finance
monthly
Personal Finance. Money. Investing.
Contribute
Newsletter
Corporate

To hear about all things joint ventures, Finance Monthly connected with David Ernst, Managing Director of Water Street Partners - a company that he co-founded in 2008.  David is a leading adviser to global companies on strategic transactions and governance, especially JVs and partnerships. In addition to a book, Collaborating to Compete, David has published articles in the Harvard Business Review, CFO Magazine, the Financial Times, McKinsey Quarterly, and a number of other publications. David was previously a Partner at McKinsey & Company, Vice President at Evans Economics Inc., and an Economist at Chase Econometrics.

Water Street Partners advises clients on transactions and governance. The firm’s transaction work specialises in joint ventures and other non-M&A partnerships, both in new deal formation and restructuring. Water Street Partners advises clients on corporate and joint venture governance, working with corporate and joint venture boards, management teams, and individual shareholders.

Since its establishment a decade ago, the company has worked on hundreds of transactions valued at more than $500 billion - supporting clients around the world and across industries.

 

What are the right and wrong reasons to use a joint venture?

There are several ‘right reasons’ to use joint ventures, and some situations when a JV is a bad idea. First, JVs are an appropriate strategic vehicle to combine complementary capabilities of two companies – for example, when one company brings product/technology, and the other company brings distribution or sales. Second, JVs are a good way to enter new geographic markets at lower risk than go-alone strategies. And third, joint ventures can be good ways to combine activities into ‘shared utilities’ – such as when multiple health-insurance or credit-card companies create a jointly-owned company to support their processing needs. JVs are also a reasonable fallback strategy when an outright acquisition would be attractive, but isn’t possible either because of national regulations which prohibit foreign ownership, or because the target company isn’t available for sale. In these cases, JVs can be a way to enter a relationship that can be a stepping-stone to a later full combination.

As for the ‘wrong reasons’ to use a JV, they include: using a JV principally as a way to access capital; venturing with a partner to try to fix a weak company; and using a JV to avoid selling a business that doesn’t fit in the corporate portfolio.

 

Once a company has decided to use a JV, what ‘killer questions’ should dealmakers ask to ensure the venture is successful, and to avoid doing a bad deal?

When clients come to us in the deal strategy phase, we aim to ensure that the JV negotiation process leads to either a ‘quick no’ or a ‘good yes’. Joint venture dealmakers should ask themselves five questions – if the answer to any of these is ‘no’, they should not proceed with a JV deal.

 

How long do JVs last, and are there ways to ensure a long-lived partnership?

 

The average span of JVs is about 8 to 9 years. JVs need to evolve to thrive and survive. Ventures are often scoped as fairly narrow-purpose entities – initially conceived to operate in well-defined product markets, with specific technologies. But the world is a dynamic place. For many JVs, there is a need to consider fundamental changes in strategy, scope or structure after three to five years, driven by technology disruption, emergence of new competitors, or the achievement of initial objectives.

The ability to evolve a venture’s strategy – and dynamically adapt to changes on the landscape – is clearly correlated with financial and strategic outcome performance: roughly 80% of JVs that have materially evolved their strategy and scope meet or exceed the performance expectations of their parent companies, whereas those JVs that have remained essentially unchanged have only a 33% success rate.

 

How should venture partners approach exit or termination? Should a ‘pre-nuptial’ be put in place?

Yes, a ‘pre-nup’ is essential. Few JVs last more than 15 years – so having an exit clause is definitely a good idea, though the discussions can be sensitive. Recognising that an eventual termination is the inevitable outcome of most ventures, most JV agreements do include exit provisions in some form. But these provisions often take the shape of boilerplate legal language, with symmetric buy-sell agreements. This is fine if both shareholders are equally able to acquire and operate the venture. More often, one of the shareholders is a ‘natural owner’, and a more tailored approach to exit clauses would provide more protection.

 

Contact details:
Email: David.Ernst@waterstreetpartners.net
Website: www.waterstreetpartners.net

To hear about valuation services in the US, Finance Monthly speaks to Gregg Dight, ASA, Senior Appraiser for Ohio-based Equipment Appraisal Services (EAS). Working from a satellite office in Redding, Connecticut, Gregg has been with EAS for 3½ years and in addition to his work in the US, he’s also completed appraisal assignments through the UK, Western Europe, Mexico, Puerto Rico and the Dominican Republic. Below, he discusses the appraisals that his company works on and offers his insights into the world of valuations.

 

What are the types of appraisal that you offer?

We provide machinery and equipment appraisals across all industries and markets for banks, leasing and finance companies, insurance, end-user business or asset acquisitions (purchase and sale), accounting purposes, and litigation support within all these markets, involving collateral review, business disputes, bankruptcy, casualties, liability issues, divorce, donations, property tax, and investment risk management.

At EAS, approximately 50% of the work I do involves some level of litigation or potential for legal intervention. In many of these engagements, I am directly hired by one of the law firms involved with the case.

 

What does a typical valuation process involve?

The process begins with an in-depth client discussion to better understand the overall scope and purpose of the appraisal within their larger project. Gaining a ‘big picture’ perspective allows us to assist the client in defining the appropriate approach to take within the valuation scope that best fits their project needs. For example, definition/premise of value and effective date.

We then review the specific assets involved and discuss the importance or relevance of completing an on-site inspection of the facility and associated equipment as part of the scope. We typically suggest a physical inspection as part of the process, however, in certain instances this may not be feasible or critical, and we therefore, complete a desktop analysis based on the data provided to us from the client.

Once the scope is fully defined, we estimate a fee level for the client, enter an engagement agreement and complete the work within an efficient time frame, usually 10-15 business days, depending on the size of the project.

Field work involves meeting with company personnel familiar with the assets to gain an understanding of the business operation and specifics of the underlying machinery and equipment pertinent to the appraisal. The research and analysis is then completed through searches of similar assets in the used and new equipment marketplace, both recently sold or available on the market, and discussions with manufacturers and dealers in the new and secondary markets, ultimately arriving at an appraised value that best fits the subject machines valued.

Certain assets have more market information available to review than others, and we therefore determine how much reliability there is to the market data while complementing the research with variables such as the normal useful life, effective age, typical physical deterioration levels and obsolescence (usually technology related) of the equipment. These two approaches are referred to as the ‘Sales Comparison Approach’ and the ‘Cost Approach’. There is a third approach called the ‘Income Approach’ to value involving discounted cash flows and review of related internal financial data, however, this approach is used primarily in the overall business valuation of a company as opposed to the appraisal of individual assets. We can, however, complete a Fair Rental Value analysis on specific assets, which estimates current and future equipment values along with market lease rates.

The final deliverable product to our clients is a narrative report summarising the work with a detailed appendix of equipment descriptions and associated values. These values may be defined under ‘Fair Market’, ‘Liquidation’ or ‘Fair Value’ premises depending on the needs of the client. Photographs and industry data is also included in the final product.

 

To what level do you guarantee the accuracy of the valuations you provide?

Given there is always a degree of subjectivity to any appraisal, and reliance on external data not identical to the subject assets being appraised, there is no guarantee behind an appraiser’s values. We state in our reports that an appraisal is an estimation of value based on the data provided and researched, so there is no ability to guarantee the equipment will ultimately sell for any exact amount. The variables involved with the actual sale of an asset can be quite different from the appraisal’s assumptions at the time of the valuation.

I am an ASA (American Society of Appraisers) Senior Accredited Appraiser which carries a high degree of experience and reliability behind it. We are governed under the Uniform Standards of Professional Appraisal Practice (USPAP) and we state that the work undertaken is thorough and reasonable for the assignment. If you ask three appraisers to value the same group of assets at the same time under the same premise and scope, it is entirely possible they will arrive at three different conclusions. The hope is they will be within a reasonable range of each other (+/- 10-20%), however, this is not always the case. This is where the subjectivity level of the final conclusion comes into play and the reason why appraisers can be on opposite sides of a legal case or business transaction, while being required to explain their findings in an effort to prove the reliability of their work.

