The hunt for hydrocarbons

Rocksource, a Norway-based oil exploration and production company, has developed analytical tools for analyses of electromagnetic (EM) data that have been proved to triple or even quadruple the likelihood of identifying hydrocarbon deposits.

The EM technology can dramatically reduce the cost of exploration by revealing the presence of oil-bearing structures in even deep and difficult waters where exploration companies are increasingly forced to search for the next high-producing well.

“Rocksource’s tools can increase the chance of success in establishing oil-bearing from 20 percent to 60 percent or more,” explains chief executive Trygve Pedersen. “Hydrocarbons are becoming harder to find and the costs are rising significantly. Our technology means you can improve exploration results and, over time, the efficiency of capital. Basically, it means you can drill wells in a smarter way.”

When correctly interpreted, the firm’s EM technology dramatically reduces the number of dry wells, as a result optimising rig capacity and slashing finding cost per barrel.

“It’s knowledge that oil companies can use,” adds Pedersen, a veteran of the industry who worked for Statoil, BP and Petoro before joining Rocksource. In just four years since the company was established, it has achieved impressive performance on the basis of its technology  based approach.

In a single year it turned a failing on-shore field in Texas into a highly profitable one producing 2000 boepd. The present production rate is not only 40 times higher than when Rocksource took over the field but also 100 percent ahead of target.

It has identified several positive prospects in UK and Norwegian waters

It has formed equity partnerships – ‘farm-ins’ – with much bigger exploration companies that wish to apply Rocksource’s tools to their much larger portfolios.

And another tool, a system for managing reservoirs to maximum potential, has proved important in the Texas field which  Rocksource has used to provide cashflow for further developments as well as to test its on-shore tools

Comparative advantage
Analysts give Rocksource the thumbs-up for its performance so far as well as for its potential. “The EM technology is proven with fast-growing acceptance as a new important exploration tool,” noted DnBNOR markets last year, rating the company as a buy. “The EM competence provides Rocksource with a comparative advantage.”

Glitnir also rates the company as a buy. “Current valuation does not incorporate the potentially huge upside potential in the company’s technology and future exploration success,” it pointed out late last year.

Glitnir also singled out Rocksource for adding “green” value to pre-existing EM technologies. “The company differentiates itself from other E&P players by utilising its own EM interpretation technology to decrease geological risk,” it noted.

Based in Bergen with offices in Oslo, Stavanger and Houston, Rocksource’s management is composed of veterans of the exploration industry. As well as Pedersen, it includes Jonny Hesthammer, vice president technology and professor of seismic interpretation, who has a PhD in structural geology and 11 years experience from Statoil. Similarly, John Howell, vice president of production and a professor in analogue reservoir modelling, has collaborated with most of the major oil companies. Gregor Maxwell, vice president exploration, holds a PhD in reservoir geology and worked for nine years with Texaco and Chevron.

“We have been able to attract the best people in the industry,” says Mr. Pedersen. Of the 40-plus employees drawn from all over the world, no less than 26 are geologists and geophysicists.

Rocksource’s technology has already attracted some blue-chip shareholders in the form of Morgan Stanley (7.75 percent), DNO Invest AS (9.09 percent), Dexia Banque Internationale (5.28 percent) and JP Morgan Chase (1.82 percent). The University of Bergen, where the EM technology originated, holds a 2.5 percent interest.

CSEM a valuable extra tool
The company was established in 2004 to develop the raw, analytical technology it acquired from the university to a point where it has become a tool on which major commercial decisions can be based. According to sources, Rocksource’s advantage is not in gathering EM data, which is now widely used in the exploration industry and is assembled under contract by a number of outside parties such as emgs, Ohm and AGO.

Instead the company’s rapid growth is based on its ability to provide much more precise analysis of EM-gathered data than was possible before, thus potentially saving considerable amounts of drilling capital, and improving success rates.

The company’s core technology is related to controlled source electromagnetic sounding (CSEM), a highly specific methodology that makes possible the identification of resistivity contrasts –crucial in hunting for hydrocarbons – in the subsurface. In simple terms hydrocarbons are resistive, meaning they will bounce back electromagnetic energy to EM sensors placed on the seabed. But if the subsurface rocks are filled only with water, the energy will pass straight through.

