In 2008 over $500bn was being managed under Islamic principles – it’s big business and growing rapidly. Tadawul FX was the first forex broker to offer Islamic trading accounts. World Finance hears from Ramzi Chamat about the company’s success.
Month: June 2010
Paulo Pinto on the future of brokerage | DIF Broker | Video
On receiving the award for Best Online Broker, Western Europe, 2010 on behalf of DIF Broker, COO Paulo Pinto goes on to explain the merits of online investment and the global opportunities it affords.
Lehman Europe creditors could get speedier payouts
Thousands of creditors of bankrupt US investment bank Lehman Brothers owed about $22bn will be offered earlier cash payments if they are willing to accept lower valuations on their claims.
PwC, which is in charge of the collapsed bank’s main European operations, said that the majority of claims should be agreed by the end of the year and payouts made in 2011.
The traditional case-by-case approach would take years. The so-called “consensual approach” would value the claims on over 6,000 unsecured creditors of Lehman Brothers International Europe (LBIE).
“The consensual approach is an innovative mechanism which will enable the claims to be determined in an expeditious manner, resulting in significant time and cost savings to both unsecured creditors and LBIE,” said Steven Pearson, joint administrator and partner at PwC.
“The timing at which cash distributions can be made will be accelerated materially.”
The collapse of New York-based Lehman in September 2008 trapped the assets of thousands of its clients around the world, including hundreds of banks, insurers and hedge funds. Administrators have since been assessing the claims of creditors.
PwC’s proposal needs the “overwhelming majority” of financial trading counterparties to support the process, Pearson said.
Scrapping, tough economy hit May Europe car sales
New passenger car sales fell 9.3 percent in May in the EU as the effects of government support for the car industry slipped away and the economic environment remained difficult, industry association ACEA have announced.
Governments helped carmakers hit by the crisis last year with scrapping incentive schemes that boosted demand for new cars, but these have finished or are running out and carmakers are worried about the second half of the year.
ACEA said the May decline to a total of 1,129,508 cars registered was the second monthly decline this year and reflected “the end to government support schemes on the one hand and the further challenging economic situation on the other”.
In the first five months in the EU, new car registrations were down 1.9 percent.
Germany, Europe’s largest car market, whose scrapping scheme ended in September, saw a 35.1 percent dip in registrations. France, whose scheme is being phased out gradually, saw an 11.5 percent year-on-year decline in May.
Spain, whose scheme is still in place, saw a 44.6 percent increase in May, compared with a low comparison in 2009.
Data released at the start of June already showed a mixed picture in some key European car markets in May, with Spanish sales up, and French and Italian sales down, showing the impact of government support.
The head of French carmaker PSA Peugeot Citroen, Philippe Varin, said earlier this month that he expected the European car market to shrink around nine percent in 2010.
Scenario simulation methods
The first type measures the sensitivities of portfolio value to some particular market variables. Usually, a portfolio’s risk profile can be described by a large number of those sensitivities. The second type is more comprehensive as it calculates the probability distribution of the portfolio value at a given horizon. This then provides com¬mon risk measures that summarise the portfolio risk, such as value at risk (VaR).
Among the commonly applied methods to estimate VaR, the simplest is “delta approximation”. The method, however, depends on two assumptions: the normality assumption of portfolio value, and the linearity assumption of the relationship between transactions’ prices and market variables. For most portfolios, especially for portfolios with options and/or embedded options, Monte Carlo simulation is an appropriate method. The difficulty with the Monte Carlo approach is its computational burden.
The scenario simulation method described here is a computationally efficient alternative to conventional Monte Carlo for multicurrency fixed-income portfolios.
Scenario simulation provides the entire distribution of future portfolio returns. From this, not only VaR, but standard deviation and other measures of risk, such as the “coherent mea¬sures of risk”, can be computed. The scenario simulation model can be applied in estimating a portfolio’s overall risk profile of joint market and credit risks.
The scenario simulation method makes the simulation computationally practical for very large multicurrency portfolios of fixed-income securities and derivatives.
Applications to Value-at-Risk estimation and stress testing
The scenario simulation model provides an effective alternative to the delta approximation method and the traditional Monte Carlo method. We can directly apply the model by valuing each transaction and obtain the portfolio’s profit and loss distribution, and with it, the portfolio risk exposure statistics.