This ASA accreditation and associated experience is critical if the client needs a formal, reliable valuation that will hold up to any level of scrutiny.

 

How important are your valuation opinions to lenders and investors, when they are considering a transaction? Are they able to override your opinion?

The importance of any appraisal is ultimately determined by the users of the report and their overlapping case or project involved. Typically, the appraisal is one part of a larger business deal or legal case which will assist in establishing a value perspective within the framework of a larger transaction. As examples, in an equipment investment approval, the pricing, profitability and credit rating of the client’s customer will factor in as much or more than the collateral value of the assets. In legal cases, establishing and proving liability is often the most important factor in a case. Once that is decided, the damages portion of the dispute will involve a review of the appraisal.

 

Which sectors do you work with most? How do you overcome the problems presented by working with a number of different sectors?

Being a ‘Generalist’ in the machinery and equipment appraisal world is common as there is simply not enough work for a valuation firm within a single industry. There are appraisers who specialise in certain markets, however, they usually have a resale component to their business that supports the revenue of the company.

A typical year of valuation work in my present capacity will cross into construction/contracting equipment, transportation, including truck/tractor, rail, and marine, manufacturing equipment of all kinds including machine tool production and packaging, mining operations, material handling, infrastructure of various kinds, high tech, including IT and semiconductor, medical equipment, and general personal property (office and warehouse furniture fixtures and equipment (FF&E). I do my best to become more versed in these markets during the course of the engagement by getting current in the industry and the equipment available. In today’s climate, data is more accessible to be able to learn what you need to quickly and efficiently. After 34 years of working across multiple industries, I have retained enough of the key factors involved in most of these markets to minimise the time it takes to bring myself up to speed.

 

Phone: (203)-644-0006

Email: gregg@equipmentappraisal.com

Website:  http://www.equipmentappraisal.com

Whether you’re looking for a (last-minute) summer holiday destination, a cultural city break or a foodie weekend getaway - Malta has it all! With history that spans 7,000 years, unique prehistoric temples, medieval towns and some of the oldest architectural designs in the world, on top of its breath-taking landscapes and clear blue waters, the small Mediterranean island is richly packed with things to do, see and discover.

The capital Valletta is brimming with grand architecture, hidden restaurants and picturesque back streets, but drive 8 kilometres inland and you’ll find yourself in the chic residential area where Corinthia Palace Hotel is located. Peppered between traditional Maltese houses, the hotel is far removed from the island’s touristy areas, whilst remaining perfectly connected.

The General Vibe

Opened in 1968, the 147-room hotel is the original flagship of Corinthia Hotels – a collection of five-star hotels worldwide. Stepping into the spacious marble foyer, you’re greeted with a glass of fresh orange juice and the instant feel that the staff will do their best to help you with any request. The rooms are traditional, elegant and they all come along with a balcony overlooking the hotel's extensive gardens.

The Restaurants

With three restaurants to choose from – Asian, fine dining or a relaxed al fresco restaurant serving summer favourites, Corinthia Palace Hotel caters to most tastes.

With a menu that is a colourful mix of dishes from Thailand, Japan, Singapore and China, the award-winning Rickshaw restaurant takes you on a gastronomic journey to the Far East. From pork, cabbage and water chestnut gyozas, through to Singaporean frog porridge – the food is exotic, innovative and absolutely mouth-watering.

For an authentic Mediterranean meal cooked with sustainably sourced, local produce, or a quintessentially British afternoon tea, cosy up in the elegant Villa Corinthia restaurant, housed in a stunningly restored century-old villa.

If you’re spending the day lazing around the pool, have lunch in Corinthia Palace’s al fresco venue - the Summer Kitchen. Set within the hotel’s lush gardens and overlooking the pool, the restaurant serves anything from fresh salads, grilled fish and meat, through to scrumptious pasta dishes and pizza cooked in their brand new wood-burning oven.

  

The Athenaeum Spa

With its stunning outdoor pool that calls for a relaxed afternoon of soaking up the sun with a good book and a cocktail in your hand and a spa that offers everything from a Jacuzzi and a sauna through to a steam garden, Corinthia Palace is the kind of hotel that you’ll probably struggle to leave after breakfast. The extensive list of treatments and procedures at the Athenaeum Spa includes manicure, pedicure, bridal and evening make-up, tanning and ‘healthy glow’ treatments, as well as rejuvenating massages, anti-ageing, body exfoliation and detoxifying body wrap therapies.

And if you get a sudden burst of energy after a day of relaxation or like to start your day with a workout, the gym at Corinthia Palace boasts state-of-the-art cardio equipment, a resistance area and a studio with morning and afternoon classes, including pilates, yoga, and more. Private training sessions and tennis lessons with a qualified coach are available too in the hotel's own tennis court.

 

Rates at Corinthia Palace Hotel start from €180/night withbreakfast for a double room and from €330/night with breakfast for a suite. For more information, please go to: www.corinthia.com/palace      

From the pending implementation of VAT to the introduction of Inter-Governmental Agreements with foreign countries, below Finance Monthly hears about Kuwait’s most recent tax affairs through the lens of one the world’s largest professional services and accountancy firms, EY, and one of its top Partners and experts in Kuwait, Alok Chugh.

 

Despite previous plans, Kuwait’s parliament has recently announced that it will not implement VAT before 2021. What could this decision mean, both in the short and long term?

We are closely monitoring the progress in implementation of VAT and are in regular contact with all the key officials. Based on our discussions, we believe the VAT may be implemented sooner than 2021 (probably by January 2020).

While some businesses take a sigh of relief, this only seems to be short term, as once the other countries implement the VAT, the pressure on Kuwait will only increase.

 

What are the key challenges that could come with this decision?

Timing difference in implementation of VAT in Kuwait and in the neighbouring countries will have concerns by businesses involved in cross border transactions that may result in higher cash outflow. For Kuwaiti businesses, this is a blessing in disguise as this gives them additional time to prepare for VAT and also leverage from experiences of other countries.

 

What have been any other tax trends in Kuwait in the past six months?

Kuwait has signed the Inter-Governmental Agreements with the United States (US) for implementation of US FATCA. The financial institutions are required to do an annual FATCA reporting to the Ministry of Finance (MoF) and audit report prepared by a certified auditor is required to be submitted by the FIs on an annual basis.

In addition, Kuwait is a signatory to CRS Multilateral Competent Authority Agreement (MCAA). The MoF has recently issued additional guidelines for CRS, which among other things include appointment of an auditor for CRS reporting purposes (similar to the requirements for FATCA reporting).

Besides, from corporate tax point of view, there have been recent legal cases decided in the Kuwaiti courts, where the MoF has subjected the foreign principals and suppliers of products to tax in Kuwait, based on certain types of agency/distributorship agreements/arrangement. This effectively means a significant potential increase in the tax base. Kuwait is largely an importer of products and services wherein a number of foreign principals sell products and services through Kuwaiti agents.

 

Are there any concerns or future considerations regarding long term attractiveness for Kuwait as a place to do business? If so please elaborate.

Kuwait government is making efforts for: ease of doing business in Kuwait and has brought about legislative changes to attract foreign direct investments in Kuwait. Kuwait continues to spend on the mega projects in strategic Oil & Gas and Infrastructure projects. In addition, there are various other mega projects in pipeline, for which the tenders will be issued soon during the course of the year.

These projects definitely have promising business opportunities for local business as well as international companies wanting to participate in the Kuwait projects as subcontractors.

In addition, Kuwait has recently announced its Vision 2035, which will require significant investments in infrastructure, education, healthcare, over the course of 5-10 years.

 

Is there anything else you would like to add?

I take this opportunity to share our firm credentials. Our firm represents about 70% of the tax payers in the country and we are proud to serve almost all the major market players. We are a team of about 50 tax specialists, the largest tax team amongst the tax service providers, which includes team of experts in VAT, BEPS, Transfer Pricing, cross border tax advisory and tax compliance services.

