issue is the concern over handling renegotiations and disputes over the financing agreements. The determination to prevent disputes needs to be coupled with appropriate dispute and renegotiation mechanisms. If credible and effective dispute settlement mechanisms such as arbitration and mediation are introduced with clarity, this will serve to safeguard potential ramifications and deter opportunists targeting project – regardless of PPPs or traditional project financing.

Stock markets run on ‘gut feeling’

Posted on by Max Tomlin

On the trading floor, every top professional knows the value of a strong hunch. While stock trading strategies focus on conscious reasoning as the key to success, traders themselves place great importance on ‘gut feeling’ to guide them towards lucrative deals.

In the wake of the 2008 banking crisis, this financial sixth-sense has often been dismissed as an industry excuse for reckless stock market gambling. Yet, according to a new study led by the University of Cambridge, such gut feelings do indeed play a very real role in the world of trading.

“I set up this study to answer a simple question: are gut feelings merely the stuff of trading mythology, or are they real physiological signals?” said former Cambridge University research fellow and Wall Street trader Dr John Coates. “I suspected from my days of trading that hunches were real and valuable, that when I scrolled through the range of possible features, one just felt right.”

Sensitivity equals success
In order to test this theory, researchers at Cambridge University recruited 18 male traders involved in high-stress trading in a volatile period towards the end of Europe’s sovereign debt crisis. These test subjects then underwent a series of experiments to measure their awareness of the subtle physical changes happening to their bodies during a high-pressure work day.

Collectively, the traders performed significantly better in the heart rate test than the control group, demonstrating a heightened awareness of their body’s sensations

“Within physiology, the term ‘gut feeling’ is a colloquial synonym for interoception – the branch of our sensory system that monitors our internal, homeostatic condition”, explained Coates. Sensations such as breathlessness, body temperature, heart rate and fullness of the gut and bladder are continuously passed to the brain from the body’s tissues by interoceptive signals. Although most people are unaware of this transmission of information, sensitivity to such sensations can vary greatly, with some experiencing stronger physical reactions to certain
stimuli than their peers.

As the most common test for interoceptive sensitivity is heart rate awareness, the traders participating in the study were asked to count their own heartbeats while at rest, without feeling their pulse or touching any other part of their body. Collectively, the traders performed significantly better in the heart rate test than the control group, demonstrating a heightened awareness of their body’s sensations. What’s more, within the group of traders, those who more accurately counted their heartbeat also performed better on the trading floor.

Not only did traders with a better heart rate score generate more profits than their peers, they also survived longer in high-pressure financial careers. The findings suggest successful traders have a heightened awareness of the body’s stress responses, and are thus able to unconsciously read the physiological signals that steer them away from high-risk, dangerous decisions.

Disproving theories
As well as deterring traders from making reckless financial decisions, these subtle interoceptive sensations can lead to success. With their brains and bodies acting as one in moments of high stress, traders can feel drawn towards a profitable stock, without even being able to articulate the reasons for the hunch.

The scientific confirmation of a trading gut feeling may well have implications for economic theory and, in particular, the controversial ‘efficient markets’ hypothesis. The hypothesis, similar to the ‘random walk’ theory (which says past movements or trends in stock prices cannot be used to predict the future movement of the same stock), suggests the market is entirely random, making it impossible for traders to improve or even control their performance through skill, knowledge or experience. This would make it impossible for traders to ‘beat the market’ and earn excess profits from stocks.

The scientifically proven importance of gut feeling in financial risk-taking may give human traders the edge over their emerging
digital competitors

Conversely, the newly discovered link between gut feeling and trading success suggests an instinct for anticipating price movements does indeed exist, and comes into play every day on the trading floor.

According to Coates: “Academic economics and finance is so focused on conscious reasoning that they completely miss the real action, which is taking place in the dialogue between the brain and the body.”

Man versus machine
The results of the study may also have a significant impact on the very structure of what is a rapidly digitalising industry. Bolstered by the aforementioned efficient markets hypothesis, which also argues machines are better than humans at trading, digital trading systems have come to dominate stock exchanges the world over. Today, openly shouted trading is largely a thing of the past, with the rise in electronic trading limiting face-to-face bidding between professionals. However, the scientifically proven importance of gut feeling in financial risk-taking may just give human traders the edge over their emerging digital competitors.

Unlike machines, successful traders appear to have an innate physical predisposition for effective risk taking. While digital systems rely entirely on hard data, humans have unconscious access to a world beyond numbers. Where computers fail to beat the system through an automatic analysis of available information, traders are able to do so thanks to the physiological clues provided by their bodies.

In highlighting the role of the human experience in financial trading, the study reignites the debate between classical and behavioural economists. Followers of the classical school tend to believe psychology and neuroscience are irrelevant to economics, whereas behavioural economists see these elements as essential to financial decision-making. Both theories, however, have failed to consider the role of the body.

Until now, physiology has been largely ignored in economic academia, which widely regards trading as a purely intellectual activity. This new evidence undermines the established belief, potentially prompting a profound reassessment of our understanding of financial markets and the decisions that govern them.

According to Coates, the landmark study shows just “how exquisitely we are constructed for rapid pattern recognition”. Armed with this new evidence, the Wall Street veteran now believes “humans can indeed compete against the machines”. For many finance professionals, the results confirm what they have long suspected: that trading skill cannot be taught and, more importantly, cannot be programmed.