The scenario simulation model can also be applied to perform stress testing. VaR analysis is usually supplemented by stress testing, using the data from extraordinary historical market events. It is also important to stress test the assumptions of VaR mod¬els such as volatilities and correlations. Because of its computational efficiency, scenario simulation method is particularly suitable for such testing. In particular, the method allows risk managers to examine a portfolio’s risk exposures within the tail of a given distribution and to identify specific stress scenarios under which the portfolio may become vulnerable.
Applications to portfolio’s credit risk exposure estimation
There are three basic ingredients that go into estimating a portfolio’s potential credit risk:
1) market value of bonds and transactions for each issuer/counterparty;
2) the probability distribution of issuer or counterparty defaults;
3) the recovery rate distribution.
A portfolio will suffer a credit loss if an issuer or a counterparty defaults, the market value of the portfolio with respect to the issuer or the counterparty is positive, and the recovery rate is less than 100 percent.
Estimating credit risk is related to, but more complicated than, market risk estimation. All the above three ingredients are random, and they are usually correlated with each other. Unlike market risk management where the horizon is usually short credit risk management looks at much longer horizons, often the entire life of a transaction.
The scenario simulation model can be applied to estimate a portfolio’s credit risk exposure as well as its joint market and credit risk exposure.
This article is an edited version of
an entry in the “Encyclopedia of Quantitative Risk Analysis and
Assessment”, Copyright © 2008 John Wiley & Sons Ltd. Used by
permission.
Default risk
The assessment of default risk is also critical in the valuation of corporate bonds and credit derivatives such as basket-default swaps.
There is an important distinction between default risk under the actual probability measure and that under the risk-neutral probability measure. Typically, a decision to lend would be assessed using the former, where risk is assessed in terms of the probabilities of actual default occurrences. Decisions relating to pricing would be assessed under the latter.
Credit ratings
Ratings are based on factors such as the agency’s assessments of the firm. It will then go through public information and meet with the debt issuer to obtain further information. Ratings might be carried out independently of the firm, with ratings revealed on a confidential basis to the agency’s clients.
Recently, institutions have developed their own risk rating systems. These produce estimates of the probability of loan default. Many also produce estimates of the loss given default. Combined with information about exposure at default, this allows a bank to estimate the expected loss on a loan.
Contingent claims approaches
Some approaches to default risk utilise the contingent claim approaches that build on the limited liability rule that allows shareholders to default on their obligations provided that all the firm’s assets are handed over to creditors.
The firm’s liabilities are contingent claims issued against its assets. Default occurs at maturity when the value of the firm’s assets falls short of the value of its liabilities. Such default risk can be modelled using regular option pricing methods.
Credit migration approaches
Some classes of models are built on a credit migration or transition matrix. This examines the probabilities of any given credit rating changing to any other over the horizon period. These probabilities are assessed from historical default data and will suggest whether a firm with any given rating is likely to retain that rating by the end of the horizon period.
The best-known migration model, the CreditMetrics model, considers the forward value of a loan at the end of the horizon period for each possible end-horizon credit rating. Values are found by discounting the loan’s cash flows at a rate equal to the risk-free end-horizon forward rate, with an estimate of the credit spread for that rating. The combination of transition probabilities and end-horizon loan values enables the modeller to apply value-at-risk (VaR) analysis and obtain the credit VaR as the loan value minus the relevant quantile of the distribution of forward loan values.
Default and migration probabilities are unlikely to remain constant over time and there is a need for an underlying structural model to tie these to more fundamental economic variables. CreditMetrics uses the Merton model to tackle this, making simplifications to obtain probabilities from the joint distribution of the equity returns of obligor firms. An alternative solution is offered by the CreditPortfolioView model, which relates probabilities to macroeconomic variables.
Intensity models of default risk
This system models default as an exogenous process that occurs randomly in accordance with a fitted intensity or hazard function. These models are empirical and don’t embody any economic theory of default. They make no attempt to relate default risk to capital structure or make assumptions of the causes of default.
Since intensity-based models are based on debt prices, they can reflect complex default term structures better than some other approaches. However, corporate bond markets can prove illiquid, making pricing data inaccurate.