 

Alok is a partner with EY’s Middle East practice and is based in Kuwait. He has lived and worked in Kuwait for over 25 years and has detailed knowledge of business and taxes in Kuwait. He has considerable experience in advising entry-level strategies for foreign multinationals wishing to do business in Kuwait.  Alok has been involved in a number of consulting assignments (including cross-border planning, application of double tax treaties and the efficient handling of tax and commercial affairs for project due diligence, business paper preparation or review, and structuring operational activities). Alok is a member of the Institute of the Chartered Accountants of India and is an active member and frequent lecturer at the American Business Council, French Business Council, British Business Forum and Canadian Business Council in Kuwait. He is also on the Board of the American Business Council in Kuwait. Alok has been consulted by various government organizations in Kuwait on the practical implementation of various regulations in Kuwait, including the Ministry of Finance. Alok also works closely with the Kuwait Direct Investment Promotion Authority (KDIPA) and a number of other government institutions.

 

Contact details

Alok Chugh

Partner - MENA Government and Public Sector Tax Leader

Mobile: +965-97223004 / +965-97882201

Phone: +965 22955104

alok.chugh@kw.ey.com

www.ey.com

Floor 18-21, Baitak Tower, P. O Box: 74, 13001 Safat, Kuwait

Few will disagree that the current banking industry is facing a turbulent future, as the incumbents continue to struggle to keep up with the seemingly endless growth of FinTech “disrupters.” Consumers are now inundated with a vast array of choice in the form of new products and services beyond the boundaries of our imagination. The challenge for big banks is to marry the needs of the current generation with new technologies, ensuring that services can still be provided to millions of active customers while new products are both practical and implemented at speed. This is far from trivial, due to current products being nestled in inflexible legacy technologies making it complex and costly for them to be changed. The incumbents’ difficulties in tackling this are highlighted by the rapid rise of FinTechs disrupting such an institutionalised and previously untouchable industry. This FinTech revolution has put big banks in an even more precarious position, as their role as the go to financial mediators is put into question.

Risks for the traditional banks have emerged in many forms, ranging from app-like services, which offer very specific products such as Trussle, to more integrated platforms that offer a wider range of services, many of which have carved out a new niche in the industry as “online banks”. The more specialist FinTechs, while often the most disruptive, may be too radical for their own good and over-engineer solutions to manufactured problems that don’t affect everyday consumers. This puts the longevity of many of these services, which could follow Icarian trajectories, at risk. Alongside the uncertainty of the products available, the vast majority of these FinTechs are young start-ups, with little to no brand recognition or trust, something incredibly important for customers whose money is on the line. Consumers are therefore left in a difficult position, to choose the big banks with frustratingly old fashioned but trusted services, or to go for start-ups with attractive products but the lack of a track record and reputation.

While some FinTechs may be flying too close to the sun, the new generation of online banks may offer the solution to the challenges faced by the consumer banking industry. They often boast the same features consumers love at traditional banks, including easily accessible funds in a current account alongside integrated saving and investment accounts, after all they are able to offer Government-backed deposit protection for up to £85.000. Some, for example Revolut, although currently not a bank and hence unable to provide FSCS guarantee, which started out from a modest background in foreign exchange for holiday money, are now allowing customers to access products traditionally offered by mainstream banks from the comfort of your smartphone. These are posing the biggest risks to the big banks, as while it was a FinTechnologically literate minority of consumers that greeted the more obscure FinTechs, online banks threaten to undermine incumbents’ hold on the mainstream market.

While traditional banks are facing threats from the FinTechs, we are still in Wild West territory. The lack of coordination between banks and FinTechs, which is only recently being addressed, means that consumers who want new products and services offered by the FinTechs, with the trust and security associated with traditional banks, are left with few options. In my view, the future of banking will see the rise of new technologies becoming integrated with traditional systems to heal the wounds left by big banks which today’s FinTechs have tried to mask over rather than address the underlying causes. This square peg in round hole approach will cause the incumbents to struggle to hold on to their customers, even when collaborating with FinTechs. Instead they should look to the seamlessly integrated online banks for guidance and co-operation.

One example that illustrates this issue is the unarranged overdraft problem. Overdrafts were first introduced by the Royal Bank of Scotland in 18th Century, and have changed little since. They are of great benefit to both consumers and banks, and hugely convenient. That is, until your agreed limit with the bank is exceeded. For half of the population the agreed limit is nil, hence going overdrawn means immediately paying unarranged overdraft fees. Last year nearly 25 million personal current accounts went overdrawn. The majority of these consumers often have no choice but to knowingly go overdrawn to unarranged levels as they have been offered no alternatives by the big banks. As a result, some also turn to alternative non-bank lenders, such as consumer credit and payday loans which not only put a black mark on a customer’s credit file for six years but also reduce people’s credit scores by an average of 10% within 12 months. This results in more expensive financial products such as mobile contracts or utility bills. This is a real paradox.

Fiinu is launching next year with an elegant solution to this dilemma. Its current account with overdraft extension prevents consumers from paying unarranged overdraft or failed item fees. This is monitored through Open Banking, and allows users’ other current accounts to pre-emptively subsidise the account low on funds to avoid fees. It also allows access to an outsourced overdraft at a fraction of the unarranged overdraft cost. In doing so, Fiinu also improves customers’ credit scores and allows consumers to access to better deals through improved credit files. These things, while possible for ground-up neobanks, are far more challenging for the established players with outdated protocols entrenched through their use by millions of customers.

The future of banking is both exciting and uncertain, however it is clear that the approach of the incumbents, who now see the use in working with FinTechs to suit the needs of a new generation, must try and rectify the structural issues within banks themselves, rather than try to patch them over with what will ultimately become stop-gap measures. The biggest threats to the banking status quo are the rising online banks, which offer both realistic and evolutionary alternatives for the everyday consumer. Their recent successes and growth in the market suggests it is not unreasonable to imagine that in as little as five years, the brick and mortar bank may well be confined to the financial graveyard.

 

Website: https://fiinu.com/

PSD2 promises a radical change, opening up the strictly regulated financial industry to new players. But Djoeri Timessen, the youngest Bank Director in The Netherlands, at the helm of innovative mobile start-up bunq, wonders whether PSD2 addresses the real issues or is simply a stopgap solution.

The much-anticipated revised Payment Services Directive, or PSD2, came into effect earlier this year. It has been dubbed a game-changing regulation. The monopoly of banks on customer account information and payment services is about to disappear. Banks will no longer only be competing with banks, a prospect that looks like it will drastically change the market and maybe even level the playing field.

The problem, however, with PSD2 is that legislation is inherently always on the back foot, making it an unsuitable driver for innovation. The financial world is in the midst of a data revolution with a landscape that is shifting so rapidly, a directive like PSD2 is already outdated before it comes into effect. Legislation dictating technology means, quite literally, that books are trying to keep up with the internet. PSD2 was created in response to the first PSD and after seeing the effects of this second directive, the process will repeat itself and we'll head straight into PSD3. A few years ago, consumers still relied heavily on branches and internet banking seemed like a futuristic prospect. In 2016, mobile interactions had already grown to account for 56% of customer’s banking engagements in Europe[1]. Nobody can beat the speed of technology.

Of course, legislation can and does bring about positive change in our industry. It wouldn’t have been possible for some of the challenger banks to obtain a financial license to operate without the EU’s progressive regulators. Start-ups would have never been able to expand across the EU in such a rapid pace if it weren’t for the European Economic Area (EEA) passport which allows them to offer financial products and services in another EU member state without needing authorisation in each individual country.

 

“Banking is necessary, banks are not”

In similar fashion, PSD2 accelerates disruption in a protected market. The ability to engage directly with consumers will no longer be just the advantage of banks but shared with corporates, technology firms, FinTechs, and even retailers. PSD2 is yet another step in the Open Banking revolution, providing new players with an opportunity to plug into traditional institutions and build new services for consumers. As Bill Gates once famously said in the mid-90s: “Banking is necessary; banks are not”.

In turn, this forces bank incumbents to rethink their service offering to stay relevant to a consumer that’s asking for financial services that are faster, personalised, seamless and easily accessible. A highly customer-centric strategy is no longer a unique selling point, it has become a necessity - mostly because of the new directive forcing banks to catch up.

