Following the central bank’s monthly report, the Bundesbank has downgraded growth forecasts in Germany for both this and next year. However, the institution suggests a recovery for the euro area may well be on the horizon, having recorded a rise in business confidence in May.
Bundesbank cut its December projections for 2013 from 0.4 to 0.3, and stated that growth would amount to 1.5 percent in 2014, a 0.4 percent drop on the previous estimation. The revised figures were “due mainly to downward revisions with regard to the external environment,” said the bank.
The downgrade follows the IMF’s decision to cut it’s 2013 growth forecast in half to 0.3 percent.
“Much will depend on whether the economic situation stabilises in the euro-area crisis countries and whether expansionary forces will gradually gain the upper hand there,” said the central bank’s President, Jens Weidmann. “A sustained upturn in the world economy is just as important as a precondition for the growth path we have assumed.”
Europe’s largest economy narrowly escaped recession through the first quarter, posting 0.1 percent growth, the likes of which was in large part due to private consumption having offset disappointing exports.
The bank wrote in a related statement: “In the euro area the economy appears to be bottoming out. Nevertheless, the Bundesbank sees continuing structural problems as standing in the way of a rapid improvement. This is likely to place a major strain on the German economy, which is integrated into the international division of labour.
“Consolidation and reform efforts appear to be slackening. This could have a negative effect on the financial markets and further intensify the debt crises. Confidence would then be further eroded, which would also have negative consequences for the cyclical outlook for the German economy.”
The bank anticipates the euro area to offer “no meaningful stimuli” to the German economy until 2014 at the earliest. However, despite the euro-area crisis, Bundesbank expect Germany to later this year demonstrate a modest recovery, in large part due to a robust labour market, significant wage increases and slowing inflation.
The bank’s inflation figures were revised upwards this year to 1.6 percent from 1.5 percent, though reduced to 1.5 percent from 1.6 percent for 2014.
At the recent IMF Spring Meetings, experts highlighted the discrepancies in the growth rates of countries around the world. PwC, who six months ago coined the term “two-speed economy”, has revised its analysis to include a third speed lane. “Whilst the eurozone continues to focus on crisis management and Japan puts the finishing touches to its reforms, the US appears to be breaking away from the pack and gradually returning to trend growth,” PwC says in its monthly Global Economy Watch.
According to PwC “emerging and developing economies continue to be in the ‘fast lane’”. According to their internal analysis BRIC countries will continue to grow at least three times as fast as the G7, “the release of the first quarter GDP data for China confirmed our view that it will continue to grow slightly faster than the 7.5 percent government target rate (actual growth was 7.7 percent year on year), whilst gradually rebalancing from investment to consumption-led growth.”
Christine Lagarde suggested in a speech at the Economic Club of New York that the US and Switzerland were ‘on the mend’, creating the medium growth rate bracket. PwC estimates that the US will grow around two percent in 2013, buoyed by sustained job creation.
Lagarde has warned that this level of imbalance is “starker than ever.”
“In far too many countries, improvements in financial markets have not translated into improvements in the real economy – and in the lives of people,” she said. “We are now seeing the emergence of a ‘three-speed’ global economy—those countries that are doing well, those that are on the mend, and those that still have some distance to travel.”
Countries in the eurozone continue to struggle, as the banking industry is still not fully repaired, and vital fiscal and monetary reform has failed to materialise. “Monetary policy is ‘spinning its wheels’—meaning that low interest rates are not translating into affordable credit for people who need it,” said Lagarde. “The plumbing is clogged up, and we are seeing more financial fragmentation.
“So the priority must be to continue to clean up the banking system by recapitalizing, restructuring, or, where necessary, shutting down banks. The oversize banking model of too-big-to-fail is more dangerous than ever. We must get to the root of the problem with comprehensive and clear regulation, more intensive and intrusive supervision, as well as frameworks for orderly failure and resolution, including across borders, and with authorities empowered to oversee the process,” she added.
