Month: July 2014

The threat of secular stagnation

Posted on by Ashton Wenborn

Former US Secretary of the Treasury Larry Summers has been doing the publicity rounds lately – talk shows, radio interviews and op-ed columns all over the world. Summers is a man on a mission. Not fighting crime or ending world hunger, the former Secretary of the Treasury wants to warn the world of the risk global economies are of becoming entrapped in a cycle of secular stagnation.

Outside of an undergraduate economics course, secular stagnation was last considered a newsworthy subject shortly after the Great Depression, but once recovery was assured, the concept was promptly forgotten by the mainstream. Since the global economic downturn, many parallels have been drawn with that grim period in the 1930s, so it was only a matter of time before secular stagnation was brought up again. However, as far as parallels go this one appears to be fairly pertinent – and it might be threatening the meagre economic recovery the US and Europe have experienced over the past year.

“Secular stagnation refers to the idea that the normal, self-restorative properties of the economy might not be sufficient to allow sustained full employment along with financial stability without extraordinary expansionary policies,” Summers told Ezra Klein of The Washington Post in January. “The idea was put forth first by Alvin Hansen in the late 1930s. Given the Second World War and the tremendous pent-up demand for consumer and investment goods after the war, it did not prove relevant. But the difficulty our economy has had for many years now in maintaining simultaneously full employment, strong growth and financial stability makes me wonder about its current relevance. So does the rather dismal growth performance in recent years of the remainder of the industrial world.”

Former US Secretary of the Treasury Larry Summers has been touring the world, warning leaders that global economies face the threat of secular stagnation
Former US Secretary of the Treasury Larry Summers has been touring the world, warning leaders that global economies face the threat of secular stagnation

In a nutshell, Summers argues, rather pessimistically, that this recovery is not a recovery at all, but yet another sign of the chronic underuse of potential resources in the economy. Over the past two decades, economies have been kept afloat not by new investments or innovations, but by asset bubbles based on ever-mounting levels of leveraging. Meanwhile, interest rates were falling, as were rates of expected profitability of investments. Crucially, however, expected profitability was sliding much faster than interest rates.

Not new, yet still prolific
Most experts agree that stagnation was indeed a risk during the worst of the slump, which is why many governments opted to inject money into economies through quantitative easing or other methods. What is unique to Summers’ argument, though, is that he suggests modern western economies have been in this slump for the past 15 to 20 years. If correct, that would mean major economies might never return to full employment and robust growth without policy support.

“While things are looking up now, it is only because the economy was performing so poorly before,” explains David Orrell, an economist and principal at Systems Forecasting. “Summers has a plot showing that GDP for the US, Euro area, Japan, and UK only recently recovered the ground lost following the crisis in 2007. The growth rate remains relatively slow, leading him to suggest that the potential economic output has been permanently lowered. Structural stagnation provides a narrative that explains the build-up to the crisis [a savings glut], the slow recovery, and the existence of asset bubbles.”

According to Summers, one of the main causes for concern is that even before the crash in 2008 the US economy was being propped up by an enormous housing bubble. But even that was “not enough to produce any kind of overheating as measured by wage and price inflation, or as measured by unemployment relative to traditional low points,” he told Klein. Were it not for the housing bubble and irresponsible credit, not much was left to drive the US economy between 2003 and 2007. “Housing investment would have been two to three percent lower than GDP, and consumption expenditure would have been considerably lower as well, resulting in very inadequate performance,” explains Summers.

In 1938 Hansen suggested that due to a slowdown in population growth, demand for capital would lower and the world would face an enduring issue of “secular, or structural, unemployment… in the decades before us.” Of course Hansen was wrong – the 1950s and 1960s saw some of the most robust employment rates on record, and growth was solid. However, it would be foolish to completely disregard Hansen’s predictions. A lot of the progress of this period was off the back of World War II, and growth was driven by the rebuilding efforts in Europe, and Cold War investments in the military in the US.

“Population growth was boosted by a war-induced baby boom and mass immigration into the US and Western Europe. New export markets and private investment opportunities opened up in developing countries,” Robert Skidelsky, a Warwick University professor and peer in the British House of Lords, writes in the Social Europe Journal. “Most Western governments pursued large-scale civilian investment programmes. Think of the US interstate highway system built under President Eisenhower in the 1950s.”

It is therefore not far-fetched to argue that these unusual circumstances merely postponed the falling demand and employment that Hansen had foretold. It is possible that when circumstances normalised and when birth rates started falling again, the global economy once again began to move towards the slump we are experiencing today.

Bending the rules
Summers is not alone in reviving Hansen’s idea of secular stagnation to explain growth patterns in the world today. Brown University economists Gauti Eggertsson and Neil Mehrotra have recently published a paper suggesting the US economy will not recover any time soon. Despite close to zero short-term interest rates, the Federal Reserve will be “unable to generate a sufficient monetary stimulus”, which they say will lead to a “permanent slump in output”. “It’s not a baseline scenario, but I think people should at least be starting to consider the possibility that this could go on for a while,” Eggertsson went on to tell CNBC.

Source: International Monetary Fund. Notes: Figures post-2013 are IMF estimates
Source: International Monetary Fund. Notes: Figures post-2013 are IMF estimates

Neither Eggertsson, Mehrotra or Summers use the term ‘liquidity trap’, as it is understood that the current state of the economy means monetary policy is effectively being held back by the ‘zero bound’. Paul Krugman has discussed Summers’ secular stagnation theory as “a situation in which the “natural” rate of interest – the rate at which desired savings and desired investment would be equal at full employment – “is negative.” He describes a de facto liquidity trap, in which “normal rules of economic policy don’t apply. As I like to put it, virtue becomes vice and prudence becomes folly. Saving hurts the economy – it even hurts investment, thanks to the paradox of thrift. Fixating on debt and deficits deepens the depression.”

Though the argument has been mainly about the US economy, secular stagnation is certainly a global phenomenon and is best observed through the development of industry. All over the world, from Europe to Japan, industrial output has cooled off and Summers argues there is virtually no chance of the industrial world recovering within the next five to 10 years, relative to potential and employment.

Since the onset of the crisis in 2008, a number of countries have been in the habit of accumulating huge amounts of foreign reserve in an effort to maintain steady exchange rates that will benefit trade; but this practice has a knock-on effect on demand globally. As a result central banks have been left with few choices to stoke demand, so interest rates have come sliding down. “Central banks have tried to boost the economy by lowering interest rates, but instead of stimulating investment and employment the money seems to have been channelled into asset price inflation, for example, house prices in the UK or here in Canada,” explains Orrell. “The problem is that monetary policy is an indirect, top-down way of stimulating economic activity. So lowering interest rates might not have the effect that the central bank is aiming for.”

Creating demand with demand
Summers suggests the only way to tackle the long-term economic slump looming on the horizon is for countries to engage in a period of expansionary investment policy by governments. “I am convinced it would still be better to raise demand in the economy in ways that do not work through reduced interest rates but operate at any given level of rates,” he told Klein. “Consider my favourite example: debt-financed infrastructure spending. Notice several things: first, when your growth rate exceeds your interest rate – which is surely going to be true for a long time for short-term debt – then you can issue debt, roll over the debt to cover interest and still have a declining debt-to-GDP ratio. Further, debt-financed infrastructure increases GDP (see Fig. 1) by increasing productivity, which makes us wealthier and stimulates demand in an economy that is demand-constrained.

“Finally, if we fix Kennedy airport today, we don’t need to fix it tomorrow. If the concern is the obligation placed on future generations, then our accounting leads us seriously astray if it teaches us to fret over the treasury debt that will be left behind but not the deferred maintenance liability that will be left behind.”

Concerned: Gauti Eggertsson, Senior Economist of the Federal Reserve Bank of New York, has co-authored a report that raises concerns over how quickly the US economy can recover
Concerned: Gauti Eggertsson, Senior Economist of the Federal Reserve Bank of New York, has co-authored a report that raises concerns over how quickly the US economy can recover

Not everyone agrees with Summers though, and many have seen his suggestions as a pot-shot at austerity policies. He has written extensively on the subject in a series of columns for The Financial Times, suggesting that though growth in Britain is picking up, it is only because of the extent of the problem Britain has created for itself with its harsh austerity measures. The argument is that the only way to avoid a prolonged period of economic stagnation is to invest in real assets that increase an economy’s capacity. “A main problem with this thesis is that it does not fully take into account the fact that money is created by private banks whose incentives are not perfectly aligned with the needs of the economy,” says Orrell. “The central bank therefore has limited influence on the way in which money is invested (which is one reason so much ends up in unproductive things like real estate). So one way to tackle this problem at source is to go to 100 percent reserve banking, and prioritise business investment.”

One of the main arguments in Summers’ theory of secular stagnation is that central bank policy is fuelling the creation of bubbles, but if it were succeeding in creating adequate demand, it is also likely the fiscal stimulus necessary would lead to huge increases in nominal interest rates. “I would argue that central bank policy, plus the fact that most money creation is private, is creating bubbles; and this has an indirect effect on employment,” says Orrell. “We need investment in green projects which don’t necessarily boost economic growth as measured by GDP. So I would say that he has put his finger on a central problem of the economy, but for solutions we need to look more critically at the way money is created and invested in the first place.” Secular stagnation need not be a threat, and should instead be an opportunity to re-evaluate economic models that pursue indiscriminate growth ahead of a healthy and sustainable economy.