On paper, legislation seems to be working. Yet in reality, it’s still only a stopgap at work. Initiatives like PSD2 force a closed off system to become more open, but they don’t address the root cause: the payments industry is still monopolised by bank incumbents that don’t allow any room for competition. It’s the same pattern we saw after the financial crisis: increased supervision and strict legislation were useful to halt the crisis at the time, but the cause was never addressed.

 

Conflict between opening up and risks

The problems become clear when we look at how banks are tackling the thorny issue of open banking and APIs, the new directive’s main enablers. Banks have to comply with providing TTPs (third-party providers) access to their customers’ accounts, yet there is an inherent conflict between opening up the system to these smaller parties and the risks they might pose. We only have to look at the Facebook and Cambridge Analytica scandal a few months ago to see how third parties might handle user data and privacy poorly. API standards initiated by legislation appear to be a solution, but are those the most user-friendly and safe? Again, technology will evolve more rapidly than the legislation dictating it.

The opening up of banking data, new technology and changing consumer preferences will all contribute to a more open banking ecosystem. But the only thing that will ever drive innovation in this industry is healthy competition in an equal playing field. In every ‘traditional’ market, disruptors are responsible for seismic shifts: Netflix has kept the TV industry on its toes, Uber revolutionised the transportation business and Amazon set a whole new standard for retail. No matter how many band-aid solutions like PSD2 are put into effect, if the banking landscape itself, beyond the realm of payments and account info, doesn’t make room for new agile players, the real problem isn’t addressed. We need a mindset change from traditional financial institutions, one in which the consumer is put first. The new players are already riding that wave, now it’s time for the rest to follow suit. One thing is for sure: it will be an interesting ride.

 

[1] https://www.cbinsights.com/research/challenger-bank-strategy/

To learn about portfolio management in Canada, Finance Monthly hears from Constantine Lycos, the Founder and CEO of Lycos Asset Management Inc., a Vancouver-based firm offering investment management services to business owners and professionals. Constantine has over 20 years of experience as an investment professional, holds the Chartered Financial Analyst designation, as well as a Master’s degree from Oxford University in Mathematical Finance.

 

In what ways does Lycos Asset Management do things differently than other investment management companies?

I believe several factors differentiate us from other firms:

 

When is the best time for a family office or business owner to take on a portfolio manager?

Immediately! Business owners and professionals with a minimum of $500K of investable assets that do not work with a team of investment professionals that are fiduciaries do themselves a huge dis-service. I will emphasise the word fiduciary again, as our industry has been very good at making things look very complicated when they don’t have to be. Fiduciaries have to do what’s in the clients’ best interest. Portfolio managers licensed to operate in Canada, in order to earn the right to be able to invest client money on a discretionary basis (i.e. the portfolio manager decides what investments make up the investment portfolio), have achieved the highest level of professional qualifications, experience and integrity and are obligated by law to act in the best interests of clients. Hiring a portfolio manager when a family’s nest egg has reached 500K is a no brainer, even if they are already working with a financial adviser, typically at a bank. Our fees are usually lower than the banks’, and perhaps more importantly - the opportunities for improvements in the family’s investment portfolio and tax efficiency are huge. If they are not working with an investment professional already, the opportunities are even bigger. Research has shown that investors working with an adviser have vastly outperformed, on average, investors investing on their own. A 2016 study by Dalbar concluded that the average investor grew 100K to 305K over the previous 30 years when over the same period, the stock market would have grown 100K to 2.3 million! Working with an investment professional, especially one that subscribes to a value investment philosophy, would likely have produced at least similar results to that of the stock market. My US stock picks over the last 17 years have outperformed the market by roughly 3.5% per year, with the market returning 202% total return and my picks returning (net of fees) 425%.

 

What can you advise for strengthening an investment strategy?

Typically, if there is room for improvement in an investment strategy, it comes from the risk management side, for example incorporating low cost hedging. Hedging is hopefully a drag in investment performance because it means that the main investment strategy is performing well, but is there just in case the strategy does not work.

 

For what reasons might a client’s portfolio need to be customised?

The two most common reasons are a family’s over exposure to specific stock or sector and tax efficiency. An Executive’s or Senior Manager’s stock options or holdings in a publicly traded stock can be dealt with by using a custom portfolio - part of which includes a hedge against that single stock risk and/or sector risk. Similarly, a business owner’s exposure to a particular sector or industry can be hedged or dealt with by using a custom portfolio approach. Additionally, every family’s tax situation is different - some carry unused capital losses for example and some don’t. Thus, different strategies can be employed depending on the circumstances of the individuals involved. Capital loss harvesting can be employed for some families but not necessarily for others. More flexibility allows for better efficiency.

 

What is your process for identifying the risks and opportunities?

We typically look after a family’s whole nest egg and the opportunities and risks can be on the investment side, the tax side, the estate side, etc. In order to help clients as best as we can, we need to (and do) get to know our clients very well. Then the risks and opportunities specific to them and their situation will reveal themselves.

On the investment side, the risks and opportunities are more investment specific rather than client specific. We typically find the best investment opportunities in equities. They typically carry with them the most risk. Our value investment philosophy of ‘buying good businesses at good prices’ helps both to identify good opportunities and mitigate risk through a margin of safety in our valuation process. Typically, we would prefer lower beta stocks to higher beta stocks (relative volatility to that of the market), if other stock attributes are similar. My best stock ideas are in the fund that I manage, the Lycos Value Fund.

We also find good investment opportunities in private equity, albeit with an even longer time horizon than publicly traded stocks. For private equity, we would rely on outside managers. The process here is more with identifying competent and honest outside managers that are also reasonable on fees, an approach every investor should be using in selecting investment managers.

Fixed income investments are challenging in this low-interest-rate environment and are going to be challenging for years to come as either rates stay low or go up, essentially devaluing the worth of longer dated debt. We are at this point underweighting high-grade corporate bonds as the additional yield these bonds offer over government bonds is not enough to compensate for the additional risk and reduced diversification benefits, due to the higher correlation to equities. At this point, we prefer shorter-term private debt financing growth companies in the US or commercial mortgages also in the US, as the yields are better and the US economy is doing well. We also obtain private debt exposure through outside managers, so the process here is similar. In addition to analysing the risks and opportunities inherent in the asset class, we try to identify competent, honest and low-fee outside managers to help us. We also use long dated US Treasuries and long dated provincial bonds that carry the so-called duration risk, i.e. that the value of our holdings will go down as yields go up, not because of the yield we are getting from there, but primarily because of their negative correlation to risky assets such as equities.

Finally, and most importantly of all - how do all the different pieces fit together? Getting the asset mix right is the most important decision for us. Our process there is that for any particular return target for a client portfolio - we optimise the allocation to the various asset classes so that the portfolio can have the highest expected Sharpe ratio, i.e. the highest expected return divided by the expected volatility of the portfolio. We have found that this method has worked quite well.

 

Of what importance are third-party custodians in the management process?

Having independent third-party custodians to hold client cash and securities is important to our clients. As managers, we make buy and sell decisions on clients’ behalf, but we do not have physical access to their money, cannot make withdrawals from their accounts and essentially, have trading authority only. This is a good standard, one that I believe should be a requirement for all investment funds and a standard that helps maintain a high integrity and trust in the markets. I believe that the Madoff scandal would have been avoided if this was a requirement then, as the custodian for Madoff’s funds was a related party, not an independent third party.

 

What are the signs of a good investment to buy into?