YDA Construction builds investor confidence

Posted on by Max Tomlin

This year marks the 42nd anniversary of the creation of AKSA Construction, YDA Group’s first construction and contracting company, and the 22nd anniversary of YDA Construction Industry and Trade. The flagship of the group, YDA Construction carries out a wide range of works, including turnkey projects, build-operate-transfer (BOT) airports, hospitals, schools, shopping malls, hi-tech business centres, industrial plants, highways, railway lines, bridges, intersections and mass housing projects. With subsidiaries operating across a wide range of sectors and completed projects amounting to $6.8bn by the end of 2016, YDA Group is one of the most influential private companies in Turkey.

Although the Turkish corporate sector is well versed in bank financing, longer tenor bond financing is relatively scarce

While continuing its operations in the construction (contracting and property development) sector to meet ever-changing market expectations, YDA Group has branched out into a range of periphery sectors, such as airport management, energy, PPP healthcare, agriculture, mining, insurance and even outdoor digital advertising.

Since extending its operations to international markets in the 2000s, YDA Group has carried out various projects in countries such as Kazakhstan, Ukraine, the UAE, Russia, Saudi Arabia, Afghanistan and Moldova. Along this vein, it continues to spearhead in BOT and PPP infrastructure projects, particularly for city hospitals, both in Turkey and abroad.

A pioneering bond issuance
Although locally issued corporate bonds are not a market norm in Turkey, YDA’s banks and lawyers have structured highly comprehensive documentation, which includes financial and non-financial covenants in order to maximise investor confidence.

One of the major constraints to the long-term development of the Turkish corporate bond markets has been the limited floating rate issuance that is priced from a market-relevant benchmark index. Consequently, the market is dominated by floating issuances that are based on a two-year government bond index, which is impossible to hedge and thus introduces basis risk for investors.

The issuance was YDA’s first bond issue and only the third in the Turkish market to be based on TRLibor as a reference rate. Hence, the issuance represented an important step that demonstrated the successful use of a different index in the market, while also eliminating non-hedgeable interest rate exposure.

Although the Turkish corporate sector is well versed in bank financing, longer tenor bond financing is relatively scarce compared to the size and potential of the market. As a consequence, the ongoing development of a functional and hedgeable floating rate index, the TRLibor, has great appeal for international investors.

Since 2010, the tenors offered are mostly two years in length, with limited issues of three years. Moreover, there is also very limited liquidity in the market. As such, the local currency corporate bond market has substantial potential for further improvement, which could include longer maturities and could be based on floating rate indices. At 1,457 days – or almost four years – the YDA transaction was the longest tenor in the TRL corporate bonds market. Before this issue, the maximum tenor in the market was 1,154 days.

42 years

YDA Group’s experience in the construction sector

$6.8bn

The group’s overall completed business volume

$7.2bn

Its ongoing and planned business volume

The YDA issuance thus demonstrated the viability of longer tenor issuances and increased the maturities available in the market. Naturally, this will attract more issuers and investors, which in turn will potentially increase liquidity as well.

In 2015, 51 local currency bond issues – amounting to TRY 3.1bn ($971m) – were placed with only one issue size of more than TRY 200m ($62.5m). The YDA issue size, on the other hand, is currently TRY 250m ($78m), which almost triples the average corporate bond issue size in Turkey. As the transaction was the biggest issuance of 2016 – and the third biggest in the last six years – it is considered to be a remarkable achievement and a real game changer by the Turkish authorities. Furthermore, the timing was especially significant: the issuance created a positive impact on Turkish markets shortly after the failed coup attempt of July 2016, and the subsequent state of emergency declaration.

These events caused a significant S&P rating downgrade and, as a result, an outflow of foreign capital, which witnessed numerous defaults and increased tension in the local private bond market. In response to this fragile environment, all possible shock scenarios were tested before the completion of the YDA deal. Thanks to its sustainable cash flow stream and its close dialogue with all major stakeholders, YDA’s corporate bond was oversubscribed.

Our new plan of action is to further improve the company’s disclosure standards, thereby raising business practices well beyond Turkey’s current regulations to the best possible international principles. Indeed, YDA has agreed to higher disclosure requirements in comparison to those that are applicable for issues to qualified investors in Turkey. These practices target disclosure in a similar manner to public issuances: they include the preparation of a company’s detailed information; obtaining a rating from a well-renowned rating agency, which will be updated and published periodically; and publishing semi-annual financial statements.

Unique factors
The issuer is a holding company operational in multiple sectors and is headquartered in Ankara. Although construction firms are not usually the first option when it comes to investing in Turkey’s private bond market, YDA Ìn˛saat’s corporate bond was oversubscribed thanks to the sustainable cash flow stream of the company and the company’s strong track record and close dialogue with all major stakeholders in the local bond market.

There were many unique features of the deal, including the strong, steady and easily predictable cash flow generation capability of the issuer. As mentioned, it also had the longest maturity on record and even attracted institutional investors. To sum up, the deal has unique qualities in terms of its four-year maturity, its spread, the size of the deal, the deal’s distribution, and the market conditions as well.

Consequently, international institutional investors invested in the second tranche, which has the longest tenor so far among real sector bonds. This tranche’s benchmark is TRLibor, which indicates the market will soon evolve into longer tenor bonds. Besides tenor, diversified benchmarks also attracted the attention of local and foreign investors. Due to the government securities’ low roll-over rates and spread with bank deposit rates, TRLibor was chosen for the benchmark of this deal to boost investor appetite.

