May | 2008 | World Finance

A new era in global islamic banking

Posted on May 14, 2008 by

Talk to Mark Hanson, Chief Executive of Bahrain-based Global Banking Corporation (GBCORP) for a short while and you realise the steadfast resolve of a man on a mission – a challenge he says to effectively address and capitalise on the growing interest globally in Islamic banking.

Islamic banking is almost as old as Islam itself, says Mr Hanson. And this from a banker who is a recent convert to Islamic banking is a strong statement on the growing acceptance of Islamic banking – not as an alternative to conventional banking – but as an effective complement to the same.

Mr Hanson, a New Zealander and a London solicitor by training, typifies the growing Islamic banking trend of experienced Western investment bankers migrating from conventional banking environments to seek the more challenging and innovative aspects of Islamic banking – to help develop a range of ethical Shariah-based Islamic investment banking products and services to address the growing demand for Islamic banking products in the region, comprising the six Arab states of the Gulf Co-operation Council trade block – and beyond.

“There is a growing confidence, a growing respect for deals done on Islamic principles, whether it’s financing or investments,” says Mr Hanson. “Look at the UK: it’s also gearing itself up to support a demanding clientele seeking an option against conventional banking. This move should not just be seen as catering to the requirement of a minority target audience but in terms of providing alternative investment opportunities to both individual and institutional investors seeking a diversified investment portfolio, both in the established markets in Europe as well as emerging markets in Asia and the Mena region.

Leading contenders
GBCORP is a young bank – though Mr Hanson bridles at the ‘young’ adjective – “look at the extensive experience of the people who work for us,” he says in response – GBCORP anticipates being one of the Middle East’s leading investment banks in the coming years, with a broad range of services on offer from private equity to real estate to fund and wealth management. So, how is all this wealth, putative and real, being driven? Not every GCC citizen is a millionaire by any means. A high oil price, unsurprisingly, helps. “Though we are seriously looking at alternative energy sources, there is no replacement for oil or gas currently, so we are certainly dependent on oil for the near future,” says Mr Hanson. “Up until early last year oil prices were expected to remain above $50 a barrel. The reality today is hugely different. What does this mean? Growing budget surpluses. In the case of a place like Qatar, they have 20 percent of the world’s gas supplies while Saudi Arabia has 20 percent of the world’s oil reserves. The governments in these countries realise the importance of this surplus liquidity and the need to distribute the wealth downwards, to the common man.”

Mr Hanson continues, “The Bahrain Prime Minister, for example has gone on record saying that the surplus money generated will go towards ensuring housing amenities for all nationals. This is true for other Gulf States also. That means there will be large private sector involvement in infrastructure projects, be it the power and construction sector. Education, housing, infrastructure development – all these are core focus areas. All that wealth will therefore trickle down. A strong private sector will spur the need for innovative investment options and this in turn will drive the growing demand for Islamic banking services.”

Mark Hanson claims GBCORP’s shareholder base (though he’s too discreet to name names) does make GBCORP stand out from the competition, as well as using their substantial shareholder support to shoulder and co-invest in deals. “When we publish our accounts in February, you’ll be seeing proof of what we offer in terms of a track record, but we can’t talk about deals we’re working on currently.”

Savvy approach
What he can talk about now though is the real estate opportunities in Saudi Arabia, Bahrain and Kuwait and other GCC countries. Bricks and mortar, from an Islamic banking perspective, is an easily understood investment, as is some private equity investment he says. Yet the recent collapse of the Delta Two bid for Sainsbury’s is also indicative, Mr Hanson says, of an increasingly savvier approach from Middle Eastern investors who simply won’t pay over the odds for Western assets, however attractive. “Where we won’t invest is in hugely technical areas which people find difficult to understand.”

“Look at the commercial property market in the UK. That’s dropped 10 percent and could fall some way yet. I think the residential property market is also likely to drop. So the hot money will pour out of the UK. I think the UK, from a Middle Eastern perspective, could become more attractive in the next year or two.” In other words, when UK Plc is in trouble.

Mr Hanson certainly thinks fantastic opportunities in the US are just around the corner – if not already there – as the US sub-prime mortgage crisis penetrates deeper. But many bankers, even at this late stage, says Mr Hanson, seem to be collectively sleepwalking towards the crisis. They simply don’t get the scale of the problem he says.

“I was in the US five weeks ago attending a conference and then in another property commercial conference in London shortly afterwards and both places the banks still thought the party was going on. They still haven’t realised that there’s been basically a market collapse. People don’t seem to understand market forces. When you have Citibank losing $10bn and Merrill losing huge amounts, it does have a knock-on effect. People still view the sub-prime issue as an isolated event.”

The potential is there
Where then does Mr Hanson feel GBCORP’s core strengths lie? And what about future alliances? Obviously, he says, they are strong in the Middle East. GBCORP’s Chairman, Saleh Al Rashed, is a well known and successful Saudi businessman in his own right, Chairman of several large corporations. “I think we have the potential to also develop interesting strategic alliances in the Far East, particularly in Singapore, Hong Kong and China. That part of the world is obviously a major growth engine. Our head of investment banking has got excellent contacts in India.” And, on the flip side of the coin, where is GBCORP weaker? “Probably in places like Russia, but then I think that’s maybe not such a bad thing.”

Yet despite the bullishness of Mr Hanson’s words, he is well aware some in the West still perceive Islamic banking to be some distance behind in issues like governance and disclosure. “I think there is a growing transparency and an inclination to come up to international standards. I think it’s going in the right direction. But to say that Islamic banking has failings…. Well, you don’t have to look too far to the regulatory failings in the UK. You’ve just had the first run on a bank in 166 years. The regulatory system has failed there.” Mr Hanson, of course, refers to Northern Rock’s humiliating injection of emergency funds from the Bank of England. Thousands of worried savers flocked to Northern Rock branches, desperate to withdraw money in case the bank collapsed. It’s a slightly moot point though: the run on Northern Rock was exceptional. That’s the hope anyway.

Certainly Islamic banking transparency and disclosure environment continues to improve says Mr Hanson. Look at the regulatory environment developed in Dubai, Qatar and Bahrain where regulators from the SEC and FSA are helping develop a rigorous regulatory framework, he says.

“I think if you look at those three jurisdictions and the level of disclosure there, you’ll find they’re meeting international standards. In the West there is this wrong perception of a Muslim world that is very closed and inhibitive. Much of that is due to a closed mindset. The reality is totally different. And I should know – I speak from experience of having worked in Pakistan, Saudi Arabia and now in Bahrain, plus the extensive experience of having interacted with the populace within the region.”

Education and learning
Another issue Westerners struggle to comprehend about Islamic banking is how it operates without charging or giving clients’ interest – the concept of usury – and something Islamic law specifically prohibits. Is this about weaving legal formulas or restructuring payment methods that, perhaps, imply a fee instead? Mr Hanson says carefully it’s an issue about education and learning. “If it is structured in the right Islamic way then interest is not charged. Take, for example, funds placed with an Islamic banker where there’s an underlying asset, be it gold or coffee beans.

An underlying trade. The result may be the same, but the actual structure is different. There’s a clear difference about putting your money with a conventional bank where interest is still being paid and income from your money with an Islamic bank. I’ll be completely honest. Like I mentioned earlier, I’ve been involved in Islamic banking for a few years, and it does take a while to have a full understanding of this banking model.”

Meanwhile, Mark Hanson remains highly upbeat about business prospects – provided the political situation in the region does not go into a reactive mode based on other global or western equations. “Apart from that, in terms of our strategy, the way our products are structured and the potential for more clients, we’re very satisfied. For the bigger picture, we’re confident.”

The new Iraq strategy

Posted on May 14, 2008 by

The Baker-Hamilton commission has powerfully described the impasse on the ground. It is the result of cumulative choices, some of them enumerated by the president, in which worthy objectives and fundamental American values clashed with regional and cultural realities. The important goal of modernising US armed forces led to inadequate troop levels for the military occupation of Iraq. The reliance on early elections as the key to political evolution, in a country lacking a sense of national identity, caused the newly enfranchised to vote almost exclusively for sectarian parties, deepening historic divisions into chasms. The understandable – but, in retrospect, premature – strategy of replacing American with indigenous forces deflected US forces from a military mission; nor could it deal with the most flagrant shortcoming of Iraqi forces, which is to define what the Iraqi forces are supposed to fight for and under what banner.

These circumstances have merged into an almost perfect storm of mutually reinforcing crises. Within Iraq, the sectarian militias are engaged in civil war or so close to it as to make little practical difference. The conflict between Shia and Sunnis goes back 1,400 years. In most Middle Eastern countries, Shia minorities coexist precariously with Sunni majorities. The civil war in Iraq threatens to usher in a cycle of domestic upheavals and a war between Shia and Sunni states, with a high potential of drawing in countries from outside the region. In addition, the Kurds of Iraq seek full autonomy from both Sunnis and Shia; their independence would raise the prospect of intervention from Turkey and possibly Iran.

The war in Iraq is part of another war that cuts across the Shia-Sunni issue: the assault on the international order conducted by radical groups in both Islamic sects. Functioning as states within the states and by brutal demonstrations of the inability of established governments to protect their populations, such organisations as Hezbollah in Lebanon, the Mahdi army in Iraq and the al-Qaida groups all over the Middle East seek to reassert an Islamic identity submerged, in their view, by Western secular institutions and values. Any enhancement of radical Islamist self-confidence therefore threatens all the traditional states of the region, as well as others with significant Islamic populations, from Indonesia through India to Western Europe. The most important target is the United States, as the most powerful country of the West and the indispensable component of any attempt to build a new world order. The disenchantment of the American public with the burdens it has borne alone for nearly four years has generated growing demands for some form of unilateral withdrawal, usually expressed in the form of benchmarks to be put to the Baghdad government which, if not fulfilled in specific time periods, would trigger American disengagement. But under present conditions, withdrawal is not an option. American forces are indispensable. They are in Iraq not as a favour to its government or as a reward for its conduct. They are there as an expression of the American national interest to prevent the Iranian combination of imperialism and fundamentalist ideology from dominating a region on which the energy supplies of the industrial democracies depend. An abrupt American departure will greatly complicate efforts to help stem the terrorist tide far beyond Iraq; fragile governments from Lebanon to the Gulf will be tempted into pre-emptive concessions. It might drive the sectarian conflict within Iraq to genocidal dimensions beyond levels that impelled American intervention in the Balkans. Graduated withdrawal would not ease these dangers until a different strategy is in place and shows some progress. For now, it would be treated both within Iraq and in the region as the forerunner of a total withdrawal, and all parties would make their dispositions on that basis.

Grand strategy
President Bush’s decision should therefore not be debated in terms of the ‘stay the course’ strategy he has repeatedly disavowed recently. Rather it should be seen as the first step toward a new grand strategy relating power to diplomacy for the entire region, ideally on a non-partisan basis. The purpose of the new strategy should be to demonstrate that the US is determined to remain relevant to the outcome in the region; to adjust American military deployments and numbers to emerging realities; and to provide the manoeuvring room for a major diplomatic effort to stabilise the region. Of the current security threats in Iraq – the intervention of outside countries, the presence of al-Qaida fighters, an extraordinarily large criminal element, the sectarian conflict – the United States has a national interest in defeating the first two; it must not involve itself in the sectarian conflict for any extended period, much less let itself be used by one side for its own sectarian goals.

The sectarian conflict confines the Iraqi government’s unchallenged writ to the sector of Baghdad defined as the Green Zone protected by American forces. In many areas the militias exceed the strength of the Iraqi national army. Appeals to the Iraqi government to undertake reconciliation and economic reforms are not implemented, partly because the will to do so is absent but essentially because it lacks the power to put such policies in place, even if the will to do so could suddenly be mobilised. If the influence of the militias can be eliminated, or greatly reduced, the Baghdad government would have a better opportunity to pursue a national policy. The new strategy has begun with attempts to clear the insurrectional Sunni parts of Baghdad. But it must not turn into ethnic cleansing or the emergence of another tyrannical state, only with a different sectarian allegiance. Side by side with disarming the Sunni militias and death squads, the Baghdad government must show comparable willingness to disarm Shia militias and death squads. American policy should not deviate from the goal of a civil state, whose political process is available to all citizens.

Protecting against infiltration
As the comprehensive strategy evolves, a repositioning of American forces from the cities into enclaves should be undertaken so that they can separate themselves from the civil war and concentrate on the threats described above. The principal mission would be to protect the borders against infiltration, to prevent the establishment of terrorist training areas or Taliban-type control over significant regions. At that point, too, significant reductions of American forces should be possible. Such a strategy would make withdrawals depend on conditions on the ground instead of the other way around. It could also provide the time to elaborate a co-operative diplomacy for rebuilding the region, including progress towards a settlement of the Palestine issue. For such a strategy, it is not possible to jettison the military instrument and rely, as some argue, on purely political means. A free-standing diplomacy is an ancient American illusion. History offers few examples of it. The attempt to separate diplomacy and power results in power lacking direction and diplomacy being deprived of incentives. Diplomacy is the attempt to persuade another party to pursue a course compatible with a society’s strategic interests. Obviously this involves the ability to create a calculus that impels or rewards the desired direction. The outcome, by definition, is rarely the ability to impose one’s will but a compromise that gives each party a stake in maintaining it. Few diplomatic challenges are as complex as that surrounding Iraq. Diplomacy must mediate between Iraqi sects which, though in many respects mortal enemies, are assembled in a common governmental structure. It needs to relate that process to an international concept involving both Iraq’s neighbours and countries further away that have a significant interest in the outcome.

Two levels of diplomatic effort:
1) The creation of a contact group, assembling neighbouring countries whose interests are directly affected and which rely on American support. This group should include Turkey, Saudi Arabia, Egypt and Jordan. Its function should be to advise on ending the internal conflict and to create a united front against outside domination.

2) Parallel negotiations should be conducted with Syria and Iran, which now appear as adversaries, to give them an opportunity to participate in a peaceful regional order. Both categories of consultations should lead to an international conference including all countries that will have to play a stabilising role in the eventual outcome, specifically the permanent members of the UN Security Council as well as such countries as Indonesia, India and Pakistan.

Riding on the crest
Too much of the current discussion focuses on the procedural aspect of starting a dialogue with adversaries. In fact, a balance of risks and opportunities needs to be created so that Iran is obliged to choose between a significant but not dominant role or riding the crest of Shia fundamentalism. In the latter case, it must pay a serious, not a rhetorical, price for choosing the militant option. An outcome in which Iran is approaching nuclear status, because of hesitant and timid non-proliferation policies in the UN Security Council, coupled with a political vacuum in front of it in the region must lead to catastrophic consequences. Similar principles apply to the prospects for settlement in Palestine. Moderates in both the Arab countries neighbouring Israel and in Israel are evolving compromises unimaginable a decade ago. But if the necessary outcomes are perceived as the result of panic by moderates and an exit from the region by the United States, radicals could raise unfulfillable demands and turn the peace process against the moderates. In all this, the United States cannot indefinitely bear alone the burden for both the military outcome and the political structure. At some point, Iraq has to be restored to the international community, and other countries must be prepared to share responsibilities for regional peace. Some of America’s allies and other affected countries seek to escape the upheavals all around them by disassociating from the United States.

But just as it is impossible for America to deal with these trends unilaterally, sooner or later a common effort to rebuild the international order will be imposed on all the potential targets. The time has come for an effort to define the shoals within which diplomacy is obliged to navigate and to anchor any outcome in some broader understanding that accommodates the interests of the affected parties.

OECD debates globalisation; WTO agreements

Posted on May 13, 2008June 20, 2013 by itsupport

The valuation of related party transactions, i.e. of transfers of goods, services, intangibles or funding among members of the same multinational enterprise, is not necessarily an exciting topic for managers: in today’s world, multinational groups want to act globally, and transfering resources from one member to another member of the family is not where the focus of the attention should be ‘business-wise.’