Mexico’s reforms make the country increasingly attractive to investors

Posted on by Ashton Wenborn

At a time when money is flowing out of emerging markets, particularly those in Latin America, Mexico stands as a bastion for investment, pulling in record flows as its growth continues to excel. Key reforms and trade agreements have helped make it the 11th-largest economy in the world, with $1.845trn in purchasing power, according to the World Bank. Its exports and manufacturing far exceed that of its Latin American neighbours, and despite erratic growth in recent years, Mexico is currently attracting unprecedented investor attention. With the Mexican Stock Exchange growing (see Fig. 1) and currently valued at some $451bn – second to only Brazil in Latin America and fifth in all of the Americas – banks and investment firms are heralding this as an economy to watch.

Now, a deregulation of major sectors such as energy and telecoms could finally boost the economy once and for all, making Mexico one of the brightest growth stories out there. Financial firms are currently seeing a second wind as key reforms are ensuring more open and regulated markets. With Mexico already racking up a track record for incredible manufacturing booms, as witnessed by its auto industry following the implementation of NAFTA in the 1990s, the economy is quickly becoming a favourite recommendation of major firms like HSBC and Scotiabank. With emerging economies in the region experiencing poor growth following the global deceleration in commodities, as well as a slowdown in manufacturing, Mexico is currently the only LATAM economy which investors can assuredly invest their money in. Mexico’s economy is the happy product of trade deals, as well as broad and effective deregulation, which has transformed the economy.

International trade
The main driver for Mexico’s growth was its adoption of NAFTA in 1994, which nearly tripled its trade with the US and Canada and made it the largest trading nation in Latin America. At the time, Mexico, similar to many current Latin American economies, was developing and had a somewhat protectionist economic stance. NAFTA helped create a more open, value-added and focused Mexican economy, led by an outward-focused manufacturing sector rather than by commodities, or in some cases inward-looking manufacturing, which dominates the rest of the region. This is highlighted by the fact that Mexico exports 1.8 times more manufactured products than the rest of Latin America combined, despite its economy being only 32 percent of the size of the rest of the region. What’s more, data proves that this divergence coincides with Mexico’s entry into GATT and NAFTA, as manufacturing exports grew from eight percent of GDP in 1980 to 18 percent in 1995, and 23 percent by the end of 2012. By way of comparison, South American manufacturing exports as a share of GDP have mostly hovered in a three-to-six percent range.

[T]he economy is considered a strong bet for growth from 2015 onwards as the effects of fiscal and industry reforms start to take effect

In addition to this, Mexico is also party to a number of free trade agreements including deals with the EU, the new Latin American trade bloc, Pacific Alliance, and the proposed Trans-Pacific Partnership, which would include the US, Singapore and Australia in addition to various other Pacific nations.

“International and bilateral trade deals have made Mexico more competitive by changing production costs, rolling back protectionist trade stances and making the economy more open. Because Mexico keeps pursuing competitiveness, we look at the economy favourably and believe we will see a trend of growing GDP bringing growth over 3.5 percent from 2015 and onwards,” explained Andre Loes, HSBC’s Chief Economist for Latin America.

Opening up energy
International trade deals aside, the Mexican government has also worked hard to reform its economy by opening up key sectors such as automobile production, energy and telecoms. This has helped bolster Mexico’s economy, the GDP of which plunged 6.5 percent in 2009 as exports dropped during the financial crisis.

The most important recent reforms have opened up Mexico’s energy sector. So far, one player has dominated the energy market for the last 75 years: government-run Petróleos Mexicanos, otherwise known as Pemex. However, this will soon be in the past, as President Nieto surprised global investors last year by gaining support for a constitutional change to open up one of the most closed energy sectors in the world to foreign investment and refashion Pemex into a for-profit company within two years. Analysts from consulting firm McKinsey expect the move to attract $20bn of investment by 2016 alone.

“The energy reform will allow for private company intervention in a notoriously closed market,” said Loes. “Given the size and perspectives of Mexico’s oil fields and shale oil and gas, energy will be a very important sector to invest in”.

There are big opportunities for the domestic economy and foreign oil companies as Mexico is estimated to have 54.6 billion barrels of oil in conventional resources, and 60.2 billion in unconventional, according to Pemex figures. Lower energy costs would help Mexican consumers and boost domestic demand. With electricity and gas prices higher than any other North American country, Mexico is keen to invest in its energy sector and bring down grid prices. This is also why the government is pushing for private companies to produce shale gas in northern regions, in addition to promoting partnerships on deep-water drilling projects in the Gulf of Mexico.

Financial sector stability
In addition to the convergence in manufacturing and energy development, Mexico’s financial system has also become more integrated with the rest of the world, making its financial services some of the most stable and regulated institutions in the region. Reforms opened the country’s financial system to foreign players in the late 1990s and recent changes have contributed to the country ranking 30th globally for its ‘soundness’ according to the World Economic Forum.

Analysts suggest that engagement with foreign institutions through NAFTA led to strong financial standards being set up by local regulators, plus the supervision of parent companies from various countries. In addition, the presence of major banks also helped Mexico import institutions from mature financial markets, and has contributed to a banking system with an average tier-1 capital ratio of 15.7 percent. “As part of the efforts to make the economy more competitive, there has been a continued push to reform institutions (with different levels of success over time), but which has over the past 20 years resulted in an independent and credible central bank, relatively liquid financial markets (one of the most liquid forex and fixed income markets in all emerging markets, and in some metrics, even a rival to lower tier developed markets), as well as a stronger balance sheet and solid institutions,” explained Eduardo Suárez, an analyst at Scotiabank, in a recent report on the Mexican economy and the impact of NAFTA.

Source: World Bank. Notes: Figures are for domestic listed companies
Source: World Bank. Notes: Figures are for domestic listed companies

By allowing for capital market integration, the domination of foreign banks and eliminating restrictions on trading, Mexico has managed to successfully link domestic incentives with those of foreign players, and this again is opening the economy to much needed foreign investment.

Balancing China and the US
That said, the Mexican administration continues to face many economic challenges, including improving the public education system, upgrading infrastructure, modernising labour laws, and fostering more private investment in the energy sector. To this end, the president has stated that his top economic priorities remain reducing poverty and creating jobs.

Dealing with labour issues is especially important as Mexico continues to compete with China when it comes to low-cost manufacturing. Although its auto-industry reigns supreme as the top North American producer, China has already caused several shocks to the Mexican economy since its entrance into the WTO in 2001, which led the Latin American economy to adjust its wages and increase trade through more reforms in order to remain competitive. Despite Mexican exports taking a slight dive in the early 2000s, there seems to be a clear lesson that developing economies can compete with the Chinese if non-protectionist policies are encouraged.

Mexico has made itself extremely dependent on trade, and as with any open economy, this makes the country especially subject to structural changes in the global economy and particularly the US, which currently absorbs about 80 percent of Mexico’s exports. Consequently, analysts at Scotiabank suggest that education reform will be crucial for the country to step up productivity and become less reliant on the US.

Finally, what’s really key for Mexico is to boost its levels of foreign direct investment (FDI). As of now, the economy is considered a strong bet for growth from 2015 onwards as the effects of fiscal and industry reforms start to take effect. According to HSBC, this will boost investment flows into the Mexican auto, energy and electronics industries, and FDI is sure to pick up as the energy market continues to develop in line with ongoing global demand. As a result, Mexico is poised to become the fifth-largest economy in the world by 2050, making it one to watch among emerging markets.

Emirates could buy 80 superjumbos from Airbus by 2020

Posted on by Ashton Wenborn

French aircraft manufacturer Airbus has been called on by its biggest customer, Emirates, to fit its four-engine A380 superjumbo with new Rolls Royce motors to boost poor sales. Emirates Airline has said it will buy 60 to 80 A380 aircrafts if the planes are revamped to include fuel-efficient engines, weight reductions and improved aerodynamics.

President of Emirates Airline Tim Clarke said his company was willing to purchase additional aircraft on top of the 140 that have already been acquired from Airbus. The fast-growing Gulf carrier has publicly called on Airbus to start work on the new planes in order for them to ready for service in six years time.

Known in the industry as the A380 Neo, Airbus is yet to commit to manufacturing the new plane, despite Emirates saying it will buy them. Instead, Airbus will assess the reengineering of the A380 to ascertain if it is possible to have the aircraft ready sometime in the 2020s.

Clarke has stressed that Airbus should treat the matter with urgency

Clarke has stressed that Airbus should treat the matter with urgency and talk to other airlines soon to find out if there is suitable demand for the revamped carrier. In an interview with the FT, the Emirates president said:“Airbus need to get on with the job and say ‘this is how [an A380 Neo] will look and this is what [the aircraft] will do and this is the price we will charge in 2020’ and go out and test the market.”

Airbus does not agree. Chief Executive Fabrice Brégier has stressed there is “no urgency” to drop its current plans and press ahead with manufacturing the untested airbus. The French company, which posted profits of €21.1bn in May, said its main priority is to continue growing the sales of the existing superjumbo, dubbed the new “Queen of the Skies”.