In order to present the deal, we conducted a one-week roadshow along with 21 different institutional investors. In addition to one-on-one meetings, teleconferences were conducted as an opportunity for investors to ask questions. We found investors really appreciated the firm’s publicity and responsiveness, even before the deal was closed.

It is also notable that the transaction was realised in a highly volatile market environment, at a time when issuers were hesitant to issue. The successful issuance has proved Turkey’s corporate bond market is becoming a stable funding market for issuers, despite its relatively short history. While investors appreciated the firm’s sound financial structure, the bond yields in question were particularly attractive.
The high number of investors who were contacted prior to the book building is also an important aspect of this successful bidding. Other factors in this success included the company’s strong track record in the capital markets, its transparency with potential investors, and the close communication it kept with all the major stakeholders of the local bond market over the last three years.

Finally, YDA’s debut issuance was paid off on June 16 last year, thus marking another significant step. Essentially, YDA was able to demonstrate its financial soundness by paying off its debut issuance with its own resources, rather than relying on capital markets to play a crucial role in the successful bidding process.

Cyber-insurance providers can’t hack it

Posted on by Max Tomlin

In October 2015, UK telecommunications company TalkTalk reported a cyber-attack on its website. Nearly 157,000 customers were affected. The data accessed included bank account numbers, sort codes and even some credit card details. While the compromised information was not substantial enough to allow serious fraud to be committed, the costs to TalkTalk were significant. Figures released by the company in February 2016 indicated the incident had cost it £60m ($76.5m) and prompted the departure of 95,000 customers. To add insult to injury, the heist had been pulled off by a teenager.

By the very nature of online systems, there will always be the potential for similar attacks to occur in the future. While companies have a number of defensive tools at their disposal, no security measure will ever be bulletproof. In fear of suffering a similar attack, businesses have done what they always do in the face of an unavoidable risk: they have taken out insurance. Established insurers have subsequently developed products to cover this risk, mitigating the potential costs of a hack or breach.

 The benefits insurance typically provides to motorists and property owners are yet to fully translate to cyber-policies

While fundamentally a sound idea, there are a number of questions surrounding cyber-insurance; principally how insurers treat it, its effectiveness in reducing cyber-attacks, and its breadth of coverage. These are questions that need to be answered. For a risk that is evolving as quickly as cybercrime is, a company’s requirements of their cyber-infrastructure are shifting faster than their insurers are. Additionally, insurers are currently underutilising data that could entirely change the face of cybersecurity. As digital infrastructure becomes ever more important, these changes
cannot happen fast enough.

Leaky ships
The large-scale attacks on companies like TalkTalk and Sony have fuelled CEOs’ fears that their businesses could be next; making cyber-insurance seem like the next logical step when protecting their investments. Generally, cyber-insurance policies cover a mixture of first and third-party losses that stem from a cyber-attack. First-party coverage accounts for the direct cost to the business: cleaning up in the immediate aftermath of a cyber-attack by replacing damaged systems and compensating for the loss of productivity while the breach is examined in greater detail. Third-party coverage then deals with the claims of those individuals who have suffered at the hands of the cyber-attack – through the leak of personal information, for example. Defining a cyber-attack can be a little less straightforward, however. These events can range from an employee losing a USB stick containing critical data, to a full-scale breach on an international level.

Although the market has recently slowed, the cyber-insurance sector has proven to be one of the biggest growth areas for insurers in recent years. A report compiled by PwC in September 2015 estimated the global cyber-insurance industry could grow to $7.5bn in premiums by the year 2020 – suggesting companies will continue to attribute greater value to both their data and digital infrastructure. Traditionally, security measures were thought to be enough to protect against intrusions, but, with the seeming inevitability of a breach, insurance has become a necessary supplement. However, the benefits insurance typically provides to motorists and property owners are yet to fully translate to cyber-policies.

Fast food
In 2014, PF Chang’s – a casual dining restaurant chain with over 200 locations in the US – fell victim to a data breach. The breach affected 33 branches and compromised the credit card information of 60,000 customers. The company was covered by a Chubb cyber-insurance policy taken out with the Federal Insurance Company. The policy covered the costs associated with investigating the breach, legal advice and the management of its obligation to notify both customers and the authorities.

$7.5bn

Predicted value of cyber insurance premiums by 2020

48%

of cybersecurity professionals think their coverage is adequate

Despite this, in May 2016, an Arizona court rejected PF Chang’s efforts to recover the additional $2m it required to reimburse the issuing companies whose credit cards had been used to make fraudulent transactions. The policy stated it was designed “to address the full breadth of risks associated with doing business in today’s technology-dependent world”, and, as a result, PF Chang’s believed this cost would be covered. Chubb, however, successfully argued the policy was not liable for any external contract or agreement the company held. By extension, PF Chang’s dispute with the company was its own to manage.

The case of PF Chang’s is one that should have any business pouring over the wording in its own cyber-policy, ensuring it has a comprehensive understanding of exactly what it is, and what it isn’t, covered for. However, the complexity of these policies, and the number of parties involved in a cyber-breach, make cases like this inevitable.

Risky business
Sasha Romanosky, a policy researcher at the RAND Corporation, is investigating the way cyber-insurers assess risk and calculate their policy fees. Speaking to World Finance, Romanosky said policies often include or exclude certain events based upon the insurer’s past experience of a product – cyber-insurance has inherited a lot of these conditions. “Say we’re talking about kinetic warfare and a government or country is bombing a whole city, the insurance company isn’t going to be able to pay out all of those losses on all of those claims”, Romanosky said.