During the Spring Meetings Lagarde emphasised that job creation should be a priority for policymakers in order to combat the deep growth inequality plaguing Europe. “Every policy maker is keen to develop jobs and to respond to the demands of the young population in particular,” she said. All job creating policies should be considered, “starting with growth and good polu mix which relies on not just one policy but a set of policies that ill include fiscal consolidation at the right pace, structural reforms and monetary policy, which provides the breathing space,” she added.
Emerging market currency exposure is becoming more important to investors and corporations alike. In the post-crisis world, emerging market regions have been seen as an investment alternative to the troubled G10. An environment of extremely low yields in developed markets has made the higher yields available in emerging markets more attractive – particularly as the fiscal and national debt positions of many emerging sovereigns now compare favourably to those of developed economies. With a large proportion of global economic growth contributed by emerging nations, the case for investment in emerging markets appears even more convincing.
Corporations, meanwhile, can also benefit from strong growth in emerging economies. As the developed world continues to de-lever, consumers in emerging markets are typically benefiting from rising wages at the same time that consumer credit growth accelerates. The connectivity and size of the emerging markets (EM) sector is greater than it has ever been. Devaluations of EM currencies used to have confined, local impact; now they affect investors and corporations all over the world.
But how to protect against the risk of these devaluations? They are still prone to occur, despite the increasing levels of development in the various regions. Local issues, both economic and political, still take people by surprise and damage investment in the country. Many investors and corporates maintain a mandatory policy of hedging their forex risk, no matter how expensive it may be in the long run.
And make no mistake, hedging EM currency exposures can be very expensive. A USD-based company which hedged 100 percent of its exposures with quarterly forward contracts in BRL, for example, would have paid out 150 percent of its original notional amount over the last decade. The high interest rates in BRL relative to USD meant that the forward contracts priced in devaluations that did not usually occur, leaving the company with a cost at the end of the majority of the hedge contracts. Is the remedy worse than the disease?
Fortunately this is not the only way to protect against EM currency risk. We illustrate some alternatives in this article, and show that using different hedge contracts, or intelligent hedge timing, can reduce overall hedge costs while maintaining a good level of
The choice of hedging instrument
First it is worth considering the hedge instrument. Forwards are the dominant choice, as they are treated more favourably under accounting standards, and they are simple and easy to understand. However, this simplicity does not imply that they are low risk. As the BRL case shows, they can have a severe and consistently negative impact. Let us consider a simple at-the-money call option as an alternative.
In Fig.1, we present the cashflows (including costs) that a USD-based hedger would have received if they had hedged their BRL exposure once per quarter with a three month contract. The two lines show the cumulative cashflows which would have accrued had the hedger used either a forward or an at-the-money call option. For the options, the premium has been deducted from the payout so that the total cost of the option is correctly included in the cashflow.
The difference is very striking. The ruinous cost of hedging with the forward contract is cut to one third of its value by the use of vanilla call options – but without much reduction in protection, the options provided an effective hedge in the 2008 crisis period.
This is quite remarkable. And it is not only BRL that shows this feature. In Fig.2 we have repeated the analysis for other EM pairs. Though in some cases there is not much data, overall the pattern is very clear. On average, the 3m hedge cashflow is 0.9 percent for options, and -1.4 percent for forwards, for data since 2003 in many cases.
This is not quite the end of the discussion on hedge products; for any specific combination of currencies, it might be that OTM (out of the money) options have offered good value, and the effects of correlations should not be ignored. But the information above is unambiguous enough to mean that options should be seriously considered in any discussion of EM currency hedging.
The importance of timing
The choice of instrument study implicitly assumes that hedging is continuous. However, if the hedger has strong information about the likely timing of any currency devaluation, then the choice of instrument becomes irrelevant, and obviously a forward hedge should be entered into prior to the devaluation event. How can we find the elusive Holy Grail and get real information about likely timing of devaluations?