The A380 can carry 500 passengers, making it the largest airborne people carrier in the world. The catalogue price for one is $414m, so the purchase of 80 would cost Emirates billions. With Emirates and Airbus at loggerheads, however, it looks unlikely that sale will happen before 2020.

Alex Brummer: banking system is ‘still living on crack cocaine’

Posted on by Ashton Wenborn

Six years on from the financial crisis, and the banks are still seen as villains. But is the reputation fair? One man who has been deeply critical of the ways in which banks have conducted themselves is Alex Brummer, financial journalist and author of Bad Banks: Greed, Incompetence and the Next Global Crisis. World Finance speaks to the writer to hear this views on why we need – in his words – a return to “plain vanilla utility banking”.

World Finance: Well Alex, everyone’s pointing fingers at banks, but are they as bad as people make out?

Alex Brummer: The record is pretty bad, and hasn’t got any better. You’d have thought that, you know, six years after the crisis, things would have calmed down, but there’s scarcely a day when there’s not some sort of regulatory action against the banks, and some new problem that we find.

Most recently we found a problem in the area of stock market trading, in a mysterious area called dark pools. And so there’s always a new area where intervention is taking place.

World Finance: As regulators and governments have tried to stabilise the industry, skeletons have come out of the closet. But surely that was inevitable?

Alex Brummer: I don’t think it was inevitable! I think that what’s interesting is that a lot of this behaviour took place since the financial crisis.

So we had the crash, which was 2007-8-9, that was a huge shock to the financial system; many of the banks had to be bailed out by governments. But many of these new actions which we’re finding – problems in the foreign exchange markets, problems in dark pools, problems of selling products to consumers which they shouldn’t really be buying – have come up since the crisis.

So that suggests that none of the lessons that they learned in the period leading up to the crisis have been learned!

World Finance: Well regulators have been working very hard to get rid of bad habits, so, have banks now cleaned up their act?

Alex Brummer: A lot of this is a kind of wash, an attempt to sort of, look better than they are, that the culture is changing and so on.

[T]here’s scarcely a day when there’s not some sort of regulatory action against the banks, and some new problem that we find

I also think that the regulators have changed their attitude too. I always regard it a bit like a football match, where the referee didn’t give a penalty in the first half, but now he’s giving out lots of penalties because he realised he was too soft in the first period of the problem.

And so that’s why a lot of these things, these skeletons, as you referred to them, are tumbling out of the cupboard.

World Finance: So which banks would you say are the worst? In your opinion?

Alex Brummer: I don’t know, I mean – a case for measuring that. But you could look at some of the fines which have been levied.

So one of the banks which came out of the crisis most strongly – JPMorgan Chase in the US – has actually now had the biggest fines on mortgage securities. It paid fines of $17bn. BNP in Paris, that paid a fine of $9bn.

Here in the UK, Barclays have been involved in almost every scandal you can think of: interest rate fixing, foreign exchange market fixing, a problem in the gold market, a problem in the dark pools which we referred to before – that’s the shared dealing markets in the US. Almost every area of activity that they’re involved in, they’ve had some disciplinary action.

World Finance: Well you talk about interest rate fixing, mis-selling, dark pools for example; some of these practices aren’t illegal, and there’s definitely a grey area there. So what’s the problem?

Alex Brummer: We have to be very careful here, because many of these cases now are actually being looked at by prosecutors. In particular the activities in the foreign exchange market, in the activities in the Libor market. A number of people have been arrested, a number of people have been charged. And we’re waiting for some of these cases to come to court as we speak now.

So in fact, that does suggest that there was some measure of illegality that went on. Although it’s only allegations at the moment.

World Finance: So where did it all go wrong? Do you think it was a case of bankers just thinking they were invincible?

Alex Brummer: I think that they live in a world of their own. I think that they feel that there is a kind of sense of entitlement in the banking world, and the bonuses in the banking sector drives a very bad culture. So the profit motive is far too strong. People are incentivised to push the boundaries as far as they can to try and improve performance and improve their bonuses.

I think if we controlled the bonus culture, made it much more long-term, that would be a big start in cleaning up the whole process.

World Finance: Well there were other industries that exposed economies on a large scale: insurance or other brokers. Are they equally to blame?

Alex Brummer: In the past they too have been involved in big mis-selling scandals. They were involved in the wrongful selling of endowment policies, the wrongful selling of private pensions to people in the public sector. So they’ve made big mistakes in the past.

I actually do think that they have cleaned up their act quite a bit. We’re seeing much fewer complaints. But you do get complaints about the way insurance is sold and so on. But it’s on a much lesser scale. And I think the banking system is where it’s really gone badly wrong.

World Finance: Now do you think there’s a case that maybe banks have had a little bit of unfair publicity? Because they were after all working under the remit of governments? So surely they should be to blame?

[T]hese skeletons, as you referred to them, are tumbling out of
the cupboard

Alex Brummer: I just think that they got out of control. While the profits were flowing in, nobody complained. When the public had to pick up the pieces? After the financial crisis, here in Britain we had to pump a trillion pounds into the banking system. A lot of that we haven’t got back.

People forget that we still own, all these years afterwards, 80 percent of the Royal Bank of Scotland. We still don’t know the story of what happened to HBOS. So you feel we’re part of a kind of conspiracy, in which the taxpayer is picking up the bill. The bankers walk off with the profits, and the taxpayer picks up the bill every time.

World Finance: So who would you say are the major players today, and are we just waiting for more scandals to hit?

Alex Brummer: We just don’t know; the regulators are looking at a whole series of things which they’ve never looked at before. So one of the things that has tumbled out of the cupboard most recently is the breaking of financial sanctions.

So, governments throughout the world, through the UN, have taken steps to prevent the flow of finance to countries like Iran, to Sudan, to Al-Qaeda and so on; and it now looks like a number of banks – BNP Paribas and HSBC are allegedly involved in this, Standard Charter here in the UK are allegedly involved in this – a number of banks have set up whole, complete systems to circumvent laws which have been put in place by governments, by the UN, by the European Union, in order to go around that to make money.

And those particular cases are now coming up now very strongly.

World Finance: Well you have suggested that we haven’t resolved the problems that led to the credit crisis six years ago, and in fact we could be headed for another one. How can we avoid this?

Alex Brummer: Probably the way we’re going, which is to try and change the culture of the banks, change the behaviour of the banks, and change the focus of the banks.
What we really need to focus on is what banks are there for. They’re there to take deposits; they’re there to make loans to companies, corporations, small businesses and individuals.

What we’ve seen is, the banks have found these other activities in financial markets, speculation of one kind or another, to be much more profitable. And so the rollback of trading on your own behalf, principal trading by banks – that’s a very important development.

And what I would like to see is a return to plain, vanilla, utility banking. Where banks do what they’re meant to do.

World Finance: Well finally your book says that the failings of the world banking system are threatening to undermine the future security of economies. How exposed are we?

Alex Brummer: We’re still living on – I suppose you’d call it crack cocaine. The US Federal Reserve has been pumping trillions into the market. It’s still doing so, and it will be doing so for most of this year, until the autumn of this year.

The problem is, when that stimulus is removed, we may see some more cracks in the system. In the emerging markets, some of the weaker banks in Europe which have still to address their serious problems. And so I think we may feel we’re getting better – prosperity is returning, the financial system is becoming normalised again – but I feel that when that artificial stimulation is taken away and the interest rates return to a proper level, we may have another series of problems. Particularly in the emerging markets.

World Finance: Alex, thank you.

Alex Brummer: Thank you.

LEI promotes transparency across financial markets

Posted on by Ashton Wenborn

The LEI is well on its way to establishing more transparency around financial transactions and markets. Its implementation will highlight some specific data management challenges, but its benefits for financial institutions and firms are wider reaching than simply reporting to regulators.

The problems financial institutions had to deal with in 2008 included the understanding that they faced full exposure to one another. Underscoring the need for additional transparency and regulation in the financial markets is the ability to uniquely identify financial interconnectedness. When the Lehman Brothers collapsed, both financial regulators and the private sector were unable to assess quickly the extent of market participants’ exposure to Lehman, or to fully trace how the vast network of participants were connected to one another.

Subsequently, regulators identified the failure of risk management processes and controls as a significant contributory factor, and focused on developing the macroeconomic tools required to monitor systemic risk. As a result, the demands for transparency on firms and understanding exposure across the business have increased.

The LEI provides the glue that will allow firms to uniquely identify and map business entity data to the many public, proprietary and internal identifiers utilised by the
industry today

Over the years, industry bodies such as the International Standards Organisation attempted to establish a global entity identification system, but efforts could not achieve the level of coordination needed to launch a single global solution. Neither was there the regulatory impetus in place required to drive broader adoption. While there are currently many ways to identify entities in financial transactions, there is lack of a unified global system to identify and link data to enable financial regulators and firms to better understand the true nature of risk exposures across companies, markets and jurisdictions.

Initiating a LEI
Post 2008, the G20 nations tasked the Financial Stability Board (FSB) – a supra-national regulatory coordination body – to prepare recommendations for a global LEI governance and implementation framework. Coordinated worldwide commitment has helped overcome previous impediments to developing a global LEI system, which is expected to be a significant achievement in responding to the vulnerabilities of the financial system, and provide meaningful long-term benefits for regulators and market participants alike.