Cyber-insurance – now almost 15 years old – is far younger than the majority of insurance markets, meaning laws and coverage are still being tested. Romanosky believes that as more cases emerge, policies will evolve. Unfortunately for PF Chang’s, the company acted as the proverbial canary in the coalmine of cybersecurity litigation.

Romanosky said: “I suspect this will reach an equilibrium, where people will kind of understand what the playing field is. The early companies that try to file these claims under the policies and were denied, that will change. There’s a self-correcting mechanism going on where companies should be informed, either by their brokers, insurance companies or their peers, to clarify these rules and help them figure out what’s covered and what’s not.”

But this lack of clarity isn’t exclusive to companies; insurers are still coming to grips with their cyber-policies, too. A recent survey conducted by PivotPoint Risk Analytics, SANS Institute and Advisen found a number of major gaps exist between the cyber-insurance market and cybersecurity professionals. One problem is the terminology different professionals use, particularly when discussing the concept of ‘risk’. Security experts see the term as meaning vulnerabilities to a security system, while insurers interpret it as the monetary cost of a breach. Another problem is the varying standards attributed to the most important cybersecurity measures, and the amount of money that should be invested in cybersecurity in comparison to cyber-insurance. All these issues have culminated in a lack of confidence. According to the study, only 48 percent of chief information security officers and other security professionals find cyber-insurance ‘adequate’ when recovering from a breach.

With the figures cyber-insurance companies have access to, they have the potential to provide unrivalled insight into cyber-attacks and why they happen

Given most companies are now highly dependent on their cyber-infrastructure, its easy to wonder why cyber-insurance is a separate product to general liability insurance. Romanosky said that, while he did not know for certain, there was a chance this was because policy limits on cyber-products are much lower. Romanosky said: “So they have an interest in creating a separate book of business that is cyber-policies, where the limits are a lot lower, to manage their costs. I’m guessing because of uncertainty in any kind of claims that might be filed. That’s a speculation of strategy, I don’t know if that’s actually true, but it’s an interesting story that I heard.”

Many will be hoping the research conducted by Romanosky will provide more clarity and transparency within the industry.

Missed opportunity
It’s unfortunate cyber-insurance is deficient in all these areas. With the figures cyber-insurance companies have access to, they have the potential to provide unrivalled insight into cyber-attacks and why they happen. By analysing this information, they should be able to determine the biggest risk factors and ultimately encourage better general cybersecurity as a result. Despite this, Romanosky says insurers are yet to address this issue: “I don’t know why they don’t do it. It seems crazy to me because you’d think they have floors of actuaries who would do this kind of thing, but in my conversations no one has really gotten there.”

While still offering clear benefits to organisations around the world, the cyber-insurance market is still relatively immature. Substantial redevelopment is required before companies can be confident in their decisions and feel fully protected by their policies. Insurers have already achieved this feat in the automotive and property sectors, so there seems little reason the same can’t be accomplished in the cyber domain. Cyber-attacks don’t just harm companies, but individuals as well, so the sooner insurers make the effort the better. Enforcing greater protection standards through well-formulated policies could greatly reduce the exposure of personal details, breeding confidence and providing clarity in a sector riddled with uncertainty.

World leaders have a mountain to climb at Davos

Posted on by Max Tomlin

This January, the world’s richest and best connected will descend on a sleepy village in the Swiss Alps for the annual meeting of the World Economic Forum (WEF). Since 1971, the global elite has gathered at the small mountain resort of Davos to discuss the world’s most pressing issues. This time round, more than 2,500 guests are expected, with attendees paying upwards of $20,000 for the privilege.

2017’s gathering will focus on a number of global events that have caused great concern, particularly in terms of the world economy

Founded by Klaus Schwab in 1971, the WEF operates under the motto “committed to improving the state of the world”. From Canadian Prime Minister Justin Trudeau and the IMF’s Christine Lagarde to leading business minds such as Bill Gates, the wide array of speakers always makes for an impressive showing.

The range of issues is broad too, with recent discussions ranging from the impact of 3D printing to global gender equality. However, there is usually some sort of overarching theme to the discussions. The 2016 edition focused on the world’s ‘fourth industrial revolution’, a concept first put forward by Schwab himself. In his most recent book on the topic, Schwab argued we are once again undergoing a revolution in economic production techniques, one that will have profound consequences for our world. Whether it is mobile supercomputing, artificial intelligence and cognitive computing, self-driving cars, or neuro-technological brain enhancements, the way society and economies are organised is set for a huge shake-up. How world leaders should approach this seismic shift was the central theme for 2016.

This year’s meeting, it appears, will take a slightly more political turn. The headline theme will be ‘responsive and responsible leadership’. Indeed, 2017’s gathering will focus on a number of growing trends and global events that have caused great concern, particularly in terms of the future direction of the world economy. According to the overview: “The weakening of multiple systems has eroded confidence at national, regional and global levels. In the absence of innovative and credible steps towards their renewal, the likelihood increases of a downward spiral of the global economy, fuelled by protectionism, populism and nativism.” How to stem this tide will be the primary concern of this year’s meeting.

The rise in anti-globalisation
Davos 2016 focused partly on the then-upcoming referendum concerning the UK’s membership of the EU. Since then, the UK electorate voted narrowly to leave the bloc, surprising most observers. Of immediate concern for WEF attendees this year will be how this decision is handled.