Rocksource’s proprietary technology also addresses a problem that has long dogged the exploration industry – the frequency of misleading conclusions from apparently correct interpretations of the raw data. For instance, “false-positive” findings result from data that identifies resistivity as indicating the presence of hydrocarbons when it is something else. And “false-negative” findings may indicate the absence of hydrocarbons in a reservoir where they are in fact present.

Used properly, CSEM data is complementary to seismic data. It integrates it and other information into the entire analytical process. For example, under normal conditions seismic energy, which reacts to variations in rock density and velocity, may suggest the presence of hydrocarbons. But the evidence is not sufficiently concrete to justify expensive decisions. In contrast EM energy provides data that points much more firmly to hydrocarbon content.

Rocksource’s proprietary technology has proved especially valuable in complex, noise-filled settings that require advanced interpretive skills. This has been particularly apparent where other resistive bodies occur near the hydrocarbon reservoir, playing havoc standard interpretative techniques.

“This is why CSEM is another very useful tool in the tool box”, explains Pedersen.

Technology proves its effectiveness
The breakthrough for Rocksource’s tool came in its analysis of the legendary Luva gas discovery on Norway’s continental shelf where BP drilled a well in 1997. Existing EM technology was unable to confirm the presence of gas, although it was known to be there. That led to a collapse in credibility for the electromagnetic detection techniques available at the time. However Rocksource was able to identify the reserves by applying its proprietary analytical tools. “The Luva case was very significant for us,” says Pedersen.

Last year, the first when it explored on its own account, Rocksource tested 39 prospects on the Norwegian continental shelf. It now believes it has identified several prospects that contain promising levels of hydrocarbons. “We know which prospects are highly likely to contain hydrocarbons and which are not,” says Pedersen.

On the basis of its analysis, Rocksource has nominated blocks for the 20th round. The company is further expecting to put down its first EM-based well next year.

The firm’s confidence in its geotechnical skills has been encouraged by the performance of its on-shore fields in Texas — Drews Landing Field and New Ace Field. It drilled seven wells in 2007 on the basis of its proprietary reservoir management technology. All were put into production and are producing well ahead of target. An eighth well was drilled in December and should enter production in January.

“We turned an unprofitable business into a highly profitable one,” says Mr. Pedersen. “It comes down to the ability to use the right tools at the right time.”

Conservative financing
Although Rocksource continues to invest heavily in exploration and development, analysts give it good marks for a healthy financial position. In the final quarter of 2007, for example, revenues increased to 15.4m Norwegian krone [US$2.9m], nearly five times up on the comparable period in 2006. The company retains working capital of around 228m krone [chk], of which 148m krone is in cash. It also has access to extensive credit lines.

Looking ahead, the management team is excited by the farm-ins – the parlaying of its CSEM toolkit into a strategic move into partnerships with bigger operators. “We plan to use our technical edge to develop relations with large companies with much more extensive portfolios,” explains Mr. Pedersen. “Over 2007 we analysed the most suitable areas around the world for our technology and talked with the significant players operating there. So far we have had considerable success in negotiations. For us, this is a very exciting part of the Rocksource story.”

Broad investment could ease emerging energy crisis

It was anyone’s guess. Tensions in Nigeria, Benazir Bhutto’s assassination or a report that claimed the Organization of the Petroleum Exporting Countries (OPEC) might fail to meet its share of global oil demand by 2024. Just three of the many explanations offered up when oil peaked at $100 per barrel in January. In truth, no one knew for sure.

OPEC, the group of nations responsible for about 40 per cent of world oil supply, chose to rebuff claims of an imminent crisis, even though January 2, 2008, represented a low point. Oil costs had tripled since 2004. At the 146th (Extraordinary) Meeting of the OPEC Conference on December 5, 2007, in Abu Dhabi, United Arab Emirates, members did note ‘with concern’ that prices were volatile. The Conference acknowledged geopolitical developments were contributing factors.