In a sense, the IMF has done some of the job for us. They have been using, and publishing, early warning indicators for more than a decade. But their signals tend to be longer term, designed to catch crisis events far enough in advance to take effective action. We would like to know about potential crises just a few months in advance in order to guide, say, a quarterly hedging strategy. This is a completely different timescale to the less precise circa two-year warning that the IMF hopes to have in order to allow remedial action to be taken should a country’s macroeconomic fundamentals deteriorate.
Many investors and corporates maintain a mandatory policy of hedging their forex risk, no matter how expensive it may be in the long run
In order to provide a shorter-term warning signal, we incorporate financial market indicators that tend to be available on a daily basis and do not suffer the longer publication lags typically encountered for economic data. A sharp deterioration in rapidly-evolving market factors, coinciding with an elevated level of risk as signalled by macroeconomic indicators, should provide a timely warning that market participants see currency depreciation as imminent. In other words, macroeconomic imbalances may persist for an extended period but market factors should help to signal when a critical point has been reached.
Including market factors has another benefit that is related to the way in which currency crises tend to differ in origin and evolution. The Asian crisis that began in 1997, for example, was clearly of a different nature to, say, earlier Latin American crises.
By including market-based factors, we increase the chances of being able to identify crises that occur for reasons other than misaligned macroeconomic fundamentals. In total, we included nine macroeconomic indicators (current account, money supply, inflation, industrial production, trade data (exports), short-term debt, non-performing loans, domestic credit, economic surprises), and four market indicators (real effective exchange rate, forex implied volatility, equity market performance, global risk sentiment). Using these factors we were able to create a risk index for each country.
In order to test the effectiveness of the warning signals provided by this method, we performed a simple back test. To account for the potentially significant carry earned by holders of EM currencies, we considered carry returns rather than simple exchange rate developments. A high reading for our early warning index is taken as a signal to remain un-invested for the subsequent two months. Fig.3 shows how risk-adjusted carry trade returns were enhanced.
It is clear that both hedge timing and hedge instrument are important decisions. Imperfect knowledge of the future means that even warning indices like the one described above can only help with a decision, rather than give certainty. Different risk tolerances and company policies mean that there is no one single hedge strategy to fit all cases. However, the above results can be used to give guidelines, which can inform and enhance any EM hedging programme.
They may be simply stated: if risk is high, consider hedging with a forward. At intermediate risk levels, an option may be more appropriate. And when risk levels are very low, consider a lower hedge ratio, or not hedging at all. These are simple guidelines and should be more widely understood and applied than they are. The study of history can be a powerful tool to help us manage the future.
Commerzbank won Best Liquidity Provider, in the 2013 Foreign Exchange Awards.
The country is grappling with a credible strategy to enable it to raise funds to remain solvent. Slovenia needs to present a suitable economic reform programme to the European Commission later this week. By selling state-owned bank Nova KBM and telecoms firm Telekom the government hopes it will be able to avoid an international bailout.
The Bank of Slovenia has urged the government to speed up privatisations in sectors where “the market is more effective than state ownership,” but gave no further details. Due to the €7bn total of bad loans amalgamated by the mostly state-owned Slovenian banks, it is likely they will have to be separated into a standalone entity before the sector can be privatised. It also stressed the importance of the government helping financially troubled companies with good prospects, as the future ventures could result in a healthy pay-back to the banks.
The financially troubled NKBM, which is 80 percent owned by the state, has a market capitalisation of €90m if the government follows through on plans to move bad loans to another bank in order to ease a credit crunch. In selling the 74 percent state-owned Telekom, the government hopes to raise hundreds of millions thanks to its market capitalisation of €624m.
EU Economic and Monetary Affairs Commissioner Olli Rehn said Slovenia would not need a bailout if it reacted quickly to bring down its budget deficit. The country successfully raised $3.5bn via a bond sale which should stave off the need for a bailout until next April, when it will have to repay a five year €1.5bn bond.