The LEI is designed to be a unique and persistent entity identifier enabling risk managers and regulators to consistently determine parties to financial transactions instantly and precisely on a global basis. It will be a common pervasive code to supersede the many proprietary vendor and internal codes already in existence. Aside from an initial registration fee and an annual maintenance fee paid by the firm requiring a LEI, it will be free of licensing conditions to encourage adoption.

Within scope are legal entities, subsidiaries and fund structures, banks, fund managers, corporates, partnerships, trusts, municipal corporations, government departments and charities which all require LEI. Individual persons, branches and operating divisions, however, are out of scope and therefore do not.

When industry adoption of the global LEI reaches critical mass, data reported both externally to supervisors and internally for risk management purposes will be more reliable. The global LEI will enhance the ability of regulators to monitor and analyse threats to financial stability and the ability of risk managers to evaluate their companies’ risks. It promises to facilitate improved risk analysis, supervision and regulation, reduce cost for industry in collecting, cleaning, and aggregating data, and in reporting data to government regulators. It also mitigates operational risks of private firms and improves their internal risk processes, and enhances the industry’s market discipline.

The LEI system is an alphanumeric code and associated set of reference data items to uniquely identify a legally distinct entity that engages in financial market activities. Following a robust International Organization for Standardization (ISO) process, ISO Standard 17442 was created as the new LEI standard, and made publicly available in May 2012. This global standard is endorsed by the G20 as a 20-digit code with associated ‘business card’ information.

Successful operation of the Global Legal Entity Identification System (GLEIS) – which was officially launched in March of last year – will require support from the global regulatory community, private sector firms, and industry associations. The endorsed recommendations define clear roles for public and private sectors. The system is based on two components, a governance model and an operational model.

For the governance model, the GLEIS is overseen through a Regulatory Oversight Committee (ROC), which was established in January 2013. The ROC has a plenary of members and observers from more than 70 authorities as well as a regionally balanced executive committee taking its work forward. Its standing committee and a secretariat in Basel, Switzerland, support it on evaluation and standards.

The Central Operating Unit (COU) will be the principal operational arm of the global LEI system. The private industry will participate and consult on the development and operations of the COU. Established as a not-for-profit foundation, it will also be based in Basel, but is not yet fully functional. In particular, the COU is responsible for ensuring the application of uniform global operational standards and protocols.

It will guarantee that all parties implementing the GLEIS will adhere to governing principles and standards, including reliability, quality, and the uniqueness of the LEI.

Local implementation will be conducted through a federation of Local Operating Units (LOUs), which will benefit from local knowledge of infrastructure, corporate organisational frameworks, and business practices. LOUs will register and validate applications for LEIs, issue LEIs, and maintain the associated reference data.

Progress of the LEI system to-date
Considering the scale of the initiative there has been significant progress since the G20 mandated the FSB in November 2011. Over the last year, there have been several developments towards full operational deployment. The ROCs implementation of a clearly defined governance framework laid the foundations for the use of pre-LEIs allocated by endorsed pre-LOUs in regulatory reporting – until the COU has been established all endorsed LEIs have ‘pre’ status as do the LOUs that allocate them.

The momentum has been further strengthened by the European Banking Authority (EBA), stating that all EU credit and financial institutions apply for pre-LEIs by the end of 2014 for supervisory reporting. Similarly, in the US, the Securities Industry and Financial Markets Association (SIFMA) has called on the Financial Stability Oversight Committee to encourage the adoption of LEI among regulators for financial reporting.

As of April this year, 13 pre-LOUs have endorsed status and this interim system of pre-LOUs and pre-LEIs will continue until the COU is set up and the GLEIS becomes fully operational. At this point, pre-LOUs will convert to LOUs, pre-LEIs will transition to LEIs, and LOUs will begin issuing LEIs. Initial adoption of pre-LEI has predominantly resided among firms that trade OTC Derivatives.

Dodd-Frank in the US and EMIR in Europe both require pre-LEIs in trade reporting, while regulators in Hong Kong (HKMA), Singapore and Australia are also introducing rules to use pre-LEIs. In addition, their use has been mandated for Solvency II reporting by EIOPA, the insurance and pensions regulator in Europe. Looking forward it is expected that the LEI will also become a requirement for AIFMD and Markets in Financial Instrument Directive II (MiFID), which will broaden across asset classes.

As the number of use cases increases, it is safe to assume the number of institutions applying for and utilising LEIs will increase significantly. Eventually it is expected that LEIs will be included in every financial transaction concerning a financial instrument as a
matter of course.

There are challenges however, as the practice of issuing and tracking LEIs becomes more complex once LEI operations have begun. With pre-LEI portals continuing to emerge in several markets, data management professionals will have to cope with the on-boarding and maintenance of LEIs from multiple venues. Without cross reference to alternative identifiers, firms need to manually map pre-LEIs into systems and apply corporate actions on an ongoing basis to maintain data provenance.

As regulatory mandates overlap, firms need to establish a holistic approach to data management to facilitate aggregation of risk exposures. This is done by connecting the disparate data held on counter parties, clients, obligors and issuers. As an identifier with a limited set of reference data, the LEI alone will not resolve all of these challenges.

The full benefits will be realised only when the LEI is packaged with additional content, such as broader entity hierarchies and linkages to the securities master, to provide transparency of organisational structure and risk exposure.

The LEI provides the glue that will allow firms to uniquely identify and map business entity data to the many public, proprietary and internal identifiers utilised by the industry today. It is that mapping and deployment across the enterprise that will yield the true benefits.

Within this model, the LEI could significantly reduce the amount of time to aggregate entity data across different systems, for a view of enterprise-wide risk exposure to a single name issuer or group of issuers by way of the securities held in an investment portfolio or fund.

From the collapse of Lehman Brothers, it is clear how important this structure is to regulators, firms and to the market as a whole. The LEI may primarily be intended to provide regulators with the tools to monitor systemic risk, but in light of its obvious benefits it is worthwhile for all market participants to accept its challenges.

Marc Faber’s financial predictions are the ones we fear, but need to hear

Posted on by Ashton Wenborn

Predicting the highs and lows of the global economy is how fortunes are made and reputations secured, but few people have accurately forecasted major economic shifts with much consistency. However, one man has been doing just that for over three decades. Swiss-born investor Marc Faber has developed notoriety for being a contrarian investor, but despite frequently going against the grain, has successfully warned of impending downturns in markets many months before any of his contemporaries.

Often outspoken, controversial, but more often than not prescient, Faber has cultivated a reputation that’s seen him become a regular commentator on the global economy, touring television studios and conferences the world over. World Finance has taken a look at his career, his biggest predictions, and how he sees the global economy developing in the coming years.

Swiss-born Faber began his career working at financial institutions in New York, Zurich and Hong Kong during the early 1970s. However, he relocated to Hong Kong in 1973, reflecting his enthusiasm for a market that offered intriguing new investment opportunities. In 1990 he launched his own advisory firm, Marc Faber Limited, and is now based in the Thai city of Chiang Mai. He keenly travels the world, advising investors on his differing investment beliefs, while also acting as a fund manager for wealthy private clients.

Faber is such a popular subject for financial journalists because, unlike other economists, he would stick his neck on the line

Gloom, boom and doom
Faber is often labelled a contrarian investor, a strategy that few people are brave enough to pursue. Such investors deliberately take an attitude that is against conventional wisdom, and look to profit from being apart from a herd mentality. While many analysts will be enthusing about a certain stock – therefore driving it up – the likes of Faber will perhaps look at the stocks that were being sold off for value.

The nature of being a contrarian investor is to proclaim ideas that are completely opposite to the consensus, and Faber has certainly succeeded in getting his seemingly outlandish views heard. He has made many of his most notorious predictions about how he sees the global economy developing, alongside his sometimes-colourful way of describing the big issues. He is famed for predicting many of the wild fluctuations to hit global stock markets over the last three decades.

Through the 1980s, while markets were notoriously surging upwards, Faber was a rare voice of caution. He advised his clients in the months preceding the October 1987 crash to withdraw their money from the stock market, saving many of them from the colossal losses that others suffered. He would then go on to make a considerable amount of money from seeing the impending bursting of the Japanese economic bubble in 1990, the collapse of US gaming stocks in 1993, the Asia-Pacific financial crisis in 1997 and the ensuing turbulence it caused to global markets.

As a result of these predictions, Faber became – certainly in Asia – the go-to person for those looking for a unique financial voice. His forthright opinions on how the markets will perform have established him as a solid source for journalists, who frequently asked for his predictions. Hong Kong-based journalist and author Nury Vittachi has worked with Faber over the years, and in 1998 published a book, Riding the Millennial Storm: Marc Faber’s Path to Profit in the New Financial Markets. He told World Finance that Faber is such a popular subject for financial journalists because, unlike other economists, he would stick his neck on the line.

“In principle, we [financial journalists] always loved Marc because he would actually make a prediction. Most of the others came out with the market may go up or it may go down or it may go sideways. He actually had an opinion – whether it was wrong or right, it was a solid opinion from a highly intelligent and analytical source, so it had more value than other people’s financial notes.”