Equities tend to make the best investments over time so I’ll focus on this asset class. Shares of businesses (“stocks”) whether traded on a stock exchange or not, represent fractional ownership of the businesses. Investors sometimes lose track of that simple fact and think of stocks as things that go up and down based on random macro-economic events, geopolitical events, company news, investor phycology, etc. While all of these may be true at one time or another, they neglect the two most important factors: the quality of the underlying business and even more importantly the price/valuation of the business in question. A good way to bring these two important factors into focus would be to think that you owned the entire business, not just a fraction of it, and that you couldn’t sell for a very long time, if ever. With that in mind, good investments will tend to be shares of good businesses bought at a good price. What makes a business a good business? This is not a particularly hard question. Some signs are:

1. The business has a good track record of profitability, for example an average return on equity over the last 5 years of at least 10% per year;

2. Good future prospects: for example, analysts are expecting decent growth over the next 3%-5% years;

3. A strong balance sheet;

4. The business has some ability to control its own destiny, rather than rely on external
factors such as the price of commodities or energy; As far as price is concerned, traditional valuation metrics here work well: low price to book, low price to earnings, low price to sales, low price to cashflow. Additionally, else being equal, given two stocks with the same attributes, a stock with a lower price volatility would be preferable.Stocks that meet the above criteria tend to do really well over time and make great investments. I have made it my aim in my professional life to look for such investments! Examples of good investments like these today would be: Walgreens (WBA) with a 5 year average Return on Equity (ROE) of 16%, price to book (P/B) of 2.26 and price toearnings (P/E) of 10; Arrow Electronics (ARW), Toyota Motors (TM) and Goldman Sachs (GS) with similar attributes.

Is there anything else you would like to add? 

I would like to reiterate the most important takeaways for investors: 1. Work with an investment advisor if you do not already have one, research has shown that investors working with an advisor vastly outperform those that do not. 2. Work with a fiduciary if you have enough money to invest such a portfolio manager. A fiduciary has to by law put your interests first ahead of their own or other clients’. 3. Do not let emotions dictate when you invest money, invest money consistently: do not sell after markets are down just because they are down and do not add to investments after they’ve gone up in value because you feel good about them. Using an investment manager with a “value” investment philosophy will go a long way in helping with that.

 

 

 

 

 

 

 

Website: http://www.lycosasset.com/

The greatest problem that is holding back innovation within the renewable energy sectors is access to project capital. To explain the ins and outs of project funding and financial backing, this month Finance Monthly hears from David Hullah, Finance Director at Allied Consultants, an international firm that specialises in strategic
financing.
Below David talks Finance Monthly through the complexities of project development, from financial matters to risk management.

 

Typically, within every major capital project or large asset acquisition, there are three principle risks; financing, commercial/market, and operational.

The project/asset financier takes the financing risk and is remunerated accordingly; likewise, the project sponsor/asset purchaser takes the commercial risk of there being a market for the output of the investment. However, what has caused issues and in many cases transactions to flounder, has been the debate on who should take the operational risk of any new project or asset acquisition. Allied Holdings and Investments Ltd have been working on this issue for the past 10 years and have solved it, with their due-diligence process which provides a funded solution- they call it Maintained Availability.

 

The Challenges for the Project Developer

The challenge for a project developer is in providing additional financial support, when their technology has limited or no track record. In most cases, if not all, this has not been possible and has led the project to fail to proceed.

 

The Challenges for the Investor

With over 1,800 investment funds, worldwide, there is no shortage of investment only a shortage of bankable projects; but what makes a bankable project? The bottom line is providing an investor with a robust mechanism that protects the projects’ ability to repay its debt and operational costs if the projects revenues fall below the projects breakeven point. Above this line, known downtime caused by scheduled maintenance can be built into the projects cashflows but what would happen if something unexpected caused by a non- physical damage event caused the revenues to fall below breakeven?

Allied Holdings and Investments Limited (“Allied”) in conjunction with Fidelis Underwriting Limited have developed a mechanism of due-diligence that is designed to assist in the financing of renewable technologies and is structured to provide extra financial support to a project where the technology does not have a relevant track record, and/or the project company does not have sufficient financial strength to provide security for finance.

The use of M.A allows funders to move further along the project risk curve, thereby increasing equity returns through increased dividends or enhanced asset values at exit.

 

Guaranteeing the consequences of the unexpected.

Understanding the process of availability in a business model is critical when it comes to assessing risk. Process availability is identified by known maintenance regimes and plant closures and this availability is used to calculate the projects minimum level of revenues that can repay the debt and cover operational expenses – Breakeven.

These events can be calculated where the technology has a proven track record, enforced by other risk mitigation procedures, but what if the technology is unproven with limited or no track record, and how can these technologies compete and bring their benefits to market? The Solution is Allied’s Maintained Availability.

 

What is Maintained Availability™

Maintained Availability provides an opportunity for a third party to ‘guarantee’ this operational risk.

 

Facility procedure

 

Project delivery

The EPC contractor will have to provide the minimum availability that is proposed by TWI availability, or better.

TWI will ensure that the commissioning process is rigorous and that any problems diagnosed are rectified prior to final hand-over. The commissioning process will include a requirement for the plant to run for an agreed period at or above the minimum limit, set by TWI, before it is formally signed off and hand-over is agreed.

TWI, as part of the due process, will have provided an operations and maintenance schedule which will be monitored by their own bespoke software “RISKWISE”, which will be used for ongoing monitoring of the project. If there is an unexpected event which reduces process availability below the breakeven level, M.A will provide sufficient funds to ensure annual debt service and operating cost obligations are met for a period of up to 10 years.

Maintained Availability does not become effective until the plant is handed over and thereby already achieving the agreed minimum limit or better.

 

What M.A does not do

 

Advantages of M.A to a funder

 

What makes M.A different from other products on the market?

Other products are annually renewable, which can put the project at risk at the end of each year. A renewable policy can be changed, have a premium increase or even be cancelled. This type of policy is a concern for investors because of its lack of certainty.

M.A is a contract that provides an agreed sum of money in support of the projects’ net revenues for a period of ten years that can only be cancelled by the project owners with agreement of the investors. The money acts as a form of credit enhancement that can be drawn upon when the revenues are unable to fully support the debt. It is then repaid when the projects’ revenues recover. Historically, it has been shown, that if the process is to under-perform it will be in the early years of the project with full availability potential being attained by Year 5. M.A is there to protect the investors should this happen.

Allied’s due-diligence will look to mitigate such events in two stages:

 

The due-diligence process

When first approached by a potential client, Allied will undertake a vigorous desktop review of the project. Should the project be accepted, and after consultation with the client, Allied will commence two detailed due-diligence reports with their independent consultant partners. Should the client have already engaged the services of a consultant, then that consultant can be used. However, for purposes of underwriting the technology process, Allied’s independent technology consultant TWI must be engaged, and the two reports must be made available to Allied if they are subsequently engaged to source funding.

 

The Technology Process

Firstly, through a series of process due-diligence measures that looks at the plant from design, to manufacture, the installation capabilities of the proposed EPC contractor and the operations and maintenance procedures proposed by the O&M contractor; and

Secondly, an additional and complimentary process security to that already installed by the technology provider, is provided through TWI’s integrated RiskWISE® interrogation software that provides additional risk based protection to the funders, and ensures that the process is optimised at all times.

Whilst each M.A contract of insurance is project-specific, Allied believes that their due-diligence process is also important for technology suppliers and innovators to consider as a standalone pre-qualification towards commercialisation.

Technology manufacturers will benefit from having an M.A approval and being able offer their buyers a technology that has the M.A stamp of acceptance. This would provide the project developers with all the added financial benefits described.

For companies developing innovative technologies having M.A due-diligence involved from the design stage can help evolve the technology from design to becoming fully commercialised with the benefits of M.A support.

 

Who Are TWI

TWI Ltd, are one of the world's foremost independent research and technology organisations. Based at Great Abington near Cambridge since 1946. TWI is a non-profit distributing, membership-based company of which Allied are industrial members. Its Members total around 3,500 from 60 countries around the world – including the likes of Boeing, Thales, ABB, Honda, Mercedes, BMW, US Army, US Navy, Royal Military College of Science, Rolls Royce, BP, Kuwait Oil Co, Shell, etc.

 

What is RISKWISE™, what does it do and how?