Despite reducing its deficit to four percent of GDP in 2012, from 6.4 percent in 2011, Slovenia has not done enough to meet its budget deficit target of three percent. The European Commission has forecast this year’s deficit at 5.3 percent.
Data released on April 25 revealed Spanish unemployment to have reached 27.2 percent, the highest such figure at least since the nation’s transition to democracy in 1976 – when records began. The report has fuelled European debate in questioning the proven effectiveness of austerity, with many wishing to switch conversely to reviving economic growth.
The figures reveal for over six million Spaniards to have endured unemployment through the first three months of 2013 – with 57 percent of under-25s out of education unable to find work. The likes of which represent joblessness having grown seven quarters in a row, in effect leaving more Spaniards out of work than the entire population of Denmark and matching the respective rates of Greece – presently in the midst of a full-blown depression.
Regardless of the grim economic outlook, Spanish Prime Minister Mariano Rajoy remained positive in parliament on Tuesday: “Next year we will have growth and jobs created in our country.”
However, the report indicates for joblessness to have fallen below IMF’s predictions, the organisation having last week cut the country’s annual growth forecast to a 1.6 percent contraction from the original 1.5 percent, and having estimated for unemployment to peak at 27 percent in 2013.
Jose Luis Martinez, an analyst at Citi, said of the results: “These figures are worse than expected and highlight the serious situation of the Spanish economy as well as the shocking decoupling between the real and the financial economy.”
The country’s darkening economic prospects are a noted contrast with current financial markets. With a global tendency towards liquidity, Spain’s borrowing costs have experienced a marked drop, all but banishing fears of the budget crisis forcing Madrid to seek international sovereign bailout.
Spain has teetered in and out of recession throughout the past five years, the economy having shrunk 1.9 percent over the past year with a return to growth likely to come as late as 2014. Analysts attest that jobs look unlikely to be created before growth rises above one percent, a feat unlikely to eventuate until mid 2014, by which time approximately two million Spaniards are expected to have endured unemployment for over three years.
Marcel Jansen of Fedea stated: “More than half Spain’s unemployed have very low levels of education and skill levels and that, combined with several years of unemployment, is the biggest risk to recovery in Spain.”
The nation is said to have demonstrated the worst budget deficit in the EU through 2012, in part due to a €41bn bailout payment meant for rescuing banks. The EU deficit target presently stands at 4.5 percent of GDP, though it looks increasingly likely for the figure to be lessened due to a worsening Europe-wide recession.
After short negotiations, Qatar has agreed to buy Egyptian bonds worth $3bn, part of an aid package that will help Egypt from sinking into financial turmoil. The announcement was made after an unexpected trip to Egypt by the Qatari premier Sheikh Hamad bin Jassem al-Thani, and has surprised many observers.
Qatar’s bond purchase comes on top of an already agreed aid package worth $5bn. Egypt will receive from its oil-rich neighbour an outright grant of $1bn and $4bn in bank deposits. The sheikh, whose government is the main financial backer of Mohamed Morsi’s Islamic-led government of Egypt, reiterated that Qatar did not expect anything in return for the aid package.
“We have agreed to add Egypt government bonds worth $3bn,” said al-Thani in a press conference. He also spoke of “the importance of relations between Egypt and Qatar continuing at the same pace and the same momentum.” Qatar is already one of the biggest foreign investor in Egypt, and investments amount to about 18 to 20 percent of all FDI.
It has been reported that some Egyptians are deeply sceptical of Qatar’s motives for offering such vast sums of money. There have been accusations of Qatar using the loans to politically influence Morsi’s government. “Sadly, the media are reporting positive things negatively,” said al-Thani. “But this will not affect Qatar’s way of dealing with our brothers in Egypt.”