Such is his confidence in his opinion that, according to Vittachi, Faber has staked his treasured ponytail against the performance of the stock market: “…he was so sure of his prediction of a turn-down in the market that he bet his ponytail against it. I was writing the daily financial gossip column in the South China Morning Post at the time and we kept a tight watch on market movements and ponytail length. At one point he had to get one cm cut from his ponytail because the market rose a certain amount.”

Unique insight
Faber recently spoke at an event in London to an audience of investment specialists and entrepreneurs. While many of those in attendance would already have clear ideas as to how they saw the world economy, Faber enthralled the room the minute it was his turn to speak. The event, titled ‘Where next for equity markets and entrepreneurial ambition’, was arranged by global investment firm Meridian Equity Partners in order to help those within the industry get a unique perspective on how the global economy will play out in the coming years.

Meridian’s CEO and founder, Anthony Venus, told World Finance how he first encountered Faber. “I first hired Marc in 1998 for an Asia Business Forecast and watched him go toe-to-toe with Paul Krugman on stage, and it was clear that he had a really unique point of view on the markets, beyond traditional economics. Later in 2003 I hired him again to speak to clients, right after he published a book called Tomorrow’s Gold when the gold price was $400 per ounce, he was urging to stock up on gold. I should have listened back then, although I got in around $600 and still did reasonably well.”

Over the last decade, Faber’s predictions have continued to be accurate, while at the same time pessimistic. At the turn of the century, Faber accurately predicted the sharp rise in price for many commodities, including oil and precious metals. He was also an early proponent of the potential of many emerging markets, most significantly China. In his book, Tomorrow’s Gold: Asia’s Age of Discovery, Faber laid out his belief that the world was undergoing a shift as profound as Europe’s late-fifteenth-century golden age of discovery and the nineteenth-century industrial revolution, pointing to Asian economies as those set to dominate the world for decades to come. By contrast, he also was correct in his prediction of a steady decline in the value of the US dollar since 2002.

The onset of 2008’s global financial crisis led to Faber’s pessimism regarding the US economy, especially in light of the Federal Reserve’s policy of sustaining extremely low interest rates. Such a strategy would eventually lead to the US economy experiencing the sort of hyperinflation seen in countries like Zimbabwe, Faber told Bloomberg in 2009.

Indeed, he has become renowned for his negative attitude towards US economic policy. A staunch critic of the US government over the last decade, Faber believes that the country has outsourced many of the industries that once propelled it to super-power status. In one of his Gloom, Boom & Doom newsletters from June 2008, Faber mocked the US governments’ economic strategy, adding that the country no longer had any serious domestic industries.

“The federal government is sending each of us a $600 rebate. If we spend that money at Wal-Mart, the money goes to China. If we spend it on gasoline it goes to the Arabs. If we buy a computer it will go to India. If we purchase fruit and vegetables it will go to Mexico, Honduras and Guatemala. If we purchase a good car it will go to Germany. If we purchase useless crap it will go to Taiwan and none of it will help the American economy. The only way to keep that money here at home is to spend it on prostitutes and beer, since these are the only products still produced in the US. I’ve been doing my part.”

Asian ascendance
His enthusiasm for Asia – and in particular China – is not unbridled. He sees a housing bubble emerging in many Asian economies, with an influx of foreign buyers taking up residence in cheaper Asian locations. In May he told business website King World News that he highly recommended buying up Asian real estate. “Over the last 12 months I increased my positions in Vietnamese shares significantly. And I also increased some real estate holdings in Vietnam. I think we have kind of a bubble in real estate in Thailand. But I can see that real estate markets are very fragmented, and I’ve seen that in the US as well. So, yes, prices of real estate in Chiang Mai have gone up substantially, but I see zillions of Chinese now coming to [live in] Chiang Mai.”

As well as excelling in real estate, Asia’s new status as the focus of the global economy meant that foreigners were increasingly travelling to all over the continent on holiday. Faber told Barron’s recently that the global economy will tilt towards eastern economies, and that the newfound affluence within Asian countries was spurring the region’s tourism sector. “From Vietnam, Laos, and Cambodia to Singapore, Malaysia, and India, tourism in the region is on the rise, propelled by the Chinese. This year, Chinese tourism in Thailand is up 90 percent. Twenty and 30 years ago, the largest tourist groups in Asia were Europeans and Americans. Today, the Chinese dominate. This is an example of how the centre of economic gravity is shifting to Asia from the Western countries.”

The coming years are not going to be as smooth as many central banks and finance ministers are suggesting, according to Faber. He believes that as Asia takes a central role in global economics, the older Western economies will have to get used to looking east for their income. Indeed, he has likened Europe to merely a museum for newly enriched Asian travellers eager to see the world, and that tourism will increasingly be a crucial part of the region’s economy.

More immediately, he believes that global stock markets are heading into treacherous waters once again, and within the next year could face a crash of the same magnitude as the one in 1987. He told CNBC’s Futures Now programme in May that things are likely to be particularly bad over the next 12 months. “I think it’s very likely that we’re seeing, in the next 12 months, an ’87-type of crash. And I suspect it will be even worse.” While such a suggestion flies in the face of the relatively upbeat proclamations from finance ministers across Europe and the West, anyone willing to bet against him should know that his track record of predicting a crash is almost incomparable.

US unemployment ‘result of people giving up’; emerging markets ‘little’ exposed, says economist

Posted on by Ashton Wenborn

It’s only a matter of time before US interest rates, which have been at a historical low, rise. But with unemployment figures better than expected, the government will raise rates sooner. So what does this mean for emerging economies? World Finance speaks to Jerome Booth, economist and leading expert on emerging markets, to hear his views.

World Finance: Well Jerome, unemployment’s link to rates rises: how useful a mechanism is this for stimulating economies?

Jerome Booth: There’s a lot of misunderstanding about what’s going on in the US! There are still about 45 million people in the US on food stamps, and that hasn’t gone down significantly since the height of the crisis.

So the unemployment numbers are actually a result of people giving up and not being part of those numbers.

[T]he unemployment numbers are actually a result of people giving up and not being part of
those numbers

The actual underemployment in the US is pretty much as high as it was. It’s improved slightly, but it’s still very high.

I think there’s also a misconception about the objective of quantitative easing, and the trajectory of interest rates, and the separation of those issues and tapering.

Quantitative easing was a policy in the absence of the fiscal authority seizing banks, whereby the central bank wanted to avoid depression. To avoid that, you have to have the banks healthy. So quantitative easing was a way – emergency measures if you like, by the central bank – to pump liquidity into the banks in order to build up the balance sheets of those banks, enable them to access capital markets themselves, and push up asset prices so that the assets on their books improved.

A lot of that money went straight around in a circle, and was deposited right back at the central bank in the form of excess reserves. So the economy was never stimulated by quantitative easing! So that’s the first point. If you then reverse that through tapering, arguably it doesn’t make any impact either.

World Finance: And in reality, how exposed are emerging markets to US rate rises?

Jerome Booth: Very little. And you have to remember that emerging markets are the bulk of savers now. They are the next savers in the world. Their central banks own 80 percent of international central bank reserves.

What I call ‘core-periphery disease’ is this idea that the core affects the periphery, but we can ignore the effect of the periphery on the core. So one of the aspects of that is when people constantly ask the question, ‘How much money might leave emerging markets IF something happens in the US?’ And not asking the question the reverse way around. In other words, ‘How much money which is in the developed world, which is owned by emerging markets, might leave the developed world?’

So: maybe $15bn – that was one estimate a few years back, by the IMF – might leave the emerging markets if there was another, you know, big problem in Europe or the US. But the central banks and sovereign wealth funds in emerging markets own about $11trn – that’s nearly two orders of magnitude more – in just the sovereign, so-called liquid bonds, of Europe and the US.

So it gives you a much better picture of where the real bargaining power is.

If there’s another problem in the US – if there’s a bond crash, as is quite likely in a couple of years time – then you may well see a huge rush of savings out of the developed world, back into emerging markets, and those currencies appreciate.

[T]he economy was never stimulated by quantitative easing!

And the precedent for this is not something recent; it’s the last time we had huge great global imbalances, which was in 1971.

World Finance: Well a couple of weeks ago when the US announced their unemployment figures, the Indian currency for example dropped quite considerably. So what is the effect on emerging markets when rates rise?

Jerome Booth: If you have Indian central bankers, and Brazilian central bankers doing nothing when there’s weakness in their currency – because it’s actually convenient and it can help them export more – that doesn’t give you a good clue as to what might happen, and the overall trend of what will happen, given the state of global imbalances.

We have seen weakness, and it’s very easy and common for people to then extrapolate from that. And then say, ‘Oh well that’s the trend, and therefore that’s going to continue.’ And that would be a large error. Because what we’re talking about here is big structural shifts.

World Finance: Well the FT reported that analysts at Morgan Stanley pointed out that the central banks in developing countries have been struggling to accumulate foreign currency reserves for the best part of two years. But some countries and emerging markets such as China, for example, have huge forex reserves. So who will be the winners and the losers if rates rise?

Jerome Booth: I would actually argue against the comment that you quoted there! In many cases emerging markets have too many reserves.

