Month: May 2008

Selling England by the pound

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When I started in the City of London, the UK was entering a terrible period. Sterling was in free fall and the IMF were being called in by the then Prime Minister James Callaghan. His nemesis came in the form of Margret Thatcher who boldly stood on the election platform in 1979, tearing a Pound Note in half and claiming that the Pound in your pocket was now worth half of what it had been. It helped the Iron lady to take power and become the UK’s longest serving Prime Minster, just recently surpassed by Tony Blair. However, this was a revolution created by the need to move the basics of economics to monetarism. This has been the foundation for the strength of the British economy for the last 25 years. A process that was not easy or painless.

So the question confronting the markets today are simple is this just history repeating itself. After all, the similarities are stark. The current incumbent in number 10 is the ex-chancellor as was Callaghan. The property market was coming under pressure but not yet in free fall. The government was suggesting long term wage settlements and the Oil crisis was just getting started. The trigger of course was the falling pound that started what was to become a very uncomfortable transition for the majority.

Vanishing strength
So where is Sterling at the moment? The answer is not in a very secure place. After a year in 2007 where the US Dollar was the dog of the foreign exchange market and Sterling had enjoyed the same strength as many of the other majors. Running to the end of the year though a lot of this strength seemed to evaporate quickly. The cause was credit markets and the twin deficits. The global credit crisis which in reality is more a western problem rather than a global issue started to bite in August. The problem for Sterling was that much of the attraction had been the high interest rates in comparison to others and the booming financial markets that are the main driver to the UK economy. This was the magical carry trade that has been the focus of the markets for some time.

What is a carry trade? In its simplest form it is the ability to borrow in one country and lend in another at a better return. The only issue with this is that you need the currency to continue the upward momentum to assist the game and the credit markets must remain solid and free flowing. In the case of Sterling when the subprime crisis started to be a real issue in August. The carry currencies such as Sterling/Yen stopped and corrected violently as the appetite for risk diminished. It wasn’t though until late November when the depths of the freeze in the interbank and credit markets occurred and the reality that economic background was slowing in the US and the UK in particular that the carry trade again came under pressure. The position now exists that the credit window has closed and it will be a case that the mega end of year smoothing operations from the central banks will be tested soon enough. All of the combine influences has now led sterling to a very weakened position.

Growth picture
The check point is whether the cut in interest rates in December will be matched in January. If it is, then it will create a further double edged sword for the UK’s Bank of England. After all it is a central banks role to manage the inflationary pressures and the longer term growth picture. It is clear that the dream of a permanent growth is a nirvana that is impossible to achieve and even more impossible if the central bank has ignored the hyper inflation that existed in the asset markets as both the US and the UK did. This was driven out of the carry trade that created a credit tsunami of investment cash into these high yielding countries. The problem is that Tsunamis wash deep inshore but when they withdraw they leave a lot of debris in their wake. The issue now for the Bank of England is that the carry trade cash is vanishing quickly and there is nothing to replace it. So the asset bubble comes under threat. So rate reduction to create the opportunity to sustain growth also reduces the carry argument, thus a vicious negative circle is created. The very reason the carry existed fails and thus the desperately needed credit needed to support a fractured credit market remains withdrawing to safer havens.

This is a difficult balancing act that is not easy to achieve. The problem is that the US stayed in denial for a long time over the extent of the subprime and its real risks to the economic background and the consumer. The UK now faces similar problems. The deepest problem is the credit markets must be unfrozen. The belief is that rate reduction is the path to find that solution. This is questionable at best. The issue in the interbank market is one of trust as the credit bubble has been collapsing. The reality is that the depth and extent of the losses from subprime and near subprime are not as transparent as the central banks and the politicians believe. The issue is that it is confidence that has to be restored, one of trust! This is also the problem that exists in the political arena as well.

Looking at the current US election race, it is clear that the candidates are all on the same path change and trust. The trust of the electorate is as damaged as the trust in the interbank market. The reality is that the credit market crisis is no different to other times this has occurred, very similar in fact to the savings and loans disaster that beset the US in the 1980s. It is a case that the Banks need to rebuild their balance sheets and this is very hard to achieve with low interest rates. Clearly, a prime borrower will be a prime borrower whether interest rates are five percent or 10 percent, thus the difficulty that the central banks now face. The political pressures will be to cut rates to give the allusion that growth will be protected. The problem is that this would be a successful direction if like post 9/11 the Tsunami of the carry trade money had not rolled in. Thus the path seems set. The central banks will continue to cut rates to relieve the panic in the markets to try and unblock the interbank and credit markets.

Double edged sword
This is where the last piece of the jigsaw starts to fall into place. In the UK which is a net importer a falling pound will lead to imported inflation and this is where the double edged sword comes into play. A frozen credit market linked to rising inflation in an environment of twin deficits makes the ability to reduce interest rates harder. The problem then becomes dramatic as faith in the economy and the country falls. Thus the chances of a currency recovery become less likely until the twin deficits are being tackled and seeing resolution.

We started this article reminiscing over the rise to power of the iron lady. It is clear that periods of fractured credit markets require decisive leadership and this develops the need for radical change. The change appears to be happening in the US. The UK though still lacks any clear decisive leaders, whether this continues remains to be seen. The incumbent party and the opposition are in a state of flux with both starting to question the leadership and the future direction. So while we are probably only in the beginning stages of a political and financial change, it is a path that looks like it may well be a trodden through necessity rather than desire.

Sterling remains pressured and we are expecting that we will see parity against the Euro and a continuation of the unravelling of the carry trade. 2008 may well become the year where Sterling takes the mantle of the dog of the foreign exchange markets which has been held so well by the US Dollar. It will be interesting to see the political fallout and this we may see first in the US with the presidential elections which may mark the start of a resurgence and recovery in the fortunes of the US Dollar though not necessarily the economy. Hard times need strong leadership with vision and these times are nearly always created from financial market crisis. 

Forex, the new futures?

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1995 represented a major turning point in the financial markets. The futures markets ruled supreme with the tail wagging the dog in the underlying cash markets. Few saw the significance of 1995 though, as it marked the introduction of Windows 95 and Internet Explorer. However, the real change came in 2000 when DSL lines became available. This provided secure and permanent access to the Internet with limited downtime. As the new Millennium progressed so did the broadband market. However, proceeding this period the futures market had moved from an on-floor open outcry system to a computer trading system where the connections were made from the exchanges to the broker’s offices. The adaptation of this model onto the internet was the next logical progression. This is when on-line trading became a reality for the many and not the privileged few in the know.

This is where Swiss, online FX brokerage firm, MIG Investments, became a reality, providing the private client in the street the ability to trade. Not on a phone driven, high-commission base, such as the futures market, but into the deepest market in the financial world – foreign exchange. The liberalisation of the FX market to the retail market was a revolution in financial markets and one that could only have taken place in the foreign exchange market where competition was global and not exchange driven.

The pattern within the retail space of FX markets has seen a great deal of competition and reputation is one of the defining elements. This has spawned the need for brokers to enhance their offerings and services to the client. As much as the offer of tight spreads is attractive, the ability to trade at the price shown is paramount. The other aspect is what the client receives as an added benefit.  In the case of MIG, this has become multifaceted. The latest string to the bow has been the introduction of a research department.

Increasingly sophisticated
Understanding that the private client market was becoming increasingly sophisticated, the company sought to provide a world class base for its research. As Head of Research, I was appointed to create an investment bank quality research department that could deliver a standard of research product as yet unseen in the Retail FX space.   The recent addition of Paul Day, Deputy Head of Research, and Bill Hubard, Chief Economist, to the team has given MIG a commanding industry edge in providing qualitative and unique research products to clients. Paul is a market professional of 14 years experience gained, like myself in tier one banks in the City of London. Bill Hubard’s appointment as Chief Economist was a coup d’état for MIG, by securing the services of a leading market professional who has been the face of economics and bonds on both Bloomberg and CNBC Europe. His charismatic charm and knowledge has provided a real depth to the company’s offering to the public. It certainly will be a pleasure for the investors and traders when they attend expos and road shows to be able to engage with top flight professionals such as these.

Research is a critical aspect to the understanding of the markets. Whether the clients agree or disagree with the analysis, ultimately it is they who will press the button to execute the trade. Thus, to have the ability to lean against such a deep experience base can only be of benefit in the long run. No trader or analyst gets the markets right 100% of the time but in times of trouble it is always more comforting to be able to know that those that are providing the analysis have ‘been there and done it’ with the top-end market and it is their desire to create an environment where the private client is getting the same advantages.

Futures market
The start of this piece talked of the revolution that the Internet and DSL provided to the private client. Previously, the only way that private clients could gain cheap and leveraged access to the market was via the futures market. This, however, was expensive and required phone calls with no surety to price until the trade had been executed. Even when the technological revolution occurred, access to the futures market remained expensive with commission on entry and exit; margin calls, in the form of variation margin and initial margin. But more importantly, few would provide exclusive trading platforms for clients which are as complete and user friendly as those in the FX markets. The trading advantages of FX have been demonstrated during 2007, with depth of market and high volatility. It is the high volatility that has been one of the strongest attractions to traders and no market has been as volatile as the FX market.

When the Futures market was started it was at a point in time when high interest rates and inflation ruled the economic background and this was one of the market’s strengths. It provided multiple users with varying demands an efficient market for hedging, trading, position neutralisation, cash futures arbitrage, and so on. All of this provided the market with movement that allowed short term traders to have a real advantage to act in some respects as short term liquidity providers as the market found equilibrium. In the FX market, the advantages today are similar to those of the futures market at its inception. A position that is now lost for the futures market as a result of low interest rates and bond yields.

The real attraction of the foreign exchange market for private clients is its cost-free trading base. Its trading platforms, like Metatrader as employed by MIG, are robust platforms with inclusive charts, position management, statements, direct access to trading and direct research delivery. As the private client becomes more advanced in their trading, some move to utilise the “black box” or expert advisors programming which MIG offer as a free product to those with professional and institutional accounts. These are facilities that are not generally provided in futures trading platforms.

The futures markets are very fee orientated, with exchange fees and clearing fees being routinely charged. When combined with the costs of running news services and charting packages, which also charge subscription fees, it raises the trading cost base for a trader.

Large advantage
This is where foreign exchange wins for most traders as it has a zero cost base with no variation margins and inclusive services. The other large advantage is that it is a 24-hours-a-day market, which opens it up for a global audience. The set exchange trading hours of the futures markets limit the ability to manage ones position should a global event occur, when it is imperative to be able to quickly exit either a winning or losing trade, or to have a stop or take profit order activated. This is a facility that just does not exist within the Futures market. Thus, the attraction for traders of a market that has liquidity for virtually 24 hours a day, 5 days a week is unquestionable.