Egypt is currently in talks with the IMF over an almost $5bn loan, part of a financing programme that will help Egypt’s economy through the crisis. Local authorities believe that the IMF loan will help restore confidence in the Egyptian market, which has struggled with political turmoil since violent demonstrations ousted long-serving President Hosni Mubarak in 2011. The country’s foreign currency reserves are severely depleted and stand at just $13.4bn; down from $36bn held before the uprising. The country is also suffering from poor credit ratings even as its budget deficit continues to soar.
There are concerns that the internal lender’s fiscal requirements for approving the loan will cause social tensions. The IMF delegation currently visiting Cairo will examine the country’s recent steps towards economic liberalisation and the final size of the loan may still change, according to IMF officials.
It has also been reported that Libya has offered Egypt an additional $2bn five-year, interest free loan to help alleviate economic tensions plaguing the country.
The Cypriot parliament, the EU and the IMF have agreed to a €10bn bailout after a tense week of negotiations. The deal will spare depositors from a controversial levy, but will force substantial losses for large-scale depositors in two of the country’s biggest lenders. The last minute aims at preventing a collapse of the island’s banking system and protecting Cyprus’ EU membership.
The deal, which does not require approval from the local parliament, involves the closure of Laiki Bank, the country’s second largest financial institution. It banks current €4.2bn worth of deposits over €100,000 will go into a ‘bad bank’ and could be lost entirely. Smaller deposits will be transferred to the Bank of Cyprus, the country’s largest, which will undergo a vigorous restructuring. Deposits over €100,000 in the Bank of Cyprus will be frozen and could also face losses after the bank has been restructures and recapitalised.
In an unprecedented move by the EU, both junior and senior bondholders will be wiped out. The Bank of Cyprus will also take on the €9bn Laiki owes to EU creditors that has been the bank’s lifeline over recent months. None of the €10bn bailout money will go to recapitalising the Bank of Cyprus and officials still face the task of determining how much of the large deposits will be required to ‘bail in’ the bank back to health, and EU mandated capital levels.
“I’m happy because we shall have a programme and it’s in the best interests of the Cyprus people and the European Union,” said President Nicos Anastasiades, though not everyone agrees with him. While the deal is far from the original, much reviled, proposal, it is still being criticised due to the perceived double-standard of the bailout. Critics have pointed that no other rescued EU member has had to impose losses on its depositors and there are worries that the bailout will set out a dangerous precedent.
“It is clear the depth of the financial crisis in Cyprus means the near future will be very difficult for the country and its people,” said Olli Rehn, economic chief at the European Commission. Banks in Cyprus remain closed, in an attempt to prevent a flight of capital and a limit on withdrawals of €100 from the country’s cash machines remains in place.
The deal was approved hastily in the early hours, as the EC had threatened to suspend the funds holding the banks together if a deal was not reached by Monday. One of the conditions of the deal is that Cyprus tackle its overinflated banking system, which has grown to seven times the size of the island’s GDP.
Last week a controversial deal had been suggested by the EU and the IMF that would see all depositors in Cyprus’ banks face a forced haircut in order to raise €5.8bn to supplement the bailout, but the deal did not make it through the local parliament. “The numbers have not changed. If anything they’ve got worse,” said Wolfgang Schäuble, Germany’s finance minister who is leading the talks in Nicosia. “It is well known that I won’t allow myself to be blackmailed by no one or nothing I’m aware of my responsibility for the stability of the euro. If we take the wrong decisions we’ll be doing the euro a great disservice.”
He is due to commence talks with Greek Prime Minister Antonis Samaras today, with the two countries financial situations being the main point of discussion. Reports indicate that Anastasiades will be asking for Greece to provide €2bn from its €48bn bank recapitalisation package to support Cypriot lenders.
Little over a fortnight ago, Anastasiades, said that in his role as President he would make Cyprus’s bailout his top priority. This radical move shows how far he is willing to go to fulfil that promise. “We’re doing everything we possibly can to pull Cyprus out of crisis but the road ahead is not strewn with roses,” Anastasiades said in talks with Greek premier Antonis Samaras.