One of the indications of this is they are often still fixated about current account surpluses. They shouldn’t be. When you’ve got big reserves it means you should have the confidence to be able to import capital, and manage the fluctuation in your currencies through active intervention.

What’s yet to happen is for them to be more active in their use of reserves, to reduce short-term fluctuations, and more confident that this gives them if you like, the self-assurance to be able to import capital. Which they should be doing! These are capital-scarce countries.

Now, they’re generating their own savings so the real issue is not that they should import more, but that they should stop exporting so much. But importing capital is also important at the margin, because foreign capital can help with transparency and governance and gives competition of ideas. So it should be welcome, and it still is.

That was always a problem back in the 90s, because things overshot. Now that you’ve got these big reserves, they need to change their policy stance and stop fixating all the time about ‘have we got enough reserves?’

What I call ‘core-periphery disease’ is this idea that the core affects the periphery, but we can ignore the effect of the periphery on the core

That doesn’t change your other point, which is that there are still some countries which don’t have enough reserves. But to be honest, all the major emerging markets have huge reserves.

World Finance: Unemployment figures have been largely disregarded as a tool for measuring economies, but the US is doing exactly that. So what would you say are the far-reaching effects, and what would be a better tool to do this?

Jerome Booth: I’m not saying that unemployment is not a useful statistic. I’m saying that unemployment typically has an impact at the margin on inflation. We have the NAIRU, we have the Phillips Curve, there’s a huge great history about this.

That doesn’t really work when you’ve got people who are simply not in the numbers, but are unemployed. That’s what I’m saying. And you know, that’s the reality in the US.

World Finance: Jerome, thank you.

Jerome Booth: My pleasure.

Private banking embraces mobile technology, but developments are slow

Posted on by Ashton Wenborn

The wealth management and private banking sectors have long been known for their highly personalised services. Now there’s a new trend in these old-school sectors, as more and more managers roll out advanced mobile banking and wealth management apps. These allow investors to not only check accounts as they would with ‘regular’ retail banking, but also handle investments, keep an eye on market developments, and hold video conferences with their advisors.

Mobile banking is revolutionising emerging markets as it ensures financial management and swift transactions for millions of previously unbanked peoples. In developed markets, apps are quickly changing the face of traditional banking, eliminating branches and personal service centres one at a time. In the UK alone, mobile banking app use for customers at the five major banking groups almost doubled in the past year. According to the BBA, UK customers now make 5.7 million transactions a day using smartphones and other mobile devices.

So far, the revolution has been driven by retail, allowing people to use mobile banking for day-to-day transactions such as checking their balance, paying bills, and taking out loans, whenever they want. However, private banks are now launching specific apps for wealthier clients, who usually receive a more personalised, advised service.

Clients want mobile
“The world today is becoming more mobile in its use of technology and it’s an accelerating trend,” says Andy Mattocks, Head of Corporate Development at the private banking group Arbuthnot Latham. “Within financial services, retail banking clients almost take online and mobile banking for granted, and whilst we don’t want to compete with that, we wanted to give our clients a choice of ways to interact with us. It supports the private banking relationship and service from our perspective.”

Wealth managers and private bankers have a long way to go to realise the full potential of mobile apps

The firm launched its mobile banking app for private clients in January, after consulting clients on the design and delivery of the application.

“Its been received incredibly well,” says Mattocks. “We deliberately took the opportunity to speak to existing and prospective clients on their needs before launching the mobile app, which happened in conjunction with a new online banking platform. About 25 percent of our online banking users use the app. Considering that this is since January alone, we believe that clients have taken it up because they are actively using it and value it.”

The industry has now reached a stage where it is the norm for a wealth manager or private bank to have at least one mobile app for client use. Some of the world’s leading universal banks already have impressive portfolios of mobile apps for wealthy clients. The trend is largely driven by the clients themselves who want to access their wealth and investments at all hours of the day.

“It is very noticeable that this is a consumer-led revolution,” says Robert Watts, Media Relations Director at the British Bankers’ Association (BBA). “Mobile banking is tremendously convenient, straightforward to use and, crucially, it’s extremely popular with the clients. Banks have been surprised at how intense the take-up of mobile banking has been – it’s happened a lot faster than expected. We’ve actually found that the amount of users on mobile banking has doubled from 2012 to 2013, and from what we can understand from our members, we’ll be seeing similar growth in 2014.”

Major players such as Credit Suisse, Société Générale, ABN AMRO, JP Morgan and Deutsche Bank have some of the most popular apps, having invested heavily. According to research from MyPrivateBanking, it is possible to characterise a general mobile approach for wealth managers, but it is clear wealthy clients need to be treated as a separate and privileged client segment when developing this technology. Core features must help them evaluate, analyse and understand their investments, the report says, in addition to providing a lot of specific content for HNW clients (including product information, and client magazines or publications for sub-segments such as women or entrepreneurs). These apps need to be integrated with other online and offline media and prompt live interactions with the user’s personal advisor.

Mobile private banking apps differ from retail banking apps in that they don’t only provide access to accounts and enable transfers, but also portfolio analysis, brokerage services and real-time market data – on top of wealth management advice. The private banking apps are more complex and cater to consumer needs in a way unseen until now, says the BBA.

“Mobile banking is a tangible and strong example of banks innovating for their customers,” says Watts. “Banks are competing with each other like never before, in order to have the best banking app out there and gain customers. Essentially, the innovation we’re seeing when it comes to mobile banking is driven by a hardy competition for customers.”

Targeted apps for the wealthy
However, only a handful of banks already have apps in place that are targeted at wealthy clients. There is a lack of integration between the apps and banks’ social media presence, which would give the apps a broader relevance. According to several reports on the mobile banking industry, this lack of integration prevents customers understanding the app better and gives an overall sense of lacking customer service.

Wealth managers and private bankers have a long way to go to realise the full potential of mobile apps. Improvements are most needed when it comes to coverage for Android devices, as most firms have focused on iPhone and iPad applications. Considering that app downloads for Android amounted to 58 percent of smartphone app downloads in 2013, and iOS only accounted for 33 percent, this represents a serious under-allocation of resources.

In addition, MyPrivateBanking says too many wealth managers and private banks are failing to provide the full range of core functions that wealthy clients could reasonably expect to find in their financial apps. When it comes to support and communication features, the average firm is meeting some basic requirements but is failing to provide a level of functionality or service that matches the needs or desires of their customers.

However, there’s a good reason private banking apps shouldn’t offer all the services normally provided by their adviser, says Mattocks: “The functionality of retail and private banking apps is really similar, but the way we do banking, whether online or mobile, is about positioning that service as part of the overall core relationship. There are many banks out there that only want to be technology, but we’re relationship-led.”

Consequently, Arbuthnot Latham’s private banking app offers a suite of account and transactions services, but is considered a supplement for advice, which, in the firm’s words, requires the intellectual capital of people. The firm primarily uses the app as a mechanism for communication – something other private banks are grossly lacking.

Notably, only half of financial institutions have taken the time to explain security measures enabled within a mobile private banking app. With a lot of money to lose, this is a cause for concern for many high-net-worth individuals, who have been sceptical of using apps that may not present a stringent security policy.

The private banking industry needs to focus on communication and marketing when it comes to its technological endeavours. That way, they will ensure clients know they’re getting the same personalised, secure and high-priority service they’ve grown accustomed to. And in this respect, it can’t hurt to ask those all-important clients: what it is they expect from their bank in a mobile age.

Client-centricity at the core of MAML’s business

Posted on by Ashton Wenborn

At Mediolanum Asset Management Limited (MAML), the Dublin-based asset management arm of the Italian Mediolanum Banking Group, we like to think we are unusual in the pre-eminence we give to embedding client-centricity into our culture, and in developing the human capital and innovation processes on which our future successes will depend.

We put a great deal of effort into the development of behaviours, processes, investment solutions and tools of superior quality that are useful to clients. The best litmus test that we are meeting our objectives is the trust of our clients. We have attracted positive net inflows every month since our inception in 1998, with net inflows of €3.1bn in 2013. This represented an increase of approximately 15 percent in total AUM for our Dublin-based mutual fund business.

We focus on designing products that meet the needs of our typically-European retail clients, using a proprietary product development process – MedInSynC – to develop, support and evolve client solutions. It embeds our core brand values of client-centricity, investment quality and execution excellence at the heart of all our services. MedInSync – combined with our investment management process, Med3, and our open innovation research and development centre, MedLab, with its innovation network – powers new product delivery and superior client outcomes.

Active investment
While MedInSynC develops, supports and evolves product solutions, our proprietary investment process, Med3, is the means by which we ensure they actually deliver against client needs and commercial promise. It is based on active investment and the understanding that, at times, assets and instruments will be inefficiently priced. We identify opportunities by using both fundamental and technical analysis combined with an appreciation of investor sentiment and behavioural biases. The fruits of these internal processes are to be found in our core retail offering, Mediolanum Best Brands Umbrella, a fund-of-funds/multi-manager offering in which each individual sub-fund targets a specific client need and each solution is carefully crafted from layered value drivers in asset allocation, risk management, manager selection and security selection.