RISKWISE™ is risk-based inspection/maintenance (RBI) planning software that has become accepted by legislative bodies as a means of risk management consistent with safety requirements. It has been driven by regulators as well as the economic needs of plant operators/owners. The application of RBI software minimises the risk of failures or forced outages. It also enables intervals between inspection/maintenance to be optimised (often extended) and inspection/overhaul resources to be risk focused during outages. The overall economic benefit to operators is to reduce plant downtime. Guidelines and standards for RBI have been produced by ASME (American Society of Mechanical Engineers) and other bodies over recent years. RISKWISE™ is fully compliant with current RBI standards.

 

Example of Maintained Availability working in practice

It is assumed that the design availability is 100%, and the agreed minimum availability by TWI was set at 80% with a breakeven percentage calculated at 66%, then our solution would involve Maintained Availability™ taking a mezzanine slice of risk from 66% to an agreed lower limit.

This means that the project sponsor takes a first loss above 66% and the M.A take the risk that the plant meets availability of between 66% and the lower limit (this being the percentage level of the design availability below which the plant is considered uneconomic).

 

Speeding up the funding process – connecting vetted projects with the right investment partner.

Allied are currently looking at the creation of an online project finance platform. The platform will match the requirements of Allied’s clients including those after Allied’s due-diligence process who have Maintained Availability. The platform will speed up connecting clients with the right capital, and investors with access to mid-market projects which can offer with attractive returns which currently would be rejected or considered not worth assessing if they have limited track record.

 

About Allied

Allied Holdings and Consultants Ltd are a team of experts, based in the UK and the US with representative offices in Asia and the Middle East. We have represented, developed, leased and funded technology. Our clients benefit from the direct involvement and attention of our team with their extensive knowledge in providing professional advice and assistance in strategic financing and are commitment to building long term relationships. Additional information can be found at www.AlliedConsultants.co.uk

“Members of the Allied team, have worked for over 10 years to bring this product to the market. When it was first conceived we believed then, that this product had a place in the market, to support innovation and promote technologies that can make a difference to the environment. Today 10 years later, the importance to support innovative technologies and the renewable energy markets are even greater.” - Roger Willmott, Business Development Director.

 

About Fidelis Insurance

Fidelis Insurance Holdings Limited is a privately-owned Bermuda-based holding company, which, through its wholly-owned subsidiaries, is a global provider of bespoke and specialty insurance and reinsurance products. Fidelis’ Bermudian platform focuses on catastrophe reinsurance, whereas Fidelis Underwriting Limited - the group’s London platform - focuses on the design and execution of large bespoke deals in areas such as: Aviation Finance, Forestry, Mortgage Indemnity, Political Risks, Structured Credit, Title and Surety, and in more traditional specialty, catastrophe reinsurance, and niche products via its MGA platform, Pine Walk. Fidelis is rated A- (Excellent) by A.M. Best Company, Inc. Additional information regarding Fidelis may be found at www.fidelisinsurance.com.

“Designing and delivering new innovative bespoke insurance products is a cornerstone of Fidelis’ business model. As such we are very excited about the launch of this insurance product within the Maintained Availability process –assisting the development of sustainable and green energy.” - Richard Coulson, FUL Chief Underwriting Officer.

 

David Hullah
Finance Director at Allied Consultants
Telephone: +44 (0) 203 195 3949 | Mobile: +44 (0) 7772 794320
Website: www.AlliedConsultants.co.uk; www.MaintainedAvailability.com
Email: enquiries@alliedconsultants.co.uk

The European real estate sector continues to flourish but competition for deals is fierce and speed is often of the essence: so much so that, according to recent Drooms research1 over 50% of real estate professionals in Europe are compromising on the quality of their due diligence to complete transactions quickly.

However, modern technology has a solution for those seeking to complete real estate deals more efficiently. Where time pressures have led to a potential decrease in the quality of due diligence, parties to a transaction have found a solution in technology enabled with artificial intelligence (AI), such as virtual data rooms.1

 

Real Estate is big business

According to a Real Capital Analytics (RCA) report published in February 2018, Europe’s commercial property investment market returned to growth in 20172 as deals of more than €500 million in value accounted for almost one quarter of the year’s acquisition volume. The UK also regained its title as Europe’s largest market after its investment volume increased by 12% thanks to several large transactions such as CC Land’s purchase of the landmark Cheesegrater building for £1.15 billion.

Successful transactions like this depend ultimately on high quality and detailed due diligence but despite the high volumes of information that need to be processed, the real estate sector is still behind the curve in terms of technology and a significant number of important processes are still conducted manually.

The volume of documentation involved in real estate due diligence continues to grow exponentially and it is becoming increasingly important for key stakeholders to quickly and efficiently navigate their way through the mass of information involved and to focus on the key points.

Our survey1 clearly shows that over the past two years there has been an overall increased focus on due diligence and 73% of real estate professionals believe this focus will increase further over the coming year. For this reason, AI is increasingly being regarded as a solution for today and not technology for the future.

 

A closer look at the benefits

More than half (54%) of real estate professionals say that they use AI to improve the keyword search process when working on transactions. However, this figure rises to 69% of respondents who say they will be using AI for keyword searches in five years’ time. Other processes that will become more widely used include foreign language translation, identifying red flags, routing documents to the right decision-makers and topic-modelling.

The majority of real estate professionals believe that AI already benefits their firms’ and provides a competitive advantage by enabling a much higher volume and variety of documents to be searched at high speed. Almost the same number say that AI speeds up the due diligence process, while a third believe it improves the accuracy of decision-making. Other benefits of AI include minimising risks and liabilities in an overall deal, reduced reliance on legal services, the ability to automatically create contracts and reports and securing the best deals before other professionals.

 

The barriers facing AI

Despite these benefits, there are still perceived barriers preventing the uptake and use of AI in the real estate industry. The biggest of these is lack of confidence in AI’s ability to match human intelligence and decision-making (cited by 53%), followed by a lack of skills available to implement relevant AI technology (51%), technology being too difficult to use (41%), a lack of trust by senior management in AI (19%) and concern that AI will replace investment professionals’ roles (17%). Only 9% say the main barrier is a ‘lack of demand’.

 

What does the future hold?

As a pioneer in the digitisation of due diligence in real estate, Drooms’ technology is helping to change existing processes by integrating AI into its virtual data room (VDR). The aim when building AI into our VDR technology is to enable real estate professionals to reduce the amount of manual review work, eliminate unnecessary errors and reduce reliance on expensive third-party costs. We are just one example of the application of AI, but a very good one.

Crucially, this is not a battle of technology versus humans. Despite its ability to automate a tremendous number of processes, AI will always work best in conjunction with human skills and intelligence. AI needs to learn from human behaviour and there is no substitute for years of experience, instinct and knowledge. However, AI complements those elements and adds huge value by making real estate processes much more automated, efficient and cost-effective.

 

Website: https://drooms.com/

___________________________________________________________________________

1Source: Drooms, April 2018 - The future of artificial intelligence in real estate transactions April 2018

2Source: Real Capital Analytics February 2018 - 2017 Year in Review edition of Europe Capital Trends.

Ivan Gowan, CEO at Capital.com, looks at the new regulations and asks whether they are all in the best interests of the consumer.

First the boring bit – or perhaps not. On 3 Jan 2018, the European Securities and Markets Authority (ESMA) received product intervention powers, as the Markets in Financial Instruments Regulation (MiFIR) came into force. This allows ESMA to temporarily dictate regulations across all 28 EU member states, either in support of or overruling the National Regulator – in the UK’s case the Financial Conduct Authority (FCA). On 27 March, ESMA decided to use these new powers to intervene in the market for CFD trading. As with many new regulations, the broad direction is to be welcomed – providing much needed protection for consumers – but flaws in the detail could lead to unintended negative consequences.

The intention is to protect unwary and inappropriate consumers from taking on risks they don’t understand and suffering disproportionate financial losses. This is a laudable intention in anyone’s book and responsible CFD providers will already be compliant with much of the detail in these recommendations. CFD providers already have a responsibility to help retail investors manage their risk and align it to their ability to withstand any financial losses. ESMA’s temporary measures provide a salutary reminder and an improved yardstick for providers to measure themselves against getting this balance right.