Cypriot banks had previously invested heavily in Greek bonds but lost around €4.5bn when the EU decided to reduce the Greek debt by about 75 percent.
The talk comes as Alexander Dobrindt, the general secretary of the Christian Social Union (CSU), said Europe should continue working on an exit strategy for Greece. Dobrindt, who is a close ally of German chancellor Angela Merkel, told German newspaper Die Welt am Sonntag: “The greatest risk for the euro is still Greece.”
He said: “We have created a situation that gives Greece a chance to return to stability and restore competitiveness. But I still hold that, if Greece is not able or willing to restore stability, then there must be a way outside the eurozone.”
Ahead of Anastasiades’s departure, Archbishop Chrysostomos of Cyprus, suggested that the island would return to the Cypriot pound if it cannot reach agreement with the troika.
“If they want to destroy us [through harsh demands], then we say goodbye to the euro… We can survive with the Cyprus pound,” he said.
After last minute discussions failed to reach a consensus, the American Congress was unable to prevent a wave of unpalatable cuts coming into effect. President Obama has since signed off on the sequester, which will see over $85bn wiped from the federal budget over the year.
When the cuts were conceived in 2011, they were meant to be as undesirable as possible for both parties, in order to force a consensus on a solution to tackle the US’s $16.6trn debt. Obama maintains that increasing taxes is the better way of balancing the books, while Republicans insist that spending cuts are the answer. “The president got his tax hikes on January the first, the Issue here is spending. Spending is out of control,” said Republican John Boehner, speaker of the House of Representatives. “I don’t think anyone quite understands how it gets resolved.”
The cuts will amount to 4.8 percent of the GDP between 2010 and 2014. About half of the $85bn cut this year will come from the defence budget. It has been estimated that the sequester, if fully realised, will slow growth by 0.5 percent and may cost up to 750,000 jobs. The cuts will total in excess of $1.2trn over the next decade. Incoming defence secretary Chuck Hagel has insisted the cuts “will cause pain, particularly among our civilian workforce and their families.
“Let me make it clear that this uncertainty puts at risk our ability to fulfill all of our missions. Later this month, we intend to issue preliminary notifications to thousands of civilian employees who put on unpaid leave.”
The impasse has come to a head as the president insists on closing a number of corporate tax loopholes. Obama has already successfully argued for a series of tax hikes that came into effect at the beginning of the year. At the end of March the temporary federal budget is due to expire, therefore a bill that will ensure the funding of the government through the end of the year must be passed. Boehner has assured that Republicans are ready to approve bill, though if it fails to pass the federal government might be forced into shut down.
“They’ve [the Republicans] allowed these cuts to happen because they refuse to budge on closing a single wasteful loophole to help reduce the deficit,” said Obama on Friday. “We shouldn’t be making a series of dumb, arbitrary cuts to things that businesses depend on and workers depend on.”
New figures from the US Department of Housing and Urban Development reveal that sales of new single-family houses in January rose 15.6 percent above the December 2012 rate, and 28.9 percent from the same time last year.
Over 437,000 single family homes were purchased in January, exceeding the forecast of 381,000. Sales have been boosted by low mortgage interest rates, an improving job market and the stabilisation of home prices. The Conference Board’s consumer sentiment index also skyrocketed to 69.6, in the same month cementing a strong start of year with positive recovery signs for the US economy.
In a separate report Standard & Poor’s home price index, which monitors fluctuations in the value of residential property in 20 cities in the US, recorded a 0.9 percent rise in prices from December 2012. It is the 11th consecutive monthly increase. “Home prices ended 2012 with solid gains,” said David Blitzer, chairman of the index committee. “Housing and residential construction led the economy in the fourth quarter.”