Building a culture that supports client-centricity
is what creates
real sustainable
competitive advantage

A paper by PWC, Asset Management 2020 – A New World, gives a flavour of why innovation will be so important to financial services companies in the future. Combined with rising life expectancy, assets under management in developing economies are set to grow dramatically, with the global middle class projected to grow by 180 percent between 2010 and 2040. Between 2010 and 2020 alone, more than one billion middle-class consumers are expected to emerge globally, representing the largest single decade increase in potential customers in history. In this new world of rising costs and flat or decreasing margins, investment in technology and data management will be core to identifying and meeting client needs, maximising distribution opportunities, and coping with the rigours of increasing regulation and reporting.

To achieve effective R&D and to keep abreast of market competition, we have embraced an open innovation business model, developing an external network of industry collaboration partners to complement existing internal skills and expertise. Our R&D expertise and capability is driven by one inter-departmental working group, MedLab, which brings together expertise and ideas from a wide range of sources.

However, such a model can only be a source of competitive advantage if supported by investments in enabling technologies, such as our internally developed ideas management system (IMS) for product development which forms part of a customised knowledge network platform to facilitate knowledge transfer. We recognise that not every idea will work, but in rapidly evolving markets, a constant flow of new ideas, and the dynamism to bring them to fruition if they are workable or close them down if not, is critical to business sustainability. MedLab provides the brokering and knowledge transfer required to tap skills and ideas from both internal and external parties in geographically dispersed locations, and supports the development process from feasibility analysis to implementation.

Our open innovation business model and centralised development process saves time spent trying to galvanise competencies in different locations, which tends to require projects run on a one-to-one basis involving a select number of predetermined participants.

It is particularly effective for complex projects, where experience is not immediately to hand and expanding the reach of inputs can make all the difference. Research shows it also opens up the potential for first-mover advantage because groundbreaking developments are, in practice, rarely conceived by potential users or firms with similar backgrounds.

In fact, a survey of business leaders by Cognizant looking into ‘innovation outside the four walls’ revealed that 42 percent of those questioned have set up a centralised R&D centre, and 58 percent use external resources to implement ideas. The respondents value the open model’s scalability and many have expanded their collaboration to clients, partners and external expert networks, with 60 percent encouraging customer input, 54 percent harnessing various types of social media and 47 percent using crowdsourcing.

Talent and attitude
The other fundamental tenet of MAML’s operations is the recognition that investing in people is essential to growing the business for the benefit of all stakeholders. In the most traditional sense, this includes the 8,100 hours of training enjoyed by staff last year, but it involves so much more: engendering a culture of creativity, self-discipline, flexibility and responsibility is written into everything we do. It would be easy to pay lip service to this ambition, but we know that the best companies in the world, and particularly those that excel at innovation, are recognised above all by their talent and the attitude of their people. You need only to run though the companies you most admire in your mind’s eye, and you will find this is true. To work, however, this kind of culture must be embraced by behaviours and processes throughout the organisation and properly supported by an HR department with the same set of beliefs and targets. For example, a flat hierarchical structure based on empowerment and trust helps to ensure ownership of tasks is effective at all levels.

In recent years there has been a growing realisation that intellectual capital is a major contributor to a company’s capacity to secure sustainable competitive advantage. Getting the best out of that intellectual capital, however, is a key challenge for management. One strand of this has been to develop digital tools that enable us to bank the company’s knowledge and, which is crucial to enabling and sustaining core processes.

When a staff member leaves, they should not in theory take with them part of the corporate memory. Substantial investments are therefore made into information systems, equipment and software with a view towards embedding flexibility in processes, providing transparency and real time information while also enhancing the risk and control environment. We have set up an in-house virtual library which is key to easing and disseminating internal knowledge flows, and MedCred, a virtual inter-employee reward tool to promote collaboration and teamwork in addition to the IMS and knowledge network platform mentioned above.

Trust in the service
Altogether, our culture and tools ensure we have the very highest quality investment management approach based on transparency and innovation, and that over time we execute it with a constant focus on adapting our investment solutions to changing client needs or changing market conditions. Trust is key in any business, but particularly one where the product is a service.

We strive to build trust with our distributors and customers by explaining our investment views in a user-friendly fashion on an ongoing basis. It is core to our distributor and client support model, as well as an effective means of receiving feedback critical to evolving existing products. We provide ongoing ex-ante updates on products throughout their lifespans, and are always prepared to discuss what did or did not happen as expected. Transparency is so much less effective if offered ex-post. Supporting this commitment to transparency have been significant investments in ‘big data’ analytics to enable us to capture different perspectives in relation to product performances, first for our portfolio managers versus their own objectives; secondly for our distributors versus their commercial promise; and finally at the level of individual clients.

Although forward-looking models for product innovation depend on broad interactivity across diverse locations that are both real and virtual, most companies will want to centralise their R&D centres in a location that can support dynamic practices, as success in financial services also depends on advances in technology linked to digital media, analytics and big data, as well as cognitive computing. Ireland’s technological knowhow, well-educated workforce, access to multiple time zones and well-regulated environment have attracted companies such as Fidelity, Citigroup, AON, Deutsche Bank and many others to establish R&D centres in the capital.

Tech hub
For us, Ireland has provided an invaluable ecosystem of global intelligence through its special mix of leading IT companies and financial services organisations. Dublin is the internet capital of Europe, with a giant cluster of blue chip technology names that includes Microsoft, IBM and Google, as well as social media firms Facebook, Twitter and LinkedIn.

In fact, Ireland has become the cloud capital of Europe and while globally the nation was ranked 10th overall of 142 countries in Cornell’s Global Innovation Index 2013, it was voted fourth in the ‘knowledge and technology’ category, behind only Switzerland, China and Israel. These attributes are great accelerators to businesses located in Dublin, especially those that have the systems and culture in place to tap everything the capital has to offer. MAML contributes to this growing pool of interconnected skills and knowledge, having supported the launch of the Diploma in Innovation offered by the Institute of Banking, a recognised college of UCD, as well as becoming a co-sponsor, alongside the State Agency Enterprise Ireland and others, of the FinTech pre-accelerator run by the National Digital Research Centre (NDRC), which aims to identify, support and grow innovators with early stage ideas which have the potential to grow into viable businesses.

At MAML, we have striven to design an open networked, knowledge-based organisational structure and to instil an innovation-driven culture supported by investment in enabling technologies that is able to generate sustainable competitive advantage. These are secondary objectives, however, to the real prize, which is to embed our client interests and needs in everything we do. Building a culture that supports client-centricity is what creates real sustainable competitive advantage, is something companies can control, and in the future will make all the difference between growing market share and simply surviving.

Alaskan Way Viaduct replacement to reshape Seattle’s future

Posted on by Ashton Wenborn

At 10:54 on February 28, 2001 the Nisqually earthquake – otherwise referred to as ‘The Ash Wednesday Quake’ – hit Washington. Peaking at 6.8 on the moment magnitude scale, the 45-second-long tremor inflicted $2bn in damages and injured close to 400 people. Roads were split in two, buildings were torn from their foundations, and the affected area was declared a national disaster zone by then-president George W Bush.

Among the worst hit sites was Seattle’s Alaskan Way Viaduct: a two-tiered, elevated roadway. Following the earthquake, repairs initially cost the Washington State Department of Transportation (WSDOT) $14.5m, but the Viaduct has more recently been the subject of a multi-billion-dollar replacement programme. In the immediate aftermath of the quake, engineers found that the viaduct had sunk several inches and concluded that if the tremor had lasted for another few seconds the structure would almost certainly have collapsed. Fast-forward to the present day and the Alaskan Way Viaduct replacement programme ranks among the most impressive projects of its kind, and amounts to a crucial fix for the region’s long-standing infrastructural deficiencies.

The topmost priorities for the project moving forwards are stability and protection against seismic activity. The original viaduct was believed by some to be in desperate need of construction work, which was made clear over the five years prior to the 2001 quake, when the Washington State Transportation Centre released a summary report entitled Seismic Vulnerability of the Alaskan Way Viaduct. The document, co-authored by University of Washington Professors SL Kramer and MO Eberhard, found that the highway was ‘clearly vulnerable to severe damage and possible collapse in a design-level earthquake’ and in need of vital repair work.

[T]he Alaskan Way Viaduct replacement programme ranks among the most impressive projects of
its kind

Nonetheless, the ageing viaduct somehow escaped the necessary updates, and safety concerns dissipated as the years progressed. Today, the repercussions for having ignored the warning signs have been picked up by the WSDOT and various agency partners, whose aim it is to deliver a seismically safe and fiscally responsible roadway in place of the original.

“The purpose of the project is to improve public safety by replacing the existing Alaskan Way Viaduct with transportation systems and facilities with improved earthquake resistance and provide efficient movement of people and goods in and through downtown Seattle,” said a spokesperson for the project.

Traffic jam
For over half a century, the Alaskan Way Viaduct has stood fast as the major north-south thoroughfare through Seattle. However, since the viaduct’s construction, congestion has steadily crept up, to the extent that the 60,000-vehicle capacity roadway accommodates close to 110,000 vehicles every day. Due to its proximity to the waterfront and central location in Seattle, the north-south passageway carries 20 to 25 percent of the traffic through downtown Seattle and is crucial for transit and freight operations to and from the surrounding industrial sites and nearby port.