General problems and future objectives in default risk modeling
All models of default risk have their weaknesses, particularly their exposure to model risk. It can be difficult to discriminate between models, making it impossible to determine which model is the “best”. Even within the confines of a model there exists the parameter risk, which is calibrated rather than estimated. As calibration requires judgement, it introduces error. Evidence suggests estimates of default probabilities are also likely to be sensitive to key parameter values, such as volatilities and correlations.
The recent financial crisis has exposed the weaknesses of credit models in the starkest possible terms. Their sensitivity to key parameters and their failure to take adequate account of market conditions have been shown to be very serious problems indeed.
This article is an edited version of
an entry in the “Encyclopedia of Quantitative Risk Analysis and
Assessment”, Copyright © 2008 John Wiley & Sons Ltd. Used by
permission.
Resolution plans cash call to fund AXA deal
Acquisitions vehicle Resolution said it would fund its planned takeover
of French insurer AXA’s British life operations by raising £2bn
($2.91bn) in a rights issue.
The acquisition would cost a total
of £2.75bn, Resolution said, adding that it hoped to announce a deal by
the end of June.
The company, founded by insurance tycoon Clive
Cowdery, aims to buy and merge at least three British insurers or asset
managers before floating or selling the combined group in 2012.
Resolution confirmed that it was discussing a takeover of most of AXA’s
British operations in what would rank as its second acquisition after
the £1.8bn purchase of British life insurer Friends Provident last year.
“This acquisition would build strong momentum in Resolution’s
life assurance consolidation project, and provides a range of options
for further activity,” Resolution Chief Executive John Tiner said in a
statement.
Under the deal, AXA, Europe’s second-biggest
insurer, would sell its British protection, annuities and group pensions
business to Resolution, but would keep its wealth management and direct
protection operations in the UK.
“This potential transaction
does not call into question in any way the AXA Group’s continuing
long-term commitment to the UK market,” AXA said in a statement.
AXA said the disposal would result in a Ä1.4bn ($1.7bn) one-off
writedown in 2010, but would generate net cash proceeds of Ä1.7bn and
boost its capital strength.
Resolution said it had requested a
suspension of its shares as the deal would be classified as a reverse
takeover under stock market rules.
Spain says has not, will not make EU aid request
Spain’s economy ministry has said it had not made a request for economic aid from the EU, after a newspaper report that the EU was preparing to activate a package in case Madrid asked for it.
“This is lie. There’s no rescue. There’s nothing asked for, nor will there be, nothing, but nothing. I don’t know where they got this from,” an economy ministry spokesperson told reporters. Without citing sources, the FT Deutschland said the EU was preparing for an aid application in the months ahead for access to the fund set up to lend to eurozone countries that run into Greek-style payments problems.
Specifically, Spain might need the aid if the problems at the Spanish banking sector get worse, the report said.
However, it also cited an unnamed European Commission spokesman as saying there were no signs of a Spanish aid request at the moment.
Spain has suffered from fears that a debt crisis contagion will sweep the eurozone, particularly affecting the bloc’s weaker southern members, after Greece needed to be bailed out by the EU because of its debt problems.
But Spain saw solid demand for a new three year benchmark bond on June 10, a positive sign for the Treasury ahead of a 16.2-billion-euro ($19.50bn) redemption in July.
Spain’s unpopular minority Socialist government is having a difficult time pushing through austerity measures and reforms aimed at restoring the economy back to health and is in the midst of a massive restructuring of its banking sector.
An austerity package aimed at slashing a deficit of 11.2 percent of GDP to three percent of GDP by 2013 passed parliament by just one vote in May.
Jeffrey Mack | Guardian Life of the Caribbean | Video
As Guardian Life receives its third World Finance award, Jeffrey Mack describes how the comany’s core qualities – integrity, growth, quality and serving people – have delivered consistent success.
South Korean FX controls loom
South Korea’s government, alarmed by the wild swings of the won in turbulent markets, is close to slapping new controls on currency trading, though a news report that banks will get two years to comply calmed investors nerves.
As Europe’s debt crisis unfolded, the won’s gyrations exceeded swings of most other currencies and officials in Seoul have made it plain they would act to limit volatility that was hurting the world’s ninth-biggest exporter.