The index also indicated that property across the country ended 2012 with strong gains of on average 7.3 percent. All urban centres covered by the report had positive year-on0-year growth, apart from New York, which lost 0.5 percent. “Atlanta and Detroit posted their biggest year-over-year increases of 9.9 percent and 13.6 percent since the start of their indices in January 1991,” explained Blitzer. “Dallas, Denver, and Minneapolis recorded their largest annual increases since 2001. Phoenix continued its climb, posting an impressive year-over-year return of 23 percent; it posted eight consecutive months of double-digit annual growth.”
Despite encouraging figures across the board, house prices remain 29 percent lower than what they were at their peak in 2006. Additional figures collated by RealtyTrac, an American housing data provider, also suggest that up to 26 percent of all homes with outstanding mortgages owe at least a quarter more on their home than what it is worth and are seriously underwater.
The pound slipped to a two-year nadir as news that Moody’s Investor service became the first ratings agency to downgrade the UK from its triple A score since 1978. Domestic and foreign-currency government bond ratings have had their scored lowered to an AA1, though the outlook on these ratings remains stable.
In a statement the ratings agency cited the UK’s weak medium-term growth prospects as the main reason behind the downgrade, though the high and rising debt burden was also mentioned. “The continuing weakness in the UK’s medium-term growth outlook, with a period of sluggish growth which Moody’s now expects will extend into the second half of the decade,” read the statement. “And, as a consequence of the UK’s high and rising debt burden, a deterioration in the shock-absorption capacity of the government’s balance sheet, which is unlikely to reverse before 2016.”
However, Moody’s was keen to emphasise the country’s creditworthiness remained high at AA1, “because of the country’s significant credit strengths,” according to the statement. “These include a highly competitive, well-diversified economy; a strong track record of fiscal consolidation and a robust institutional structure; and a favourable debt structure, with supportive domestic demand for government debt, the longest average maturity structure of 15 years among all highly rated sovereigns globally and the resulting reduced interest rate risk on UK debt.”
In the wake of the announcement the sterling dropped to its lowest level since the summer of 2010, against the dollar, but stabilised soon afterwards. Analysts have suggested that a weaker pound might be beneficial for the British economy as exports will become more competitive, though inflation is likely to increase as a result of the weak currency.
The British Chancellor George Osborne has tried to remain positive about the downgrade, referring to It as a “stark reminder of the debt problems facing our country.
“Far from weakening our resolve to deliver our economic recovery plan, this decision redoubles it,” he said. “We will go on delivering the plan that has cut the deficit by a quarter.”
Departing chairman of Novartis, Daniel Vasella was set to receive a payout of $78m over six years, supposedly for consulting services and a very strict non-compete agreement. But the generous ‘golden gag’ package- as the payout has been dubbed by the media- caused waves of protests in Switzerland, a country on the verge of a referendum on excessive executive pay.
As a result Novartis has been forced to backtrack and rescind the offer. “The board and Dr Vasella agreed to cancel the non-compete agreement and to forgo all compensation linked to his non-compete,” said Ulrich Lehner, vice-chairman of Novartis in a statement. The decision was announced three days before the company’s board comes face to face with investors at the shareholders’ annual meeting.
“We continue to believe in the value of a non-compete, however the decision to cancel the agreement and all related compensation addresses the concern of shareholders and other stakeholders,” Lehner’s statement continued.
The original payout had outraged Swiss lawmakers and shareholder activists two weeks before a planned referendum on whether or not shareholders should have more power in determining executive compensation. Novartis was also criticised for not making the payout deal public sooner, as it was only announced on the day of Vasella’s planned stepping down.
In a statement Vasella conceded that the amount was “unreasonably high, despite the fact I had announced my intention to make the net amount available for philanthropic activities.”
The outgoing chairman’s compensation has been the focus of shareholder criticism before. His annual salary before stepping down was valued at $13.4m in Novartis’ annual report for 2012. The board has decided to consider reforming the way senior executives are compensated following the backlash.