But another reality of today’s world is that governments are not global and that direct and indirect taxes are assessed and levied domestically. Beyond differences in tax rates there are a number of reasons including cash repatriation strategies that may explain why it is not neutral for an MNE group to earn its profits in one country or another.

In addition, a number of industries such as the pharmaceutical industry or the financial industry have to deal with strict domestic regulatory requirements and are affected by the valuation of their intra-group transactions. Furthermore, corporate law, rules that protect creditors and labour law may all require, to a lesser or greater extent, that each member of an MNE group be treated as a separate legal entity and, as a consequence, that the terms and pricing of transactions with other parts of the same group be determined independently of the special relationship that exists within the group.

In fact, it is ironic that, with the development of global business models, cross-border transactions between related parties play an increasingly significant role in world trade and economy. While businesses develop operating models that tend to abolish the borders, governments see increasingly important revenue stakes in cross-border flows and tend to reinforce their control over transfer pricing compliance through transfer pricing regulations and audits, with a view to protecting their tax base while avoiding double taxation that would hamper international trade.

A phenomenon
One difficulty arises from the existence of various sets of rules and enforcement agencies looking at the valuation of related party transactions. One obvious example of this phenomenon is found in direct taxes (transfer pricing rules) and customs duties. For direct tax purposes, a higher transfer price may reduce the taxable income in the country of importation and increase the taxable income in the country of export. But for customs purposes, the lower the transfer price, the lower the customs value and the applicable customs duties. Hence, inevitably, there can be some conflicts of interest or contradictions between customs and revenue authorities within the same country, or between the direct tax department and the department in charge of customs duties within the multi-national group. (This, again, irrespective of the possible effects on other aspects such as the price of regulated drugs or the amount to be contributed to employee profit sharing by a particular entity of the group.)

Let’s have a look first at the applicable principles. Direct tax authorities tend to follow the arm’s-length principle and OECD transfer pricing guidelines for multinational enterprises and tax administrations which set the international standard for transfer pricing. Customs authorities apply the relevant provisions of the WTO Customs Valuation Agreement (the WTO Agreement). As a basic principle, both sets of rules require that an ‘arm’s-length’ or ‘fair’ value be set for cross-border transactions between related parties and associated enterprises. That is, the transfer price must not be influenced by the relationship between the parties or it must be set in the same way as if the parties were not related. However, there are significant differences in the application of this broad principle in relation to such major factors as policy objectives, operational functioning, timing of valuation, valuation methods, documentation requirements and dispute resolution mechanisms. Furthermore, it is often the case that two administrative bodies assess or review the valuation of cross-border transactions.

Unnecessarily complicated
The business community has explained on several occasions that the existence of two sets of rules, and, in many countries, of two different administrative bodies to deal with direct taxes and customs duties, can make cross-border trade overly complicated and costly, contrary to the objectives of the international organisations and national governments concerned. Does this situation make sense from theoretical and practical perspectives? Is there a need for greater convergence of the two sets of rules? If so, what should be the conceptual framework at national and international levels?

It is obvious that, while common purposes and similar concepts exist in international transfer pricing and customs valuation rules, there are also significant divergences. Tax and customs authorities are not obliged to accept a value that is calculated in accordance with each other’s legislative requirements. MNEs need to comply with obligations under both tax and customs legislation and regulations as well as other regulatory requirements where applicable.

In May 2006 and 2007, the WCO and the OECD held two joint international conferences on transfer pricing and customs valuation of related party transactions. The common objective of the two organisations was to provide a platform for public and private sector representatives to collectively explore, and attempt to advance, the issues identified and to encourage global coordinated efforts among business and governments, tax experts and customs specialists.

At those conferences, two schools of thought emerged on the desirability and feasibility of having converging standards for transfer pricing and customs valuation systems. The first was made up of those who viewed convergence of rules as highly desirable and largely feasible, pointing out that a credibility question does arise if two arms of the same Ministry can come up with different answers to virtually the same question (what is the arm’s-length / fair value for a transaction?), and that the current situation results in greater compliance costs for businesses which must follow and document two sets of rules and greater enforcement costs for governments which must develop and maintain two types of expertise (i.e. have customs specialists and transfer pricing experts examine the same transactions at different points in time and in light of two different standards). Those who are more cautious about convergence point out that the two systems are grounded in different theoretical principles (direct versus indirect tax systems) and fear that convergence could be more costly than the status quo. Concerns were also raised about the capacity of administrations in developing economies to deal with transfer pricing issues and with possible changes in customs valuation rules or enforcement. In effect, developing economies are often more dependent on customs than on direct tax revenues, and many of them are still experiencing difficulties in the application of the basic provisions of the WTO Agreement.

Looking to the next step
As a follow-up to the joint WCO-OECD conferences, four areas for possible further work were identified:
1) Examination of the interaction between the valuation methods used by customs and revenue authorities.
2) Provision of greater certainty for business, e.g. though the development of joint rulings and of more effective dispute resolution mechanisms covering both direct taxes and customs duties.
3) Achieving greater consistency in the transfer pricing and customs documentation compliance and better flows of information between tax authorities and customs authorities.
4) Improving the administrative capacity of tax and customs departments and reviewing the experience of countries that have merged or demerged their customs, VAT and direct tax departments.

Much remains to be done between direct and indirect taxes; other areas – corporate law and regulatory rules for example – also require that multi-national enterprises continue to pay attention to the valuation of related party transactions. Today’s world is not global in all respects.

The author would like to thank Mr Liu Ping from the World Customs Organisation for his contribution to this article.

This article expresses the views of its author and not necessarily the views of the OECD or of its members.

Sarbanes-Oxley Act and Basel 2 take pace on financial services and IT structures

Posted on May 13, 2008 by

Financial services software is big business. In 2005, European banks’ IT expenditure will total more than €50bn, almost 20 percent of which will go on external software, according to IT research and consulting firm Celent Communications. IT costs in the US securities industry will reach $26bn this year, of which external software accounts for a quarter. And the market is accelerating in expenditure.

And in the world of finance technology, getting a custom-built financial software package is also all the rage. Satellite firms offering advanced functionality and customised solutions on top of existing large-scale systems have always been around. But as companies have focused more and more on increasing efficiency of all systems, improving integration of disparate systems and consequently pulling value out of all business processes, so has interest in these custom solutions grown.

One of the biggest developments in the role of the finance function in recent years is an increasing focus on developing and managing new technology aimed at increasing process efficiency across the financial supply chain. With limited IT budgets, these executives are tasked with the need to show a convincing return-on-investment (ROI), often over a short timescale. But as the technological desires of large-cap companies have grown, so has the gap grown between what big-name system suppliers offer and what those companies are looking for.

That is where the small but specialised solution provider comes in. The financial technology market has seen a huge surge in interest in the offerings of smaller firms that aim to make existing enterprise applications better—not necessarily by changing those systems but through add-ons and custom functionality to turn those enterprise apps into the solutions that finance executives dream of.

Sanjay Srivastava, chief operating officer of specialist IT firm Aceva, says the development of external firms dedicated to providing custom add-ons to major systems is a natural progression. “This has occurred in most other industries, so it makes sense for it to happen in the financial technology market. The breadth of functionality that the big banks and system suppliers are trying to achieve is simply not possible.”

Srivastava says that within the enterprise space most enterprise resource planning (ERP) software began by focusing on the physical supply chain. “The reality is that ERPs have done a good job on the physical supply chain, but when you turn around and look at the financial supply chain, there are large gaps between what users need and what ERPs provide,” he says. Consequently, companies can end up with multiple ERPs managing different functionality across different parts of the organization. This works for the physical supply chain, but for the financial supply chain it does not stand up. Thus, having a custom or at least a highly customizable packaged solution can fill the gaps left by the big names.

This is particularly relevant for large-cap corporations that have active M&A programs. With many new purchases this generally means many new systems that must somehow come together. This can either happen by rolling out head-company systems to subsidiaries, or it can mean developing complicated in-house solutions to get the various systems to speak with each other. Either way it involves a long, highly complicated and generally expensive procedure.

Honeywell hosts most of the major ERP platforms across their various business units, says Sue Sadler, Honeywell’s director of cash management. “With many acquisitions under our belt we naturally had numerous systems across our organisation,” she notes. The biggest problem, she explains, was that the information they needed to make good customer decisions resided in different databases that did not speak to each other. “We knew what was causing difficulties in our invoicing, but we could not fix them without a huge process involving many different system suppliers,” she says.

Honeywell set out to find a solution and discovered that Aceva could provide true customization with all systems. “They could pull together all our systems—shipping, manufacturing, forecasting and so on—into one system and give us all the information in one screen,” Sadler says. “We are able to have a whole information trail as well,” she adds. “We can look up about 150 different things on an invoice and fix it by ourselves before an invoice is generated.”

According to Stephen Blythe, founder of Blytheco, which offers custom add-ons to Best Software’s accounting systems, the size of the organization dictates whether a custom solution is appropriate. Smaller companies tend to want a pre-packaged solution, but the larger the corporate the more likely that they will want some form of customisation. A mid-size company, for example, will likely want a package that out of the box handles 98 percent of the functionality that they are looking for. “But they want this to follow their workflow needs; they do not want to change the business to suit this piece of software,” he says. For a large-cap company the package must mold to the business, he says: “Clearly, after that there will be much customisation that needs to be done to meet their business model.”

Getting that type of customization from the big system suppliers is possible but is generally a colossal task. “Every time we wanted to do something group-wide, it was a huge undertaking, and no one system could talk to everything,” says Sadler. “This is really what drove us to look at Aceva.” By choosing an outside firm that could work across the various systems, it made for a relatively painless implementation, she explains.

Software offers compliance solutions
The financial sector should be familiar with change by now. In addition to coping with general upheaval in the world economy such as globalisation and increased competition, the sector has faced its own specific changes, too. The spread of electronic networks has changed the financial markets fundamentally with the disappearance of most “open outcry” trading. Elsewhere, advances in technology have also created new markets and enabled new ways of operating – at the price of more investment and upheaval.

The swing back to tighter regulation of the international finance sector adds yet more pain. In November, the first impact of the Sarbanes-Oxley Act, which aims to enforce better corporate governance and accountability, will hit the larger US public companies. The act will primarily affect US-based companies and international companies that trade in the US. But it seems likely that other parts of the world will follow the US lead and introduce similar codes of practice. The UK, for example, is known to be reviewing the issue following recommendations of the Higgs Report.

While many of the international companies most affected are financial sector businesses such as international banks and insurance companies, the Sarbanes-Oxley Act is not specific to the financial sector. The Basel 2 accord is, by contrast, specifically aimed at the financial sector and defines a framework for risk management and capital “adequacy”.

It is no surprise that the combination of new regulations and technological change have led some to compare the current scramble for compliance with the run up to year 2000. The rush has inevitably been accompanied by a similar degree of vendor hype: “The drive to comply has not been helped by vendors hyping up the issue. You have good consultants and bad consultants. The bad ones sell their time based on the apparent mess they say they have to deal with,” says Peyman Mestchian, director of risk management practice at SAS Institute, the software developer.

While some organisations might panic and adopt a scatter-gun approach – dealing with each new regulation as it comes into force – the prevailing wisdom is to stand back and look at the regulations as a whole. “The analogy is with enterprise resource planning (ERP) in manufacturing during the 1990s. Projects failed because of the lack of an overall strategy. You really have to put compliance on one side and work out a business case, which includes benefits as well as obligations,” Mr Mestchian says.

This “holistic” approach is supported by the fact that, while the various regulations aim to achieve different ends, there are common areas, especially in the data required. “Most of the smart organisations are looking at the regulations altogether. There are, for example, overlaps in the data required for Sarbanes-Oxley, Basel 2 and the International Accounting Standard (IAS),” says Paul Cartwright, managing partner of risk and regulatory management at consultants Accenture.

Barclays Bank recognised this early on and put in place a formal Integrated Regulatory Programme (IRP) to tackle regulatory issues in one go. Brendon Kirby, Barclays’ programme director, says the bank wanted to take a consistent approach and look for potential gains at the same time.

“We had discussions a few years ago which led us to take a consolidated approach to regulation. You can see regulation as a nuisance – but if you can go the extra step you can get real benefits. I see it as a sort of regulatory aikido where you turn a liability to advantage.”

He adds that the approach has not only justified itself, it has put the bank in a good position to meet its obligations: “The work we have done over the last few years has given us a good feel for Basel 2 and we have realised we are pretty close. I was personally quite surprised because when we looked at the detail we found it was incremental changes and only about 10 per cent of the work we expected.”

More importantly, Barclays sees opportunities to use the data gathered for risk management to drive through improvements in business operations. “In the key area of non-financial risk under Basel 2, for example, we can see ways to leverage the data for other purposes,” says Mr Kirby.

Andrew Barnes, global marketing director at KVS, a data archive specialist, echoes this: “It is not only compliance that needs data. If you are putting in systems to make it easier to get at records for compliance, then you might as well go further and get some benefit.”

Jeffrey Rodek, chief executive of Hyperion, the US business process management (BPM) specialist, also advocates the holistic approach and says the drive to compliance gives companies new ways to improve their performance. “Compliance and external pressures on financial organisations are certainly challenging, but they can all be dealt with. BPM can provide the framework to drive compliance – but it can also bring benefits.”

Rodek says companies should not be satisfied with meeting the minimum requirements of the regulations; they should strive for the best. “The point of the regulations is to restore trust in business and the markets. Companies should not invest only to comply – they should go beyond this and get an insight into their business so they can run it well.”

Jean Louis Bravade, managing director of financial services for Europe, Middle East and Africa at EDS, says the result should be good for the industry.

“By and large, financial organisations are not at the leading edge of industrial-strength systems. The need to comply is forcing them to review their IT infrastructure, their controls and their workflow. The direction that is being set is definitely a good one.”

By the end of 2004, the success or otherwise of large US companies’ efforts to comply with the Sarbanes-Oxley Act will be revealed. The Basel 2 accord is still three years away – but the requirement for historic data means that for many, the work should have already begun.

It looks as if some banks have yet to get this message. A recent survey by PA Consulting Group of the world’s top banks showed that progress towards complying with the accord is mixed.

“While 81 percent have clear objectives, only 39 percent have committed budgets to compliance,” says Eddie Niestat, PA’s head of risk management and capital strategy. “If we have any faith in the timetable for Basel, for some elements it is already too late.”

What customers say
John Dakin, group head of information security, UK investment bank

“Data integration is a continuing challenge. There is frustration that arises from knowing that the data you need is there, but to get it out of different systems is difficult. We have found part of the answer in tools that can capture the data to assess risk, such as Citicus’s early lifecycle tool.”
Chris Crate, group compliance director, UK-based financial services company.

“You can put in the processes and tools to assist people. You can introduce a system to police what they do. But it is the change to the culture that takes the time. Compliance requires a permanent process of education so people know what they are meant to do.”

The new regulations explained
Sarbanes-Oxley Act

Introduced in the US following several high-profile financial scandals, the act aims to improve corporate governance and make directors liable for the data they publish on company performance. Section 409 is especially tough and requires that companies “must disclose information on material changes in the financial condition or operations of the issuer on a rapid and current basis.” Large companies were to comply by November 2004.

Basel 2 accord
An agreement by the international banking community to introduce formal risk management techniques for financial institutions. Companies who opt for the “advanced” model of risk management will be required to keep less capital in reserve to meet their liabilities (capital adequacy) than those who opt for the basic minimum approach. Basel 2 is due to come into force in 2006/7 although regulatory deadlines have traditionally been flexible.

Risk Based Capital Directive (RBCD)
This is the European version of the Basel 2 accord. It incorporates the earlier European Capital Adequacy requirements.

International Accounting Standards (IAS)
These are new regulations defining how companies should report their assets and liabilities which came into force at the end of 2004.