But it insisted market tightness was, in major part, the responsibility of market players, ‘exacerbated by non-fundamental factors, including the heavy influx of financial funds into commodities and speculative activity in the markets’.

Having evaluated the market, including the overall demand and supply projections for the year 2008, in particular the first and second quarters, the Conference insisted that market fundamentals had effectively remained unchanged. The market was continuing to be well supplied, the members agreed, and with commercial crude stocks described as at ‘comfortable levels’, the Conference convened. Production has remained constant, yet unchanged, post January 2; as has the OPEC position.

Supply and demand
Heavy price falls followed in January, but traders warn of further runs at $100 in 2008. Some are predicting $200 by 2010. Despite OPEC’s optimism, the long term concern remains the same – the real issue is supply and demand.

Although shorter term fears in the market during the first part of 2008 mostly related to instability in Iran and Nigeria, by the end of January traders were looking to Europe, rather than the Middle East and Africa, where their real focus was on Vienna.

The OPEC Conference had agreed to convene an Extraordinary Meeting in the Austrian capital, on Friday, February 1, 2008, in case ‘necessary measures’ were required to maintain production in balance. Consumer nations called on OPEC for an increase in supply, and The International Energy Agency issued a statement on January 3, 2008, claiming that more oil production was necessary. But it was not a lone solution.

“$100/bbl may be just a symbolic figure but it is a strong reminder that consumers and governments have to implement measures that improve energy efficiency,” warned the agency. Reiterating the need for investment in efficiencies, IEA Oil Analyst David Martin added: “Governments have talked about energy efficiency a lot but not much has happened. “$100 oil is a clear signal that the market is tight. Either we have to get more production or consumers will have to use less.”

Recession and depression?
The IEA’s stark message came just three weeks after energy experts met in London to warn a Parliamentary group that the UK government was failing to recognize how oil and gas depletion could undermine efforts to mitigate climate change. Fears abounded that cheap coal would be used to fuel the country’s furnaces.

Speaking at the All Party Parliamentary Group on Peak Oil, Jeremy Leggett, Executive Chairman of Solar Century, Britain’s largest solar energy company and a government energy adviser, called on the government to enact an urgent contingency study into the prospect of declining world oil reserves. Leggett warned that failure to address oil depletion would lead to ‘a shock to the global economic system that is capable of taking us not just into the next recession, but into a depression in the way that the events of 1929 did’.
Chris Vernon, an oil analyst and commentator for The Oil Drum website, echoed the warning.

Several speakers at the meeting on December 5, 2007, claimed world oil production had reached a plateau, and that terminal decline was likely to set in before 2015. John Hemming MP, Chair of APPGOPO said: “If the government fails to act, the economic, social and environmental consequences are likely to be dire.”

New discoveries
While debates over demand, fuel alternatives/efficiencies and production costs continue, upstream developments within the oil industry have not been insignificant. The world’s second largest discovery in the past 20 years occurred at Brazil’s Tupi field, in November, 2007. Estimated recoverable reserves could reach eight billion barrels.

Galp Energia – owner of a 10 percent stake in Tupi – climbed to a record in Lisbon trading amid reports production may deliver one million barrels of crude a day. Galp’s shares more than doubled to a market value of €15.8bn.

Oslo-based Rocksource announced on January 8, 2008, that production targets for the year had been met from its US subsidiaries, exceeding 2,000 barrels of oil equivalent per day. Two days later, Swiss-based Manas Petroleum stated that a resource evaluation in north-western Albania had assigned 2.987 billion barrels of oil with 3.014 trillion cubic feet of associated gas.

Upstream investment
Despite the successes, oil suppliers in general are struggling to increase production. Investment is increasingly being seen as the panacea for the supply/demand conundrum. While some experts (Ernst & Young 2008 Global Oil & Gas Industry Forecast) predict an even more cautious approach to upstream spending in 2008, others suggest more substantial, untapped oil and gas reserves could be realised.