“The company was right to end the payment to Vasella. It goes against good corporate governance to have non-compete agreements and it makes little sense,” one of the top 10 shareholders at Novartis has said.
The referendum is still scheduled to go ahead on March 3, and will address proposed changes to labour laws including binding shareholder votes on executive pay, bonuses and payouts for outgoing executives. “Swiss labour laws do not allow non-compete agreements of more than three years, so in that sense Vasella’s pay-off was disguised as a ‘golden parachute’,” said Brigitta Moder-Harder a shareholder activist involved in the proposals set out in the referendum. “It is far too late; the whole thing is still a debacle.”
The European Commission has announced plans to demand global manufacturers importing goods into the EU to apply a ‘made in’ label to all their products or risk sanctions. The World Trade Organisation is a staunch critic of such labels which it describes as making little sense in a world of globalised supply chains. Similar regulations have been in place in the US since the 1930s and countries like China and Japan also require clear labelling of imports. Past attempts by the EU to introduce mandatory labelling of imports were largely supported by southern member states but have been vetoed by free-trade proponents like Germany and the UK.
The regulations, if approved, will force European companies who manufacture goods abroad to divulge if their products are produced in countries with lower wages or less stringent labour legislation. High-end fashion and luxury goods manufacturers are likely to approve of the new labels, though other industries might not be as enthusiastic.
“It’s a ground breaking decision,” says Paloma Casto, global director of corporate affairs at LVMH, the luxury goods conglomerate. “Imposing a concept of reciprocity on labelling between Europe and the rest of the world is a very good move for the higher end industry.”
The director of an unnamed German sportswear group who asked to remain unnamed is less enthusiastic, “Our products are of very high quality, but if we put the China label then a lot of our potential customers might think that the good is of lower quality because of the bad and unfair reputation Chinese goods have in Europe,” he told reporters.
EU trade commissioner Karel De Guchtm who has already been forced to drop previous proposals for labelling rules, says the decision to introduce the new rules are a “consumer protection measure is a clear sign from Brussels that we are not erecting trade barriers, we are simply making sure consumers know the origin of the product they buy.”
But the WTO remains opposed to the legislation, arguing that the labels are misleading. “Gross statistics can be misleading and give the impression that a Nokia smartphone imported from China is made in China, suggesting that all the jobs necessary to produce this good are Chinese jobs, “ says Alejandro Jara, the WTO director-general. “But this is hugely misleading, if we look at research carried out in Finland.
Critics have also argued that simplistic labels might give countries like China and India more credit than they have earned for their exports, which are often assembled from parts manufactured in a number of different countries.
The British chancellor has proposed a ring fence separating high-street retails banking from investment banking branches within institutions will need to be ‘electrified’ with severe sanctions. Osborne will publish the Banking Reform Bill giving regulators the power to split banks up if they do not comply fully with new rules designed to protect British taxpayers.
“My message to the banks is clear: if a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether – full separation, not just ring fence,” Osborne said in a speech in Bournemouth.
The British Bankers’ Association (BBA) said the new bill would bring “uncertainty for investors” and make it more difficult for banks to raise capital, leaving them with less available money to lend to the private sector. Anthony Browne, chief executive of the BBA has warned that moving away from the universal model of banking will compromise banks’ abilities to provide all the services British businesses will require.
For the time being regulators will only have the power to split up individual non-compliant banks, rather than a complete industry-wide separation. However, there have already been calls to give regulators sweeping powers over the ring fence.
The new bill comes in the wake of the Independent Commission on banking, whose chairman Sir John Vickers has already announced that he “would not resist” a complete break up of banks if the proposed ring fence fails to achieve its goals.
“When the RBS failed, my predecessor Alastair Darling felt he had no option but to bail the entire thing out. Not just RBS on the high street, but the trading positions in Asia, the mortgage books in sub-prime America, the property punts in Dubai,” said Osborne.
“My message to the banks is clear: if a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether- full separation, not just a ring fence.”