Bank of Korea Governor Kim Choong-soo threw his weight behind the plan saying it would not run counter to Seoul’s commitment to opening up its economy.
“We have never retreated in terms of liberalisation, market-opening and international regulations and have been praised for that,” he told reporters after the central bank kept interest rates unchanged.
Kim indicated it was getting ready to counter growing inflationary pressures and start lifting rates from their record low. He also said the bank was considering controls on domestic bank lending in foreign currencies to South Korean companies to limit market volatility, but did not elaborate.
Given that the won is one of Asia’s most actively and freely traded currencies and short-term debt makes up a large part of its foreign liabilities, South Korea feels particularly exposed to market movements.
In the course of one week in May, the won dropped 6.5 percent from the end of the previous week before turning to rally nine percent.
Improved stability
A senior government official told reporters that the new steps would include limits on banks’ dollar/won forward trades linked to their equity capital.
The official largely confirmed what has been mooted in the media. The limits would be set at 50 percent of equity capital for domestic banks and 250 percent for foreign bank branches to level the playing field, given they tend to have much lower capital.
“This is not aimed at imposing direct restrictions on foreign bank branches but at improving the medium- to long-term stability of our financial system,” EDaily quoted an unidentified finance ministry official as saying.
“Therefore, existing positions that they have will not be affected right away.”
The new policy was likely to include foreign currency liquidity risk controls for foreign bank branches and the authorities were considering a three-month grace period before the new rules came into force, officials told reporters.
No discrimination
The proposed rules appeared to address concerns before details of the plan emerged that any appearance that discriminated against foreign banks could hit South Korea’s standing in the eyes of foreign investors.
The EDaily also reported that the authorities would also tighten restrictions on companies’ forward trades that were announced last November alongside other regulations and came into force early this year.
It said the cap on such trades would be lowered to an equivalent of the volume of the company’s physical foreign trade transactions, down from initially imposed 125 percent.
Bankers say limits on bank’s own exposure to forward trades may help reduce somewhat South Korea’s high short-term foreign debt, but were sceptical whether it would achieve its main goal and mitigate sharp won swings.
Some economists also questioned the wisdom of implementing new controls so soon after the latest batch.
“It’s not a good sign to have to bring in a new set of rules just seven months after the last set. If the November 2009 regulations didn’t address the causes of KRW volatility, how confident can we be about another round?” said Sean Callow, currency strategist at Westpac in Sydney.
Germany, France press EU over ban on short selling
German Chancellor Angela Merkel and French President Nicolas Sarkozy
have urged European Commission President Jose Manuel Barroso to consider
an EU-wide ban on short selling of shares and state bonds.
In a
letter published by the German government on June 9, the pair said the
Commission should step up efforts to introduce tougher controls for
credit default swaps on sovereign bonds and short selling, and present
measures in the next few weeks.
“In particular we think it’s
imperative to improve the transparency of short selling positions on
shares and bonds, particularly sovereign bonds,” the two said.
“The work of the European Commission should also extend to the
possibility of an EU-wide ban of naked short-selling of all or certain
shares and sovereign bonds as well as all or certain naked CDS on
sovereign bonds,” they added.
Hernan Cheyre on Chile | Invest Chile | Video
Hernan Cheyre discusses what challenges arise in investing in Chile, and which sectors show the most potential. He also touches on the goals of CORFO and his vision for the future.
Frans Otten and John Rooymans | Lemnis Lighting | Video
The directors of Lemnis Lighting demonstrate their latest light innovation: LEDs are the future of energy efficient lighting, but the challenge is creating a warm white light instead of colder, less hospitable glows.
Dr Hans Lauermann | PwC Germany | Video
As Germany comes to terms with the understanding that there is little or no room for tax cuts, Dr Lauermman explains his expectations and hopes for reform in an occasionally anachronistic tax regime.
The age of the atom
One of the founding principles of traditional economic theory, is that
when making economic decisions, we are independent. Like self-contained
atoms in a gas, we only interact by bumping up against each other in the
marketplace.
In the 19th century, neoclassical economists such
as William Stanley Jevons and Léon Walras were directly inspired by the
atomic theory of physics. Individuals or firms were equated with atoms.