India – with its unprecedented growth (alongside China’s) fuelling the global oil and gas demand – is among those nations pushing to develop new energy resources. Mr M.S. Srinivasan, India’s Union Secretary for Petroleum and Natural Gas, issued a stark warning while addressing delegates at New Exploration Licensing Policy-VII road show, in Mumbai, India, on January 8.
Crude oil prices could reach $150 a barrel within two or three years, he said, and therefore the Government intended to put more efforts into oil exploration and production.

As Asia’s third largest oil consumer, the country remains fearful that soaring crude prices will curb its record economic growth. Attempts are ongoing to attract major companies such as Exxon Mobil and Chevron to invest their specialist knowledge and expertise to explore the remotest regions.
But the government is not alone in seeking to develop resources. India is competing with countries such as Nigeria to attract global explorers to search in deep waters and formerly inaccessible districts.

Several hundred experts and delegates attended the 7th International Conference & Exposition on Petroleum Geophysics, in Hyderabad, over three days from January 14-16 to discuss new upstream strategies. Supported by Society of Exploration Geophysicists USA and European Association of Geoscientists and Engineers Netherlands, the theme was: Energy Security: Exploration, Exploitation & Economics.

“This was a unique opportunity to present and share the benefits from technical experiences, achievements and advances made by fellow professionals,” said Apurba Saha, President of the Society of Petroleum Geophysicists, India. The Union Secretary for Petroleum and Natural Gas, Mr M.S. Srinivasan, stated at the conference that the Government would decide within a fortnight on a moratorium for oil exploration.

Poor infrastucture
The statement followed a request made by major oil companies to extend deadlines regarding delays in exploration. The problem was a shortage of rigs for exploration. The IEA believes poor infrastructure is an issue affecting energy resources worldwide. The agency is confident large amounts of untapped oil and gas remain available, but it fears access is limited when utilising aging infrastructure in areas of high demand.

Chronic new project delays and cost inflation mean significant delays in consumer delivery. Others are in agreement with the IEA assessment that more investment is required. Latest analysis by the IMF suggests that supply is lagging demand growth because of the increasing technological and economic challenges for oil production.

The IMF predicts a prolonged price surge will have an effect of curtailing demand—especially in the United States, by inducing greater substitution into other energy sources and by increasing incentives to conserve energy.

But tight market conditions are expected to persist and possibly intensify, assuming strong GDP growth continues in the emerging markets of India, China and others.

China’s growing economy is believed to be the most important factor in the oil price rise over the past four years, with India not far behind. Although global figures have been revised for 2008, GDP remains strong, and is likely to intensify pressure on demand whatever happens in America.

Gas to liquids in 2008
The demand issues will increase focus on synthetic fuels this year. Research and Markets, the world’s largest market research resource, has announced the addition of a report: Analyzing Gas to Liquids Market – 2008 1st Edition, to its portfolio. Major international oil companies (IOCs) such as BP, ExxonMobil, Royal Dutch Shell continue to investigate options in the gas to liquid market. South African national oil companies PetroSA remains among the most active in its production. Global LNG demand is now expected to reach more than 500 bcm/year by 2015 and 635 bcm/year in 2020.

The International Energy Agency estimates that European imports of gas from Africa and the Middle East (mainly in the form of LNG) will at least quadruple by 2030. As for long term predictions regarding crude oil? A finite source that will one day run out. Beyond that we are all guessing, even the Middle East.

Economies braced for bumpy ride

A year ago, it all seemed so much simpler. Following a bumper year in 2006, most economists were looking for a continuation of the good times into last year. Some talked about worries over the health of the US economy, but the expectation was that any downturn would be short-lived. Sub-prime may have been on many economists’ radars, but the phrase would have meant little to the public.

At the start of this year, things look gloomier. Most economists expect the US to grow by less than 2.5 percent, with a sharp slowdown in the eurozone to about 2 percent, and the UK, worse affected than many, down to about 1.9 percent.

However, thanks to continued robust growth in the likes of India and China, globally growth should stay above four percent. If this proves to be the low point in the current economic cycle, that would not be a bad performance overall.