Deloitte, PwC: World Bank and OECD lead way in corporate governance

Posted on May 13, 2008 by

Corporate governance has come to the head of the international agenda. Public and private sector agencies have put the issue centre stage as the importance of corporate governance has been recognised as critical to both business and economic agendas. Intergovernmental organisations have made corporate governance a centre piece of their policy work, beginning with the OECD’s decision in 1998 to develop a set of principles that would set out the essential framework for corporate governance for its 39 member countries in the industrialised world.

As the Asia crisis brought chaos to the developing world just as these principles were being agreed, the World Bank was urged by the G7 to promulgate improved standards throughout the developing world. Corporate governance moved from being an issue of discussion and debate on Wall Street and the City of London, to a national reform priority in markets across the world. The OECD Principles drew upon a report from a Business Sector Advisory Group which brought together leaders from five countries, chaired by Ira Millstein, drawing upon the pioneering work of Sir Adrian Cadbury’s Committee on the Financial Aspects of Corporate Governance in the UK. Their advice to the OECD became the global standard, and now over 70 countries followed the powerful example of Cadbury, and developed their own national codes of best practice amplified by the OECD advice.

Although the reform efforts of the US with Sarbanes-Oxley and the European Commission with its Action Plan, may have caught the headlines, countries as diverse as Brazil, South Africa, China, even Kyrgystan, where the President has sponsored a national corporate governance centre and Rwanda which appointed a Minister for Corporate Governance, have shown that the corporate governance agenda has resonance in every region. The reasons are simple. The international corporate governance movement has grown to fill vacuum. It is a simply a movement which is seeking to ensure accountability for the exercise of power, a notion well understood in the international movements to promote democracy, but just as important in the economic realm as the political.

The corporation, put simply, has never been more important to the economic health and social fabric of the international community. Not only are we dependent upon companies for goods and services, employment, taxes to fund the public purse, with attendant concerns about their role in society on ethical, social and environmental grounds, but also the bulk of their shareholders represent the collective savings of the wider community for retirement, home purchase and welfare. Much of the regulatory debate and effort is focused upon attempting to balance private interest with the public good.

The drivers for this burgeoning interest in corporate governance were the privatisations of the 1980s (over $800bn according to OECD figures), liberalisation of capital markets which led over a decade to global flows from the private sector coming to represent five times the stagnated sums of public lending and investment. Critically, the bulk of the money available for domestic and cross border equity investment has come from the rapid growth in the assets of the public’s savings, channelled to pension funds, insurance and mutuals.

Those who view the long list of corporate scandals and collapses of recent years may feel justified in complaining that the reform agenda in governance has been a rehearsal of the obvious, by the politically correct. But cynicism is premature. There has been real progress over a relatively short period of time, and clearly still some important areas on which progress has barely begun, or where different ideas about solutions still compete. What though are the areas of progress?

The first cannot be underestimated in a global market. We have consensus internationally that convergence should be around function not form – we’re no longer arguing about which system works better. Remember the arguments about the Anglo-American versus its alleged alternative the German-Japanese bank financed, long term relationships model. Now – transparency, accountability are the understood principles. Remember discussions on disclosure – Vienot arguing to OECD this was voyeurism.

Are you ready for non-financial reporting?
Mark Hynes assesses the requirements of non-financial methods of reporting and asks whether UK companies are prepared for them.

Adding “real shareholder value” has long been a key focus for the directors of public companies. It has come to encapsulate all the measures of success, from free cash-flow to non-material assets of the business. Yet non-material assets have traditionally been harder to define, report and measure and have thus not been a substantive part of a company’s overall valuation. But pressure from investors is poised to change this.

Accounting standards such as IFRS have no means of recognising the worth of non-material assets such as experienced employees, customer loyalty, corporate strategy, market growth, product innovation and demographic change. Yet IFRS is what many companies think of as ‘corporate reporting.’

National Australia Bank finance director Michael Ullmer said recently, “I think you’d find around the world at the moment that boards are probably spending more time reviewing regulatory and compliance issues than looking at growing shareholder value.”

Further, many boards of directors and senior management have a difficult time identifying non-material performance measures and monitoring their impact.

A survey conducted on behalf of Deloitte Touche Tohmatsu by the Economist Intelligence Unit in October 2004 supports this. Of 249 board members and top executives polled, only about one third (34 percent) said their companies are proficient at monitoring critical non-financial indicators of corporate performance. Those surveyed blamed this on “the absence of developed tools for analysing non-financial measures, and scepticism that such measures directly impact the bottom line.”

And yet, research shows that regulatory financial reporting alone is failing to meet the needs of investors. For example, in interviews with over 1,800 managers and investment professionals across 16 industries, PricewaterhouseCoopers’ Value Reporting have consistently found that only 25% of the measures cited as critical for understanding a company in a given industry are covered by the regulatory reporting model – 75% lie outside the regulatory reporting framework.

Chief investment officers are increasingly looking for metrics beyond typical financial indicators to provide a more robust view of a company upon which to base their valuations, giving rise to a number of initiatives aimed at addressing this issue. In Europe, the Enhanced Analytics Initiative comes from a group of asset managers and asset owners with assets under management totalling over 380 billion euros, who actively support better sell-side research on “extra-financial” issues.

Putting their money where their mouths are, these fund managers are dedicating brokerage commissions to analysts who produce research on “fundamentals that have the potential to impact on companies’ financial performance or reputation in a material way, yet are generally not part of traditional fundamental analysis.” This has already led to new, fundamental research.

However, creating the research and analysis of the ‘extra-financial’ issues solves only one part of the problem; the format in which it is delivered is crucial. In financial reporting, a new standard, eXtensible Business Reporting Language (XBRL), is expected to change the useability of data. XBRL is a language for the electronic communication of business and financial data.

By providing a computer-readable identifying tag for each individual item of data, XBRL benefits both the preparers and users of financial information. This helps automate the analysis, giving advantages of speed, accuracy and cost savings.

To date, no such reporting framework exists for non-financial information. However, the not-for-profit Enhanced Business Reporting Consortium is taking a lead in creating one. Their aim is to define and build XBRL taxonomies for different sectors, which would allow businesses to report on their non-financial assets, in a way that is easy for investors and stakeholders to use and compare.

And finally, a key piece of the jigsaw is the wide communication of this non-financial information. The information used to value a company, whether material or non-material, is worthless if it doesn’t reach the widest audience possible.

As financial information is fed through the media, such as news agencies, newspapers, radio, TV and the internet, businesses can expect that the news disseminators are there to help ensure that their non-financial information, comparable and measurable in easy-to-use formats, is distributed to the widest possible investor audience.

True transparency in all aspects of corporate reporting is within sight.

For further information on the Investor Relations Society visit www.irs.org.uk
For further information on the Enhanced Business Reporting Consortium please visit www.er360.org

Sarbanes-Oxley reforms ‘go too far’, says author
One of the architects of the controversial US Sarbanes-Oxley legislation admitted yesterday that some of the reforms were “excessive” and could have been introduced more “responsibly”.

Congressman Michael Oxley told a London conference that the legislation “was not a perfect document” because it had been rushed through in the “hothouse atmosphere” following the collapse of WorldCom.

However, he defended the right of federal lawmakers to push through investor-friendly reforms, deflecting accusations made this week that Congress was usurping the role of individual states to draw up corporation laws.

The Sarbanes-Oxley legislation, based on bills introduced by Mr Oxley and Paul Sarbanes in 2002, sought to clean up corporate America following the spectacular financial scandals that engulfed Enron and WorldCom and which cost investors billions of dollars.

Sarbanes-Oxley requirements, such as the need for companies to test their internal financial controls against fraud, have angered members of the US business lobby, who claim it has led to big rises in compliance costs.

Small- and medium-sized corporations are also critical of the legislation because it makes no exemptions for the size of a business.

Oxley told the International Corporate Governance Network annual conference: “After WorldCom happened it was difficult to legislate responsibly in that type of hot-house atmosphere. But I am proud of the bill. Compliance [with it] is an investment in the strength of the US capital markets.”

Speaking to the Financial Times before his speech, Oxley said: “If I had another crack at it, I would have provided a bit more flexibility for small- and medium-sized companies.”

However, Mr Oxley app-eared to quash hopes that smaller companies would gain concessions as a result of the Securities and Exchange Commission considering whether they should abide by a different set of accounting and governance requirements compared with larger ones, to reduce costs. He said: “Congress will not re-visit this issue. The SEC reform [on smaller companies] is not going to happen either.”

IBM, Procter & Gamble, Omron, CEMEX, Cisco become transforming giants

Posted on May 13, 2008 by

Yet talk to the leaders of some of the world’s biggest companies today, and they’re claiming new abilities to shift organisational gears on a global basis and produce meaningful innovations quickly.

To discover the truth behind these claims, I assembled a research team and ventured deep inside a dozen such giants. After two years of visiting their operations, I am convinced that the transformation these leaders describe is real. Companies such as IBM, Procter & Gamble, Omron, CEMEX, Cisco and Banco Real are moving as rapidly and creatively as much smaller enterprises, even while taking on social and environmental challenges of a scale only large entities could attempt.

A decisive shift is occurring in what might be called the guidance systems of these global giants. Employees once acted mainly according to rules and decisions handed down to them, but they now draw heavily on their shared understanding of mission and on a set of tools available everywhere at once. Authority is still exercised and activities are still coordinated – but thanks to common platforms, standardised processes and, above all, widely shared values and standards, coherence now arises more spontaneously.

In this article I will set forth the pillars of this new model of big business.

Shared values, principles and platforms
Large corporations must respond quickly and creatively to opportunities wherever they arise and yet have those dispersed activities add up to a unified purpose and accomplishment. Companies that meet this challenge rely in part on clear standards and disciplines.

Consider the “CEMEX Way.” Around 2000, the Mexico-headquartered global cement company CEMEX launched this companywide program to identify best practices and standardise business processes globally. The point was to foster sameness in areas where sameness would make life easier.

In every one of the company’s plants, for example, pipes carrying natural gas were painted one color and pipes containing air were painted another color. This made it simple for transferring employees or visiting managers not to waste time figuring out the setup.

Providing a platform on which creative people can build is only half the battle. What’s also required is a shared set of values to guide their choices and actions. Once people agree on what they respect and aspire to, they can make decisions independently and not work at cross-purposes.

At IBM, three simple sentences about customers, world-improving innovation, respect and responsibility were repeated everywhere we visited. Those values were credited with clarifying decisions and cutting through internal politics.

Getting close at a distance
The payoff for companies that have embedded values and principles in their guidance systems comes in many forms. The first benefit is integration, which permits collaboration among diverse people.

Innovations do not simply emanate from the home country and radiate outward. They emanate from many places. Know-how is transferred to and from emerging and developed countries through a web of global connections.

Sometimes companies achieve collaboration by bringing people from diverse backgrounds together physically. CEMEX is especially adept at getting people to the problem and gaining speed in the process — for example, seconding large numbers of experienced people to newly acquired operations to work on post-merger integration teams for periods of a few months to a few years. This encourages every manager to train replacements and ensures deep bench strength.

Empowerment in the field
Common values and standards also allow people at the front lines to make consistent decisions, even in culturally and geographically disparate locations. Expressing values and standards in universal terms is not meant to inhibit differences. In fact, it helps people see how to meet particular customers’ and communities’ needs by adding localisation to globalisation.

At P&G Brazil, leaders called this “tropicalising.” As a marketing executive told us: “The values and principles don’t change, but we respect the local trade, the local consumer, the local organisation.”

Innovating in markets
People are even more inclined to be creative when their company’s values stress innovation that helps the world. Banco Real, the Brazilian arm of a European bank, discovered this when it put social and environmental responsibility at the core of its search for differentiation.

The result was a spate of new financial products, including consumer loans for green projects (such as converting autos or houses), microfinance for poor communities and the first carbon credit trading in the region. By 2007, it had more than doubled its profitability and grown in size to become the third-largest bank in Brazil.

A stronger basis for partnering
Companies that have established strong guidance systems find themselves more effective in selecting and working with external partners – increasingly a necessity for competitive success.

Omron’s principles, for instance, form the basis for choosing partners and gaining trust. The knowledge that partners would share Omron’s values and standards helped the Japanese company’s research and development transform what one manager called a “not-invented-here, ivory tower” research approach into collaborative information sharing with partners.

Fire in the belly
Values and standards offer people a basis for engagement with their work, a sense of membership and an anchor of stability in the midst of constant change.

Values arouse aspirations to increase the company’s positive impact on the world, and that is worth more to many people than increases in compensation, as a manager in India pointed out to me. This, he believed, was why his rapidly growing unit could attract the best talent without offering the highest pay scales.

How the fabric is woven
The key to success with the new model may seem counterintuitive to leaders operating under the old paradigm. More than anything else, we heard in our interviews about a loosening of organisational structures in favor of fluid boundaries and flexible deployment of people. Managers and professionals generally appeared less concerned with where they worked and to whom they reported than with what projects they were able to join or initiate.

Many of these companies have a tradition of making mobility a part of career development, which ensures a degree of international mixing as well as the carrying of expertise from one place to another. Working with extended networks of partners across inter- and extra-company boundaries requires large numbers of people to serve as connectors among activities – not as bosses but as brokers, network builders and facilitators.

One last element that seems central to the success of the global giants we studied is that they have explicitly added mutual respect and inclusion to the values they live by. Diversity programs are valued because they help people form relationships more quickly and overcome tensions between groups.

A giant change
The new model yields a way of doing business that is more localised and humane. The interplay of corporate standards and local conditions puts companies in a position to influence the ecosystem around them and to generate innovation. If these vanguard companies lead others to adopt their way of working, not only will that be good for business, it will also be good for the world.

One company’s return on values
Imagine a developing country where workers like their beer and like it cheap – to the extent that alcohol use has become a serious public health problem. Now imagine you are the country manager there for a multinational corporation that profits by selling alcoholic beverages. Your goal is to gain more market share. Is this anywhere for values to hold sway?

Here’s how the story played out in Kenya. UK-headquartered Diageo, the world’s leading producer of premium alcoholic beverages, had entered the market with a large investment in East African Breweries but couldn’t match the low price of its competition. That was because the competition was home brew, subject to no standards or inspections and sold out of garages.

Illicit beer was downright dangerous in a country where water supplies are often contaminated – it was known to cause blindness as well as the intense hangovers and related illnesses that routinely lowered productivity in Kenya’s labour-intensive industries. But it was popular because, with no government taxes added to its price, it offered the most sips for the shilling.

Diageo had the benefit of local talent with global thinking who could recognise the opportunity in the situation and seize it. (Over the years, the company encouraged members of the internationally educated African diaspora to return to Africa at expatriate pay rates.) Using Diageo’s global resources, including a Web-based innovation tool, the local team attacked the problem. Importantly, it put the focus on the best outcome for society and was therefore able to open lines of communication with the national government.

The company proposed producing a low-cost beer and making it widely available, giving the buyers of illicit beer an alternative they would consider reasonable. The safer product would succeed, however, only if the government agreed to reduce the surtax on it, so the price would be truly comparable. The government, of course, had no interest in corporate charity, but it became clear that if more people bought legal beer, taxes would be collected on a greater proportion of the alcohol being consumed. A tax cut, therefore, was likely to yield higher tax revenue overall.

Distribution channel
To make the new beer, now called Senator, widely available, Diageo needed to develop a new distribution channel: responsibly managed licensed pubs. The team talked to community leaders throughout Kenya to identify influential solid citizens, such as shopkeepers and sports club owners, who could set these pubs up. Diageo provided equipment and trained them in business operations, eventually establishing 3,000 new outlets.