Many in the professional markets see FX as the new futures market because its ability to access the market on a 24-hour basis with large leverage is so attractive. The futures market used to be as good as it got but, with the advent of computer trading and secure stable Internet connection, the tables have turned very much in favour of the private client trader. They now have the ability to access a liquid permanent market with high leverage and low trading costs. The days of picking up a phone to execute an order with a delay are now consigned to the history books. In the new digital age the click of a mouse executes the trade instantaneously and at the price shown. Add to this the pure size of the market and the private client can feel secure that he is always dealing on the best price. Access to reliable trading has never been easier and now comes at a cost that makes it attractive to all. So if you want to trade then foreign exchange is the new futures market, but one that is cheaper, more liquid and hardly ever sleeps. 

Banks’ losses fail to dampen bonus season goodwill

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If large banks had suffered losses, it seemed logical that their highly-paid employees would share the pain. The reality is likely to be more complicated. Though several institutions have not yet reported their results, it increasingly looks as if the bonus pot shared between employees of the world’s largest investment banks will be larger than ever before.

Even though several bulge bracket banks have suffered catastrophic losses on investments linked to the US subprime mortgage crisis, many parts of their business enjoyed a record year in 2007. Moreover, not all banks have been equally affected.

This has produced some surprising results. Take Morgan Stanley, for example. Despite reporting a huge fourth-quarter loss and raising $5bn (£2.5bn, €3.4bn) in new equity from a Chinese state investment fund, the US bank paid out $16.6bn in compensation last year – an increase of 18 percent. This pushed the ratio of compensation to revenues – a closely watched measure of cost discipline – to 59 percent for the year. Most investment banks aim for a ratio below 50 percent.

But Morgan Stanley is unlikely to be alone. Citigroup and Merrill Lynch, which are both due to report fourth-quarter results this week and have both been forced to seek fresh capital, face a similar dilemma, as does UBS, which is due to inform staff of bonuses later this month.

Scarce resources
The problem is not just about how to reward good performers in spite of scarce financial resources. Uncertainty over the economic outlook also makes it hard for banks to predict which business areas will be active this year, and therefore which staff they need to keep happy.

Some parts of the industry, such as the structured finance desks that created complex fixed-income securities, have been scaled back. But in other areas, such as commodities, banks are still looking to expand and human capital remains scarce.

“The major risk to our business is people. For each vacant seat there are probably only around five people out there who could do it. We’re hoping [rival] banks screw up and underpay this year, which could make it easier for us to hire,” says the head of commodities at one European investment bank.

The challenge is reflected in the variety of ways in which banks have tackled the problem. At one end of the spectrum are those institutions – such as Goldman Sachs and Lehman Brothers – that have escaped large losses in the fixed-income business.

For them, the bonus round has been almost business as usual, with top performers well rewarded. Those identified as poor performers will have received little or no bonus – a bank’s way of suggesting they should start looking for another job if they do not want to be ignominiously presented with a bin bag and told to clear their desk.

Even so, the slowdown in corporate activity and the weakness in the bond markets has curtailed overall rewards even at the healthier institutions.

At Lehman, for example, individuals whose contribution was up 10 times would have seen their bonuses rise about seven times, according to a person familiar with its compensation policy this year. That helped to soften the blow for talented individuals who happen to work in the slower areas of the bank. So a valued employee whose contribution was 10 times less last year might have seen his or her bonus fall only four times.

Feeling the pain
Merrill’s compensation ratio – pay and benefits as a percentage of net revenues – is expected to rise to more than 70 percent as it seeks to cushion key staff from feeling the pain of the bank’s losses. Some observers believe it could exceed 100 percent if the bank reveals fresh losses on subprime securities.

Merrill is believed to have increased its bonus pool for its investment banking division, although not by as much as its revenue contribution rose last year. It is thought to have been brutal with its fixed income division, including staff not directly responsible for losses.

UBS, meanwhile, has taken the controversial decision to cap cash bonuses and make up the difference with shares. Executives argue that the bank’s depressed share price makes this more attractive than in other years. Nevertheless, UBS’s rivals are expecting a rash of senior defections in the next few months.

Coming after a year of losses, it seems odd that so many should be receiving large bonuses. Wall Street’s apparent largesse to its staff is hard to square with senior bankers’ expectations. Most predict that revenues derived from the US will be flat to down, with Europe flat at best. Growth is being pencilled in only in Asia.

Yet even if the investment banks are behaving rationally in attempting to hang on to staff, this year’s bonus round is bound to be controversial. The prospect of institutions whose behaviour helped create the current financial crisis continuing to reward its staff lavishly is likely to add to pressure on banks fundamentally to rethink their compensation structures.

Huge incentive
The crisis has revived the debate about whether investment banking bonuses encourage excessive risk-taking. This argument suggests that traders have a huge incentive to pile on risks because the rewards for success – a large bonus – are much greater than the consequences of failure, which is unemployment.

Writing in the FT last week, Raghuram Rajan, professor of finance at the Graduate School of Business at the University of Chicago and former chief economist at the International Monetary Fund, argued that banks should claw back payments to risk-takers who cream bonuses in good years but whose actions sow the seeds for large future losses.

It is an idea that appeals to investment bank managers and is being taken up by some institutions. For example, Credit Suisse each year holds back some of what it pays its proprietary traders, who take risks with the bank’s capital. If the traders do well again the following year, the retained bonus is released, plus an extra reward. But if their strategy blows up, they lose the retained part of the bonus.

However, investment banking executives insist the scope for such schemes is limited by intense competition for talented traders, particularly from hedge funds, where the rewards for success can be even greater.

They also argue that the current crisis was largely caused by other factors, such as poor risk management and a lack of discipline with capital. “There is an assumption that compensation was the cause of the crisis and I don’t think that was the case,” says one senior executive. “It is a very competitive market and we don’t believe we can change the system.”

This is scant consolation to shareholders in investment banks, who are effectively subsidising the payout. Their only consolation is that if the broader business slows down this year, as expected, it will be some time before the bonuses reach such heights again.

© The Financial Times Limited 2008.

Looking at the future

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The fast-paced world of international business demands decisions in real time. From multi-million pound deals to large scale mergers and acquisitions, executives need to be immediately accessible to provide counsel to clients and colleagues across the globe. Successful business interactions and agreements are facilitated when trust and a solid relationship have been established. Particularly in finance, where significant sums and pressures are involved, individuals need to be able to gauge reactions and emotions across time zones.

While email and telephone offer instant and reliable contact, they lack a crucial component of communication: meaningful personal interaction. Video conferencing enables individuals to see and hear each other for a more intimate conversation from the comfort and convenience of their desk. Designed to meet the real needs of business users, the high-quality audio and video of Sony’s desktop video conferencing solutions enable colleagues to read expressions, observe body language and hear voice tones for improved inter-personal communication.

As a cost effective, hassle free and environmentally friendly alternative to travel, video conferencing is becoming increasingly widespread. Across a range of industries, both large and small corporations are investing in video conferencing solutions to reduce travel budgets, time spent out of the office and an improved work-life balance for employees. Easy to install and operate, the near universal adoption of global broadband networks is helping make video conferencing a viable solution for time-poor executives eager to avoid the stress of airport security queues, plane delays and the effects of jet lag. From the comfort of your desk, you can speak with colleagues abroad, call meetings between distant parties and then return home at the end of the day.

Essential tools
With environmental concerns at the top of every corporate agenda, video conferencing is becoming an increasingly essential communications tool. Reducing the number of flights required for business travel, would significantly reduce a corporation’s carbon footprint: a staggering 22.3 million tonnes of CO2 would be saved were 20 per cent of business travel within Europe to be replaced with video conferencing. As environmental concerns continue to grow, we at Sony are also committed to responding responsibly. Through investing in technology and researching carbon intensive alternatives, we are aiming to achieve a ‘zero environmental footprint’.

With a diverse range of video conferencing applications, Sony offers accessible solutions for businesses of all sizes and budgets. Extremely affordable and easy-to-use, the personal desktop systems from Sony minimise desktop clutter while increasing communication efficiency between geographically distant offices for a complete all-in-one solution. Sony’s IPELA range of IP (Internet Protocol)-based communications combines Sony’s expertise in video conferencing and high-end desktop LCD technology to offer unrivalled communications possibilities. With your PC monitor doubling as the video conferencing screen and safeguarded video, audio and data measures, colleagues can share files securely and display data for a more flexible and productive work environment.

Environment creation
Efficiency, performance, autonomy – video conferencing reduces training costs and travel expenses for the Portuguese Immigration and Border Control Department by 75 percent. Like many of today’s businesses, public sector organisations are increasingly looking to create an environment where decisions are made faster, and where ideas, knowledge, and inspiration can flow securely from colleague to colleague.

The Portuguese Immigration and Border Control Department (SEF) is a security department, attached to the Ministry of Home Affairs, which has administrative autonomy and forms part of the country’s domestic security operation. The department’s objectives are to control the movement of people at the borders as well as the residence and activities of foreign nationals in the country. Its job is to monitor and control border posts, including international areas of ports and airports. Besides performing these functions, the Portuguese Immigration and Border Control Department aims to provide effective management and communication of data relating to the Portuguese area of the National Schengen Information System (NSIS). Other information systems under the SEF’s jurisdiction include those common to the Member States of the European Union regarding controlling the movement of people, as well as the systems relating to Portugal’s passport issue data base (BADEP).

The Portuguese Immigration and Border Control Department realised that it urgently needed to adopt a video conferencing system capable of covering each one of the departments it deals with on a daily basis, including the regional offices. The main driver was a need to exchange information in real time, but without jeopardising data confidentiality.

The SEF’s main requirements were:
• To increase communication efficiency between all the offices by means of a multi-conferencing system;

• To share thousands of files effectively and securely;

• To guarantee integration between the information and communication systems of its offices, while ensuring the flexibility and scalability of both systems; and

• To allow for the possibility of managing communications and system usage times centrally.

Sony Professional Solutions Europe designed a global solution that combines the Sony PCS-1P group systems and Sony TL30 individual desktop systems with network infrastructure products from Radvision. Besides this, Sony created a complete solution that allows the SEF to control and manage all sections and users on a central basis. As well as guaranteeing information-sharing in real-time and an increase in internal productivity, the Sony solution allows the SEF to access reports of all its communications, whenever it so wishes.

In order to implement its video conferencing solution, Sony Professional Solutions Europe went into partnership with Datinfor, a Portuguese market-leading systems integrator with a strong public sector background. Determined to ensure that the whole solution implementation and optimisation process was completed quickly, Sony Professional Solutions Europe decided to draw up a virtual configuration for the entire installation of the video conferencing systems and network infrastructure products in advance. As a result, the complete implementation and optimisation stage was carried out speedily and without delays. From ascertaining the SEF’s needs and devising a tailored solution through to the centralised management and monitoring of the system, Sony fulfilled all of the SEF’s requirements quickly, and the efficiency of the organisation’s internal communications was immediately increased. The Sony solution currently incorporates the headquarters, regional offices and other departments and consulates, with a total of 37 units installed to date.