The Organisation for Economic Co-operation and Development is trying to remain optimistic. Jørgen Elmeskov, its acting head of the economics department, said in its most recent report: “Several shocks have hit OECD economies recently: financial turmoil, cooling housing markets, and higher prices of energy and other commodities.

“Fortunately, they have occurred at a time when growth was being supported by high employment, which boosts income and consumption; by high profits and strong balance sheets which underpin investment and resilience in the face of financial losses and tighter credit; and by still-buoyant world trade, driven by robust growth in emerging economies.”

Merrill Lynch echoed the sentiment that the world economy ought to be robust enough to cope with the fallout from the credit crisis. Its global economics team wrote: “We remain optimistic that the global economy remains resilient in the face of a US slowdown, and forecast a moderation of global growth ex-US to 5.6 percent this year from 6.0 percent, even as the US slows… to 1.4 percent.”

Goldman Sachs is among those taking a more sanguine line. Jim O’Neill, its head of global economic research, said: “Our gross domestic product forecasts show a period of weaker-than-consensus growth this year, before a gradual return to trend next year.

“Our forecasts for both the US and the Bric economies of Brazil, Russia, India and China for 2008 are now below consensus. Given that close to 70 percent of all the growth so far this decade has originated in either the US or the Brics, this suggests it will be very difficult for the world to avoid a further slowing unless others surge.”

Merrill is even gloomier than Goldman on the prospects for the US this year. Its economics team wrote: “The US consumer is on the precipice of experiencing its first recessionary phase since 1991, the last time we had the combination of high, punishing energy prices; weakening employment conditions; real estate deflation and tightening credit conditions.”

It sees a sharp decline in the early part of the year. The economists wrote: “A more solid tone to the global economy and a weak dollar will help bolster exports but it is doubtful this will be enough to prevent overall GDP growth from declining in real per capita terms in the first half of 2008.” The bank expects it may take until late this year for a sharp recovery to take hold.

In Europe, inflation is a growing worry, at least in the short term. Deutsche Bank wrote: “Inflation has deteriorated and the European Central Bank hawks are growing more vocal. The question is, will growth slow enough to prevent inflation risks from materialising? We think yes, on balance.” For the rest of the world, the outlook is also uncertain.

Merrill Lynch wrote: “In Japan, a profits squeeze at smaller firms has derailed the labour market, with a bottom likely only from the middle of this year as wages resume their rise and the Bank of Japan adopts a more reflationary policy bias. In the rest of Asia, liquidity is abundant, but economic resource constraints are drawing near.

“We see upside risks to inflation, domestic asset prices, or both. Latin America looks forward to another year of solid growth.”

Some of the biggest questions remain with the UK, with the impact of the credit crunch on the housing market, and hence on consumer spending. With inflation still at the upper end of the Bank of England’s comfort zone, it may be more reluctant than others to cut interest rates in the event of a slump. If so, it will be the country as a whole, not just the capital’s financial community, that is likely to be in for a rocky year.

Ten geopolitical risks to watch out for this year

1) The Middle East
Iran: The perceived risk of military intervention against Iran’s nuclear programme is likely to remain the biggest single political influence on the price of oil. However, we continue to judge the probability of such an attack as low.

This is because: although there are conflicting assessments of Iran’s progress on uranium enrichment, most experts – including the US intelligence agencies – agree the Iranians are several years away from building weapons; diplomacy continues and there are signs that non-UN financial sanctions are starting to bite; political turmoil within Tehran is encouraging hopes that President Mahmoud Ahmadinejad’s supporters may suffer a setback in the March 2008 majlis (parliamentary) elections; and the risk military action poses to the global economy all stand to weigh heavily, especially in a US election year.

Israel/Palestine/Syria/Lebanon: Despite some positive signs from the November 2007 Middle East peace conference in Annapolis, expectations of progress on resolving the region’s conflicts are low.

2) Pakistan
Pakistan has topped international news since former Prime Minister Benazir Bhutto’s assassination on December 27 (at least until Kenya hit the headlines thanks to post-election rioting) and is probably set to remain there for some time. Pakistan has been in continuous political turmoil for most of the past year with no visible impact on market sentiment towards India.