The launch of Senator beer saw success on many fronts. Beyond the high market share it immediately claimed, Diageo received a prestigious award for contributing to reduced rates of blindness and increases in workplace productivity. Meanwhile, thousands of new small businesses flourished, and government policies started to change. The work was gratifying to Diageo managers both locally and internationally.

At the time of Diageo’s formation in 1997 (by the merger of Guinness and Grand Metropolitan), its leaders had articulated the company’s values and operating principles to emphasise both high global standards and local community responsibility. With that kind of guidance system in place, local decision makers – even in a ‘sin industry’- can have a transformative positive social impact.

Having it both ways
When do you know a paradigm is shifting? When long-standing contradictions begin to resolve. In the giants my research team and I studied, I was struck by the number of areas in which they achieved a balance between seemingly opposing goals.

– They both globalise and localise, deriving benefits from the intersections.
– They both standardise and innovate, endeavoring to prevent consistency from becoming stifling conformity.
– They foster a common universal culture but also respect for individual differences, seeking inclusion and diversity.
– They maintain control by letting go of it, trusting people educated in the shared values to do the right thing.
– They have a strong identity but also a strong reliance on partners, whom they collaborate with but do not control.
– They produce both business value and societal value.
– They bring together the “soft” areas (people, culture and community responsibility) and the “hard” areas (technology and product innovation).
– They do not abandon values in a crisis; in fact, as leaders put them to the test, crises serve to strengthen commitment to values.

Rosabeth Moss Kanter, a professor of business administration at Harvard Business School and author of ‘America the Principled.’ She was also the editor of Harvard Business Review from 1989 to 1992

Wall Street and SEC must work for future, suggests Bloomberg

Posted on May 13, 2008 by

Is the writing on the wall for Wall Street? It could be, according to a gloomy warning from US Senator Charles Schumer and New York City Mayor Michael Bloomberg. The two published a worrying report in January saying that New York could lose its status as a global financial market without a major shift in public policy. The report, commissioned from consultant McKinsey, says New York’s financial markets have been stifled by stringent regulations and high litigation risks and are in danger of losing businesses and high-skilled workers to overseas competitors. New York could sink to the lowly status of a ‘regional market,’ which would have wide-reaching implications, both for the city and the US economy, it said. “If New York goes from being the financial capital of the world to becoming only a regional market, as this report predicts will happen within the next 10 years, every aspect of New York life will suffer, not just financial services,” Mr Schumer said at a press conference to release the report; Sustaining New York’s and the US’s Global Financial Services Leadership. Speaking with typical New Yorker bravado, Mr Bloomberg told the same audience that excellence in financial services had made the city “the world’s capital,” but that title could soon be up for grabs.

Economic dominance
“The 20th century was the American century in no small part because of our economic dominance in the financial services industry, which has always been centred in New York,” he writes in the introduction to the report. “Today, Wall Street is booming, and our nation’s short term economic outlook is strong. But to maintain our success over the long run, we must address a real and growing concern: in today’s ultra-competitive global marketplace, more and more nations are challenging our position as the world’s financial capital.” While London has traditionally been the city’s chief competitor, “Today, in addition to London, we’re increasingly competing with cities like Dubai, Hong Kong, and Tokyo.” And this isn’t just an issue for New York. Financial services drive eight percent of US gross domestic product, and create more than five percent of all jobs nationwide. Seven states, including New York, have more than 10 percent of their state’s GDP derived from financial services. McKinsey argued that, left unchecked, certain key trends could knock a big dent in the US economy. The country could miss out on between $15bn and $30bn in financial services revenues annually by 2011. Those revenues, if retained, could translate into as many as 30,000 to 60,000 jobs in the US, said the consultants.

Financial markets
So what are these trends that are doing so much damage? Much of the pressure on New York is due to improved financial markets abroad, and the fact that sophisticated technology has virtually eliminated barriers to the flow of capital. Physical location is simply less important than it used to be. But a significant number of the causes for the city’s declining competitiveness are self-imposed. For instance, US-based financial services firms are now unable to attract and retain many of the highly skilled professionals they need because of caps on the number of visas available under US immigration rules, the report said. And a greater perceived litigation risk has reduced the appeal of the US market to many foreign firms. Ironically, at the press launch of the report Mr Bloomberg and Mr Schumer shared a platform with state Governor Eliot Spitzer who, in his previous role of State Attorney General, vigorously prosecuted Wall Street wrongdoing and probably did more than anyone to create a climate of fear. On top of all that, a complex and sometimes unresponsive regulatory framework has not only prompted many foreign firms to stay out of the US markets, but also is forcing more business overseas because of the complexity and cost of doing business in US financial markets, regardless of where they are located.

The findings of the report break down into three main areas. First, the US regulatory framework is a thicket of complicated rules, rather than a streamlined set of commonly understood principles, as is the case in the UK and elsewhere. The flawed implementation of the 2002 Sarbanes-Oxley Act (Sox), which produced far heavier costs than expected, has only aggravated the situation, as has the continued requirement that foreign companies conform to US accounting standards rather than the widely accepted – many would say superior – international standards. “The time has come not only to reexamine implementation of Sox, but also to undertake broader reforms, using a principles based approach to eliminate duplication and inefficiencies in our regulatory system,” Mr Bloomberg writes. Second, the legal environments in other nations, including the UK, far more effectively discourage frivolous litigation. “While nobody should attempt to discourage suits with merit, the prevalence of meritless securities lawsuits and settlements in the US has driven up the apparent and actual cost of business – and driven away potential investors,” says Mr Bloomberg.

Overblown reputation
“In addition, the highly complex and fragmented nature of our legal system has led to a perception that penalties are arbitrary and unfair, a reputation that may be overblown, but nonetheless diminishes our attractiveness to international companies.” The proposed answer is legal reforms to reduce spurious and meritless litigation and eliminate the perception of arbitrary justice, without eliminating meritorious actions. Third, and finally, a highly skilled workforce is essential for the US to remain dominant in financial services. “Although New York is superior in terms of availability of talent, we are at risk of falling behind in attracting qualified American and foreign workers,” says Mr Bloomberg. “While we undertake education reforms to address the fact that fewer American students are graduating with the deep quantitative skills necessary to drive innovation in financial services, we must also address US immigration restrictions, which are shutting out highly-skilled workers who are ready to work but increasingly find other markets more inviting. The European Union’s free movement of people, for instance, is attracting more and more talented people to their financial centres, particularly London.”

Competitiveness
The report sets out an action programme to rescue New York’s future. The measures it calls for include short-term administrative actions that can signal renewed focus on competitiveness, actions to level the playing field for both domestic and foreign companies doing business in the US, and longer-term initiatives to address more complex policy, legal, regulatory and other structural issues affecting the US position as the world’s leading financial centre. Action number one on the list (see sidebar on next page) is a move to make compliance with Sarbanes-Oxley easier. No doubt the New York burghers were cheered by the fact that they got much of what they wanted on this score before the ink had even dried on their report. Just before Christmas US regulators proposed to alter the basis on which the notoriously onerous provisions of Sox operate. The Securities and Exchange Commission (SEC), the US financial regulator, and the US audit standard setter the Public Company Accounting Oversight Board (PCAOB) each published proposals aimed at making life easier for those companies that have to comply with the act, which affects US listed companies and their affiliates. The SEC said its proposals would encourage more of a risk-based approach to compliance with section 404 of the Act, by setting out the principles it expects companies to follow, rather than strict rules.

Section 404 requires companies to evaluate the company’s internal controls over financial reporting. It has been a major bugbear for companies, and has massively increased their compliance workload. SEC chairman Christopher Cox suggested companies had turned to PCAOB’s guidance on interpreting the requirements about internal control in the act in the absence of any clear guidance from the SEC, which, he said, “was not what was intended.” With the proposed new guidance and the new auditing standard from PCAOB “management will be able to scale and tailor their evaluation procedures to fit their facts and circumstances,” he said. The SEC says the guidance will address the main concerns companies have raised about section 404. These include excessive testing of controls and excessive documentation of processes, controls, and testing. The new guidance – still only in a proposed form – is organised around two principles. First, management should evaluate the design of the controls that it has implemented to determine whether there is a reasonable possibility that a material misstatement in the financial statements would not be prevented or detected in a timely manner. This change will allow management to focus on controls needed to prevent or detect material misstatements, rather than all the financial reporting controls.

Associated risk
Second, management should gather and analyse evidence about the operation of the controls being evaluated based on its assessment of the risk associated with those controls. This will allow management to align the nature and extent of its evaluation procedures with those areas of financial reporting that pose the greatest risks to reliable financial reporting. The guidance goes on to address four specific areas: how to identify the risks to reliable financial reporting and the related controls that management has implemented to address those risks; how to evaluate the operating effectiveness of controls; how to report the overall results of management’s evaluation; and how to document controls.

Assessment procedures
“The proposed interpretive guidance should reduce uncertainty about what constitutes a reasonable approach to management’s evaluation while maintaining flexibility for companies that have already developed their own assessment procedures,” said John White, director of the SEC’s division of corporation finance. “Companies will be able to continue using their existing procedures if they choose, provided of course that those meet the standards of Section 404 and our rules.” In a coordinated move, the PCAOB published several proposals including a new principles-based standard to replace Auditing Standard Number Two.

The standard-setter said the proposed new standard on internal control is a principles based standard designed to focus the auditor on the most important matters, increasing the likelihood that material weaknesses will be found before they cause material misstatement of the financial statements. The proposed standard also eliminates audit requirements that are unnecessary to achieve the intended benefits, provides direction on how to scale the audit for a smaller and less complex company, and simplifies and significantly shortens the text of the standard. Another proposed standard focuses on the grounds on which external auditors can use the work performed by internal auditors, management and others in an integrated audit of financial statements and internal control, or in an audit of financial statements only. This proposed standard is intended to further clarify how and to what extent the external auditor can use such work to reduce the amount of work they have to do.

Those changes, if they are introduced, will be a big help in the short term. But Mr Bloomberg emphasised policymakers must avoid complacency about New York’s long-term future. “Our capital markets and financial services firms will only enjoy continuing growth – growth that our city expects, needs and demands – if we take seriously the challenges from rapidly-expanding competitors in Europe and Asia,” he said. If the first step it to acknowledge the extent of the problem, Mr Bloomberg has certainly achieved that.

EU and US question IMF guidelines on sovereign wealth funds

Posted on May 13, 2008 by

Wall Street tends not to be too choosy about where it gets its money. Normally, one investor’s dollar is as good as any others. But lately, that’s not been the case. With their balance sheets squeezed by the global credit crunch, many US banks and financial firms have opened their arms to so-called “sovereign wealth funds” –investment vehicles controlled by foreign governments. The move has got some people very worried.

The US Senate recently ordered the Government Accountability Office (GAO) – a financial watchdog – to investigate the activities of sovereign wealth funds, after a string of investments topping $35bn in blue chip firms such as UBS, Bear Stearns, Morgan Stanley, Merrill Lynch and Citigroup.

The concern is that funds owned by foreign governments might use their financial clout to somehow exert improper influence. According to a recent Morgan Stanley study, such funds represent some $2,300bn in assets and could reach $12,000bn by 2015. These funds are mainly held by oil exporting countries, such as Norway, Alaska, Russia, Dubai and Qatar, which have seen a large growth in trade surpluses because of rising energy prices. It’s not likely that Norway’s intentions are going to worry anyone, but most of the sovereign wealth funds are run by governments in Asia and the Middle East. Their recent deals with the Wall Street institutions represented their first significant investments in key American companies.

Investment funds
It’s not just the US Senate that is worried about the influence of sovereign funds. The recent growth of these special state-owned investment funds have caused disquiet among many governments, which fear political influence by other states on strategic sectors, such as energy and defence.

The GAO, according to press reports, is trying to find out how much money these opaque funds control, where it has been invested and how the investments have been treated. It is also examining what information the funds are required to disclose on their investments and what action can be taken to discipline them if they misuse their power. David Walker, head of the GAO, told journalists that sovereign wealth funds did not initially cause too much of a stir in Washington, “But as the number of these kind of transactions rises Congress is becoming interested.”

That follows comments last year from Clay Lowery, the acting under-secretary for international affairs at the US Treasury, who said the spread of sovereign wealth funds could create new risks for the international financial system and spur hostility to cross-border capital flows. Lowery called on the International Monetary Fund (IMF) and the World Bank to develop a set of best-practice guidelines for such funds. He said there was a danger that imprudent risk management by sovereign wealth funds could affect financial market stability.

“Little is known about their investment policies, so that minor comment or rumours will increasingly cause volatility,” he said, adding that such funds “are typically not regulated by their domestic regulators, and the extent of indirect regulation may also be limited.”

Lowery also warned that, over the medium term, the size, investment policies and operating methods of these funds could fuel financial protectionism. “There will likely be much public attention to whether sovereign wealth funds exercise the voting rights of their equity shares and, if so, how,” he said. Lowery warned of the danger that, in the absence of good checks and balances, these funds could invite corruption. He cautioned that funds could become “self-perpetuating” interest groups and urged countries to tackle the causes of reserve accumulation, including undervalued currency regimes.

Market efficiency
Other US agencies have voiced concerns, too. The rise of sovereign wealth funds raises questions of “particular significance” for US financial regulator the Securities and Exchange Commission (SEC), including concerns about enforcement, transparency and market efficiency, the chairman of the agency said recently. Christopher Cox said the issue of conflicts of interest arise when the government is both the regulator and the regulated. “Rules that might be rigorously applied to private sector competitors will not necessarily be applied in the same way to the sovereign who makes the rules,” said Cox.

Cox highlighted enforcement as one issue and said that if foreign private issuers are suspected of violating US securities laws, the agency almost always expects the full support from the foreign government and regulatory counterpart in the investigation. “If the same government from whom we sought assistance was also the controlling person behind the entity under investigation, a considerable conflict of interest would arise,” he said.

Cox raised questions over whether government-controlled companies and funds would use business resources in the pursuit of other government interests. He also highlighted transparency as an issue for the investor protection agency and said in many industrial countries the ability of citizens to inquire into government affairs, or to criticise the conduct of government, is severely limited. “In some countries, criticism of government policies lands you in jail, or worse. Is it reasonable to expect that these same governments will be magically forthcoming with investors?” Cox said. “This raises significant questions for regulators such as the SEC, whose mission includes investor protection.”

Majority stake
It’s not just the Americans who are worried. In Australia, a government study has also called for the IMF to impose standards that would stop investment funds owned by sovereign governments from buying a majority or controlling stake in foreign corporations.

“Attempts by foreign interests to purchase controlling stakes in strategic industries or iconic domestic companies can sometimes cause broadly based domestic concerns,” the study from the Australian Treasury says. “Resistance can be even stronger if the purchaser is an overseas government, and can raise suspicions over whether the purchase is … for strategic or other non-commercial reasons.” The study says the biggest problem is that the funds are highly secretive about their investment practices, which raises concern about their motivation. Most provide no public reporting.

The European Union, however, is taking a more benign view of the emergence of sovereign funds, and trying to develop a common approach to tackle its concerns about their activities in Europe.

“There are good reasons for an EU common approach,” Commission President José Manuel Barroso said recently. However, the Commission is seeking to avoid legislative action and envisages soft measures, such as “ground rules or guidelines”, accompanied by efforts to increase transparency on sovereign fund activity. The Commission underlined that it seeks to “avoid all forms of protectionism.”

The Commission’s stance was reaffirmed in a recent speech by Internal Market Commissioner Charlie McCreevy. He pointed out that sovereign wealth funds have been around for decades. The Kuwait Investment Authority has been in existence since 1953 and the Abu Dhabi Investment Authority, one of the biggest with almost €600bn in assets, was set up in 1976. Temasek from Singapore dates from 1974. People have expressed concerns about these funds in the past, he said. “I am old enough to remember the concerns when oil rich Middle-Easterners were buying up prestigious companies and landmark London properties. As time went by and oil reserves tapered off, so did the fuss.”