Increased efficiency
The rapid integration of the Sony solution with the existing information system, the easy management of the system and the immediate increase in communication efficiency within the SEF, have had a significant impact on the running of the agency. The solution supports mobile video conferencing whenever the customer needs it (via simple access to an IP line), and so it is possible to adapt the communication network without involving major investment. In this way, Sony Professional Solutions Europe has guaranteed not only that the whole solution may be mobile, but also that it may be managed on a central basis, making the Portuguese Immigration and Border Control Department self-sufficient in controlling and training all users. It is no wonder, therefore, that the Sony solution has rapidly become the main training tool used at the SEF.

People typically process information faster and retain it when ideas are shown rather than just told, especially when the subject is itself a visual idea. Video conferencing creates an environment where informed decisions are faster and stronger and more informed teams are built across geographies. In addition to helping organisations achieve greater profitability and enhanced long-term value for stakeholders, video conferencing also helps an organisation reduce its carbon footprint.

For further information:
www.sonybiz.net/video conferencing.

A combined effort

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The international accountancy profession has spent years trying to harmonise its myriad financial reporting rules, so that investors can compare statements produced under one code with those produced under another. The rule-makers have now produced their first common standard, one that covers the thorny issue of accounting for mergers and takeovers. Many of the new provisions look like a simple tidy-up of existing rules, but there are important changes, particularly for US companies, experts say.

The world of accounting standards is dominated by two bodies. The London-based International Accounting Standards Board (IASB) produces International Financial Reporting Standards (IFRS), which are used in most countries around the world. The New York-based Financial Accounting Standards Board (FASB) is responsible for the generally accepted accounting principles (GAAP) that US companies use. It’s a highly charged political issue, but an increasing number of US companies are opting to produce their financial statements under IFRS, rather than their domestic rules.

The two bodies have been working for years on efforts to bring their standards into line with each other. But they have just published the first new standard that they have worked on together. The aim of the so-called business combinations project is to develop a single, high-quality accounting standard that would ensure that the accounting for business combinations is the same whether a business is applying IFRSs or US GAAP.

For the IASB, completion of the project entailed revising two of its existing standards: IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements. Its new requirements take effect on 1 July 2009. The FASB, meanwhile, issued FASB Statements 141 Business Combinations, and 160, Non-controlling Interests in Consolidated Financial Statements. These are effective for financial years beginning after December 15, 2008.

It might sound confusing, but the upshot is that the accounting requirements in IFRSs and US GAAP will be substantially the same. This is thanks largely to the changes that the FASB has made to US GAAP; the changes to IFRSs have, in contrast, been relatively small.

Capital markets
Standard-setters say the effort taken to get this far should deliver important benefits. Business combinations are an important feature of the capital markets. Over the past decade the average annual value of corporate acquisitions worldwide has been the equivalent of 8-10 percent. “Investors and their advisers have a difficult enough job assessing how the activities of the acquirer and its acquired business will combine.

But comparing financial statements is more difficult when acquirers are accounting for acquisitions in different ways, whether those differences are a consequence of differences between US GAAP and IFRSs or because IFRSs or US GAAP are not being applied on a consistent basis,” said Sir David Tweedie, IASB chairman.

The completion of the joint project is “a significant convergence milestone,” said FASB member Michael Crooch. The common approach will eliminate some of the most “significant and pervasive” differences between the two accounting regimes, he said. The new US rules should improve reporting by creating “greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements.”

US companies have been able to use a range of legitimate tricks in the past to ensure that the way they accounted for an acquisition or merger put the deal in a good light. Now they will have to recognize all – and only – the assets acquired and liabilities assumed in the transaction. The date used to determine the value of the assets and liabilities will be the date of the acquisition, not some other one. And the company making the acquisition will have to disclose to investors all the information they need to evaluate and understand the nature and financial effect of the deal.

Transparency
Other changes should make the US rules less complex. And amendments to Statement 160 will improve the “relevance, comparability, and transparency” of financial information provided to investors by requiring all companies to report non-controlling interests in subsidiaries in the same way – as equity in the consolidated financial statements.

Mary Tokar, head of the international financial reporting group at accountants KPMG, said the fact that the international and US standards are very similar is a further step towards greater consistency. “Although not 100 percent identical, the two boards worked to reach agreement not just on concepts and principles, but also on using the same wording,” she said. Progress on convergence is one of the factors supporting the recently published changes to the US Securities and Exchange Commission (SEC) rules, which allow the use of IFRS as published by the IASB in financial reports filed by foreign private issuers that are registered with the SEC without having to reconcile those results to US GAAP.

Tokar agreed that the international standards require less change for IFRS users than for entities reporting under US GAAP. Partly this is due to the option that is available in the international standards, but not in the U.S. standards, to limit the recognition of goodwill to the controlling interest acquired. It is also because the boards drew on the IASB’s current business combinations standard, which was issued after the comparable US standard. In several areas existing IFRS requirements were the starting point for the two boards.

Tokar also warned that the limited changes to existing international standards should not lull companies into complacency. “Companies applying IFRS are advised to look carefully at the new requirements. In particular, the new standards require purchases and sales of non-controlling shareholdings when control is retained to be accounted for fully as equity transactions, which will reduce the current diversity in accounting for such transactions,” she said.

Several other changes mean that business combinations are likely to have an immediate impact on reported profits, she added. For example, any pre-existing interests in the acquired company will be remeasured to fair value at the acquisition date, with any gain or loss recognised in the income statement rather than directly in equity. Additionally, many transaction costs that currently are capitalised will be required to be recognised as an expense instead.

Cause for consideration
Another area of significant change is contingent consideration – when the buyer agrees to a possible adjustment to the purchase price, often based on post-acquisition performance. Contingent consideration will be measured at fair value at the acquisition date, with subsequent changes recognised in the income statement if the contingent consideration is classified as a liability, rather than as adjustments to the purchase price.

While the IASB says the changes to the international rules are less significant than the changes to US GAAP, accountants Ernst & Young have warned companies to tread with caution. The new rules will affect the amount of goodwill arising and lead to greater performance volatility, said the firm, and may result in some other surprises if they are not understood before entering into future transactions.

And while the international changes do not come into effect until July 1, 2009, any transactions negotiated prior to this date need to be carefully evaluated – particularly if they are not expected to be complete until after that date, the firm said.

“Having a clear understanding of the effect of the new requirements before entering into a business acquisition will be essential because it is highly likely that changes will also be needed to debt covenants, management remuneration and other performance measures in place,” said Will Rainey, global director of IFRS services at Ernst & Young. “Some of the consequences can also be avoided by carefully structuring the arrangements during the negotiations.”

Of particular concern to many is the fact that all transaction costs (such as lawyers’ and advisers’ fees) will be expensed. Also, where former owners remain employees of the business after acquisition, a bright-line test has been introduced, that in many cases will result in payments made after the acquisition being treated as compensation, not consideration. “Management will need to think carefully about the terms of any such payments to avoid unintended consequences,” said E&Y.

“It is quite common for acquisitions to have an element of contingent consideration payable in the future,” explains Rainey. “Under these new requirements, its fair value will need to be determined at acquisition – which can be a time-consuming and expensive exercise. The resulting liability will probably be a financial liability to be carried at fair value subsequent to the acquisition, thereby introducing greater volatility into future results. Management will therefore need to consider how any contingent consideration is structured.”

Rainey said the most controversial change arises when, after gaining control, a company holds less than 100 percent interest equity. The new requirements include a choice as to how the non-controlling interest (NCI) is measured. If management measures NCI at its fair value, it will effectively result in goodwill relating to the entire business – not just the percentage acquired – being recognised. If management stays with today’s method, and measures NCI at the share of the fair value of the net assets acquired, goodwill will be significantly lower.

Minority interest
“On the face of it, this doesn’t appear to be a big deal,” says Rainey. However, if management later acquires the outstanding minority interest, no additional goodwill can be recorded. Therefore, if management do intend to gain a 100 percent ownership, they will be better off fair valuing NCI when they gain control. This can also be a time-consuming and expensive exercise. “But this will require management to consider their longer-term objectives of the transaction, which will then be obvious to the market.”

Tokar said that the US standards requires companies to measure a non-controlling interest at fair value, which effectively means that an acquirer will recognise the full goodwill of the acquirer, including goodwill relating to non-controlling shareholders. The international standards allow the full fair value method, but companies also have an option to follow the current IFRS model whereby goodwill relating to non-controlling shareholders is not recognised. The IASB decided on this option during the Boards’ debates of the comments they received after exposing their proposals.

More widely, says Rainey, the changes will affect the way companies negotiate acquisitions. “Disclosures will also be more extensive and managers will need to ensure that sufficient information is given without having an adverse impact on future operations.”

The greater clarity should also make it easier for investors to work out whether a deal has been a success or not, as it will be easier to untangle the financial statements. That makes this particular accounting reform especially interesting. Normally, the effect of a new accounting rule is apparent when it is introduced, but the real impact of the business combinations standards will be seen in a few years time – that’s when investors will be able to look back on the deals reported under the new rules to see whether the financial returns have lived up to management’s promises, or not. In the past, it’s been easy for unscrupulous companies to fudge the issue. In the future, if the new rules work, that should be a lot harder.

The new economic frontiers

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Shariah-compliant investment and Takaful insurance have seen the interest in them pique as both markets display exceptional levels of growth. As with the space race of the 1960s the superpowers are scrambling to explore and capture market share as much of this emerging global market for themselves.

However much like the cold, dark recesses of space there is much left to discover and learn with innovation the key to discovering its secrets. The FWU group has long been a leader in the industry and is, to stretch a laboured metaphor even further, the NASA of the Islamic investment and Takaful world.

The Munich based company, while acknowledging and revelling in the industry’s successes, is warning that the full potential of the products and services still need to be fulfilled. By taking their lead and examining some of the innovations they have introduced a roadmap for the future of the industry can be developed.

The steady and consistent growth of Islamic financial services over the last six years can be attributed to a number of factors. Firstly Islamic financial products meet the increasing demand for socially responsible investment.

The Shariah law that governs them ensures that investment is not made in businesses related to, among others, gambling, alcohol and tobacco. It also enforces a ban on securities that receive revenue made from financial interest, referred to as Riba. As such there is a greater sense of transparency and accountability, which is of great importance for everyone living in the recent aftermath of the sub prime credit crisis.

Powerhouses
However, a clear conscience and social responsibility alone are not the only reasons why traditional powerhouses such as Deutsche Bank, BNP Paribas and Goldman Sachs have entered the market. Due to the expansion of the range of products there are many more consumers turning to Islamic solutions, from inside and outside the Muslim world. The Dow Jones’ and MSCI’s global indicies for Islamic finance include about 40 to 45% of all stocks. There are now a wide range of products available including: hedge funds, private equity, Sukuk, Murabaha, real estate, commodities, leasing and trade finance.