Nevertheless, the risk which Pakistan poses in terms of exporting terrorism – to India and globally – remains a real one and another terrorist strike against the Mumbai infrastructure could have an impact on market sentiment towards India. One way or another, we expect political turmoil to continue in Pakistan for a protracted period – and for the long-term trend to remain downhill.

3) US elections
Opinion polls continue to suggest that former First Lady Hillary Clinton will win the Democratic Party primary and ultimately become the next US President, and that former New York Mayor Rudolph Giuliani will win the Republican primary. But there is plenty of scope for an upset in either party’s primary. The Democrats are expected to retain their majority in the House of Representatives and to increase their seats in the Senate from the current 51, which includes two independents.

4) Trade friction
Failure to reach agreement in the Doha multilateral trade round has highlighted concerns over swelling protectionist sentiment – especially in the run-up to the US elections – with the focus likely to remain on China’s alleged “unfair” trade practices and problems over product safety. Absent accelerated renminbi appreciation, such sentiment could rapidly spread, notably to the EU, where the Commission is seeking additional powers to impose “countervailing duties”.

5) Sovereign wealth funds
National security concerns, legitimate or otherwise, around the rising power of SWFs, their desire for greater diversification of their holdings and the emergence of new funds in China and Russia stand to fuel protectionist sentiment in Europe and the US.

6) Taiwan
The opposition ‘pan-blue’ alliance led by the Chinese Nationalist Party (KMT) looks likely to win the January 12 parliamentary election, with its candidate Ma Ying-jeou favoured to win the March 2008 presidential election, having been cleared late last month of corruption allegations that could have prevented him from running. KMT wins should bring some easing of economic constraints with China in the months ahead but are unlikely to lead to a major political shift.

7) Thailand
Despite a reconstitution of the electoral process that was widely thought not to favour supporters of the former prime minister Thaksin Shinawatra – now largely reconstituted from the banned TRT into the PPP – the PPP leader, Samak Sundaravej, announced at the end of last week that, following the December 23 general election, he expects to be able to form a (narrow) majority coalition with the support of three small parties.

Samak may be able to persuade Chart Thai and Peua Pandin, which have 65 seats between them, to join, too. PPP emerged from the election as expected as the largest single party with 233 seats out of 480. PPP’s lead over the Democrats (165 seats) is such that, in our view, the Election Commission – currently investigating 139 petitions over alleged electoral misdemeanours – looks unlikely to disqualify sufficient PPP members to alter the outcome.

The election outcome has underlined that Thailand remains a country deeply divided between its pro-Thaksin rural population and the urban middle class and elite. Political uncertainty looks set to continue.

8) Russia
The pro-Kremlin United Russia party emerged from the December 2, 2007 parliamentary elections with the majority required to push through constitutional amendments. This could help President Vladimir Putin’s intention to retain a grip on power after he steps down following this year’s March 2 presidential election.

9) Korea
The GNP’s Lee Myung-bak won last month’s presidential election (with 48.7 percent of the vote – higher than expected albeit on a low turnout), but is subject to a renewed corruption investigation. However, our judgment is that Lee will take office on February 25. Parliamentary elections are due on April 9.

Pro-business Lee is expected to put significant emphasis on economic growth but looks likely to do little to slow the growth of economic nationalism in Korea. He is also expected to foster closer ties with the US as the six-party talks on dismantling North Korea’s nuclear programme enter a critical phase early this year.

10) South Africa
Jacob Zuma has been elected leader of the ANC despite the efforts of President Thabo Mbeki. But the National Prosecuting Agency has charged Zuma with corruption and scheduled a trial for August – a move his supporters claim is politically motivated to block him from election as President of South Africa in January next year. We therefore judge that any hope of reconciliation between Mbeki and Zuma is slim and that political uncertainty will continue.

Industry prepares to be wrapped in more red tape

The regulatory burden for banks, brokers and fund managers trading in Europe is set to increase this year, as the authorities try to improve their oversight of an increasingly complex business. However, regulators must ensure there is consistency between national and European rules.