The central aspect of a CFD which provides both the main risk and the main benefit is the ability to take a relatively large financial position with a smaller upfront margin payment – what’s called leverage. ESMA measures include putting a leverage limit on the opening of a CFD. This level varies according to the volatility of the underlying instrument, from as little as 2:1 for cryptocurrencies to 30:1 for major currency pairs. They also include a margin closeout rule of 50 per cent of the initial required margin, meaning the position must be closed as it moves against the client. Very sensibly, negative balance protection is mandated, which prevents a client from losing more than their deposit – this is already a common aspect of dealing with most reputable providers. ESMA also recognise the importance of new clients to the industry fully understanding the likelihood of success and are proposing the use of a specific warning that details the win/loss ratio.

This all seems very sensible, doesn’t it? So, where is the issue? Well, there are two interlinked issues here. What makes the CFD a popular way of trading the financial markets and hedging out other risks is the leverage it offers - the ability, as mentioned earlier, to take a relatively large financial position with a smaller amount of upfront margin. Clients enjoy using leverage sensibly. Coupled with the risk mitigation measures already offered by reputable providers in the industry, or now mandated by ESMA going forward, clients should be free to use appropriate levels of leverage commensurate with their knowledge and experience. The industry has a responsibility to help ensure they do not over-expose themselves to risk, which is done by way of thorough questionnaires designed to establish their understanding of the risks and practicalities of CFD trading. Responsible CFD providers are increasingly developing platforms that offer users an experience in line with their ability to manage risk. CFD providers can offer less experienced users lower levels of leverage as those users gain the necessary knowledge and experience to take on larger trades. This approach, though not mandated, could and should form part of the provision of a responsible trading environment.

The corollary to not offering appropriate and desired levels of leverage to more experienced users, and the main unintended consequence is that clients simply go somewhere else – somewhere where the protections are either lower or non-existent. But where? Well, in the world of the internet, unscrupulous trading providers abound – either real platforms, simply unregulated, where behaviours are questionable at best, or sophisticated financial scams, with no underlying trading ever taking place – think Wolf of Wall Street. Since February, the FCA has warned about three firms operating illegally in the UK, but unfortunately the FCA website is not bedtime reading for many. But these providers appear to offer users the levels of leverage they seek, levels which the reputable providers are being forced to withdraw.

So, what is the answer? A mix of the above, with the best outcome for the consumer at the heart of all changes; regulations that allow and encourage compliant CFD providers to offer consumers what they seek, while presenting them with risk mitigation tools and targeted education to allow them to go on enjoying the trading experience in a controlled environment – while understanding the likelihood of ultimate financial success. Good regulations will encourage innovations which benefit the consumer, such as some of those we have seen in the recent past: stop losses and limits, which ensure that a trader’s position will be closed as soon as their losses or profits reach a specific point: alerts to notify them when a market hits a certain price, providing them with either an exit or entry point in a specific market: or the game changing developments in mobile app trading.

So, in summary, the ESMA regulations will help to create a level playing field between responsible CFD providers and mandate a number of measures to protect consumers from irresponsible risks. However, the medicine here could be worse than the ailment if the impact of overly restrictive levels of leverage is to drive consumers offshore to unscrupulous operators, where there are no protections and the likelihood of losing your money is 100%. ESMA should consider the imposition of leverage restrictions not as a standalone, but in the context of the other protections in place. Insisting CFD providers make a responsible assessment of the level of risk that a retail trader can take, alongside negative balance protection and the margin closeout requirement, should enable levels of leverage which will keep traders onshore, protected by a compliant industry with a vested interest in sustainability and longevity.

In January this year, Trump slapped tariffs of up to 30% on imports. In March, he added tariffs of 25% and 10% on imported steel and aluminium respectively. China and the EU retaliated with actual or threatened tariffs on hundreds of imported US products, but Trump hit back with a threat of further taxes.

Companies and investors caught in the cross-fire between tit-for-tat trade wars are concerned because:

The Financial Times suggests that a global trade war could knock 1-3% off GDP over a few years. They also reported that whereas capital expenditure (capex) by some US companies had risen, a Credit Suisse survey suggested that many businesses remained more hesitant about investing. Some have opted to hold onto their mountains of cash because of the uncertain outlook caused by trade war and geo-political tensions.

 

Capex

With reduced capex comes reduced employment and reduced productivity gains. Inefficiency eats into profit margins and competitiveness, lowering company values and economic growth, which leads to less capex, and so the vicious downward spiral continues.

Some companies might manage the situation by shifting production overseas, but in the process losing exported jobs. Relocation would also consume investment and time to raise production and adjust to the new dynamic, and in the meantime, the profit margin would diminish.

 

Uncertainty

A great drag on companies’ profits and a disruptive influence on supply chains, is the uncertainty that trade wars create. When will they end? Will they escalate? Which sectors will be affected and to what extent?

Chinese parts, for example, relied upon by US manufacturers, could become unavailable, or they might not. Just a month later, the US is backpedalling on its April 2018 ban on selling US company parts to Chinese company ZTE, a reversal that will cause turmoil among exporters and importers that must now reverse their plans to circumvent the ban.

Governments might retaliate to their counterparts in other ways. In 2016, China shut down Korean companies operating in China in retaliation to South Korea's actions. Hyundai and Lotte (both Korean) were denied car parts from local suppliers and 100 Lotte shops were closed. Countries have been known to expropriate foreign companies’ assets.

In the aftermath of the 2007 global financial crisis, investors stood on the sidelines for years with their pockets full of cash until asset prices and markets stabilised from the shock. The same hesitation could occur during trade wars and other geopolitical crises.

 

Higher funding costs

We have already seen some shareholders switching out of volatile equity investments into safer havens such as government bonds. That is likely to raise yields for borrowers, especially for high-yield borrowers, increasing interest payments and lowering corporate profits.

 

Currency risk

Investors’ flight to safety could significantly impact exchange rates as they dump risky currencies (such as those of some emerging market countries) and buy safer ones (such as USD), causing currency losses for companies that have not hedged their currency risks. Conversely, companies with a depreciating currency could benefit – for example, from the increase in value of overseas earnings that are reported in the depreciating currency. Those gains could be offset more or less, by higher import costs.

The IMF reckons that (without trade retaliation) the USD could appreciate by 5%. Appreciation of the USD could accelerate, causing further rises in costs of USD-denominated commodities, such as oil.

 

Commodity prices

Higher oil prices would adversely affect heavy users of energy, such as aviation, motoring, and manufacturing sectors. For example, American Airlines’ share price went down 6% after it expected $2.3 billion in additional fuel costs.

Winners and losers are expected from conflicts, such as trade wars, but sometimes the outcome can be unexpected.

 

Unintended consequences

American company Metal Box International was going to shut down after its sales had been decimated by cheap imports, but Trump’s protectionist trade policies changed its mind.

Metal Box, and other US manufacturers of products slapped with US import duties, should have seen its market sales rise as it filled the market gap created by reduced imports.

Anti-subsidy and anti-dumping duties imposed by the US on Chinese imports did result in a pick-up in Metal Box’s sales, but it was short-lived, because, according to the company, consumers and retailers feared trade war disruption so they stocked up pre-emptively. The company increased its capex in anticipation of higher sales volumes, but the machinery now sits idle.

The company’s hopes for business success were set back further by tariffs imposed by Trump on imported steel, because the company will now probably have higher costs of steel raw material.

 

Stagflation and GDP

Moody’s notes that workers employed by US business sectors that use steel far outnumber those employed in its manufacture, by around 5:1. That is also the ratio of job losses: gains predicted by Trade Partnership as a consequence of US tariffs.

“Protectionist trade policies, including tariffs on raw-material imports, could exacerbate these inflationary pressures [caused by global economic growth], running the risk of tighter margins and possible supply-chain disruptions in the manufacturing sector,” said Moody’s. Inflation could necessitate faster monetary policy tightening, i.e., more interest rate hikes. That would raise companies’ costs, denting their profits.