According to McKinsey’s 2007 “World Islamic Banking Competitiveness Report”, Islamic finance has reached new heights-Islamic banking assets and assets under management are estimated around $750bn in 2006. The sector outside Iran has reached $400bn to $450bn and is on track to exceed $1trn by 2010. Islamic assets represent six percent of GCC investable assets of $2.4trn to $2.8trn.Saudi Arabia is by far the largest market in a sizeable and growing HNWI environment. The market continues to grow at an estimated rate of 15 percent annually and there is a further $200bn of assets housed in Islamic windows or divisions of conventional banks. According to McKinsey, Islamic products in Malaysia are growing faster than conventional products by a significant margin.

Takaful, the insurance product where a fixed rate can not be charged and the return is based solely upon the performance of the supplier’s portfolio, is an example that shows the entire Islamic market in microcosm. The Takaful market has been greatly aided by the growth in of commercial banking within the Muslim world and is reaping the rewards of a period of product innovation.

In both of the Mudharabah and the Wakalah models the Takaful product family now spans across general, life, health and pensions business line. Its growth can also be seen by the development of new distribution methods, Bancatakaful and in the growth of the secondary market Retakaful. Takaful has become a $1.77bn industry in Malaysia alone and is a prevalent force in the insurance market across Asia and the Middle East.

The introduction of compulsory health insurance for expatriates and motor third party liability in Saudi Arabia and compulsory health insurance for expatriates in the UAE has led to surge of Takaful in the Middle East. Additionally the introduction of a comprehensive Takaful regulatory framework by Securities Exchange Commission of Pakistan (SECP) and the establishment of Allianz Takaful in Bahrain as the company’s Takaful hub have also boosted the market.
 
Further development
But while this growth is impressive there is a lot of room for further development, Takaful has the potential to generate huge sums of money if it can expand upon its traditional power base within the Muslim community.

It is a market that is estimated as being potentially worth more than $20bn annually with Europe and North America considered capable of delivering half of it. Estimates have speculated that 20 percent of that pot of $20bn a year could be generated from non-Muslim customers.

The key factors and phrases are “potential” and “could be” because for all the optimism and excitement around the market more needs to be done in order to realise this potential.

While the Shariah regulations make Islamic products appealing they can also put some consumers off. Many non-Muslims perceive there to be an imbalance with religious considerations given more credence than financial ones. This perception can lead to a lot of policyholders to believing that the portfolio being created is vulnerable to religious crisis’s unconnected to financial matters.

In order to grow and win customers away from the traditional markets clearer profit sharing mechanics need to be established. This was the conclusion of a series of meetings held in 2006 between the Islamic Financial Services Board (IFSB) and the International Association of Insurance Supervisors (IAIS).

If these issues can be dealt with, the European and US markets represent a significant opportunity for Takaful suppliers. The UK has already established a Takaful company (British Islamic Insurance Holdings) to go alongside its other Islamic financial banking institutions (Islamic Bank of Britain and The European Islamic Investment Bank).

Commonly accepted
In a report on the future of the market by Fitch Ratings it is stated: “It is commonly accepted that if there is no suitable Shariah-compliant option then it is acceptable for Muslims to use conventional insurers. As Takaful firms become more established and accepted, it may well become less acceptable (both ethically and socially) for Muslims to use conventional insurers.

“This is certainly a potentially important factor in Muslim countries but also in some Western European countries such as France, Germany and the UK, which have significant Muslim communities. Currently, only a tiny proportion of these individuals use Takaful, but this could change in future.”

Constant innovation and adaptation is not only required but is vital across the entire Islamic Banking market globally. This is because, of the estimated $4 trillion that the Islamic market could be worth by Standard and Poor, currently only 10 percent of it is being utilised.

There is a trend for Islamic funds to be skewed towards smaller funds, an Ernst & Young report in 2007 revealed that half of all funds managed less than $50 million of assets. The report entitled “Islamic funds and investments” further revealed that geographically allocations remains based in the Asian Pacific or the Middle East and equities remain the dominant asset class.

There needs to be a shift towards “best of breed” solutions and the development of an Open Investment Architecture for Islamic investment. Concepts such as multi-manger solutions, where the investment in multiple funds helps to reduce risks through diversification or increased sub-advisory arrangements must be offered on a greater scale. Additionally ‘white label partnerships’, offering a distribution partner an established service under their brand, are an excellent way for Islamic services to develop.

The success of a ‘white label’ solution can be seen by the asset management subsidiary of FWU. This is a specialist quantitative equity manager that implements a fund selection and allocation model that is radically different to the buy and hold strategy of traditional investment. The philosophy behind the model is to get the best risk adjusted returns by selling for a profit in bull markets and reducing equity market exposure in bear markets.

Capitalise
The selection of funds is determined not by trying to predict the movements of markets but to react to it and attempt capitalise on the largest part of a trend. It attempts to react to market movements by following an investment that is on an upward trend and attempt to sell for even higher but as part of the model there is a willingness to sell at a loss when the trend falls.

There is a strict criteria employed for funds to be considered part of the model’s target universe. The prevailing factor is that it must be Shariah-compliant however the fund must also be managed by a reputed investment house and must also hold total net assets in excess of $20m. Additionally it must also have a minimum track record of two to three years and offer superior risk-adjusted returns.

Following the selection of funds the allocation is determined by each fund’s individual alpha or ‘relative strength’ (RA) rating. The funds are then ranked by their RA from best to worst with a greater weighting given to those with the better ranking. In this way the higher performing funds are overweighted while low performing funds are underweighted. This model has allowed FWU to continue offering competitive risk adjusted returns in what has been a recent recessionary economic environment.

The success of implementing a solution with Open Investment Architecture shows how Islamic investment services can outperform traditional investments and are a salutary lesson. The future looks to be bright for the Islamic Banking industry so long as an emphasis is kept on innovation, the sky is literally the limit.

For further information:
Website: www.fwugroup.com 

Making change good

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They say change is good, and in the case of MiFID, the new EU regulatory regime that will affect investment services firms across the 27 EU member states, it certainly can be, but it will take some work — now. For, while the first compliance deadline fell in November 2007, many firms are still unprepared. And it’s no wonder.

MiFID is ambitious — it aims to make the compliance process more transparent and to create a single EU market for investment services, thus spurring competition, enabling cross-border services, and ultimately protecting investors.

Rethink and retool – or regret
Yet, all this is easier said than done. Because MiFID requires fundamental changes in the way firms process data and maintain records, the bar to entry is high. To achieve MiFID compliance, companies will have to prove ‘best execution’ on all deals and keep all transaction-related records for five years. Given that many firms currently trade off-book and don’t have systems in place to record and store this information, this is indeed daunting.

In short, for most companies, MiFID requires a massive overhaul in Information Technology (IT), a task that British analysts are predicting will cost the financial services industry approximately £1bn or €1.345bn. Every firm is scrambling. Thirty percent of EU firms surveyed said that they plan to spend 10 to 20 percent of their annual IT budgets on MiFID compliance and more than 20 percent said that they will be spending more than 20 percent.

The risks of non-compliance
While the figures seem high, they’re not out of range. Costs for IT escalated with the introduction of Sarbanes Oxley and Basel II. Nonetheless, when compared to the potential costs of non-compliance, from a loss in business to a loss in reputation, the investments will be worth it.

History bears this out. Recent penalties for non-compliance include a total of $8.25m (€5.6m) in fines paid in 2002 by five of the largest investment banks in the world for failure to show proper document retention and a 2004 fine by the SEC of $10m (€6.788m) on a top retail bank for being unable to produce appropriate records across all mediums of communication.

What’s more, statistics show that for every $1 paid in penalty, firms lose an estimated $10 – $20 or €6.8 – €13.6 in new business. Conversely, the General Counsel Roundtable reports that for every $1 spent on compliance, companies save $5.21 or €3.54 due to increased efficiency and transparency, and avoidance of legal liabilities.

An integrated solution
Whether or not MiFID will result in more competitive business landscape or simply a less crowded playing field remains to be seen. However, one thing is certain: the firms that can get their house in order in terms of processes, compliance, and security will ultimately realise benefits not only for their business but also for the environment.

The key is an integrated approach and a good partner, and that’s where Hewlett-Packard comes in. HP’s Compliant Document Capture is a vertically integrated, bundled solution of HP multifunction printers, Scanjet scanners, software, and services ideal for firms seeking MiFID compliance. It not only consolidates document workflow and increases information security, it also creates a more environmentally friendly organisation by reducing paper and energy consumption.

Efficient, effective, secure
To visualise Compliant Document Capture in action, consider a typical trade. Currently 35 to 45 minutes pass from the time a customer requests a trade to its execution as the document goes from email to fax to filing to fax again. At each stage of the transaction, eight to 12 documents are generated for a total of roughly 15 to 25 pages, each of which must be generated, tracked, and retained.

HP’s Document Capture, on the other hand, takes information from order to execution in just 10 to 15 minutes, automatically scanning, electronically storing, and properly routing it, not only saving the company time, money, and paper, but also creating an audit trail and increasing information security for the firm and client alike.

Winning the paper chase
An end-to-end solution, HP’s Document Capture includes cutting-edge digitising devices and software, all supported by services that assess, design, and implement ongoing maintenance for all systems.

Hewlett-Packard’s Compliant Document Capture solution for Financial Services covers nearly all document intensive workflows including opening new accounts, letters of authorisation, tickets and confirmations, disbursement documents, portfolio accounting, maintaining and providing performance information, new account funding, withdrawals, and account terminations.

The key to success
For over 30 years, HP has been designing multi-function solutions for 130 of the world’s top stock and commodity exchanges, all of the top 200 US banks, and the top 50 US brokerages, developing leading-edge technology for handling credit card transactions, electronic funds transfers, and enterprise solutions. For example, recently HP’s multi-function solutions, including workgroup printing across multiple capabilities, were used to lower total cost of ownership (TCO) by 20 to 30 percent for a European retail bank.

To increase efficiency and security for the credit card division of UK’s Coventry Building Society (CBS), HP in conjunction with one of it’s Solutions Business Partners, BlueMega Technology Ltd, worked with CBS to replace its multi-part PIN dissemination and printing process with a tamper-evident, secure process linking HP printing and imaging devices directly to an encryption device. In both cases, the systems are linked to disaster recovery sites, a key element of any mission-critical application, and are scalable so that they can evolve with business needs.

Streamlined and green
In addition to streamlining business processes and increasing efficiency, HP’s integrated solutions also increase companies’ environmental sustainability while cutting costs, increasing productivity, and saving space. An internal study at HP showed that by using HP’s Universal Print Driver (UPD) to configure company printers for two-sided or duplex printing, the company saved up to 800 tonnes of paper for an annual savings of $7.7m (€5.2m).