The public consciousness
McCreevy said such fears have come back thanks to the growth in sovereign funds as a result of rising energy prices and large trade surpluses. “Their size and wider geographical disparity have impinged on the consciousness of policy makers and the wider public.”

What should be done about their growth? “One thing is clear to me: Europe must remain an attractive place for investment,” said McCreevy. “Without continued inward investment our economies will stagnate. We have no interest in erecting barriers to investment.” While they might be unpopular in some quarters, “I suspect in the time ahead we will see many more enterprises seeking investments from such funds,” he added. “Cutting off access to these important sources of liquidity would be like cutting off our noses to spite our faces.”

However, there were aspects of sovereign funds that need to be addressed, he said. “Who controls them? What is their investment strategy? These are legitimate questions? There are also concerns about restrictions on inward investments that EU firms may want to make in the countries concerned.”

“But in raising these issues we must avoid them being used to foment protectionist sentiments. I would not like to see the rise of sovereign wealth funds, which are the by-products of increasing globalisation and benefits of international trade, being used as an argument against the entry of emerging markets investors into the First World corporate sector.”

McCreevy suggested two ways in which the debate should move forward. “Firstly, we need to explain to our citizens that investments which have the potential to compromise national security can be blocked,” he said. “It is often forgotten that a member state is entitled to restrict Treaty freedoms on the basis of legitimate national security concerns. This is true in respect of all investments, be they from sovereign wealth funds, state-controlled companies, private companies or whoever.” A number of EU members have measures in place to restrict investments in the defence sector, the Commission recently proposed controls on investment in the energy sector, and there is already a requirement on investors in European financial institutions to be “fit and proper”.

Secondly, McCreevy said sovereign wealth funds should be transparent in their operations, preferably on the basis of an international code of best practice. “We are working in international organisations and bilaterally, together with our US colleagues, to bring this about,” he said.

Sovereign funds
The IMF is working on a set of guidelines. Last year its chief economist, Simon Johnson, said the organisation was growing increasingly uneasy over the role of sovereign funds. Concerns focused on the lack of disclosure about their activities and the amount of leverage that funds might employ.

“There are an increasing amount of financial flows going through black boxes. Hedge funds are black boxes. Sovereign wealth funds are black boxes. We don’t know what happens and we should worry about that,” he said. “Black boxes should make us uneasy . . . People are beginning to feel uncomfortable about this.” Johnson added that the IMF’s efforts to understand the potential financial risks from sovereign funds remained at a “pretty early stage”.

In the meantime, what do the countries behind these funds make of all the concern? Writing in China Business News recently, Wei Benhua, deputy head of China’s State Administration of Foreign Exchange, said the developed world should not discriminate against funds from developing countries or subject them to “financial protectionism”. Wei characterised such worries as baseless: “The China Investment Corp drew the attention of international society as soon as it was established, with certain countries intentionally disseminating the view of Chinese investment as a threat,” he wrote.

Sovereign wealth funds would benefit international markets by increasing liquidity and by making global resource allocation more efficient, said Wei. “There should be no discrimination in the treatment of sovereign wealth funds; the funds of developing and developed countries should be treated the same way. International society should clearly oppose investment protectionism and financial protectionism in any form.” As the IMF develops its guidelines, China would get actively involved in discussions, he added. There will be many companies in the developed world – Wall Street Banks especially – that will hope these powerful new funds are not dissuaded from investing: in the current climate especially, they need the money.

WEF tackles global risk and raises doubts over Kyoto

Posted on May 13, 2008June 20, 2013 by Ashton Wenborn

What are the big issues that risk managers worry about, and are the world’s leading organisations capable of dealing with them? A new study provides some useful answers to the first question, but raises worrying doubts about the second. According to a study by the Federation of European Risk Management Associations, top of the list of concerns for the leading risk managers working in Europe are a breakdown of critical information infrastructure, crime and corruption, terrorism, and catastrophic flood. FERMA asked its members to pick the most worrying items from a list published by the World Economic Forum (WEF) in its recent Global Risks Report. The WEF highlighted what it called “a growing disconnect between the power of global risks to cause major systemic disruption, and our ability to mitigate them.”

It gave a list of 23 core global risks and said they had worsened over the preceding 12 months, despite growing awareness of their potential impacts. FERMA members said the second most important group of core risks includes energy price and supply shocks, catastrophic windstorm and earthquake, and pandemics. A third group of risks, named in less than half the responses, covers climate change, war, loss of freshwater services and nanotechnology.

It may be surprising that only 17 of the responses said climate change is a significant risk for their organisation, but Franck Baron, a FERMA official, explains: “It is not that risk managers are not concerned about climate change, but we do not yet know how it will affect individual companies operationally, and this is the province of the risk manager.”

He also points out, as does the WEF report, that many of these risks are inter-dependent. “This is why we need a holistic approach to risk management to create sustainability for the business. We need to identify and manage not just individual risks but the way they interact.”

That is a view endorsed by Jesse Fahnstock, global leadership fellow for the WEF global risks programme. “The survey really shows how the relationship between global risks and corporate risk management is evolving,” he says. “Risk managers are clearly looking hard at the interconnected, non-business issues that define the global risk landscape. But translating the understanding of these issues into the world of operational, financial and regulatory risk management remains a big challenge. Priority is still being given to well understood, insurable risks, but managing exposure to complex, currently uninsurable global risks will be a key competitive advantage in the coming years.”

Specific industries
Some of the risks mentioned reflect specific industry worries. In relation to freshwater services and nanotechnology, for example, it is possible to see concern from specific industries, such as a UK company that owns paper mills and a multinational food and drink company for whom continuity of supply of fresh water is important. But overall the survey is a useful indicator, as it included responses from a mix of multinational corporations, businesses operating only within the European Union, and national companies.

Asked what the most significant risks are now and in the next five years, respondents most frequently mentioned supply chain and business interruption risks. Other important ones were regulation and compliance, political risks, availability of a choice of insurers and capacity, a shortage of people skills, and age discrimination.

Restrictions on carbon dioxide emissions and more extremes of weather were the most commonly mentioned corporate concerns in response to a changing climate. One risk manager who said climate change was now a concern represented a multinational company in the infrastructure, environment and energy sectors. He said that the company was doing an inventory of its CO2 emissions and had created a position for a company specialist to keep management updated continuously about the consequences in general and for the business. The survey gathered similar views from other managers. The risk manager for a multinational food and drink group commented, “climate change does not affect us now, but we are monitoring effects.” His company’s concern is that higher temperatures could create pressures on water resources and lead to civil conflicts.

An airport and shopping mall operator said government action on CO2 emissions might lead to decreased demand from passengers and airlines for airport services. A multinational retail company risk manager said climate change was not having an impact on its business yet, but it could foresee pressures from restrictions on CO2 emissions from transport, water and energy consumption and the associated price changes.

More severe and less predictable weather is another possible consequence of global warming, which comes up in the responses of two risk managers from multinational companies in the construction sector. “We see much more frequent extreme weather phenomena, such as heavy snow in one of our Chinese plants where there had been no snow for more than 50 years. This has important consequences for construction planning,” said one manager.

An airport operator and a logistics and stevedoring company both mentioned the risk of more severe weather conditions. The airport operator said it might lead to more flight cancellations and an increase in the number of interruptions to the revenue stream, albeit short-term. “But that’s an industry-wide risk that cannot be diversified away,” he commented. The logistics company said more frequent and severe windstorms could increase property losses.

Greater extremes
A Russian risk professional says a warmer climate could reduce demand for the oil and gas industry in his country, and much of the country’s economy depends on the sector. He believes that greater extremes of weather and more variability will increase demands on risk management. A multinational energy company is concerned about possible increased volatility in supply and demand for power “since electricity cannot be stored,” while a company that produces energy from renewable and natural sources is also concerned about future demand.

According to a Polish risk manager, there will be contractual risks for travel companies that depend on a cold climate in winter, such as those offering skiing holidays. The risk manager of a UK company whose business includes paper mills said climate change could affect the water supply it needs, while a food and drink company said demand for drinks might be affected.

What would help organisations to tackle their big risks? The WEF called for two changes that would improve global risk management efforts: the appointment of Country Risk Officers and the creation of flexible “coalitions of the willing” around specific global risk issues, which it said would provide crucial momentum to mitigation efforts.

The first of these changes would provide a focal point in government for mitigating global risks across departments, learning from private-sector approaches and escaping a “silo-based” approach where risks are dealt with in isolation, it said. The second would allow efforts to tackle risks to “emerge from dynamic interplay between governments and business, achieving a balance between inclusiveness and decisiveness.”

The large majority of respondents to the FERMA survey thought the appointment of country risk officers was a good idea. But some were sceptical and several questioned how practical it would be. “Very impractical,” was the response from a Polish risk manager. “It’s going to be driven by politics and politicians. It should be practical. That’s why it’s not going to happen,” was a Swiss response.

Another FERMA member pointed out it would depend on governments’ ability to use collected information, while an Italian risk manager commented, “I think the state system is not ready today to make a correct risk assessment.” One Swiss risk manager says the approach should be less parochial. “They should rather look at the global perspective and start a coordinated international effort on risk mitigation in respect of the mega trends and risks, such as global warming, aging society, water shortage and distribution, as well as alternative energy resources.”

Managing public risks
Another Swiss risk manager says he would like to see the government creating a clear definition of competences, structures, organisation and resource allocation ahead of a crisis situation like earthquake, terrorism, pandemic or civil commotion. A similar view came from a risk manager based in Portugal. The government should pay more attention to managing public risks like pandemics, natural catastrophe, terrorism and crime and corruption, he said.

Several responses asked governments to give clearer and stricter requirements for risk management in listed companies, and suggested that some regulations for unlisted companies could also be considered. A Swiss risk manager said that the risk reporting requirements of corporate governance frameworks such as Germany’s Kontrag did not exist in many countries. From Bulgaria, came the comment that it would be good if essential risk management standards were adopted and widely publicised, and a Russian risk professional said he would like to see the government build up national standards of risk management.

“It would be very practical to map risks,” said a UK risk manager. “It could be useful in managing the population’s perception of risk. It should educate the population to understand risks and take responsibility to manage them, instead of the state making legislation.”

Above all, there is a need to take a more comprehensive view of global risks. “Risks are often still viewed and dealt with in isolation. However, in today’s world global risks are tightly interwoven,” says Jacques Aigrain, Chief Executive Officer of insurer Swiss Re. “To address our contemporary risk landscape, governments and enterprises need to take a holistic approach to overcome silo-thinking and acting. We need to prioritise risks effectively, improve preparation and strengthen public-private partnerships to mitigate risks and to finance economic losses.”

In part, that means being more proactive. “There is continued evidence of a disconnection between risk and mitigation,” says Mike Cherkasky, President and Chief Executive Officer of Marsh & McLennan Companies, the insurance and risk group. “The focus of government and corporations must not only be on reacting to events, but on utilising effective enterprise risk management to set priorities, increase business focus, allocate resources and maximise efficiency.”

“Catastrophic natural disasters in recent years have demonstrated that our ability to confront emerging risks depends more on the choices we make before a disruption, than the actions we take during a crisis,” he adds. “Only a systematic planning approach will ensure that countries and companies are prepared for the risk environment we presently face.”

Tackling global risks
The World Economic Forum says four big changes would help to address global risks:
– Linking energy security with considerations on climate change;
– Urgently beginning work on a successor to the Kyoto agreement on climate change, which needs to include the US, China and India;
– Renewing terrorism insurance schemes that are due to expire this year; and
– Checking supply chains are resilient against a pandemic illness, such as Avian Flu.

Ernst & Young celebrate Switzerland’s attraction

Posted on May 13, 2008 by

Twelve months ago, when American multinational Kraft announced it had taken a long-term lease on new corporate headquarters in Zurich, the business sector presumed the move was driven solely by the fiscal prudence of low tax rates. The US firm, which owns a portfolio of famous brands, such as Philadelphia cream cheese, Kenco coffee and Terry’s Chocolate Orange, was following in the footsteps of Procter & Gamble and Colgate-Palmolive, which have all shifted their European headquarters to Switzerland.

The Alpine country’s attractive tax regime was one reason. But there were others, including lifestyle, quality and cost of accommodation, and excellent public transport.

In a statement at the time Kraft said that the company had conducted a survey of different headquarter locations and Zurich came top. The statement cited the ease of getting about: good transport to the airport, good rail links. “We have a lot of expatriate staff so availability of schools and good quality accommodation are important.” Biogen Idec, a US pharmaceutical company, last year decamped from Paris to Zug, a canton which boasts a corporate tax rate of nil.

In the more cosmopolitan Zurich, the normal range of corporation tax is between 15 percent and 24 percent but foreign holding companies using Zurich as an administrative base are exempt from tax on their non-Swiss earnings.

A recent World Bank survey bolstered the view that Switzerland is highly rated for its favourable rates and ease of paying taxes. And research released in July 2007 also appeared to confirm Switzerland is attracting companies for tax reasons. It found that a record number of firms had set up shop in the country in the first six months of 2007.

The World Bank survey ranked Switzerland 24th worldwide in terms of total tax rate – all taxes that businesses pay – and second in Europe, behind Ireland. The Pacific island of Vanuatu headed the table with a fiscal rate of just 8.4 percent. With a total tax rate of 29.1 percent, Switzerland is only 0.2 percent behind top-ranked Ireland with 28.9 percent, said the Bank.

Switzerland was placed ahead of eastern European and Baltic countries, which have nominally lower corporation taxes but which carried the burden of higher capital tax and social insurance costs as well as customs and transport levies. And it did considerably better in the world listings than its neighbouring countries: Germany (50.8 percent, ranked 124), France (66.3 percent, ranked 157) and Italy (76.2 percent, ranked 168).

Tension
But the results come at a time of niggling tension between Switzerland and the European Union over the Swiss corporate fiscal system. Brussels wants the Swiss authorities to scrap a practice applied by some of its cantons that exempts company profits generated in EU countries from tax. It claims doing so violates a 1972 free trade accord.

Switzerland has repeatedly refused to negotiate with the EU over the issue. The government says that corporate taxes are a cantonal issue and are not covered by the trade agreement. The Swiss position is straightforward: that the 1972 free trade accord does not apply to the tax benefits granted to foreign companies by a number of cantons. It argues that the 1972 agreement is only applicable to certain goods such as agricultural and industrial products.

The EU is calling on Switzerland to give up the tax practice and adapt to its demands. Switzerland has so far refused, although the possibility of some distant compromise emerged in October 2007 when the two sides at least agreed to talk. One of the key questions for Switzerland in 2008 is whether the talks will proceed amicably, or whether the EU will stay on the front foot and turn this into a larger conflict.

If the tax spat is striking a somewhat discordant note in otherwise harmonious relations, there was more cause for concern, however minor, at the beginning of 2008 when the president of the Swiss National Bank, Jean-Pierre Roth, said the threat of inflation is rising, along with possible risks to the Swiss economy.

Mr Roth seemed to suggest Switzerland would not be immune from fallout from the sub-prime lending crisis in the US. He said there were ‘question marks’ over the economy, especially concerning possible knock-on effects from problems in the US. He warned that economic growth in Switzerland could fall below the Bank’s forecast in December of around two percent for 2008.

None of this is dissuading multinationals from setting their sights on Switzerland as a cost-effective and attractive base.

According to Ernst & Young, Switzerland is the leading European choice of international companies for locating an International/European headquarter, an R&D centre, or a centre for administration/accounting functions.

The company’s “Swiss Attractiveness Survey – What Foreign Companies Say” Ernst & Young conducted of international executives currently working within Switzerland shows that 74 percent of the executives surveyed would choose Switzerland again as a business site.