UK Prime Minister Theresa May has said the formal exit process will begin no later than March, with the activation of Article 50 of the Lisbon Treaty. The UK will then have two years to negotiate the terms of its exit. The direction of the UK’s departure and what terms it should both seek and receive will be a hot topic for all involved.

Questions will be raised about the precise nature of the separation; specifically, whether or not the UK will remain in the single market. The answer to this question will have serious implications for firms around the world that currently use the UK as the base of their European operations. Financial institutions based in the City of London, for instance, will be keen to maintain passporting rights in order to operate in the EU. However, these may be lost should the UK go for a ‘hard Brexit’ and leave the single market altogether.

Economic implications aside, the sentiment behind the vote will also be up for discussion at the WEF meeting. For many commentators, the Brexit vote was indicative of a rising populism across the continent, which the WEF has identified as one of the key threats facing the future of the global economy. Panellists are likely to discuss the recent surge in populist and anti-EU groups, including Germany’s Alternative für Deutschland and France’s Front National.

Davos in numbers:

444

people attended the original meeting in 1971

$20,000+

The cost of attending

30%

Fall in local CO2 levels during the annual meeting

2,500

delegates travel to the summit every year

$50m

The amount the World Economic Forum contributes to Davos each year

For many attendees, this ideological shift will raise the spectre of a growing sentiment against globalisation, chiefly in its forms of international governance and increased mobility of labour. Speakers and panels will explore why growing numbers of people are becoming disenchanted with, and hostile towards, globalisation – with many now sceptical of its outcomes and processes. The focus will be on how leaders around the world can maintain a global and open economy, while also placating the fears and concerns of their electorates.

This will involve finding solutions to some of the most pressing issues faced by Europe today. Top of the agenda in this respect will be Europe’s migration crisis. Since the last WEF gathering, millions of migrants have entered Europe from war-torn countries, including Syria and Afghanistan, in order to claim asylum. Europe was woefully underprepared for this mass movement, and rifts quickly emerged within countries and even within political parties as to whether to welcome or turn away those in need. With migrants still making their way into Europe, how the continent can coordinate a coherent and unified strategy will be of vital importance.

Likewise, other perceptions of the EU are likely to be addressed. While the southern European debt crisis was largely out of the news during the latter half of 2016, questions over the currency union’s viability and Greece’s financial health persist. Other threats to the fiscal health of the continent are also likely to be on the agenda, including Italy’s weakening financial position, the effect of the European Central Bank’s negative interest rate policy, depressed profitability for European banks, Hungary’s own referendum vote to reject EU migrant quotas, and Deutsche Bank’s increasing volatility. On an existential level, attendees will have to grapple over whether European integration should continue, and how it could continue in a way that is acceptable to the citizens of Europe.

Talking about trade
After years of ever-greater advances in global trade, voters in many countries have started to assert their dissatisfaction with the direction of the trend. In the US, both of last year’s presidential candidates opposed the Trans-Pacific Partnership (TPP). Donald Trump called it a “bad deal”, while Hillary Clinton – once a TPP advocate – reversed her policy to oppose it on the campaign trail. This rare point of agreement between the two figures was reflective of a rising anti-trade sentiment within the US.

Now, with the victory of Donald Trump, the US’ commitment to free trade seems very much in doubt. Even without the consent of Congress, as president, Trump will be able to impose tariffs on other states. The extent to which he will pull the US away from its commitment to free trade – and, indeed, globalisation in general – is yet to be seen. But, with his campaign for office staked on the promise of ending the US’ reliance on other nations – and the backbone of his support coming from Americans who ranged from disillusioned about to openly hostile towards global collaboration – the US’ long commitment to free trade appears to be coming to an end.

Indeed, after decades of growing trade, momentum appears to be slowing worldwide. In September, the World Trade Organisation announced it was revising its estimates for global trade growth in 2016 to just 1.7 percent, from an earlier estimate of 2.8 percent. This new figure is the slowest predicted rate of trade growth since the start of the 2008 financial crisis.

Economic implications aside, the sentiment behind the Brexit vote will also be up for discussion at the meeting

Trade growth, relative to GDP, has been weak since the end of the global recession. As an analysis by the Peterson Institute for International Economics noted: “Following the recession of 2008-9, global trade and FDI performance did not resume their accustomed growth rates, unlike in the aftermath of previous recessions.” Since 2008, the world has seen “the longest post-war period of relative trade stagnation”.

It will be of vital importance then for the bigwigs at Davos to discuss the future of international trade. Generally a pro-trade crowd, top on the agenda for meeting participants will be how to reverse this slowdown.

Economic inequality
In addition to worries over trade and growing protectionist sentiment, as well as populist sentiment within in the EU and beyond, another topic is of increasing concern among the global elite today: economic inequality. The subject is rife in today’s political and social discussion: Thomas Piketty’s book Capital in the Twenty-First Century is one of the most popular economic tomes of recent years; think tanks and charities regularly publish reports measuring inequality around the world; and indeed, Barack Obama himself labelled economic inequality as the “defining issue of our age”.

Many economic commentators see the issue as holding back growth through lowering aggregate demand, and much of the anti-trade sentiment in the US stems from growing inequality. Trade has, it is argued in some quarters, damaged the US’ middle class through offshoring and reduced wages. A hot topic at last year’s WEF gathering, attendees will once again hold counsel on how to address the growing gap between top-end wealth and average incomes.