Further, HP’s Laser Jet Printers with Instant-On Technology can save up to 50 percent on energy consumption per year, yet they print pages four times faster than competitive products. The company’s space-saving Multifunction Printers use 40 percent less energy and supplies than comparable stand-alone devices. Similarly, HP’s Web Jetadmin, a print and image managing software, reduces fleet power and paper consumption with pre-set wake and sleep modes, ongoing monitoring of duplex printing rates, and automatic management of under-utilised devices.

All HP packaging is 100 percent recyclable, and customers can take advantage of the company’s free Planet Partners programme for environmentally responsible disposal of used ink cartridges and toner and for re-sale or re-use of used equipment. To date, this program has recycled over £1bn of electronic equipment, a figure projected to increase to £2bn by 2010.

Turn change into opportunity
All this means, in short, that change is good for firms needing to achieve MiFID compliance. And the timing is perfect: while studies show that energy costs make up 10 percent of the average IT budget, these costs are projected to rise to as much as 50 percent in a matter of years. Given that, it’s clear that the choices firms make today can mean the difference between profitability, productivity, and sustainability or penalties, lost business, and mounting costs. Choose to save — money, time, and energy. Choose an integrated solution and choose your partner wisely. Again, that’s where Hewlett-Packard can help turn change into opportunity.

The cultural revolution

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There is no denying, hiding or changing from the fact that the internet has changed the life of every man, woman and child in the developed world. We spend most of lives on it looking for information, spurious gossip or even watching over people via YouTube. Yes it’s fair to say the internet is the biggest cultural revolution since the invention of the car.

But by connecting millions of people around the world has it broken down barriers and led to a truly global market place?

Are the phone lines paved with gold or has it allowed those with a monopoly to strengthen their dominance and also given new opportunities to a generation of ‘cyber-criminals’?

Some of the biggest changes have been seen in the stock market and in the area of personal banking. A good way of looking at the impact of the internet and whether or not it’s been a force for good or bad can be made by looking at these markets as well as looking at the growth of cyber crimes and the use of the web for traditional crime.

The growth of internet based automated stock brokering systems and services have had a profound impact on how investment is made on the stock market. The internet has allowed greater access to foreign markets for investors. Many chose to invest directly in these newly available markets making a saving on commissions and allowing them to further diversify their portfolios.

The broadening of the market and greater access for all has changed the way that investors trade. Before the growth of web services ‘day trading’ was the preserve of professional investors and speculators but it has grown to become very popular with casual traders. The average person who would be at work during the opening hours of an investment firm would not be able to carry out day trading in their domestic market very difficult. However now Joe Blogs working in the UK can finish his day at work and go home and use the web to day trade on the US markets from the comfort of his home.

While this change has given casual traders greater control over how they trade it could be tainted gift. While day trading provides the opportunity for great profits it can also lead to huge losses. Many professional investors and speculators who day trade are underwritten by large companies and the stories of those who walk away with massive earnings are few and far between.

International markets
A number of internet based stock brokering services, such as Selftrade and AWD Moneytrader, have been set up over the last decade. The internet has also allowed a number of foreign stock brokers to enter international markets and it has allowed other financial providers to offer stock brokering services. Because web services are direct and can be done without a face to face meeting they remove the intimidation that visiting a traditional brokerage could pose to the casual trader. As a result there are now greater opportunities to trade on the stock market for the average person.

This threat from the new entrants has led to established brokerages changing their attitudes and offering web based solutions. For example Charles Schwab and Morgan Stanley now offer investment opportunities via their website aimed at casual traders. Quite clearly the internet has made investing on the stock market a lot easier for a great number of people.

Because internet based brokerage services are based in an information rich and execution only environment they offer a great number of advantages that again open up the market. Also because they are offering a standard product it is a price sensitive market. Therefore the growth of the internet has led to a cheaper more convenient service for consumers.

This is also true for web based services across a number of other financial services. Internet banking has made it easy for customers to carry out transactions such as money transfers and bill payment from their home. For working professionals who would find it difficult to get to banks during the week or at the weekend this has made personal banking far easier.

However, while there have been many benefits due to substitute or additional services offered via the internet there are also unwanted negative repercussions. While online brokerages are convenient and price sensitive it can be very difficult and expensive to move from one broker to another. So although the growth of internet based services means there is now greater competition and choice once a customer has signed up with a brokerage it is very difficult to make a change in the future.

Online banking
As far as internet banking is concerned the popularity of online and telephone banking has led to the widespread closure of branches or the introduction of limited services. In the UK the number of branches per 10,000 people has fallen from 2.13 in 2002 to 1.88 in 2007. Very often the branches closed are those in rural or isolated areas, it is these areas that will also have the most limited access to the internet and lower speeds of connection. The sad reality is the growth of online banking is making personal banking for the people who need it most and are least likely to be able to benefit from the new services the medium offers.

It has been argued that the internet could eventually lead to brokers becoming obsolete and that the customer could deal directly cutting out the middle man. While the web does offer the technology and the opportunity this is a barrier that is unlikely to broken down.

Currently to become a broker there are a number of exams and rigorous training that must be carried out. In the US the Series 7 examination must be taken and in the UK two separate papers must be passed to become ASI qualified – Unit 1 Financial Regulations and Unit 2 Securities. For brokerages to be rendered obsolete every person who wanted to trade direct would have to be forced to first get the relevant training. The time and effort required would make this extremely unappealing.

Additionally the prospect of the internet leading to the end of a financial institution such as a brokerage seems highly unlikely when you look at the opportunity for corruption the web has offered. Money-laundering has been aided by the growth of the internet as has the practice of defrauding people via the web and in particular the crime of ID theft. Because the internet has proved adept at removing traditional barriers that, as well as offering greater opportunities to people, can be exploited by the criminal element there is a fertile environment for a new generation of criminals

There has been an attempt to create new barriers in order to counter act this for example regarding the crime of money laundering the Financial Action Task Force (FATF) was established at a G7 summit in Paris in 1989 and has set forth a number of recommendations which have been revised at intermittent periods in order to adapt to changes in techniques.

Virtual worlds
But as the web continues to grow so do the opportunities for corruption. One of the biggest developments has been the growth of virtual worlds like ‘Second Life’ where virtual money is used as real money. It is possible for real world criminals to use the real estate and banking facilities that are part of that virtual world to clean their money. The issue has been raised by the England and Wales Fraud Advisory panel which has called for an investigation into how virtual worlds could be used to commit crimes.

There have also been examples of virtual crimes being carried as all around the world in countries such as Brazil and Korea. Additionally as online payments become more common place and a greater amount of personal details are stored on the web the number of cases of fraud have increased. Recently released figures by the FSA in the UK showed that online fraud using phishing scams was up by 8,000 percent.

The sad truth is that as the internet has broken down barriers some people have seen the opportunity to take advantage of this for criminal gain. The ever increasing and relentless use of phishing scams on those who use online banking and the twisting of a non financial activity such as Second Life for money laundering has shown that the freedom offered by the internet can, and is, regularly misused.

However, it would be a criminal act ignorance to neglect or underplay the opportunities that the growth of the internet offers to the average person in terms of financial services. As with anything that changes the fabric of society it’s about hoping the greatest number of people feel the benefits and in time we will discover how many people feel these benefits and if they outnumber those who lose out. 

Will the Islamic boom continue?

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It’s a funny old world when Western banks attempt to become more Islamic. But that’s increasingly the reality says Haitham Abdou of International Turnkey Solutions (ITS), which should know. ITS has developed an all-new Shariah-based IT solutions approach allowing clients to design their Shariah-based product range from the ground up.

There’s no existing IT template to push clients down avenues they don’t want to go, or which don’t quite fit them says Mr Abdou. “Many Western banks say to their customers, ‘oh, we offer Islamic banking, we can accommodate your needs’. But many of these products are simply models of their Western-based product range. The trouble is, a good Islamic banking product is often much more complex than a Western-based approach because the workflow, how the arrangement is structured, is so very different. And our solution reflects this.”

Why Islamic banking demands new solutions
Islamic banking products are more complex than traditional Western banking solutions. That’s because an Islamic bank is also a partner in any banking deal or arrangement. The Islamic banking model might often, for example, be based on a retail model.

For example, if a client wishes, using the Islamic model, to take a loan for a new car, the Islamic bank will usually buy the car for their client. Some Islamic banks might even have their own vehicle retail operation, with their own car showroom. The impact on the bank, of course, is that such a deal has to be structured in a way that’s profoundly different from the way most Western retail banks operate.

This Islamic banking approach to risk sharing could again be illustrated by a company wished to finance a new office building explains Haitham Abdou. “The company, for example, might visit an Islamic bank to discuss their business plan. If they agree to finance the project, then the Islamic bank plays a major part in the deal. Effectively, they share the risk, 100 percent of the deal together. The bank would pay the contractor; the bank would monitor progress of the building; they would also ensure that the building was built to the exact specification. When the building is finished, there would be a joint agreement as to what percentage of revenue is then returned to the bank. In every aspect, this is a shared venture between the company which takes on the investment, and the bank.”
Transparency attracts new clients

Much of the attractiveness of Islamic banking is built on the fact that Islamic banks way of doing business is highly transparent. And this approach is becoming rapidly appealing to Western consumers says Haitham Abdou, simply because money always changes hands in return for solid, tangible assets. “There are no penalties; you cannot end up in a situation where you are being charged interest on interest. The banks feel more secure in doing business too because they are always loaning on a physical asset, be it a car or property. So their risk exposure is much less. They would never find themselves in a situation like the current US credit crisis, where no-one knows exactly where bank liabilities really lie.”

Plenty of difference – but similarities too
Islamic banks offer a range of services to their clients that mirror Western banks too, such as

Credit cards

Cheque books

ATM access

Internet banking

Mobile ‘phone banking


Flexibility built in from the start
What ITS’ solution was determined to offer from the beginning was genuine flexibility. “We did not want our clients to have to replace their own core banking solutions,” says Mr Abdou. “You’ve got to allow companies to build their own products in their own way. To build it as they see fit. You can’t dictate to other people’s businesses how they should engineer their software. Perhaps previously – but not now.”

That meant creating a software workflow pattern that could sit on top of an existing core system, allowing the business to define freely just how it could interact with a bank’s branches and ATMs. “We spent two years doing R&D to achieve this within our own software house, on the way gaining CMM Level 5 Certification. It was only after we were satisfied with the flexibility of the product that it was launched globally, in Zurich, London, New York and Singapore.”

ITS’ instinct that Islamic banking was growing fast outside its traditional Middle Eastern home ground has since proved highly accurate. “We were sure many banks would want to open up an Islamic banking window in their offering,” says Haitham Abdou. “And we knew what our competitors would find it difficult to offer a product that would work well as an Islamic window in a conventional Western bank. That’s where our own product scores. By engineering it so that it fits, front-ended, means it allows conventional banks to plug in an Islamic Window ‘IT’ Infrastructure without touching their own IT. It shows that many conventional banks can now launch an Islamic window fast – and with very little fuss.”