Other factors
While traditionally taxes have been one of the key reasons for locating and investing in Switzerland, Ernst & Young says the relative importance of other factors is definitely increasing. A key reason Switzerland rates so highly is its outstanding quality of life, which 71 percent of the executives rated as very attractive. Almost 80 percent of those surveyed also rated as very attractive Switzerland’s clear and stable political, legislative and administrative environment, with 65 percent rating the stable social environment very highly as well.

Other particularly strong features include the flexible labour laws and the favorable tax environment or tax incentives, with 56 percent of those surveyed giving each factor the highest rating.

Ernst & Young said Switzerland’s enduring focus on developing a highly skilled and specialised labour force, as well as a competitive business environment, have allowed it to take advantage of the changes created by globalisation. “Once a company has settled down in Switzerland, it will most probably stay,” Ernst & Young concluded.

This assessment seems to be borne out by figures that show 2006 was a record year of investment within Europe and Switzerland continued to be one of the most attractive locations for foreign direct investment.

Globalisation
One of the reasons for rising FDI in Switzerland is the country’s increased level of globalisation. In the 1970s, Switzerland was hampered as a global investment centre by its traditionally isolationist policies. Even as recently as 1996 the OECD warned that the Swiss federal government and the cantonal authorities needed to strengthen and approves Switzerland’s attractiveness as a place to do business.

This call for political action stemmed primarily from Switzerland’s rejection of EU membership. But it also came from a recognition that the internal Swiss market was not fully integrated, with lack of competition in some areas resulting in higher operating costs for foreign investors.

Liberalisation of internal markets has been slow and sometimes controversial, but progress has been made. Switzerland has to all intents and purposes become a “virtual member” of the EU and this has also increased the pace of globalisation. A referendum in 2001 went against opening talks on joining and Swiss-EU relations continue to be based on an extensive range of bilateral agreements.

Ties became closer in 2005 when a referendum backed membership of the EU Schengen and Dublin agreements, bringing Switzerland into Europe’s passport-free zone and increasing cooperation on crime and asylum issues. A further referendum in 2007 saw the bilateral agreement on the free movement of people come into force for the ‘old’ 15 EU member states, Malta and Cyprus as well as Efta nations Iceland, Norway and Liechtenstein.

Flood prevention
In other words, residents of these countries were suddenly free to compete for jobs in Switzerland alongside the Swiss. But a clause will allow Bern to place limits on immigration if too many EU citizens flood into the country (10 percent above the average of the past three years). Parliament will decide in 2008 the extent to which it will confer similar rights to the people of Bulgaria and Romania.

According to Switzerland’s Federal Migration Office, both Bern and Brussels favour a gradual, controlled opening of the Swiss job market. But whatever parliament decides, voters will have the final say in a referendum later in the year or in 2009 since such a move requires a change to the constitution.

This has all helped increase the pace of Switzerland’s globalisation. Indeed, in Economic Institute KOF’s 2008 Index of Globalisation, which compared 122 countries, Switzerland came fourth – up two places on 2007.

Zurich-based KOF said globalisation in Switzerland has increased continuously since the 1970s and particularly since the 1990s. Since 1991 Switzerland has been among the world’s 10 most globalised countries. The 2008 position was partly the result of a substantial rise in foreign direct investment, said KOF. One aspect of Switzerland’s cosy stability that has never seemed under threat is its politics. Switzerland’s long-standing neutral status has given it the kind of political cohesion envied by just about every other nation.

And yet last year, in the run-up to federal elections in October, Swiss cities saw riots on a scale rarely known. The unrest was the result of protests against the right-wing Swiss People’s Party (SVP), which ran what many saw as an overtly racist campaign. The party’s controversial leader, Christoph Blocher, was accused of wrongly depicting Switzerland as a society under siege from immigrants who have scant regard for the country’s laws and customs. Violence flared in the capital of Bern when left-wing protesters tried to stop a pre-election SVP rally. There were similar incidents in Lausanne and Geneva.

The level of concern over the tactics of the SVP was such that the United Nations refugee agency strongly condemned the party for an advertising campaign in which it appeared to blame the country’s rising crime rate on asylum seekers.

Success

But Mr Blocher’s rhetoric, and his embracement of traditional Swiss values, struck a chord with the electorate. The SVP was the most successful party at the election with 29 percent of the vote at the October 2007, but moved into opposition following parliament’s refusal to re-elect Mr Blocher to the Cabinet.

Analysts believe the political scene will remain unsettled in 2008 as the SVP settles into its opposition role. But this is still Switzerland, and “unsettled” is relative. The new government is expected to last the full four years, and its policy goals remain bullish.

Despite remaining outside of the EU, the Swiss economy will become more closely integrated with those of its neighbours as a new series of bilateral agreements comes into effect. The government also plans to continue efforts to improve micro-economic conditions to boost GDP growth. This includes measures to increase competition by liberalising previously sheltered industries such as electricity, energy, telecommunications and postal services.

Switzerland special place in Europe – part of it, but not part of it – seems destined to remain little changed, at least in the medium term. Bilateral agreements will be a necessary part of that arrangement as long as there is an EU and the ‘island’ of Switzerland in the middle of it.

Overcoming Russo-American tensions

Posted on May 13, 2008 by

Washington seeks Russian assistance on non-proliferation while pursuing policies on Russia’s borders that Moscow and many Russians consider highly provocative. In the meantime, both countries are threatened by radical Islam; co-operation between the nuclear powers of the world is imperative; and an emerging set of issues, like environment and climate change, can only be solved on a global basis. Given the extent to which their national interests have become interconnected, neither side can want or, indeed, afford a new Cold War. But the new chill is harmful to the prospects of a peaceful and creative international order.

The two countries have reached this point under presidents who took office nearly contemporaneously and will leave it about the same time. Remarkably, the personal relationship between the two presidents has remained much more constructive than the overall relationship. To the extent that personal trust can shape policies, the two presidents have an opportunity to use their remaining months in office to overcome some of the tensions that have weakened the basis for long-term co-operation.

The estrangement falls into two categories: on the American side, disenchantment with domestic trends in Russia, disappointment in Russia’s foot-dragging on the nuclear issue in Iran and reservations about the abrupt way Russia has dealt with the now independent former parts of the Russian Empire. On the Russian side, there is a sense that America takes Russia for granted, demands consideration of its difficulties but is unwilling to respect those of Russia, starts crises without adequate consultation and intervenes unacceptably in the domestic affairs of Russia.

Historical experience
Though each side’s complaints are to some (and often considerable) extent justified, the difficulty in resolving them reflects a vast difference in historical experience. In the 19th century, acting on the surface in parallel, both countries had devoted much of their national energies to expanding into contiguous, thinly settled regions. But there was an essential difference. America’s expansion was carried out by men and women who turned their backs on their countries of origin to shape their individual futures. Russia’s pioneers arrived in conquered territories in the rear of armies, while the indigenous populations were absorbed into the Empire. Almost all the cities in southern Ukraine and, of course, St. Petersburg were created by tsars who moved thousands forcibly into newly conquered regions.

The vastness of the territories and the openness of the frontiers produced a claim to exceptionalism in both countries. But American exceptionalism was based on individual fulfilment, Russia’s on a mystical sense of national mission. America’s exceptionalism produced an essentially isolationist foreign policy, interrupted occasionally by moral crusades. Russia’s exceptionalism expressed itself in military expansion. Between Peter the Great and Mikhail Gorbachev, Russia expanded from the heartland of Slavic Russia to the centre of Europe, the shores of the Pacific and deep into Central Asia.

Until the end of World War II, Russia and America rarely interacted on a global basis. America turned its back on world politics. Russia was in the paradoxical position of, on the one hand, often being seen as a threat to the established balance of power, while becoming an indispensable element in its preservation when it was attacked by Charles XII, Napoleon and Hitler.

America felt secure behind two great oceans, at least until the emergence of Russian long-range missiles and perhaps until 9/11. Russia, with no natural borders, especially in the West, considered itself permanently threatened. America identified normalcy and peace with the spread of its political values and institutions; Russia sought it through a security belt in contiguous territory. Yet the more polyglot the Russian Empire became, the more vulnerable Russian leaders felt, until expansion turned into a defining characteristic of the Empire.

This dichotomy explains the psychological tensions of recent years. To America, the collapse of the Soviet Union was a vindication of fundamental democratic values; to most Russians – even anti-Soviet Russians – the disintegration of empire is a shocking affront to Russian identity. To Americans, the 1990s in Russia were a period of reform and progress. Most Russians view them as a time of humiliation, corruption and national decline. Many Americans criticise Putin for reverting to an autocratic system. His supporters would argue that Russia’s immediate priority must be the restoration of its international standing. That perception, according to independent polls, seems to be shared by a large majority of Russians.

Putin sees himself in the tradition of Peter the Great and Catherine the Great, who established Russia as a great power. Autocratic beyond the standards of even 18th-century monarchies, they nevertheless considered themselves reformers who would drag a backward country and recalcitrant population into the modern period. Peter spent a year in Europe learning as much as he could of European technology; Catherine corresponded with Voltaire and invited Diderot as well as many scientists to Russia.

America must keep in mind that Russia, containing 11 time-zones, abuts principal areas in rapid transformation: Europe; the Middle East; and China, India and Japan, under whose aegis the centre of gravity of world affairs is moving from the Atlantic to the Pacific. Then there are the republics of Central Asia, repository of some of the world’s largest energy resources.

For Russia to regain its historical status, America is in many respects the most desirable partner. Russia will have an incentive to foster relations with China, partly to enhance its bargaining position vis-à-vis other regions. But it will stop short of making Asia the focal point of its policy, partly because China itself would shrink from such a partnership and because Russia has too many concerns about Siberia to place all its bets on its Asian ties. Russia’s ties with Europe are traditional, but Europe, until its unity is further advanced, is highly reluctant to accept the risks that may be needed to overcome radical jihad or to pose the penalties and rewards to prevent nuclear proliferation.

Tactical issues
Strategically, the US and Russia are very important to each other. Yet their dialogue has concentrated too much on tactical issues. Russian concerns have sometimes been treated as an exercise in tutelage. There is some merit in an exasperated comment made to me by a Russian policymaker; “When we tell you of a Russian problem, you have a tendency to reply that you will take care of it. But we don’t so much want it taken care of as we want it understood.”

For many Russians, the post-Soviet experience represents a reversal of 300 years of Russian history. Most of the acquisitions since Peter the Great having been severed from Russia, the Russian strategic position vis-à-vis its Western neighbours has changed fundamentally for both sides. Russia sometimes repeats its historical emphasis on power in relations with its neighbours. It finds it difficult to adjust its thinking to a world where it faces no threat in the West. At the same time, Russia is no longer the strategic threat to the balance of power that it was during the Cold War, even under the worst assumptions. But if the worst assumptions come to pass, it would be the result of a policy failure on both sides.

A new constructive relationship between America and Russia will require the modification of two traditional attitudes: the American tendency to insist on global tutelage and the Russian proclivity to emphasise raw power in the conduct of diplomacy. Specifically:

As the two largest nuclear powers, the United States and Russia have a special responsibility for non-proliferation. Iran is the key. The haggling over Security Council tactics needs to be brought to a conclusion. Is Russia striving for a special position in Iran and, if so, to what purpose? If the disagreement is tactical, wherein does it arise? Is there a different assessment of the imminence of an Iranian nuclear capability? Or of the efficacy of diplomacy? At what point is the Iranian nuclear weapons capability irreversible? Answers to these questions should guide tactics, not be driven by them.

The most sensitive psychological aspect of America’s relations with Russia concerns what Russians call the ‘near abroad:’ the new independent states that were once part of the Russian Empire. Many Russians find it difficult to think of them – especially those close to the centre of traditional Russian power – as entirely foreign countries and react truculently to what they consider American hegemonic attempts to infringe on historical patterns.

This issue requires restraint on both sides. As someone who strongly supported the expansion of NATO to its present limits, I am uneasy about pushing these territorial limits even further outward except under extreme provocation. At the same time, Russia must understand that America is bound to consider the genuine independence of these countries, like Ukraine and Georgia, as an essential component of a peaceful international order.

Affecting attitudes
A major challenge is the degree to which Russia’s internal evolution should affect US-Russian relations. This has two aspects: To what extent will Russian internal conduct affect America’s attitudes? To what extent should America try to affect Russia’s internal evolution by exhortation or pressure?

With respect to the first question, Russian leaders must understand that the American public is as shaped by its national history as is Russia by its own. America will always judge other societies, to some extent, by their respect for human rights. In many intangible ways, this defines the range of action available to American presidents.

When the line is crossed from advocacy to overt pressure, more intractable issues arise. Russia’s internal condition necessarily is an amalgam of its autocratic, historic past and the new opportunities generated by the collapse of the communist ideological system. A Western-style democratic political system cannot quickly emerge from the building blocks of Russia’s political past; new vistas are needed. Putin’s Russia is an inherently transitory synthesis produced by the impact of the USSR’s closed system on the requirements of a globalising world. This synthesis combines elements of Russia’s historic authoritarian, centralised bureaucratic state and the new opportunities opened up through a co-operative relationship with a unifying Europe and a friendly America.

For the moment, the authoritarian, centralising aspects are dominant, though arguably less so than in any previous period of Russian history. The goal of sound US policy should be to maximise incentives for Russia’s evolution to become more compatible with democratic norms. The dominant factors shaping this evolution will be domestic, not external. Overreaching efforts to determine political evolution in Russia will be more likely to strengthen authoritarian tendencies than the reverse.

In that spirit, a relationship between Russia and the United States that goes from removing frictions to active cooperation will make a major contribution to peace, progress and stability.

Steady progress of improvement

Posted on May 13, 2008 by

Russia’s biggest companies – the likes of Gazprom, Rosneft, and Lukoil – feature regularly in the world media and their actions are watched closely by both business and political leaders around the globe. Recent years have seen these firms embark on an aggressive expansion binge, but behind the scenes they have also been active in trying to transform themselves from former state-held behemoths or cobbled-together holdings into more effective, efficient, and profitable companies.

A new report from the Economist Intelligence Unit and sponsored by Ernst & Young – Corporate transformation in Russia’s emerging multi-nationals – explains what these companies are doing and why. It paints a fascinating picture of what is going on inside corporate Russia, and one that is very different to the traditional representation of the Russian business scene.

“Many of Russia’s fastest-growing firms are beginning to bump up against capital constraints, meaning they need to tap global financial markets to continue growing. This means they are under heavy pressure from the investor community to become more transparent and tighten up management practices,” says Matthew Shinkman, the editor of the report. However, as Russia’s leading corporates expand into new markets, they are increasingly competing head-on against global leaders, providing another source of pressure to improve their competitiveness.

“Recent changes in corporate governance are being driven to a large extent by capital market requirements. Thus far in 2007 there have been 18 public offerings by CIS companies for a total of almost $26bn raised,” says Karl Johansson, Managing Partner of Ernst & Young in Russia and the CIS. “The process of Russian companies going public in international markets will continue and will help these companies become global players.”

Restructuring
The report’s examination of the internal reform efforts of Russia’s emerging multi-nationals reveals several key themes. Reform is indeed happening, if at a slow and uneven pace, it says; “The biggest Russian firms, with the most contact with the outside world, have been very active in corporate restructuring, implementing modern, best practice corporate governance systems, upgrading internal processes and procedures, and building environmental sustainability into their businesses. Firms that are closer to the state, not surprisingly, tend to move more slowly in this regard.”

The report also argues that change is being driven in part by funding requirements. To minimise their cost of capital on global markets, “Russian multi-nationals are being forced to introduce more transparency, improve reporting procedures, and get corporate governance right.” Acquisitions and establishment of operations in western markets have also forced these companies to play by western business rules.

However, it would be wrong to conclude that these reforms are being forced upon the Russian multi-nationals, the report says. “The senior executives with whom we spoke confirmed that corporate transformation efforts are not being made just as pre-IPO window dressing,” the authors write. “In most cases executives understand that the long-term competitiveness of their firms will depend upon meeting or beating global best practices in operations, governance, and finance.”