On the surface, the focus on responding to the threats facing the world economy seems overtly political. However, embedded in these political challenges are deeper social, economic, financial and existential ones. At the heart of the WEF discussion will be how leaders can make the global economy and its integration more palatable and more inclusive for the world’s citizens. Political trends reflect a growing malaise with the globalised economy and world at large, and the meeting at Davos will provide a forum for the sharpest minds to work out the cause of this sentiment, and how best to address it.

Teva Pharmaceuticals has acquired success with Actavis Generics

Posted on by Max Tomlin

The best deals are not always the quickest to close, as Teva Pharmaceuticals learned in 2016 after its much-lauded acquisition of Allergan’s generic business, Actavis Generics. In its acquisition of the firm, Teva’s dealmakers coupled two leading generics businesses with complementary strengths, research and development capabilities, product pipelines and portfolios while matching their geographical footprints, operational networks and cultures.

Although regulatory reviews lengthened the deal, those timeline delays ensured a smooth and seamless transition between companies, resulting in improved operational capabilities and efficiencies and a harmonious ‘day one’ transition that transformed Teva into the largest global generic pharmaceutical company in the world.

Generics drugs are low-cost copies of expensive, branded drugs. Today, Teva’s generics division is a $14-15bn pro forma revenue company, with nearly 16,500 employees operating in 80 markets. It utilises the most advanced research and development capabilities in the generics industry.

Following its acquisition of Actavis, Teva now has around 340 product registrations pending FDA approval and holds the leading position in first-to-file opportunities, with approximately 115 abbreviated new drug applications pending in the US. In Europe, after divestitures, Teva will have a pipeline capable of sustaining over 5,000 launches. In Teva’s growth markets, including Asia, Africa, Latin America, the Middle East, Russia and the Commonwealth of Independent States, there are now approximately 600 pending product approvals. Overall, Teva is planning 1,500 generic launches globally in 2017.

Behind the deal
The story of the deal began in July 2015, when Teva announced the acquisition of Allergan’s generic business for a total consideration of $40.5bn, consisting of $33.75bn in cash and approximately 100 million Teva shares. The $33.75bn cash component was to be funded through a combination of equity and debt financing, and was backstopped by a $33.75bn bridge loan facility.

In late November 2015, Teva announced a public equity offering of approximately $6.75bn, consisting of $3.375bn of its American Depositary Shares (ADSs), each representing one ordinary Teva share, and $3.375bn of its Mandatory Convertible Preferred Shares (MCPSs).

Teva sells approximately 120 billion dosages per year, or nearly 20 tablets for every person in the world

The outcome was an additional 54 million ADSs priced at $62.50 each, significantly above the 30-day average price, and 3.375 million seven percent MCPSs at $1,000 per share. Significant demand led to a three-times oversubscribed common equity order book and 1.8-times oversubscribed mandatory convertible preferred shares order book. Shortly thereafter, the offering’s underwriters exercised in full their option to purchase an additional 5.4 million ADSs and 337,500 MCPSs. As a result, approximately $7.4bn was raised from this public equity offering.

The decision to split the offering between common and preferred shares was driven by a desire to deepen demand and offer investors an additional and unique investment vehicle.

In July 2016, Teva issued a multi-currency bond offering in the US and Europe for a total notional amount of $20.4bn at a blended rate of 2.17 percent. The combined bond financing represented the second largest debt offering ever in the healthcare sector, and the fifth-largest corporate debt issuance ever.

The decision to split into two road show teams – one led by CEO Erez Vigodman, and the other by CFO Eyal Desheh – was instrumental in the company’s success in meeting with over 260 global investors, and driving 4.3-times and 6.4-times oversubscribed order books in the US and Europe respectively. While one team marketed and priced the US deal, the other began marketing in Europe. The US team then flew overnight to join the marketing effort, before meeting up to price the euro and Swiss franc offerings in the following days.

The $20.4bn that was raised in combined capital across three currencies in three days is evidence of credit investors’ commitment to Teva’s long-term strategy. To complete the financing, Teva also put in place a $5bn term loan with a group of global relationship banks.

Teva’s strong credit rating and disciplined financial policy were key to providing the financial flexibility and wherewithal to access capital markets across a range of financial instruments, in both jumbo size and at historically attractive terms.

The acquisition’s close was delayed due to an extensive antitrust review and requested divestitures. The deal was then approved just over a year later in August 2016. The resulting firm positions Teva as a top three generic pharmaceutical company in over 40 markets, offering more than 16,000 different products to patients around the world. Teva sells approximately 120 billion dosages per year, or nearly 20 tablets for every person in the world.

Savings strategy
Throughout the Actavis deal, Teva focused on building a strong financial foundation, while also examining new ways to introduce increased efficiencies from existing assets. Recent network optimisation and efficiency improvements have delivered tremendous value across Teva’s global generics business, which has proven to be a key strength. Additionally, a strategic decision to focus on larger markets, coupled with the larger scale of delivery offered by Actavis, has significantly improved the efficiency of the overall business.

Cost synergies and an intelligent acquisition, while important, are not the whole story. The generics industry remains one of the most attractive in the world in terms of profitability and investor returns (see Fig 1), but its contribution to healthcare systems and societies across the globe represents its key mission.