Islamic banking is evolving fast
Consumers are demanding higher standards from banks, particularly those in the West. The recent rise in ethical banking and socially responsible investing is evidence of this. But Western banks themselves are increasingly realising that a genuinely Islamic approach can also mean a lot less pain across their product range. “An Islamic model,” says Mr Abdou, “manages to avoid all the trouble, for example, of bad debt and collection agencies. It’s a lot less aggravation. Western banks know that Islamic banks don’t go through this, so that’s another reason for adopting an Islamic window for their business.”

Global names such as HSBC and ABN Amro have already pioneered Islamic banking. Islamic banking, to some people however, may have an image issue: the fall-out from 9/11 and great unease about Islamic fundamentalism though is a long way off the reality of mainstream Islamic banking practices says Haitham Abdou. “Islamic banking is really nothing to do with religion for most switched-on Western banks,” he says. “It’s just another way of making a profit. It’s, quite simply, a new business model. I think that in the future the actual phrase ‘Islamic Banking’ is at risk from disappearing, simply because Islamic Banking is just another business – it’s really about the bottom line.”
Added value

ITS launched this innovative Islamic banking solution almost a year ago. The feedback from clients has, so far, been hugely positive says Mr Abdou. “Feedback has been amazing. Business users are realising that that the software is incredibly flexible. It gives them the power to define how and what they want to do. It’s really given us a very strong competitive edge – it really adds a lot of value.” There’s no need for additional software expense or equipment: ITS’ solution sits on top of existing software points out Mr Abdou, simply plugging in immediately.

A rash of awards have subsequently followed, including World Finance Magazine’s prestigious Best Universal Banking Solutions Provider, Islamic Finance as well as “Best Technology Provider for Islamic Banks” in Kuala Lampur from the renowned “Kuala Lampur Islamic Finance Forum”.

The boom has just started
The Middle East economic boom looks likely to continue for some time, thanks to a rocketing oil price and much surplus budget washing around. It means huge projects, new cities as well as new infrastructure being built. It also means, of course, more banks opening up to accommodate this wealth. “Countries like Kuwait, Qatar, U.A.E, Sudan, Saudi Arabia and Bahrain, they’re the ones particularly seeing the effects of high oil prices. Egypt too,” says Mr Abdou.

And while the Middle East booms, Islamic banking can only boom with it. The British government, for example, knows this. It is already determined to make London ‘a global gateway for Islamic Banking’. With 25 percent of the world’s population now estimated to be Muslim, no wonder many traditional banking heavyweights are increasingly taking Islamic banking very, very seriously.

About ITS
ITS solutions span Banking, Telecommunications, and Higher Education sectors. It offers leading ERP, CRM, and e-Commerce products and services for Enterprises in Retail, Government, and Oil sectors. ITS has an expanding user-base of over 170 customers. Cutting edge solutions are developed and implemented through a resource pool of over 1,700 skilled IT professionals in 21 offices across the globe.

For further information:
Tel: +965 240 9100
Email: haitham.abdou@its.ws
Website: www.its.ws 

As Islamic banks boom, scholars are hard to find

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The green-fronted Kuwait Finance House Auto mall on Bahrain’s main showroom highway is a bank that sells cars. Here, the motorist can pick the model that takes his fancy and, at the same time, fix up the Islamic financing and Islamic insurance to buy it – a sign of the rate at which Islamic banking is growing.

Opened in June last year to meet rising demand in the oil-rich Gulf archipelago, the bank offers murabaha-based purchase plans, a method of Islamic financing that lets customers buy automobiles without taking an interest-based loan.

As traditional Western bankers count the cost of a reckless lending spree, Islamic banking – which complies with Islam’s law banning the receipt of interest – is surging. Estimated by some experts to be growing by about 15 percent a year, the sector has been forecast by management consultants McKinsey & Co to reach $1trn in assets by 2010. Even as new bank branches pop up almost daily in Bahrain – a hub for banking in the Gulf and home to one of the sector’s most influential standards bodies – some bankers are worried.

Their concern is that the training of scholars essential for the Islamic banks’ supervision may not be able to keep pace. A small group of usually robed and bearded Islamic scholars — experts in Islamic law, known as shariah – holds sway over the booming bank sector, and some in the industry wonder whether their expertise is being stretched too thin.

“There is lots of growing interest and we have many more sophisticated shariah scholars who are graduating now, (but) it’s not growing fast enough to meet demand,” Sheikh Nizam Yaquby, one of the world’s most respected shariah scholars, told Reuters. “This industry is growing phenomenally.” Some shariah experts say it may take more than a decade to train more scholars and even the optimistic ones do not expect a new generation of scholars for at least five years.

“The industry can’t wait that long,” said David Pace, chief finance officer at Bahrain’s Unicorn Investment Bank. “Two to three years is about enough … The lack of scholars does not mean the industry is paralysed but it slows down development.” Established in 2004, his bank is one of several Islamic lenders set up to tap rising demand from the world’s 1.3 billion Muslims for financial services that comply with their beliefs.

Instead of interest, Islamic banks operate on the principle of sharing risk and reward among all parties in a business venture. Murabaha, for instance — the instrument on offer at the Auto mall — involves the bank buying a car and selling it to the customer for a stated profit, with payment deferred. Investment in sectors such as alcohol, pornography and gambling is prohibited.

Scholars are essential for the supervision of the industry, but a handful currently dominate the Islamic review boards at the world’s top banks and financial institutions. There is a lack of consensus on what qualifications and experience are needed for the role, and some experts ask whether the shortage could lead to conflicts of interest and inadequate supervision.

“These bankers think the wombs of mothers are going to deliver graduated shariah scholars. I tell them you have to take steps,” Yaquby said.  Yaquby, who has been involved in Islamic teaching since 1976, estimated there were roughly 50 to 60 scholars in the world qualified to advise banks operating internationally on Islamic law. Ten times as many are required for the Middle East alone, he said.

Scholarship not easy
Like most scholars, Yaquby divides his time among several banks. One of them, HSBC, lists advisory roles for him at Abu Dhabi Islamic Bank, BNP Paribas, Dow Jones, Lloyds TSB, Citi Bank, Standard Chartered and others. He is also a board member of the Bahrain-based Accounting and Auditing Organisation for Islamic Financial Institutions, one of the world’s top Islamic finance standards bodies.

In Britain – the most active European market in the Islamic banking scene – the Financial Services Authority watchdog in November highlighted possible “significant” conflicts of interest in that concentration of expertise. “The shortage of appropriately qualified scholars … raises concerns over the ability of sharia supervisory boards to provide enough rigorous challenge and oversight,” the FSA said in a report on the industry.

Last month the London-based Chartered Institute of Management Accountants said the rapid growth of Islamic banking had fuelled a need for both Muslim and non-Muslim financial experts, and it hoped to set up both a diploma and perhaps a master’s degree in conjunction with a university. However, being considered a scholar skilled enough to advise on deals sometimes worth billions of dollars is not easy.

Scholars must be expert in Islamic law and Islamic banking, but also have a thorough knowledge of conventional laws and banking systems, which requires a high standard of English. Even then, a scholar will only be taken seriously after years of experience, according to many of the delegates at a Bahrain conference on Islamic banking in December.

“You can learn the technical aspects relatively quickly,” said Mansoor Ahmed, a shariah student. “But it’s not as easy as that. It does take 15 or 20 years. It requires a lot of experience … mere knowledge will mislead.” Yasser Dahlawi of consulting firm the Shariyah Review Bureau, which advises companies on shariah compliance, said scholars need at least a doctorate and a decade’s experience.

You say you’re a scholar?
Complicating matters is the lack of a globally accepted qualification as a shariah scholar, just as there are no globally accepted standards for shariah rules, which are to some extent open to interpretation. Illustrating this, the head of shariah structuring at one of the world’s largest banks, who spoke on condition of anonymity, disagreed with Dahlawi on what it takes to be a scholar.

He said it was better for students to learn through apprenticeships with scholars who can trace their learning to Islam’s roots. “I don’t care whether they have a PhD or not,” he said. “The way traditional Islamic teaching has been handed down is not through certificates or degrees. You need to trace your teaching back to the Prophet. It’s a lineage of understanding.”

Energy costs

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Shares in onshore drilling contractors have rallied alongside natural gas prices, but some say it’s too early to call a recovery in the market that has been dogged by overcapacity. Land-based drilling companies have outperformed most oilfield service companies this year, as cold winter weather and smaller-then-expected imports of liquefied natural gas have pushed gas futures prices up nearly 40 percent.  

But so far, there are only small signs of life in the US onshore markets, suggesting that the stocks may have gotten ahead of themselves.

“While we can’t blame most for jumping on the bullish bandwagon, our view is that natural gas prices will still fall this summer,” Raymond James wrote in a note to clients in late March. “This should drive activity lower and leave the market oversupplied and overly optimistic.” As a result, Wall Street earnings estimates are too high and need to be lowered, the firm said.  

Raymond James sees higher imports of LNG and increased production weighing on natural gas prices in coming months, although the research firm has become less bearish in it’s outlook due to the winter’s colder than expected weather. Still, shares of Nabors Industries Ltd are up 15 percent this year, Grey Wolf Inc has risen 15 percent, Patterson-UTI Energy Inc is up 16 percent and Pioneer Drilling Co has climbed 25 percent.

By comparison, an index of drilling companies which includes offshore drillers GSPOILD is up about one percent on the year. In January, analysts had forecast gas prices would average $7.30 per thousand BTU, up from $6.95 in 2007, although many experts have raised their expectations by about $1 in since the start of January because of strong demand.

Too early
Carl Blake, senior high-yield analyst with corporate bond research firm Gimme Credit, said it is too early to call a recovery in the land drilling sector. “I think you’ll need to see natural gas prices sustainable at higher levels before you see companies expanding their capital budgets,” Blake said.

The budgets of smaller oil and natural gas exploration companies will be more sensitive to the ups and downs of natural gas prices, while larger companies are more likely to stick to their capital expenditure plans, the analyst said.

The market will also need to see storage levels decline below historical averages to sustain higher natural gas prices, Blake said. And while the rate of decline in prices for drilling rigs has slowed, prices are still down four percent in the first quarter, according to data from energy analysis and advisory firm Spears and Associates Inc.

In a recap of an investor conference held in Las Vegas in early March, Simmons & Co said there were about 400 land rigs not working in the US market, suggesting an 80 percent industry utilisation. Historically, Simmons said, 85 percent utilisation is needed for higher prices.

Exploration and production companies are still acting cautiously and not signing term contracts, although there are some inquiries about long-term prices, Simmons said. But some argue that the worst times for the US land drillers are in the rear-view mirror.

“We have been very surprised that the land dayrates have not fallen further,” Richard Spears, vice president of Spears and Associates Inc, said. “While you can certainly find 200 rigs lying in the grass not doing anything, it looks like the industry is stabilising at around $20,000 per day.”