The globalisation of the capital markets, characterised by increased cross-border investment, is well-documented but less apparent are the challenges this presents to national and international regulators.

In Europe, national regulators, such as the UK’s Financial Services Authority, and multinational authorities, such as the European Commission, are increasingly required to work in partnership to ensure consistency between procedures for transacting business within a jurisdiction and between one market and another.

But while they attempt to stimulate market harmonisation, they do not always practise what they preach when it comes to the unification of different regulatory regimes. This has the potential to become a problem this year, with more reforms in the pipeline.

Consistency between regulators is sometimes complicated by the different approaches taken by these watchdogs. A recent report by consultancy TowerGroup argued the contrasts between “principles-based and rules-based approaches to financial regulation among major financial services centres will inhibit global financial regulatory harmonisation”.

The warning followed a pledge by the FSA to adopt more principles-based regulation this year, a move TowerGroup called “a radical and controversial stand against the trend in financial regulation globally, which is towards rules-based regulation”.

Political resistance
Bob McDowall, a senior analyst at TowerGroup, said: “Although they may wish to adopt principles-based regulation, most regulatory jurisdictions will be prevented from doing so by the difficulty of enacting national primary legislation and by consumer and political resistance.”

McDowall said principles-based regulation will demand “innovative approaches in the deployment of technology, presenting significant business opportunities for vendors and service providers” but added that financial institutions “will succumb to regulatory arbitrage by using principles-based jurisdictions to accelerate implementation of financial innovation”.

Such regulatory arbitrage would be mitigated, in Europe at least, by a single, centralised EU regulator – a proposal that was discussed last year. For the time being, European finance ministers are working on a comprehensive work programme, which provides for evolution of the existing framework, but the focus will be on practical steps to improve the quality of its output, rather than a leap to more centralised EU arrangements.

Some parts of the market have benefited from the co-operation between different regulators. Jon Carr, head of public policy at Swiss bank UBS, welcomed the news late last year that the US Securities and Exchange Commission will consider allowing US companies to use international accounting rules following the regulator’s decision that non-US companies could submit accounts using the international standard.

The rules eliminate the need for foreign companies to reconcile their financial statements prepared under the International Financial Reporting Standards with the US’s Generally Accepted Accounting Principles.

Carr said: “The November 2007 decision by the SEC to allow foreign issuers listed in the US to file their accounts under IFRS without reconciliation to US GAAP, was a significant and welcome step towards a high-quality, global accounting language, for which the EU authorities, led by internal market commissioner Charlie McCreevy, deserve considerable credit.”

Less well received has been the roll-out of the markets in financial instruments directive, the trading reforms led by the EC but implemented – or not, as it turned out in some cases – by the local regulator in each of the 30 European countries.

Eleven countries failed to meet the November 1 deadline for passing the trading rules into law in their individual markets, with four countries only partly hitting the target and seven, including Spain, Poland and Portugal, not getting that close.

The Netherlands and Finland left it to the day before to define how the laws would be applied in their domestic markets, despite having originally been set a deadline of January 31 to do so. The regulators have committed to catch up this year but their tardiness is causing confusion for investment companies operating in multiple countries.

Customer challenges
Jitz Desai, a director at Mifid think-tank JWG-IT, said: “The reason the EC set a January deadline for transposition was to allow companies in those markets nine months to prepare for the changes. Until the rules are enforced, investment companies may find themselves unclear as to their position regarding customer challenges.”

Recent research by JWG-IT suggests that as many as four in five European banks, brokers and fund managers expect to be questioned over their compliance with Mifid, while two in three of those surveyed think they will be called to task before the end of March.

PJ Di Giammarino, chief executive of JWG-IT, said the failure by a third of European countries to implement the rules has left “thousands of firms little time to adjust”. He added: “This is a critical time for the market, as it has taken the first few steps in the four-year Mifid implementation.”

Niki Beattie, head of market structure at Merrill Lynch, has welcomed the Mifid changes, which allow banks and brokers to challenge the quasi-monopolies historically enjoyed by European stock exchanges. However, she is under no illusion that the industry’s Mifid efforts were eased by the passing of the November 1 deadline.