Worldwide, governments – as well as other public and private players – are struggling with increased healthcare costs. Generic medicines are a crucial part of the solution. With an older population, increasing instances of chronic disease and the changing landscape of the middle class has meant that, for billions of patients, their healthcare must be delivered at the highest quality standards while presenting an ever-improving value proposition.

The transaction between Teva and Actavis Generics transformed the playing field by combining two of the industry’s best generic companies in a way that brings tremendous healthcare savings for patients globally.

According to the 2016 Generic Drug Savings report produced by the Generic Pharmaceutical Association (GPhA), nearly 3.9 billion of the 4.4 billion prescription drugs distributed in the US during 2015 were not brand name drugs, but instead the FDA-approved generic equivalent. In a recent report, GPhA noted that generic drugs represent 89 percent of prescriptions dispensed in the US, but make up only 27 percent of total drug costs. This presented more than $227bn in 2015 savings to the US healthcare system, and more than $1.46trn of savings between 2006 and 2015.

What’s next?
Teva’s recent Actavis acquisition proves there is strategic power in smart mergers. A thoughtful acquisition that introduces new capabilities and global efficiencies can create the foundation for positive growth for a pharmaceutical company, while also benefiting the patients it serves. Teva’s acquisition of Actavis will improve speed to market, introduce new market capabilities and create innovative platforms for growth, all of which will prove to be essential tools as Teva works to serve unmet medical needs in the therapeutic areas of respiratory problems, movement disorders, pain and neuro-degeneration.

This deal positions Teva to compete aggressively on commodity products while simultaneously contending with some of the most complex products in the world, thanks in large part to the firm’s extensive manufacturing network and the high standards it meets. That commercial breadth, coupled with a strong market scale and operational network, will consistently deliver high-quality products on time.

Every day, Teva serves 200 million patients through the largest portfolio of drugs in the world, with one of the largest, most competitive, fully integrated, operational networks in the industry. This portfolio enables Teva to maintain its role as a transformative healthcare company that delivers ever-improving value to our shareholders, healthcare systems and patients around the world.

Cashing in on blockchain technology

Posted on by Max Tomlin

The technology behind bitcoin, known as ‘blockchain’, has been touted as revolutionary, holding the potential to transform anything from the insurance industry to international aid. However, it is in the hands of central bankers that the technology could reach its true potential.

Central banks around the world are currently devoting their resources to research the concept of a central bank digital currency – a kind of ‘digital cash’. The reason for its potential power: it gets to the heart of the function of a central bank, and, indeed, the very nature of money. “Prospectively, it offers an entirely new way of exchanging and holding assets, including money. It’s an irony, therefore, that some of the economic questions it raises have actually been around for a long time, for as long as economics itself”, said Ben Broadbent, Deputy Governor of the Bank of England, in a speech earlier this year about the possibility of a central bank issued digital currency.

The nature of money
Of course, electronic money is nothing new– in fact, the majority of money in our system exists in electronic form. However, a key difference between electronic money and a possible digital currency is the latter would allow people to transfer money to one another without the need for a commercial bank. People could have a digital wallet, of kind, and move money in a secure way without commercial banks acting as the middleman – much like ordinary cash.

This is a crucial difference, because commercial bank money and currency are different types of capital. World Finance spoke to David Clarke from Positive Money, an organisation campaigning for monetary reform that supports the idea of a central bank issued digital currency. Clarke explained how commercial bank money differs from cash: “The money in your bank account is just an IOU from the bank, created from thin air when the bank issues a loan. It doesn’t correspond with any physical currency or commodity, and it’s technically the property of the bank.” A central bank issued digital currency, on the other hand, would be an extension of cash – a direct claim on the central bank. It would, by definition, be fully protected from default.

Individuals have been excluded from… hold[ing] such a digital currency, but this could change thanks to blockchain technology

Not only is currency a different type of asset, it enters the economy in a different way. While central banks have control over the creation of physical currency, the amount of commercial bank money in the economy is determined by decisions made by the commercial banks. Banks inject fresh money into the economy each time they extend a new line of credit, and thus the quantity of commercial bank money in the economy depends on the willingness of banks to lend. Central banks, however, can only influence money supply indirectly, through monetary policy and regulation.

In a sense, a central bank currency in digital form already exists, as commercial banks can already hold accounts with ‘central bank reserves’. These reserves are the currency deposits that form the basis of a banks’ payments system. When a customer withdraws cash, commercial banks must be able to provide real currency on request, so they need to hold enough in reserve to meet the demand of withdrawals. Similarly, when someone makes a transfer, banks settle payments using reserves.

Individuals, however, have so far been excluded from the ability to hold such a digital currency, but this could change thanks to blockchain technology. If central banks issued a digital currency that was open to all, people could hold their money as digital currency rather than in a commercial bank – with potentially radical implications. For example, if everyone banked with the central bank, “in principle, it would… make for a safer banking system. Backed by liquid assets, rather than risky lending, deposits would become inherently more secure. They wouldn’t be vulnerable to ‘runs’ and we would no longer need to insure them”, said Broadbent.

Set for takeoff
Digital currency could pave the way for ‘helicopter money’ being used as a viable tool by central banks. According to Clarke: “The idea of helicopter money has got a considerable intellectual pedigree – the term was actually popularised by Milton Friedman, who imagined the central bank dropping dollar bills from the sky as a way of boosting spending. But technological innovation has given the idea new relevance.” The concept of helicopter money has most recently been brought into the spotlight after being aired by Ben Bernanke as a possible addition to central bankers’ tool kits.