Currently, dayrates for rigs in the US are around $20,000, up substantially from the lows of $10,000 to $11,000 in 2003 and the beginning of 2004, Spears said. In a meeting with investors in March, Mark Siegel, the chairman of Patterson-UTI, said that he sees the market “more in balance and more stable” than it has been before, and natural gas and oil markets are likely to remain favourable in the long-term.

Climate change and the corporate arsenal

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UN Secretary General, Ban Ki-moon, “The danger posed by war to all of humanity – and to our planet – is at least matched by that of climate crisis and global warming.” Prince Charles, addressing the European Parliament, “Fighting climate change is comparable to war, and a “courageous and revolutionary” approach is needed to avoid catastrophe. The private sector has a crucial role to play.”

Statements such as these, combined with the overwhelming scientific evidence on climate change, have led to a concerted shift in consumer, business and government opinion and action. Yet, investment in climate change initiatives and the environment pale in comparison to the numbers invested around the world in the military. Could such a simple change as calling it the “War on Climate Change” affect the decisions of government, corporations and individuals?

This article looks at the individual weapons in the corporate ‘arsenal’ in the war on climate change and how they can support and ensure corporations manage and reduce the risk associated with climate change. Further, it looks at the benefits, both financially and to the health and welfare of your brand, of a comprehensive carbon management strategy.

Commitment
The first and most crucial step for corporations to make is commitment. The ethics and vision of a company should be the guiding light that helps determine how crucial the climate change issue is to the brand, both now and in the future. In addition to asking, “can we enhance our stock market value through climate change initiatives?” brands need to answer the question, “does our climate change policy and actions fit with our values and mission?” They need to make a public statement of their intentions, including setting out measurable steps to calculate, manage and reduce their carbon footprint, which is backed up by senior management, as a group, ‘walking the talk.’

Leadership     
‘Walking the talk’ includes clear leadership. Experience has shown when major corporations make a stand on key issues, the world listens.  Brands who are prepared to take on this initial fight can guarantee long-term brand image benefits, positioning themselves as an industry leader. Sector leaders who have embraced climate change early and consistently are seen by the public as the leaders and the ‘greenest.’ In a world where scepticism of business’ intentions and claims is rampant, leadership has to about actions and consistency, not press releases and tag lines. Leadership is the weapon in the corporate arsenal setting “direction”.

Engagement    
‘Direction’ may be influenced by stakeholders. Stakeholders, including consumers, government, employees and others are crucial to a brand’s reputation. A company needs to be able to answer the following questions: Is the brand listening to and acting on stakeholder concerns? Are the climate change issues that keep them awake at night the ones that companies are addressing? What role do employees see for themselves in the war against climate change?

Effective communication channels are critical in any military campaign and this war is no different.  Without companies engaging with their stakeholders, how will the knowledge and resources be deployed and used to best effect?

Dedicated resources   
A clear sign that business is serious about climate change is the level of internal resources dedicated to environmental issues. Lady Young, the Head of the UK Environmental Agency, recently stated, “This is World War Three. We need the sorts of concerted, fast, integrated and above all huge efforts that went into many actions in times of war.”

Again, there are several questions that a company needs to answer to ensure that they are addressing the issue. Is business factoring in climate change into each and every major decision? Is the most senior climate change person at the board level? Where is climate change on the risk register and in product design? This is not about this year’s budget, but rather how much is being invested over the next 10 to 20 years. Dedicated resources are about translating the commitment and leadership into sustainable planning and actions.

Transparency
Setting clear, visible targets that relate directly to the brand’s ethics and vision are the key to transparency. Being transparent and consistent on internal processes, including the ones that generate the most emissions, as well as publicly setting improvement goals helps stakeholders better understand the issues. It also enables them to make more informed judgments about a brand, turning commitment and leadership into a tangible benefit for the brand. Transparency is also the most effective way of internally ensuring implementation of a brand’s vision, applying the business model of “what gets measured gets managed.”

Verification
In independent research, 70 percent of consumers want independent, third-party verification of corporate “green claims.”¹ The most difficult tools to put into use for corporations are commitment and engagement. Those two require the most change within an organisation and are, therefore, the most likely to be met with resistance. Verification, on the other hand, is the part of the process that validates all of the hard work and struggles. Verification is the final step that provides business with the platform to go out and shout about their accomplishments. With nothing less than a brand’s credibility on the line, who can afford not to have climate change data and claims verified?

Trust
Trust is the reason that corporations start this long journey. Trust from employees, customers as well as trust in what a brand stands for. It seemed ever so elusive in the early stages. Now, with all of the early struggles a distant memory and the confidence that independent verification brings, the full competitive advantages and benefits of the initial commitment are clear. Trust is the output of all of the other weapons in the corporate arsenal. Take all of them into account and trust is a natural result. Leave or discount any of the tools and trust can be lost forever.

What is victory in the war on climate change?
Let’s go back to our original comparison of climate change to war. If we put our entire arsenal to use, what would victory look like? Transparent efforts will lead to increased brand awareness and profits. From there, concerted stakeholder engagement leads to trust, which can enhance a company’s reputation as an innovative industry leader. One needs look no further than Toyota and their image as the greenest car maker. How much money will their rivals have to spend on research and marketing to level the playing field in the eyes of consumers?

How bad can defeat really be?
Turn the question around and the issue becomes more urgent. Companies failing to address climate change could face a public backlash from stakeholders, who see the brand as not doing their part, even worse, as proactively contributing to the destruction of our planet. Back in 2001, Dr. Andrew Dlugolecki, director of general insurance development at CGNU, the United Kingdom’s largest insurance group, stated “the rate of damage caused by changing weather will exceed the world’s wealth. Damage to property due to global warming could bankrupt the world by 2065.” Need further proof of that damage? CNN reporter, Dr Sanjay Gupta, reported on July 31, 2007 that the Carteret islanders in the South Pacific will be the first island community in the world to undergo an organized relocation, in response to their island sinking. The people of the Carteret are being called the world’s first environmental refugees.

Words and actions
Changing the words we use to describe the current climate change danger is not going to solve the problem. Business leading the way and applying all of the tools described here in a dedicated and transparent manner could just set the example that individuals and governments need to help them make the hard choices that will inevitably be necessary to sustain our planet. Could the stakes possibly be any higher?

When the juice runs out

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It’s indisputable that we are running short of traditional sources of energy. And it’s our seemingly insatiable use of these sources that could prove calamitous for the global economy unless we make a serious attempt to redress the balance.

Some facts. We depend on oil for 90 percent of our transport, and for food, pharmaceuticals, chemicals and just about every aspect of modern day life. But some oil industry experts calculate that current reserves will last for just 40 years. So if we continue down this route we’ll need to find new reserves. But where? Although developments in technology have made oil extraction more efficient, the struggle to find alternative oil sources means that we’re now using less productive methods like deep sea drilling, often in environmentally sensitive regions like the Arctic.

Supplies of gas are finite too. And, although there’s still plenty of coal in the world, its use is difficult without causing even worse pollution to our already over-polluted planet.

Energy alone won’t determine the global economic landscape of the future – but it’s a major factor, and is already influencing the shift in political power, demographics, population movement and the dominance of what are now the burgeoning economies. Put simply, the rising economies of India, Indonesia, China, Brazil and Russia, and probably a few others still waiting in the wings, as either major users or producers of energy – or both – will shift the global economic centre of gravity. And, like everyone else, they’ll have to battle with the problems of energy shortage.

Who’s to blame?
Although the new economic powerhouses like China and India are major energy consumers, it would be unfair to point to these new kids on the economic block as the sole villains of the piece. While China’s consumption of oil is rising as a consequence of its rapidly expanding manufacturing base and the demands of its growing affluence, it doesn’t come close to the appetite for oil of the United States, whose population is a mere 300 million compared to China’s 1.3 billion. Currently, the US uses 2.7 million barrels of oil a day – more than India and Pakistan together.

But let’s not put all the blame on the US either. They’re just such a big target it’s difficult to miss. The UK government’s experts have estimated that 56% of energy used in UK homes could be cut using currently available technologies. We can install solar tiles, or miniature wind turbines the size of a satellite dishes. But how many of us can be bothered?

The penny is however beginning to drop with most of the world’s politicians. As energy sources decrease a whole new set of issues will surface – the main one being, of course, ‘Where will we get our energy from, and what will it cost?’

Already, the energy for our fuel, heat and light travels vast distances to reach us, and as recent events have shown, that means it crossing not just continents but political hotspots. An uncomfortable reminder of what the future could hold happened when Russia cut its supply of oil to Europe because of a row with Belarus. Russia accused Belarus of siphoning off oil from the pipeline en route, while Belarus countered that Russia hadn’t paid the tax for moving oil through Belarus – itself a ‘tit for tat’ move following Russia’s doubling of the price it charges Belarus for gas. It was when Belarus began legal action to recover the tax that Russia halted its export of oil.

While the disruption to supply was short lived, it brought home just how reliant Europe is on Russia for its energy supply. And of course, events like this only serve to trigger price rises too. EU Trade Commissioner Peter Mandelson succinctly summed up the situation – and the possible solution – in a speech at the EU-Russia Centre in Brussels last October.

He said that the key to improving the strained relations between the EU and Russia would be for Russia to join the World Trade Organisation, as this would create an obligation to more equitable trading conditions, and for Russia to commit to providing a secure and steady supply of energy to Europe. And when you think about it, both parties would benefit from that. But even if that did happen, it’s still a relatively short term answer – the problem is still that the world’s traditional oil resources are drying up.

What then is the answer?
New, sustainable sources of energy are being developed, and when they get here no doubt they’ll help us – or rather our grandchildren – live longer, healthier lives.

But till then our world will change to reflect the geographical and ethical shift in power, wealth and poverty created by dwindling supplies of energy. Pretty soon, we’ll be living in a world whose make-up is far removed from the one that we know today. International borders will still exist, but they’ll be different borders and they’ll have a different meaning.

We’ve seen already how the flow of people, ideas and information across borders bring into question ingrained assumptions about the nature of sovereignty and politics. How many of us can truly say that our beliefs of right and wrong, good and bad, progressive and reactionary, are neatly aligned to ‘party’ politics anymore? In the future, as this extension of cosmopolitanism continues, and power shifts from governments to individuals, markets and private enterprises, so new kinds of community will grow up, built around common values based on the way we live now, not how our forefathers lived. What we describe as ‘Western’ values will be challenged as economic and political power is redistributed. And growing migration for economic, political and, increasingly, environmental reasons will mean we can no longer define ourselves by where we were born.

Utopia or dystopia?
Predicting the future is always a dangerous exercise. Our predictions can always come back to bite us when they turn out to be wide of the mark. Science pundits in the ‘60’s often painted a picture of 21st century citizens being transported on hover-shoes to their pristine paperless office modules for their eight hours a week jobs: the rest of their time taken up with hi-tech pastimes from three dimensional chess to virtual golf. But occasionally they were right. A BBC programme from that time – ‘Tomorrow’s World’ – previewed hole in the wall cash machines in 1969, the digital watch in 1971 and the compact disc in 1981.