Later,
economists would compare the apparent random walk of the marketplace
with the so-called Brownian motion of tiny particles of dust or pollen
as they are buffeted around by colliding atoms. The ultimate realisation
of this atomic vision of the economy was Eugene Fama’s efficient market
hypothesis, which asserted that the actions of independent investors
would drive prices to their optimal level.
Today, risk models
used by companies and banks implicitly assume that economic decisions
are taken independently. In economic terms, we are still in the age of
the atom. But thanks to input from other areas of science – including
physics – that is beginning to change. Economics is entering the age of
the network.
It has long been known by physicists that atoms or
molecules are capable of organising themselves into connected networks,
with a dramatic effect on the material’s properties. For example, when
water freezes, large clusters of molecules spontaneously align
themselves into the highly ordered network known as ice.
In the
late 1950s, mathematicians gained insight into such phase changes
through their study of randomly connected networks. As connections are
randomly added to a large enough collection of nodes, at first most of
the connected groups will only consist of two individuals. As more
connections are added, larger clusters slowly begin to form. And at a
certain threshold the group suddenly gels into a cohesive whole, like
water freezing.
Random networks have the advantage of being
mathematically tractable, but they are a rather coarse model of society,
which – being made up of people instead of atoms or molecules – is not
like the random disorder of a gas, or the pure order of a solid, but
shows a richer and more complex structure.
This was illustrated
in the 1960s by Harvard psychologist Stanley Milgram, who performed
experiments in which he mailed out a number of letters to randomly
selected people in the US. Each letter gave information about a target
person, and asked the recipient to forward the letter to a personal
acquaintance who they thought would be likely to know that person.
Milgram was amazed to find that, although some letters never made it to
their destination, others did in just a couple of mailings, and the
median number of mailings was only six.
Thus was born the idea
of “six degrees of separation.” This became the title for a 1990 play by
John Guare, the title of the film adaptation, and eventually a cliché.
Attractive
as the “six degrees” notion is – it’s nice to think that we’re all part
of one big family – scientists have since questioned its accuracy. In
Milgram’s experiments, less than 30 percent of the letters reached their
destination, and the rest were omitted from the results. As psychology
professor Judith S. Kleinfeld wrote, the empirical evidence suggests
that the world is not uniformly connected, but more “like a bowl of
lumpy oatmeal,” with some of us well-connected, and others much less so.
While
it may be debatable to say that human society is what scientists call a
small world network, it is certainly getting smaller all the time – at
least for some things. The rapid spread of diseases such as SARS or the
recent swine flu is evidence of that. The existence of fast transport
links between countries means that diseases can spread around the world
in a couple of days.
So what relevance does this have for the
economy? Well, network scientists have recently shifted their attention
to studying financial networks – and their findings are in some respects
alarming. In recent decades, the world financial system has become
increasingly connected.
The figures below, from a Bank of
England report, show the cross-border stocks of external assets and
liabilities in 18 countries, in the years 1985 and 2005. Node size is
proportional to total external financial stocks, and the thickness of
the links is proportional to bilateral external financial stocks
relative to GDP.
Over those two decades, the node sizes have
increased by about a factor 14, and links by a factor six. As the
report’s author Andrew Haldane notes, “The network has become markedly
more dense and complex. And what is true between countries is also
likely to have been true between institutions within countries.”
Instead
of six degrees of separation, the average path length between larger
countries is now more like 1.4. This isn’t a small world – it’s a
crowded bar. Information propagates rapidly, but – as shown by the
recent crisis – so do problems. If anyone gets a cold, everyone gets it;
and a credit freeze can turn the entire network to ice. Robust
networks, such as those found in healthy ecosystems, tend to be built up
from smaller, weakly-connected subnetworks.
A first step
towards making the financial system more robust is therefore to
introduce a degree of modularity. Some ideas being floated include:
separating investment banks from commercial operations; breaking up the
largest institutions along regional lines; or introducing a Tobin tax
(or variant thereof) on financial transactions that would slow the
global flow of money.
These might make the system less efficient
in the short term, but they should also make it more robust. After all,
when it comes to deadly viruses or credit crises, “It’s a small world,
isn’t it?” is the last cliché you want to hear.