In economic terms, helicopter money is a tax cut financed by a permanent increase in the money stock – an action that could be administered in order to combat deflation. It would technically be possible without a digital currency, but given a scenario where each person held a digital cash account, the central bank could easily dispense a newly created digital currency to every citizen. Each person’s account would simply be credited with fresh electronic money in a move akin to ‘helicopter drops’ spreading newly printed money.

Helicopter money is, of course, an unconventional monetary policy, and administering it would come with a host of complications (World Finance, however, has argued that it could be useful if administered in a disciplined and moderate form). It has similar economic underpinnings to quantitative easing, but Clarke argues it can avoid one of the key failings attributed to asset purchase programmes: “Compare it to how the government injects money into the economy through quantitative easing ­– one of the main effects of which is to inflate the wealth of those who own pre-existing assets.” It may sound drastic, but there was a time when quantitative easing was entirely off the cards, so helicopter money should certainly not be dismissed along the same lines. Moreover, with the emergence of blockchain technology, the discussion is gaining momentum.

A brand new tool
The nature of the change created by issuing a digital currency would depend on many factors. For example, if digital cash did not acquire interest, it is unlikely that many people would convert their deposits. However, in a scenario in which it did acquire interest, the macroeconomic effects could be huge.

The digital currency revolution could… eliminate commercial bank money altogether; leaving only paper cash and digital currency issued by the central bank

The Bank of England released a working paper earlier this year investigating the idea of introducing an interest-bearing, digital currency. The authors, John Barrdear and Michael Kumhof, note that there is “very little historical or empirical material that could help us to understand the costs and benefits of transitioning to such a regime, or to evaluate the different ways in which monetary policy could be conducted under it”. In short, it has never been done before.

To forecast such a scenario, the pair created a model based on the US economy, envisaging a world in which digital currency makes up 30 percent of the GDP, but ordinary commercial bank money continues to exist. Under such a set-up, the dynamics of the financial sector would see a dramatic change. Ordinary banks would have to compete with the central bank for deposits in order to maintain cash flow; offering relatively higher interest rates as a result. Their modelled scenario comes out with many notable implications, including the economy gaining a three percent boost to GDP. Perhaps most interestingly, the central bank would acquire an entirely new monetary tool.

Because the digital currency would be held directly by households and businesses, changes in interest rates would have a direct effect, meaning when central banks changed rates it would affect the real economy directly. This contrasts to policy rates as they are currently administered, which only work by indirectly influencing the banking system. The new tool would complement the policy rate, as both would exist simultaneously. Control over the digital currency could help central banks respond to deviations from target inflation. For instance, during an economic expansion they could increase the spread between the policy rate and the (lower) digital currency rate in order to hold back inflation.

Going all in
The digital currency revolution could go even further and eliminate commercial bank money altogether; leaving only paper cash and digital currency issued by the central bank. This could occur if there was a full shift in deposits from commercial banks to the central bank and electronic commercial bank money was no longer used to make payments. This would move the system towards what is known as ‘narrow banking’ – a concept that has a long intellectual history, and notably, was favoured by David Ricardo and Adam Smith. The concept gained ground during the Great Depression of the 1930s, when a group of economists at the University of Chicago proposed the ‘Chicago Plan’. The famous plan, supported by Irving Fisher, envisioned an end to the destructive boom and bust cycle. Under the plan, only the central bank would be able to issue new money, reducing the role of banks to pure intermediaries. The idea has experienced a resurgence following the global economic crisis of 2008, with economists exploring it as an opportunity to bring about an end to the financial instability that shook the global economy.

A paper by the International Monetary Fund published in 2012, named The Chicago Plan Revisited, lent further support to the concept, claiming: “The Chicago Plan would indeed represent a highly desirable policy.” The paper further explains how an economy would look under such a plan: “Credit, especially socially useful credit that supports real physical investment activity, would continue to exist. What would cease to exist however is the proliferation of credit created, at the almost exclusive initiative of private institutions, for the sole purpose of creating an adequate money supply that can easily be created debt-free.”

Positive money argues such a scenario – in which central banks have control over money supply – could have far-reaching benefits, and be achieved through the means of a central bank digital currency. That said, Clarke explained they do not advocate implementing digital cash all at once: “We think the starting point is for the Bank of England to introduce a certain amount of digital cash. It could offset this over time by reducing the amount of bank-created money by raising reserve ratios. Under the system we propose, decisions about how much money is created – and when it is created – will be a matter for the monetary policy committee.”

Never say never
The potential implications of a central bank digital currency are certainly radical. However, the concept is quickly gaining momentum, with research taking place in Germany, England and China. In Sweden, the central bank has initiated a debate over the issuance of a digital currency with the stated aim of making a decision within the next two years. Meanwhile, Switzerland is set to hold a referendum regarding a potential ban on commercial banks creating new money after a petition reached 100,000 signatures. Iceland has also issued similar proposals.

Furthermore, private banks themselves have taken an interest in harnessing blockchain technology, which has the potential to undermine the central bank’s role as a trusted third party through which transfers can be made. Moreover, a decline in the use of ordinary cash is rendering the power of central banks to issue cash progressively less relevant. As Clarke said: “It is a radical idea, but we are living through a time where the nature of money and the nature of cash is changing rapidly. In our lifetimes, we will probably see the demise of physical cash as we know it, and central banks will have to respond to that. We have to ask ourselves the question – are we prepared to completely give up control of our money and means of payment to the private sector?”