Sustained high interest rates and inflation could stymie global economic growth and create stagflation. A March survey by BoAML found that 90% of investment managers thought protectionism would cause either inflation or stagflation, and protectionism was investors’ primary fear.

Whereas some steel users will have the ability to pass on rising metal costs (either contractually, or through their brute forces of negotiating or price-setting), smaller companies will have to absorb higher input costs to maintain market share. For the former, profit margins will be protected, for the latter, they will contract.

Where investors are concerned, borrowers also need to be concerned, because the fortunes of both are intertwined. When investors become risk-averse and hoard cash, borrowers lose access to capital or pay a higher cost. Reduced profits ultimately hurt workers’ incomes, the economy’s GDP, and investors’ return on investment.

Unchecked, stagflation could deteriorate into recession, leading to job losses, reduced investment and further corporate financial distress. With many companies and individuals already highly geared with debt, a recession or stagflation that reduces income and the ability to service debt interest obligations, could trigger a wave of personal bankruptcies or corporate insolvencies, reducing GDP further and leading potentially to recession.

Companies might have to lay off employees to remain profitable or in business. Where last-in-first-out stock valuation accounting policies are used, profits will be quickly dented, reflecting higher stock costs. Cashflow will fall because of more expensive stock, or else companies will try to stretch their trade creditors’ goodwill even farther. Companies that can control their working capital interactions are more likely to survive than those with poor credit, stock, and trade creditor management practices.

 

Credit insurance

Companies’ trade credit insurance premia might increase, or be stopped of their financial position deteriorates. Credit insurance providers stopped providing credit protection to Woolworths’ suppliers, meaning it had to pay in cash, exacerbating the strain of its debt pile and leading to its administration. Without credit insurance, factoring of invoices, and conventional credit from suppliers, Toys R Us had to buy its games and toys as they were delivered. Without cash, a company’s shelves soon begin to empty, payments become overdue, staff are not paid, and operations grind to a halt, i.e., bankruptcy or insolvency ensues.

 

Gearing

Companies that have low gearing or operate in strong cashflow sectors such as fast-moving consumer groups, might withstand a cash crisis by raising additional debt, but companies already creaking under a mountain of debt and/or debtors, are more likely to break under the strain, and relatively sooner.

Almost 2/3 of aluminium and 1/3 of steel are imported by the US. Caterpillar and Boeing were caught in the firing line between the US and its trading partners because of their heavy and critical reliance on metals, and their international operations. Investors realised the negative implications so both companies’ shares dumped, sending their prices down more than 5%.

 

Winners and losers

Shareholders in US steel makers made a mint from US tariffs, US Steel and AK Steel, for example, rose 6% and 10% respectively. In the longer-term, US steelmakers could lose out from trade wars, however, for example, if manufacturers relocate, cut back on domestic production volumes, or use alternatives materials.

Other winners in the latest trade spat are companies that are more inward-looking or resilient to tit-for-tat retaliation, such as healthcare and BioTech. For example, shareholders in Johnson & Johnson, Merck, and Pfizer were some of the biggest winners in March. Other defensive regions and sectors include: Australia, Brazil, parts of Europe and Japan, and sectors such as telecoms, utilities, insurance, and retail. Countries whose GDP depends heavily on exports to the US, such as Mexico and Canada, are likely to suffer most from US protectionism.

 

Conclusion

Companies are in the cross-fire between trading countries, so they need to, above all, pay close attention to their cash flow and their survival over the longer term, even at the expense of near-term profit and revenues. They also need to monitor a changing geopolitical landscape and adapt accordingly. At such times, a company is likely to soon find out how committed banks and other investors really are to the company’s survival.

 

Website: www.permjitsingh.com

 

Finance Monthly speaks to Kristinn Gils Sigtryggsson, the Founder of Bankers Confidence ehf, an Icelandic company that offers small and medium-sized banks a comprehensive backup and added value support services to enhance their reputation and confidence.

 

Tell us about the inspiration behind Bankers Confidence – is it what you hoped it would be?

On 8 October 2008, my family was due to fly back from a holiday in Crete. On the way to the airport, we were told that there’s the possibility of our aircraft not landing, as the Icelandic banking system had collapsed and there could be problems connected to paying for the flight. Eventually, the plane landed and brought us back home, but soon after this and after I had fully understood what really happened, I kept asking myself what could be done to prevent this from happening again? What could be done to build trust and confidence in the global banking system again?

Bankers Confidence is now in the process of building its recourses team and funding to target full-service operations within the next 12 to 18 months.

 

What would you say was the primary cause behind the 2008 collapse in the Icelandic banking system crisis? Is there anything, in your opinion, that could have been done differently to prevent it?

The primary cause can be traced to the collapse of the ‘too big to fail banks’ in the United States.  Some had to file for Chapter 11 but others were kept alive by pumping a lot of public money into them. This immediately hit all Icelandic banks

Yes, something could have been done to avoid this. The construction of the Icelandic banks balance sheets was wrong in a number of major aspects. They had been lending out long-term mortgage loans to support massive investments in the country and they had been financing this by short-term loans from foreign banks. When Lehman Brothers went bankrupt, not only did the American banking system freeze, but all confidence and trust within the Global banking system was lost. Suddenly, no short-term funding was available anywhere.

Even though it can be argued that the beginning of the Icelandic banks crisis was imported, in my opinion, this would have happened sooner or later anyway - all of our banks had been too greedy, trying to grow too fast and consequently, they had been taking unacceptable risks, involving themselves in business deals that carried tremendous risk.

 

What lessons should auditors take from how the crisis was handled? Are there any that you now keep in mind in your own work?

Auditors’ work will always have to be based on their professional judgement. This judgement has to be based on a comprehensive knowledge and understanding of the environment the client is operating within. Too many of my colleagues concentrate on following the auditing standards, which is good but not enough. The standards are just a manual to be used as a guide, when questions arise on how to handle certain issues. A tunnel vision is dangerous for auditors; a wider horizon and understanding of the business is vital.

 

In what ways does Bankers Confidence provide safeguarding against the unforeseeable problems that could arise in the future?

Bankers Confidence’s terms of business agreements with small and medium-sized banks will allow them to use what we call the BC Stamp in their PR materials and inform customers and other stakeholders that they are under our independent scrutiny and protection. This could also mean access to backup funds in case of sudden short-term liquidity requirements and access to high-security data backup. For its own security and to be able to safely offer these services, BC will take over the relevant banks’ internal audit risk reporting function, which will be performed on a daily, live assessment basis.

The members of the Board of Directors of Bankers Confidence are highly skilled professionals that have been carefully selected to ensure a balanced mix of extensive senior management experiences. They have all held very senior positions in both large and small banks and responsibility for risk assessment and management. They have held CEO positions in smaller banks, high-level appointments in the European Commission, within the banking sector and CEO roles in insurance.

Our mission is to become visible within the Global banking sector as the people who introduced a new approach to build trust and confidence in the banking sector. This trust and confidence is still missing, even though it’s been nearly ten years since the 2008 crisis.

 

What are the next steps in Bankers Confidence’s future development?

We are now in the process of selecting two to three banks to participate in our pilot project. This work will take four to six months and during that period, we should be able to finalise the funding and become fully operational.

 

Website: http://bankersconfidence.net/

 

About Finance Monthly

Universal Media logo
Finance Monthly is a comprehensive website tailored for individuals seeking insights into the world of consumer finance and money management. It offers news, commentary, and in-depth analysis on topics crucial to personal financial management and decision-making. Whether you're interested in budgeting, investing, or understanding market trends, Finance Monthly provides valuable information to help you navigate the financial aspects of everyday life.
© 2024 Finance Monthly - All Rights Reserved.
News Illustration

Get our free monthly FM email

Subscribe to Finance Monthly and Get the Latest Finance News, Opinion and Insight Direct to you every month.
chevron-right-circle linkedin facebook pinterest youtube rss twitter instagram facebook-blank rss-blank linkedin-blank pinterest youtube twitter instagram