The report notes that while the behind-the-scenes corporate modernisation activities of the emerging Russian multi-nationals may not be well-documented, their increasingly confident forays into both emerging markets – including Russia’s backyard CIS countries – and even the more sophisticated markets of Europe and the US has made front-page news, and forced western rivals to take note.

It cites research by M&A Intelligence, a Moscow-based consultancy, which suggests that last year Russian companies completed almost 100 cross-border mergers and acquisitions worth some $15bn. The most well-known and controversial of the Russian firms venturing abroad is gas giant Gazprom, which has gained control over assets in the CIS and eastern Europe which allow it to exert major influence over the supply of gas to western Europe.

In contrast to the prevailing view in the global media, though, “aggressive corporate expansion abroad is not solely the purview of the biggest firms, nor those most closely-linked to the Kremlin, and in most cases is based on purely commercial motives,” the report says. Russian companies such as Lukoil, UC Rusal, and Severstal – all highly active in overseas M&A – are all several steps further removed from the state than Gazprom, while smaller Russian multi-nationals such as the telecommunications company MTS and food manufacturer Wimm-Bill-Dann are barely more than a decade old and are less central to the Kremlin’s economic strategy, it says.

The report argues that for the largest Russian energy and natural resources firms, years of high global oil and commodity prices, accompanied by exceptionally high demand from both emerging and developed markets, have produced a windfall of export earnings and left these firms cash-rich and in a buying mood. This rapid earnings growth, along with robust macro-economic growth, has also trickled down into rising incomes for a growing Russian middle class, which has in turn boosted the performance – and ability to invest – of financial services, consumer goods, and technology firms as well.

“Russian companies have for years been active in the CIS countries, leveraging common language, similar business practices, and trade and other links established in former Soviet Union times to build market share in and extract natural resources from Russia’s near-abroad,” it says. “Russian companies account for over a third of all foreign direct investment in the CIS countries. This investment is led by the oil and gas sectors, but telecommunications, financial services, and consumer companies are also heavily active in the region.”

Many Russian emerging multi-nationals are now looking further abroad, re-tracing the steps of Soviet state enterprises, which were active in the Soviet Union’s former spheres of influence, ranging from Asia to Latin America and Africa, the report says. “These firms are now using the skills built up in both the challenging domestic Russian market and the still-undeveloped CIS to venture into far choppier waters – including places few Western companies are willing to go.”

Expanded market
Currently, the international presence of Russian telecommunications companies, including MTS and VimpelCom, is largely limited to the former Soviet republics. As opportunities in this expanded home market become harder to come by, though, they suggest they are considering entering markets like North Korea and Afghanistan to sustain growth beyond 2009. The report refers to comments made this summer by Alexander Izosimov, chief executive of VimpelCom, who told journalists that, “We will be ready to look at markets that are riskier, the markets that, in the mind of western companies, are taboo.” Other reports have suggested that Altimo, the telecoms arm of billionaire Mikhail Fridman’s Alfa Group conglomerate, has been in talks to buy into Iranian mobile phone company Iraphone.

While Russian multi-nationals hold a commanding position in the CIS and operate comfortably across a range of emerging markets, their experiences entering the developed western markets have been more mixed, the report says. “This experience has been in large part driven by ongoing concerns over transparency and corporate practice, but the circumstances have been made more difficult for Russian firms by the rise in political tensions between the administration of Vladimir Putin and the US and Europe.”

The report cites research from M&A Intelligence on failed cross-border deals that highlights the troubles Russian firms have had accessing developed markets. Between January 2006 and January 2007, the consultancy reports that Russian companies failed to clinch 13 foreign deals with a total worth of $50.2bn (well ahead of the $15bn in closed deals). The thwarted deals included five by Gazprom, three by Lukoil and two by Severstal, with the biggest being Severstal’s $13bn bid to buy Luxembourg-based steelmaker Arcelor. During the same period, companies from the Middle East lost just $18bn worth of deals in Europe and North America.

“Political considerations have worked against Russian firms in recent cross-border bids,” the report says. In early 2006, for example, rumours that Gazprom was considering a bid for Centrica, the UK-based energy supplier, raised such concerns within the UK government that then-Prime Minister Tony Blair issued a statement officially confirming that the government would not actively block a bid. And Severstal’s bid to takeover Arcelor, the Luxembourg-based steelmaker, in 2005 drew a sharp response from European politicians and the company was eventually thwarted by a rival bid from Mittal Steel.

“Political sensitivities are even greater in the former communist countries of eastern Europe,” the report claims. Steel and mining company Evraz Group bought the ailing Vitkovice Steelworks in the Czech Republic in 2005. It was the group’s first international purchase and the memories of the two countries’ common communist past complicated the bid. “We faced serious challenges in this acquisition,” the report quotes Irina Kibina, vice-president for corporate affairs and investor relations at Evraz, saying. “All the memory, all the fears, they are still alive. Besides, it was our first international acquisition and we were just learning how to do it right.”

Studies
Inexperience is only half of the problem, according to the report. Russian firms – and Russia itself – currently suffer from a very poor image within the global business community, it says, citing numerous studies, including several from the Economist Intelligence Unit.

“The news for Russian multi-nationals trying to get into western markets has not been all bad, though,” it says. Evraz has since gone on to conclude a string of acquisitions, including the highly-publicised purchase of Portland, Oregon-based Oregon Steel Mills, which was completed in January, 2007 despite concerns that US anti-trust authorities might not approve the purchase due to Evraz co-owner Roman Abramovich’s ties to the Kremlin.

“While Russian firms’ efforts to transform themselves via acquisition have been met with some backlash, a more collaborative approach has reaped rewards for a number of big Russian firms in potentially sensitive industries,” the report says. The most successful of these firms are increasingly seen as credible business partners and important vehicles for access to the big Russian home market and the country’s vast natural resources.

While the report puts Russian enterprise in a new light, it notes that the country’s multi-nationals are still hampered by an image problem. “Many senior executives around the world are still either wary of or at least uninformed about the actions of Russia’s biggest firms,” it says. “These companies have a big image problem to solve, and it’s not just a case of prejudice: Russian executives need to become more open to communicating with the business world.”

It concludes that there is still a long way to go. “Impressive progress has been made, but the emerging Russian multi-nationals are still emerging. Substantial room for improvement still exists, which presents an opportunity for these firms to continue their vault into the upper echelons of the global business world, if they choose to take it.”

Principles to replace rules

Posted on May 13, 2008 by

The US world of business regulation is run by lawyers, and lawyers it is said, like rules. They are clear, and they encourage innovation, because anything not strictly forbidden by a rule is deemed to be okay. In the UK, and in many other jurisdictions around the world, the preference is for principles. American business has traditionally turned its nose up at this approach, but attitudes are now changing.

US financial watchdogs are starting to take the view that their rules-based approach is not going to work for much longer, if indeed it works now. In recent years, the sheer volume of corporate rules and regulations created in the US has grown enormously. Partly that is a response to financial scandals such as Enron, WorldCom and the rest. Partly it’s an effort to keep up with innovations in the financial markets, where banks and other institutions continually churn out new products that don’t look like anything else in the regulatory rulebook.

Principles-based approach
The most prominent regulator to come out in favour of principles rather than rules, is Federal Reserve Board Chairman Ben Bernanke. He used a recent speech to argue in favour of developing a UK-style, principles-based approach to US financial market regulation, rather than creating new rules for each new financial instrument or institution.

Mr Bernanke said the rapid growth of the credit derivatives market and the increasing prominence of hedge funds did not warrant specific regulation to address possible risks that they pose. “Central banks and other regulators should resist the temptation to devise ad hoc rules for each new type of financial instrument or institution,” he said. “Rather, we should strive to develop common, principles-based policy responses that can be applied consistently across the financial sector to meet clearly defined objectives.”

This would not be a complete U-turn for US regulators. Mr Bernanke stressed that development of a principles-based approach is consistent with recent US guidance on hedge funds, which did not call for any new regulations to mitigate potential risks that the massive pools of capital pose to the financial system and economy.

Instead, the guidance, developed by the US Treasury Department, the Federal Reserve System, the Securities and Exchange Commission and other regulators, suggested that those risks would be kept in check by market discipline, due diligence by hedge fund creditors, counterparties and pension funds, and with adequate disclosures to sophisticated investors. The hedge fund guidance makes it clear that regulators and supervisors should adopt a principles-based approach similar to that used by the Financial Services Authority, the UK’s lead financial regulator, with a supervisory focus on the areas with the biggest potential risks. He said the guidance emphasised that “risks to financial stability are best addressed by focusing our attention on the large institutions at the core of the financial system.” he said a narrower approach to regulation could provide incentives for ‘regulatory arbitrage,’ driving investors to less-regulated financial instruments if rules are not applied consistently to instruments or institutions that pose risks for policy objectives.

Financial stability
Why is the US suddenly finding principles more attractive? Mr Bernanke said the biggest regulatory objectives should be ensuring financial stability, investor protection and preserving the integrity of the market. Rapid financial innovation has presented challenges to these objectives, particularly with the complexity of contemporary instruments and trading strategies, the potential for market illiquidity to magnify the riskiness of such instruments and the greater use of leverage that they often entail.

A principles-based approach would be better than ad-hoc rules for addressing such risks and taking into account financial innovations. “To avoid moral hazard and let market discipline work, investors must be allowed to bear the consequences of the decisions they make and the risks they accept. But investors are entitled to the information they need to make decisions appropriate to their personal circumstances,” he said.

The irony is that the US is being won over to principles at the same time that some in the UK are stressing the benefits of rules. The FSA is working on plans to tear up large parts of its growing rulebook, replacing prescriptive requirements with more general principles. The UK financial sector has voiced enthusiastic support. But there are doubts about whether the enthusiasm is justified. More sceptical observers say the promised benefits of this fundamental change could prove illusory.

The FSA has been experimenting with a principles-based approach to regulation for at least two years. In April it outlined plans to make a more radical switch to principles. In a paper called ‘Principles-Based Regulation,’ focusing on the outcomes that matter, the regulator said its approach to supervision would be more “outcome-focused” in future.

The FSA says it will have reassessed 80 percent of the rules in its regulatory handbook by the end of next year to see which ones it can replace with principles. Some rules will have to remain, as they are dictated by the European Union, and it has refused to hint at how many will go.

Business requirements
The idea is that by removing as many of the rules as it can, the FSA will give firms more choice about how they meet outcomes set by the regulator. For some, that means they will be able to bring their compliance work more closely into line with their business requirements.

The FSA says that well controlled and managed firms that “engage positively and openly with us” should experience real benefits in the form of what it calls a regulatory dividend. “No longer will regulation be seen as a side-line occupation that imposes costs in >> >> addition and in parallel to business costs,” its paper proclaims.

Another reason for the shift to more principles is that the FSA wants to push responsibility for compliance higher up organisations. In a prescriptive regime with thousands of rules, compliance requirements are beyond the understanding of senior managers at many firms, and can be “bewildering” for smaller firms, says the FSA. By focusing on outcomes and principles instead, the FSA expects to see key regulatory decisions taken at a more senior level, with heavy involvement from the board of directors. “This will mean a significant change in behaviour and management attention for many people in financial services firms,” it says.

FSA Chief Executive John Tiner described the shift to principles as, “the natural next step in the evolution of our regulatory system,” when he launched the paper at an industry conference in April. Financial sector organisations were quick to support the FSA’s view that a shift to principles would help lift the compliance burden. The Association of British Insurers said it backed the principles approach. The Financial Services Practitioner Panel also welcomed the FSA paper. “This is an ambitious undertaking for all concerned,” says Ron Leighton, its chairman. There are big challenges in making the switch to the new approach, but “the potential benefits of doing so are significant,” he added.

Others in the industry are less enthusiastic. Rachel Kent, head of the financial services team at lawyers Lovells, questions whether the benefits that the FSA foresees might prove illusory. “I don’t think this will reduce the compliance burden at all,” she says. “In fact, I think it will increase it.”

Ms Kent sees several reasons for questioning whether either financial firms or the FSA can successfully manage the shift to principles-based regulation. It will require a great deal of work on both sides, and she is not sure either can pull it off.

Framework of processes
A prescriptive regime has benefits for firms, she says. Not least, it gives them a degree of certainty about what they should be doing, and a framework of processes to follow. If the regulator does not provide those rules on a plate, many firms will have to write their own internal rulebooks, says Ms Kent. If they do that properly, they will be able to operate in line with rules and controls that suit their business better than the FSA’s generic handbook. “But there is a risk, particularly among smaller organisations, that they will not be able to put in the hard work required.”

To provide certainty in the absence of FSA rules, Kent expects other financial sector bodies to publish their own guidance, which the FSA will endorse. “We will end up with a proliferation of secondary level rules and guidance to fill the gaps,” she says, making the regulatory map more complex, not less.

Kent points to the Treating Customers Fairly project, the regulator’s first big attempt to make its principles-based approach a reality. It has avoided creating detailed rules on how firms should treat customers, but has published reams of discussion papers, policy statements and speeches from its senior staff, all of which provide information about how to understand its principles. “Are we now regulated by speeches?” asks Kent. “I don’t think that’s very satisfactory.”

Her biggest concern is that the FSA will use unfair hindsight when it considers enforcement action. Instead of looking at whether a firm broke the rules, it will have to decide whether, at the time an action was taken, it contravened a principle. The regulator says it will only take action if it should have been clear at the time a firm was doing something wrong. “As a lawyer, that makes me breathe a sigh of relief,” says Kent. “But I wonder how it will work.” Combined with a desire to push compliance higher up the organisation, and to try to hold individual executives accountable, “that gives rise to a bit of a worrying cocktail.”

Clifford Smout, a principal in the financial services advisory group at consultants Deloitte, says the new strategy will have important implications for compliance functions. “Implementing these changes effectively will be a real challenge and, in some cases, will require a transformation of the compliance function,” he says. “If it is going to work properly, it is going to require much more active engagement between compliance and senior management.”

Rather than saying whether an action breaks the rules or not, compliance functions will have to find ways of measuring the extent to which a firm is achieving the outcomes set by the regulator, says Smout. They will also have to learn how to manage and archive knowledge, so that if the regulator challenges an action, the firm can demonstrate that it was in line with the principles, based on what it knew at the time.

Those are all very difficult challenges. Of course, if US financial companies do find their regulators going down the principles road, and they have to write their own internal rulebooks, to make up for those that their regulators once provided, who will they turn to? Their lawyers. Maybe that’s one reason why the business establishment is warming to the idea.

Promoting transparency and co-operation in financial markets

Posted on May 13, 2008August 6, 2019 by

The integration of capital and financial markets has been driven by the removal of barriers between national markets – today no OECD country has controls on inward or outward investment or on exchange transactions – and by the rapid development of global communication networks and the information economy. In this more open environment financial services and investment have become increasingly mobile. These developments open up new opportunities for improvements in our economies, but also raise important challenges for policymakers, as the scope for financial crimes widens.

Money laundering, misuse of corporate vehicles, terrorist financing, tax crimes, and other inappropriate exploitation of regulated financial markets for personal gain: all have changed in both nature and dimension. Today the potential for financial abuse can threaten the strategic, political and economic interests of sovereign states. Widespread financial abuse undermines the integrity of the international financial system and raises new challenges for policymakers, financial supervisors and enforcement agencies. In certain jurisdictions such abuse may go so far as to undermine the democratic basis of government itself.

Veil of secrecy
Financial crimes thrive in a climate of secrecy where normal good governance measures are undermined by a lack of transparency and a failure of financial centres to co-operate effectively with the law enforcement agencies of other countries. And, of course, behind this veil of secrecy there is a darker reality. Terrorist networks, arms dealers, drug traffickers and other international criminal syndicates which exploit secrecy and non-transparent arrangements to legitimise the profits from their illegal businesses.