Now we are beginning to see the early signs of a world economy changed by the scarcity of energy, and we can predict with some accuracy that it can go one of two ways, depending on the action that our governments – and we as individuals – take.

Left to their own devices, the countries that own the sources of energy could theoretically hold the rest of the world to ransom. The price they charge countries which have no energy resources of their own will determine the economic competitiveness of those other countries. But in the end that would be self defeating. No country – even one self sufficient in energy – can exist wholly on its own. That’s like the selfish school kid who won’t let anyone else play with his football. Eventually, if he’s got any sense at all, he’ll see that cooperation has far more benefits. Similarly, it would be far better for nations, however they are defined in the future, to find ways of reaching agreement on a consistent and controlled supply for everyone.

And to control their own use of scarce fuels until sustainable alternatives are readily available. Yes, that would mean legislation and additional tax, but it’s a price well worth paying.

There’s also of course a genuine need for individuals to take responsibility for the sake of the planet. We can all take steps to conserve existing sources of energy. The vehicles we drive – if we drive at all – the way we heat our homes, our choice of holiday destination and how we get there. Maybe it will take some harsh law making to steer us in the right direction – many of us would far rather that it was a matter of conscience and intelligence. Perhaps that’s a little idealistic – but I’d like to think it isn’t.

Defining sustainability value

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Are companies leading in their sustainability performance being undervalued by the market? Are companies with poor sustainability performance over-valued by current valuation models? There would be no bigger coup for the shareholders of sustainable businesses, (not to mention the health of the planet), if companies leading in their sustainability performance were to get their day at the bank in the form of premiums in market capitalisation. Global companies are taking brave decisions and have been investing significant capital to ensure that their business models are robust enough to withstand the long term risks of a carbon, water and ecosystem constrained world. Some companies are creating models of business that directly address global challenges and focus on value to society.

Yet to-date there has been little evidence that sustainability performance is being considered a significant contribution in the valuation of these companies. Perhaps until now. The world’s largest metals transaction, the $38bn acquisition in July 2007, priced Alcan’s stock at $101.03 representing a premium of 65.5 percent. According to Richard Evans’ statement above, is the Rio Tinto Alcan acquisition a sign of things to come in terms of sustainability performance increasingly being considered in business valuations? And if so, what does it mean? This paper argues three points:

New definitions of business value are starting to emerge – from the CEO
Climate change and other global challenges (i.e. sustainable development more broadly) are important issues for society, and are becoming increasingly important for business.

In 2005 CEOs of global businesses, and members of the World Business Council for Sustainable Development (WBCSD) conducted a study that concluded, “Leading global companies of the future will be those that provide goods and services and reach new customers in ways that address the world’s major challenges.”[1] Therefore, a company’s value will need to reach far beyond economic value to sustainability value. In reference to the Rio Tinto Alcan case, it seems that enlightened company executives are starting to communicate a new definition of value, sustainability value, to the investment community.

The brand valuation journey, which began with recognition in mergers & acquisitions, could provide a model for sustainability valuation
Intangibles such as brand, reputation and patents (once thought inconceivable to be assigned value) have transformed how modern business is valued in recent years. An Interbrand study of acquisitions shows that intangible assets represented less than 20 percent (on average) of the amount bid for companies in 1981, and has escalated up to about 80 percent (in some cases) today.  

It was the series of brand acquisitions in the late 1980’s that exposed the hidden value in highly branded companies and brought brand valuation into the spotlight. If the Rio Tinto Alcan example represents evidence of sustainability value being included in acquired valuation, could we be at the start of the sustainability valuation journey? Will companies start to be acquired for their track record on sustainability?

Sustainability value must be differentiated from brand value in business valuations for optimal benefit
Sustainability value must be differentiated from brand value because it is different, and because business valuation could play a very important role in promoting a sustainable future. For global companies of the future to be those that provide solutions to global challenges, these business models must be rewarded by the capital markets. In turn, for the capital markets to reward a company’s value to society, this sustainability value must be weighted highly in business valuations. If sustainability value were to be simply integrated into brand value, a unique opportunity to institutionalise sustainability value and sustainability valuation could be missed.

Why is this important? – A summary
Progress towards sustainable development, addressing the world’s most urgent challenges, must involve the capital markets. Business valuations need to link environmental and social performance with business value. The Rio Tinto Alcan case could signal that company executives and market actors are ready to act regarding the inclusion of sustainability performance in business valuations. The lessons learned from the brand valuation journey could provide a step by step guide for market actors and companies to accelerate this process. To fully optimise the opportunities that lie ahead in defining sustainability value, careful attention should be paid to differentiating sustainability from brand value – this will be good for business and good for sustainable development.

 “There is no doubt that the premium received by Alcan shareholders in the Rio Tinto combination was largely a reflection of financial performance. But, Alcan’s track record on sustainability, environmental stewardship and stakeholder relationships was also a very significant contribution.”[2]

Richard B. Evans, chief executive, Rio Tinto Alcan

 

 
 

The new era of responsible investment

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Until recently, the role of capital and investment markets in sustainable development was little understood and widely discounted. While it has been clear for many years that financial liberalisation and cross-border investment grease the wheels of globalisation and help to fuel growth in mature and developing economies, the ways in which investment – particularly private investment – relate to the triple-bottom-line agenda have remained largely unexplored.

Two specific projects have helped to break the ice – the UN Global Compact’s Who Cares Wins initiative and the UN Environment Programme’s Finance Initiative (UNEP FI), both unique public-private partnerships within the UN system. Working in close collaboration, these efforts brought together a range of financial-market actors – principally fund managers and analysts – to explore the materiality of environmental, social and governance (ESG) issues to investment returns. Their work led to what we consider to be a breakthrough in understanding how various ESG issues – through transmission factors such as operational risks, reputation risks, innovation, and access to resources – relate to the value drivers of the underlying investment asset.

In many ways, these projects complement other initiatives in the financial world – such as the International Finance Corporation’s Equator Principles, the Carbon Disclosure Project, the Global Reporting Initiative, and the Enhanced Analytics Initiative, the last of which focuses on stimulating more mainstream research on ESG issues.

Corporate agenda
Most importantly, all these efforts helped investment markets “catch up” to the rapidly growing corporate sustainability agenda, reflected in initiatives such as the UN Global Compact, which today includes more than 3,900 corporate participants and hundreds of other stakeholders in more than 120 countries. Indeed, a major source of frustration for corporate sustainability leaders has been the apparent lack of interest by investment markets in corporate efforts to manage the risks and opportunities of ESG issues – be they related to climate change, human rights, or anti-corruption, to name just a few areas.

However, it has become clear that targeting the financial intermediaries would not be enough to truly move the agenda forward – asset owners would need to be mobilised on a much larger scale. This belief led the Global Compact and UNEP FI to form a special partnership with a small group of institutional investors. The aim was to develop an international understanding and associated framework related to a new concept of responsible investment – one that placed the materiality of ESG issues at the centre, while recognising the broader societal benefits of such an approach.

Launched in April 2006, the Principles for Responsible Investment (PRI) are in essence a set of global best practices for responsible investment. Rising numbers of institutional investors – from all regions of the world, and today representing more than $10trn – have embraced the PRI, marking a major advance in mainstream financial markets. The growth of this initiative has been extraordinary, and the principles – endorsed by both asset owners and asset managers – have quickly become the global benchmark for responsible investing.

Improving performance
By incorporating environmental, social and governance criteria into their investment decision-making and ownership practices, the signatories to the PRI can directly influence companies to improve performance in these areas. This, in turn, can contribute to our efforts to promote good corporate citizenship and to build a more stable, sustainable and inclusive global economy.

Two examples point to the potential of this approach: Recently, a group of PRI signatories – through the initiative’s Engagement Clearinghouse – began to engage with 33 automobile and steel companies that face supply chain risks related to slave labour in Brazil. And in January 2008, another group, representing approximately $2.13trn in assets, wrote to the chief executive officers of 103 companies in more than 30 countries to recognise frontrunners in the integration of ESG issues, while pressing laggards to improve their performance.

It is clear that we are essentially witnessing an evolution beyond the ethical for SRI movements – one based on the notion that ESG issues are material to long-term value creation and must thus be considered. And, by definition, this has special appeal to long-term investors – many of whom have long wished to break out of what’s been called the “tyranny of short-termism” – a situation that, in its most extreme form, sees asset owners – pension trustees, for example – pressuring fund managers to outperform quarterly indices rather than taking the long-term view for the benefit of their fiduciaries.

To be sure, these short-term pressures can also lead companies to behave irresponsibly. Indeed, the entire philosophy of the Global Companies is based on the long-term benefits of corporate citizenship and sustainability, which can also be recognised if companies diffuse universal values and principles deeply throughout their organisations and value chains – within boards, subsidiaries, and business partners.

The good news is that new dialogues are starting. More and more companies in the Global Compact are actively communicating their sustainability strategies and performance to the mainstream investment community.

In the meantime, it is clear that companies need to do a better job of disclosing information on potentially material issues. Many of the glossy CSR and sustainability reports we have seen in recent years still fall short of presenting meaningful data on performance and impact. The Global Reporting Initiative’s G3 guidelines are a significant advancement. And we are continuously refining the Global Compact’s Communication on Progress policy so that it is more relevant for the investment community. What is also clearly needed is more research on emerging and frontier market companies, particularly given the rising prominence of Southern transnationals. Here, the PRI initiative has once again taken the lead by launching a special push into emerging markets.

Wealth funds
What should also be noted is the importance of asset classes beyond the listed ones – including fixed-income, real-estate, and private equity. How sovereign wealth funds may or may not pick up on the responsible investment agenda will be a fascinating area of discussion and study moving forward.

Another powerful development is the convergence of corporate sustainability and corporate governance. Indeed, more and more companies in the Global Compact see sustainability as an essential component of good corporate governance, from the vantage point of risk management, transparency and sustainable long-term value creation. This is an expanded notion of corporate governance and one that goes much farther than many compliance-orientated schemes currently in use.

There are, of course, many challenges ahead. The majority of corporations in the world have yet to make a serious commitment to sustainability. Scaling up good practices thus remains both a challenge and an opportunity. And there is a danger that the ESG islands of activity within investment houses get pigeon-holed. Mainstreaming must be a priority.

Stock exchanges, too, have a role to play, through awareness-raising, the development of special indices, and even through listing criteria – an area that should be more actively explored. Unfortunately, the exchange industry generally seems reluctant at this point to take up the challenge and opportunity.

Overall, the leadership of those institutions that have committed themselves to this agenda deserves our recognition. Other investors around the world should join this historic effort to make investment markets truly responsible.

For further information:
Websites: www.unglobalcompact.org and: www.unpri.org