She said: “Implementing regulation, like Mifid, was a great challenge last year and its impact will continue to drip-feed into this year as it is implemented fully across Europe. I suspect that we won’t see any major regulatory change this year at a pan-European level for secondary markets as the Committee of European Securities Regulators and the national regulators assess the full impact of Mifid, particularly looking at new challenges such as liquidity fragmentation.”

Beattie is convinced there will be a Mifid II at some stage, focusing on “some of the issues that arose out of the first directive and other asset classes, such as the European debt and derivatives markets”. She advises European authorities to assess the impact of the regulation that is in place, rather than press ahead with new directives.

Mifid-related problems have arisen, with brokers complaining about the lack of a centralised list of pan-European stocks, making trading and trade reporting more complex. The emergence of dark pools – alternative trading systems that allow banks, brokers and fund managers to trade anonymously, thereby reducing market impact – is another concern for regulators.

Mifid may have left some of Europe’s national regulators wanting but the EC seems to have done rather better with its voluntary Code of Conduct on European clearing and settlement. The code, which came into effect on January 1 with the backing of Europe’s top exchanges, clearers and settlement depositories, exemplifies a more flexible approach by European regulators.

Coming to Europe
Beattie also welcomes the code, arguing that clearing and settlement will come into regulatory focus this year, with the London Stock Exchange moving into these services after its acquisition of Borsa Italiana, and the Depository Trust and Clearing Corporation, the dominant US clearer, set to come to Europe with its EuroCCP.

Beattie said: “The code of conduct is not a piece of regulation and we prefer the lighter touch of the code rather than a directive, which could take another two or three years, but we also want to see progress in harmonising European clearing and settlement.”

She has argued a single clearing house could drive down the cost of clearing and settlement in Europe, making it more competitive with the US for international trading.

New regulations – including Solvency II; capital adequacy rules in the insurance sector; Ucits, which determine the practices of collective investment schemes; as well as more Mifid – are being lined up for this year, but banks are quick to warn the watchdogs against overreacting to market crises.

It is unclear how global and EU public authorities will decide to respond in the longer term to recent market developments, although the markets like the fact they have tended to refrain from any kneejerk regulatory response.

The UK’s Walker report on private equity has proposed increasing the disclosure requirements for buyout companies, while Alistair Darling, UK Chancellor of the Exchequer, is proposing reforms to the capital gains tax requirements that could force private equity firms in the UK to pay as much as 18% tax on profit.

The regulatory burden on companies trading in Europe looks set to increase again this year but, unusually, London-based investment banks seem broadly pleased with the scale and tone of regulation in Europe, citing the famous principles-based approach of the FSA as a factor in this success. However, they are quick to warn the regulators against complacency.

In an industry that thrives on innovation, it is the responsibility of regulators to ensure they are matching the pace of change set by the banks and honouring their commitment to protect investors without hampering companies’ endeavours to make money. 

Selling England by the pound

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

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

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

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

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

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

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

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

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

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

Forex, the new futures?

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

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

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

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

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

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

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

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

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

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

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

Banks’ losses fail to dampen bonus season goodwill

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

© The Financial Times Limited 2008.

Looking at the future

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

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

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

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

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

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

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

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

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

• To share thousands of files effectively and securely;

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

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

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

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

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

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

For further information: conferencing.

A combined effort

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The new economic frontiers

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Commonly accepted

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

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

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

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

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

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

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

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

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

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

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Making change good

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

The cultural revolution

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Will the Islamic boom continue?

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

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

Why Islamic banking demands new solutions

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

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

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

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

Plenty of difference – but similarities too

Islamic banks offer a range of services to their clients that mirror Western banks too, such as

Credit cards

Cheque books

ATM access

Internet banking

Mobile ‘phone banking

Flexibility built in from the start

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

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

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

Islamic banking is evolving fast

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

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

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

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

The boom has just started

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

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

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

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As Islamic banks boom, scholars are hard to find

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Energy costs

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

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

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

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

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

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

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

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

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

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

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

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