Poorly regulated financial markets not only open up new opportunities for financial crimes but can also threaten the stability of the international financial system. As new technologies reduce the importance of physical proximity to major on-shore financial centres so a new generation of Offshore Financial Centres (OFC) have emerged. Remote jurisdictions bereft of natural resources and too remote to benefit significantly from the global economy have established OFC characterised by strict bank secrecy, criminal penalties for disclosure of client information and a policy or practice of non-co-operation with law enforcement agencies of other countries. This new generation of OFCs have succeeded in attracting brass plate banks, anonymous financial companies, asset protection trusts and increasingly have become the focal points for private equity and hedge funds.

Enron, Worldcom and Parmalat have all revealed serious weaknesses in corporate governance and in certain market functions. Such scandals have lead to a massive destruction of financial wealth. Incentives were misaligned and key checks and balances failed. Market participants tolerated, and in some cases contributed to, deceptive practices. All this reflected shortcomings in the quality of corporate governance needed to insure investor confidence, economic dynamism and competitiveness. Good corporate governance serves as an early warning system to corporate and financial problems. Moreover, strengthening transparency and accountability in particular are critical in combating efforts to put wealth beyond the reach of law enforcement and tax agencies. An economy characterised by high standards of transparency and one in which members of management are accountable to their boards and the boards are accountable to their shareholders –including minority shareholders – is one where financial fraud and other financial crimes, including tax crimes, will be less likely to flourish.

Governments have responded to these threats by developing legislation to detect and deter financial crimes and by strengthening their law enforcement and tax enforcement capacity. Money laundering has been criminalised. Financial institutions are required to report suspicious transactions. Stricter regulatory and supervisory measures have been put in place. Access to beneficial ownership information and trust formation rules have been revisited and strengthened.

Fighting money laundering
These national initiatives are reinforced by multi-lateral actions. OECD countries took the lead in developing new international standards (see box out). In 1992 the Financial Action Task Force (FATF) was created to counter money laundering. It developed criteria to identify non cooperative jurisdictions and establish recommendations which guide governments in their fight against money laundering and, at a later date, terrorism financing. In 1997 the Financial Stability Forum was established to promote international financial stability through information exchange and international co-operation in financial supervision and surveillance. It also compiled a list of poorly regulated OFC which threatened the stability of the international financial system. In 1998 the OECD launched its effort to address the problems raised by tax havens as part of a broader initiative to counter harmful tax practices. Key features of this initiative are the promotion of transparency and effective exchange of information.

Each of these initiatives recognised that unilateral actions are insufficient. Each was launched by countries committed to high standards of financial integrity. While each initiative was separate, dealing with distinct issues and encompassing different country groupings – both OECD and non OECD – all were directed at establishing new international standards and within similar time frameworks.

The success of these initiatives can be seen from the way in which OECD and non-OECD countries have worked to implement these standards. Today OECD countries have criminalised money laundering and are in broad compliance with the FATF recommendations. Many key non-member countries including OFC’s have followed this lead. The FSF has been successful in promoting new supervisory standards. But the response to these initiatives has perhaps been most dramatic with regard to the OFC. Today almost all of the OFC’s identified in the FATF original list have been removed and 33 of the potential tax havens identified by the OECD in 1998 have committed to the principles of transparency and effective exchange of information. Clearly even in today’s global environment multilateral action can achieve high standards.

The role of the OECD in promoting financial integrity:

Promoting tax co-operation
The more open and competitive global market of recent decades has had many positive effects on tax systems. Tax rates have generally fallen and tax bases have been broadened. Some tax and tax-related practices, however, undercut the gains that tax competition generates. This occurs especially if some countries engage in practices that encourage non-compliance with the tax laws of other countries. The ultimate losers are honest taxpayers. They end up paying for dishonest practices by shouldering a greater share of the tax burden, and their confidence in the integrity and fairness of their tax systems, and in government in general, declines. Since 1998, the OECD has co-ordinated action so that countries – large and small, rich and poor, OECD and non-OECD – can work together to eliminate harmful tax practices with regard to geographically mobile activities, such as financial and other service activities. The concrete results of the OECD’s efforts are reflected in the commitments to transparency and effective exchange of information which have been made by Offshore Financial Centres. In parallel, all of the 47 harmful preferential tax practices identified in OECD member countries in 2000 have been either eliminated, modified or, on further inspection, found not to be harmful.

Promoting good corporate governance
The OECD Principles of Corporate Governance, issued in 1999, have become the international benchmark in this area. They cover six main areas: the legal and regulatory framework for effective corporate governance; shareholders rights; equitable treatment of shareholders; the role of stakeholders (employees, creditors, etc); transparency and disclosure, responsibilities of the board.

Counteracting the Misuse of Corporate Vehicles and Trusts
Corporate vehicles and trusts can be misused to facilitate financial crime such as money laundering, bribery, fiscal crimes, improper self-dealing and market manipulation, as well as terrorist finance. The critical concern is the potential for anonymity provided by the veil of a separate legality which may be strengthened in certain jurisdictions by stringent secrecy laws and the availability of instruments that obscure beneficial ownership. The OECD produced first a report giving a menu of alternative approaches that a jurisdiction could adopt and then a template that can be used for assessing a jurisdiction’s capacity for obtaining ownership and control information and sharing that information with authorities of other countries.

The fight against Money Laundering
The Financial Action Task Force (FATF) was established in 1989 to combat money laundering around the globe. Following the events of September 11 in 2001 the FATF began waging a financial war on terror as well. The members of the FATF have committed collectively to follow a set of ‘40 Recommendations,’ which were revised significantly in 2003. The FATF has also agreed to eight special recommendations to counter terrorist financing. Since 2000 the FATF has undertaken an initiative to help ensure that all significant financial centres adhere to international anti-money laundering standards. This initiative on Non-co-operative Countries and Territories (NCCT) has triggered significant improvements throughout the world. Some 23 jurisdictions were placed on the NCCT list in 2000 and 2001. Today only six remain on the list and of these five have enacted reforms significant enough to be placed in the ‘implementation stage.

Despite the initial success of these initiatives much remains to be done. Setting standards is but one step in the fight against financial abuse. Monitoring their implementation and getting a ‘buy-in’ from OFC’s is the next challenge. Jurisdictions that have committed to work with the FATF, the IMF and the OECD will require on-going assistance to implement their commitments: assistance which can be more effective if co-ordinated. The emergence of new financial centres will have to be monitored to ensure that they meet international standards. Renewed efforts will be required to ensure that financial centres which achieve high standards will not be put at a competitive disadvantage.

Moral leadership
OECD countries will continue to be the driving force behind initiatives to improve the integrity of financial markets (see box out). To maintain their moral leadership they will need to continue review their own money laundering, law enforcement, supervisory and tax enforcement powers. This in turn will require balancing integrity needs against legitimate privacy and competitive concerns and ensuring that there are no free riders in the system.

Offshore financial centres which meet and implement high standards will continue to play a role in the international financial system. Some, however, may decide that the costs of meeting such standards is too high in comparison to the expected gains and will decide to exit from this business. Some may decide – few I hope – that by not meeting these standards they will become more attractive to those who want to engage in illegal financial activities. These may prosper in the short term but risk inflicting long term damage on their economies and democracies as OECD countries take coordinating action to counter such abuse. International Institutions are committed to working with those financial centres that want to stay in the Financial Services business and enhance their reputation by implementing high standards of transparency and engaging in international co-operation.

Further information:
jeffrey.owens@oecd.org

Into the unknown

Posted on May 13, 2008August 6, 2019 by

This year was never likely to get off to a particularly jolly start. With an election looming in the United States, a credit crunch haunting the global financial system, and growing political instability at every turn, the mood in January was gloomy to say the least. If there were any die hard optimists trying to lift the mood, the World Economic Forum soon snuffed out their hopes. The influential Geneva-based think tank released a remarkably downbeat report in January, forecasting the highest levels of political and economic uncertainty for a decade.

The outlook was so grim that the WEF in its Global Risks 2008 report called for “new thinking and concerted action” on a number of problems. The big threat, the report said, was that the current liquidity crunch would spark a US recession in the next 12 months. But there are three other major risks highlighted by the report: threats to the global food supply, the increasing cost of oil, and supply chains that are stretched to breaking point. These risks cannot be avoided, the WEF report said, but they can be better understood, managed and mitigated.

That financial risk should top the list of threats is no surprise. This time last year, some observers, including the WEFs own Global Risk Network, were predicting a re-pricing of risk in financial markets. They certainly got that one right, but nobody foresaw the scale and nature of the systemic financial crisis of 2007-2008. In the US alone, the Federal Reserve has projected direct losses related to the sub-prime crisis of US$15bn. The crisis “has raised fundamental questions as to the vulnerabilities within the current model of financial markets,” the WEF report said. In the good times, diversification of risk may have strengthened stability, “but systemic financial risk remains acute,” it added.

Changes in financial markets over the past two decades have led to the ownership of risks being decentralised, said the WEF, and generally this has been a good thing. For one, it creates greater opportunities for risks to transmit between individual firms and markets. But this also makes effective risk management all the more critical. Under normal market conditions, the financial system has improved its capacity to assume and distribute risk, and has become more stable, said the WEF. But, to mitigate the impact of the types of challenges seen in 2007, the report calls for increased public and private sector collaboration on stress testing, liquidity management, risk assessment and prevention to address what it describes as the “fragmentation of ownership of global risks.”

Divided economists
In the meantime, and looking at the year ahead, the WEF said a US recession is possible and noted that economists are divided on whether consumption-led growth in Asia is strong enough to drive the global economy. In Europe, the WEF warned that the prominence of the United Kingdom’s financial sector had made the country as a whole vulnerable. There were also large current account deficits in some central and eastern European economies that may prove increasingly unsustainable in 2008.

“Systemic financial risk is the most immediate and, from the point of view of economic cost, most severe risk facing the global economy,” said David Nadler, vice-chairman of insurance group Marsh & McLennan Companies, which helped to produce the report. “With so many potential consequences of the 2007 liquidity crunch unresolved, the outlook at the beginning of 2008 is more uncertain than it was a year ago.”

If the appearance of financial instability at the top of the big-risks list is a no-brainer, the mention close behind of “food security” might take more people by surprise. How many even know what the phrase means? In simple terms, this is the question of who gets to eat what, and how much we have to pay for our food. The WEF says this issue will move “from the periphery of the global risk landscape to its centre” and will become one of the major risks of the 21st century.

The world is moving into a period where food prices will be higher and more volatile. In 2007, prices for many staple foods reached record highs. Global food reserves are now at a 25-year low. That means world food supply is vulnerable to an international crisis or natural disaster. In some cases this has caused political instability, such as the “food riots” that hit some countries in 2007.

Looking ahead, the WEF said that the drivers of global food insecurity – population growth, lifestyle changes, use of crops to manufacture biofuels and climate change – were likely to sharpen over the coming decade, “positioning the world for a potential long-term trend reversal in food prices and leading to a set of complex challenges to global equity.”

Dealing with this insecurity will become an increasingly complex political and economic problem over the next few years, said the WEF. The consequences for some countries “may be harsh”, it warned.

Food is not the only area where the WEF is worried about the stability of future supply. The global supply chains on which international trade depends are vulnerable too, it said.

Increased efficiency
Improvements in technology and global logistics, along with reduced trade barriers, have led to a historic expansion of international and intra-regional trade over the past 20 years. On the whole, this has been a good thing. These improvements have generally led to increased efficiency and global prosperity. However, the WEF warned that “hyper-optimization” of supply chains – stretching the links in the chain to breaking point – might create new threats. The risk of a chain breaking becomes much higher, as does the damage that such a break could inflict. These threats “are often not fully understood,” warned the WEF, which added that while supply chains can share risk between many parties, “they can also cause risks to be aggregated.”

As every company and government that depends on external suppliers faces disruption to their supply chain, the WEF called for “an international approach to supply chain risk management across private and public sectors.” That would be one of the first steps to mitigating this risk.

The last of the four big risks highlighted by the WEF is the availability of energy resources. Energy is key to the global economy, but guaranteeing a safe, secure and sustainable supply – and doing so in line with global commitments to reduce greenhouse gas emissions – is increasingly problematic, it said.

With predictions of a 37 percent increase in oil demand over current levels by 2030, the WEF report sees limited scope for a fall in energy prices over the next decade. This may be good news for oil and gas producers, but it creates an inherent mismatch between those who bear risk and reward.

“The global economy has demonstrated remarkable resilience to increases in energy prices since 2004. But the limits of resilience may be close to being reached,” said Nadler from MMC. “Over the next two decades the supply of primary fossil fuel will become tighter with the world economy becoming much more vulnerable to price shocks as a result.”

The WEF report called for better dialogue on this issue at all levels – between emerging and developed countries and between the corporate sector and government and regulators. “A move towards a forward-looking regulatory framework is needed in order to ensure long-term economic viability,” said Nadler. “This framework should seek to unlock investment and innovation in cleaner energy and, ultimately, deliver an economic price for carbon.”

Highlighted risks
While the global financial markets could be blamed for causing at least one of the big risks highlighted by the WEF, the think tank said that financial markets will play a key role in mitigating all four of them.

Despite the financial turmoil of 2007, the financial markets are an increasingly important tool to transfer and mitigate an increasing variety of global risks, it said. The growth of financial markets has opened up new ways of doing this, including the rapid emergence of a new market in insurance-linked securities (ILS). These products help to provide additional capital to the insurance industry to protect against major catastrophe losses. While the early “cat bonds” were issued into the capital markets to help mitigate losses from wind damage and earthquakes, the ILS market has grown considerably in recent years in the range of risks covered, with total bonds outstanding now at more than US$34 billion.

Christian Mumenthaler, Member of the Executive Board of Swiss Re, who served for three years as the group’s chief risk officer, said: “The development of the ILS market has increased the ability of insurers and reinsurers to accept peak risks such as US hurricanes. This has become increasingly important because climate change has elevated the frequency and severity of tropical cyclones. The extra insurance capacity available through these instruments helps private companies and governments mitigate and manage these peak risks.”

Besides ILS, a wide variety of other financial instruments are now being developed to transfer insurance risks, including weather derivatives. “The weather derivatives market has grown at an explosive rate in recent years,” said Mumenthaler. “For example, these instruments can provide rapid payments to governments and farmers who can use them to hedge against too little rainfall and excessive heat in the growing season, along with too much rain in the harvesting season. In this way, both the state and commercial growers can invest in crop production with a greater degree of confidence, helping to optimise food production and security.”

Another way of mitigating these big risks is improved coordination between governments, said the WEF. When it published its 2007 risk report last year, it recommended the institution of country risk officers and flexible issue-based international coalitions to manage the complexity of the global risk environment.

Institutional arrangements
Its 2008 report looks at the specific example of the UK’s Civil Contingencies Secretariat and establishes a set of principles for country risk management which may apply across different institutional arrangements. An international forum of country risk officers could potentially offer a much improved capacity to exchange information about inherent cross-border global risks, and also improve the global ability to anticipate and respond to risk, it said.

“In order to maintain the benefits of globalisation, improved governance of globalisation is vital,” said Charles Emmerson, associate director of the WEF and editor of the report. “In all the focus areas of this year’s report, principles of equity, management of trade-offs and long-term global cooperation will be necessary. The short-term outlook is highly uncertain in 2008, but we must not lose sight of longer term challenges.”

Professor Klaus Schwab, founder and executive chairman of the WEF, said the current global risk outlook “points to a future of tremendous challenges, but also opportunities for business and government decision-makers to demonstrate their leadership.” The fact that so many of the global risks discussed in its latest report are connected with each “reflects the need for a collaborative framework for response.” Whether governments can provide that level of leadership and a willingness to work together remains to be seen.