“The Alaskan Way Viaduct portion of State Route 99 is critically important to local and regional transportation,” said one spokesperson for the Alaskan Way Viaduct replacement programme. “Because of its age (more than 60 years), design, and location, a decision was made to replace the roadway with a bored tunnel. This project will also replace the existing Alaskan Way with a new road and is a key component to the redesign of Seattle’s central waterfront.”

Once the Alaskan Way programme is completed two years from now, a two-mile-long tunnel and a number of related developments will fundamentally reshape the way in which traffic runs through Seattle. In short, the replacement tunnel and waterfront improvements will make for a vastly improved roadway through the city and create better economic and social prospects for those living in the vicinity.

Arriving at the replacement tunnel proposal, however, was a process littered with debate and disagreement, as opposing parties argued on the many specificities of an alternative thoroughfare. One proposal aimed to simply replace the existing viaduct with a more stable, larger alternative and to entirely reconstruct the sea wall. However, critics were quick to make clear that deconstructing the viaduct presented an opportunity to better connect the city and the waterfront, and so, after state and local agencies evaluated over 90 proposals, the WSDOT decided on a tunnel option.

“Replacing the viaduct opens up enormous opportunities to improve quality of life in Seattle by increasing mobility through the downtown while making the waterfront more accessible to the public,” said the WSDOT’s programme administrator for the Alaskan Way Viaduct and Seawall Replacement Programme, Ron Paananen. “We need to clearly communicate our design proposals to the project stakeholders and the public – helping them understand and visualise how they can reclaim their waterfront.”

Even so, parties opposed to the tunnel plans continued to put forward the benefits of an alternative solution. And after a lengthy period of debate, the majority finally agreed that, all things considered, the tunnel option was by far the best solution.

“In January 2009, leaders from the state, county, city and port recommended a bored tunnel – along with a host of other improvements – to replace the waterfront section of the viaduct,” says the WSDOT. “It was the only alternative that would allow SR 99 to remain open during construction, maintaining a vital stretch of state highway.”

Digging in
Since construction work on the project began in 2008, just over half of the original viaduct has been demolished and replaced towards the southern end of downtown Seattle. And while some of the lesser tasks, such as column safety repairs and electrical line repositioning, have been completed in full, the biggest development thus far is the tunnelling work, which began in earnest at the mid-point of last year.

Boring a tunnel beneath Seattle, however, is an expensive and technically challenging process, and one that requires highly capable digging tools. Christened ‘Bertha’ by the WSDOT, the resulting custom-built, tube-shaped tunnelling machine is the largest worldwide and now sits 60 feet below downtown Seattle, 1,023 feet along its 9,270-foot journey.

Manufactured in Osaka by Hitachi Zosen Corporation, the machine was ferried in on the Jumbo Fairpartner on April 2, 2013 and reassembled west of Seattle’s stadiums in an 80-foot-deep trench. Beginning July 30, 2013, the 7,000 tonne behemoth set off on its two-mile journey beneath downtown Seattle, only for it to be halted in December, due to seal system issues. Nonetheless, Bertha is scheduled to come back online by late March 2015 pending repair work and upgrades, during which time building work will begin on the one-kilometre-plus of tunnel that has been burrowed so far.

One issue that has taken centre stage since talk of the replacement programme began is financing. The state’s viaduct replacement project will cost an estimated $3.15bn, with funding coming from a combination of state, federal and local sources, together with the Port of Seattle and tolls. Of the estimated $3.15bn, over $2bn has been allocated to the SR 99 tunnel project, and the rest to viaduct removal and replacement projects, alongside various other smaller repair works, management fees and environmental impact studies.

As far as funding is concerned, a little over $1.8bn has been derived from tax, and the rest, tolls excluded, has come from other state, federal and local sources. One major amendment, made in August of last year, relates to the issue of toll funding. Whereas the original 2009 legislature read that the finance plan would include no more than $400m in toll funding, the amount was later revised in 2012 to $200m, and an additional $200m in federal funds were donated to the project to offset the shortfall. Also in August of last year, the Port of Seattle pledged $300m to the project, primarily for programme-related items on the waterfront.

The related street, transit and waterfront improvements are being led by the Alaskan Way Viaduct programme, King County, the City of Seattle, and the Port of Seattle to ensure the project’s social and economic benefits extend to those in the community. The Alaskan Way Viaduct replacement project is more than simply a solution to local congestion issues, but a means of boosting the region as a whole. From new parks and pathways to a new pedestrian promenade and a two-way cycle track, a string of regeneration projects will follow the old viaduct’s demolition in 2017.

The new road is scheduled for completion in 2016, and once opened will remedy long-held safety concerns, ease congestion issues and fundamentally reshape the way in which traffic is carried through downtown Seattle.

Standing in the way of capitalism

Posted on by Ashton Wenborn

The saga of the recent attempted takeover of British AstraZeneca by American rival Pfizer kept industry participants glued to their seats with each twist and turn. Over the course of a month, Pfizer tried again and again and ultimately failed to secure a deal, despite its final offer valuing AstraZeneca at £69bn. After this final bid failed, international rules for the takeover of public companies came into effect, dictating that Pfizer must wait at least another six months before attempting to rekindle negotiations.

Pfizer’s pursuit of AstraZeneca was significant for more than just the stratospheric financial values involved; it was a high-profile sign of an important shift in the market. This was a so-called inversion deal, in which Pfizer would acquire AstraZeneca in order to move its operations to a more competitive tax environment on the other side of the Atlantic. Over the past two years, a number of American pharmaceutical companies have secured inversion deals with European drug manufacturers, particularly in Ireland, as they seek more favourable tax rates (see Fig. 1). The result has been that, as with the attempted AstraZeneca deal, premiums for companies residing in these coveted tax environments have gone through the roof.

Inversion deals are fast becoming a stalwart of the mergers and acquisitions market, highlighting the important role governments play in the establishment of tax environments.

Fig-1-corporate-tax-rates

Since the huge amount of publicity generated by the Pfizer bid, US lawmakers are taking aim at this kind of merger in order to protect the country’s corporate tax revenues. But this is precisely the sort of deal that the UK Government has been hankering for: a repatriation of funds that would boost tax receipts. In fact, UK Chancellor of the Exchequer, George Osborne, devised the current tax scheme and policies with this specific sort of deal in mind.

As the world becomes more globalised, it is natural that companies will seek out better deals abroad. The risk governments face is that of a race to the bottom when it comes to corporate tax rates.

Pfizer’s bid for AstraZeneca has brought into the spotlight a number of important questions about the role governments play in attracting foreign companies to their shores, but also to what extent they should intervene when a takeover might not be in the public interest, irrespective of, for example, tax revenue.

In the UK, the coalition government was reluctant to get involved, despite significant political pressure from the opposition, but in France that would not have been the case. In fact, only weeks before the AstraZeneca/Pfizer ordeal hit the papers, the French Government enthusiastically threw itself into negotiations for the takeover of Alstom’s energy arm as General Electric, from the US, and Siemens, from Germany, went head-to-head in an attempt to takeover the company. Despite Alstom’s board clearly favouring General Electric’s bid, the government actually changed legislation in order to tilt the scales in favour of Siemens.

The role governments play in cross-border mergers and acquisitions is often downplayed as the spotlight shines on the more titillating aspects of a deal. But over the past few years a significant number of deals have been boosted or scrapped after officials got involved – for better or for worse.

In 2014 alone, $300.5bn worth of acquisition bids have been rejected or pulled, close to double the figure for the same period in 2013, and the highest since 2008, according to research by Dealogic (see Fig. 2), suggesting perhaps that industry leaders need to reassess their approach to cross-border mergers and acquisitions.

Pfizer tries to take over AstraZeneca
Though the attempted deal dominated headlines in the business pages for most of May, it had been in the works since late 2013. As early as January 2014, AstraZeneca had already refused to enter talks on the back of a proposed sale at £58bn. At the end of April, however, Pfizer’s interest had not waned and it went public with its interest in the British counterpart, and made no secret of the fact that it was looking to shield its non-US earnings from US taxes.

Because the British government had been very public in its campaign to attract foreign companies by creating a more welcoming tax environment, Pfizer’s CEO Ian Read wrote a letter to Prime Minister David Cameron assuring him Pfizer would base its operations in the UK, and guaranteeing 20 percent of the merged company’s research and development capabilities would be based in AstraZeneca’s Cambridge facility for at least five years.

By including the prime minister in negotiations, Pfizer was hoping for a spot of governmental pressure to ensure the deal went through. It might have got more than it bargained for when the leader of the opposition Labour Party, Ed Miliband, waded into the debate by accusing Cameron of “cheerleading” for a foreign company, at the expense of British jobs and the wellbeing of British industry. Suddenly the deal was being debated on the front page of every newspaper, and Pfizer was losing support. The heads of both companies ended up being hauled in front of a parliamentary committee to thrash out the deal, which by now was being presented as the pinnacle of British national interest.

In the end, despite raising bids and many reassurances, the public backlash against the deal provided the AstraZeneca board the confidence it needed to hold its ground, and demand a better deal or no deal. Pfizer lost out as the deadline for an agreement expired, but AstraZeneca shares plummeted in the weeks following the collapse of the deal. According to industry researcher Dealogic, the Pfizer/AstraZeneca deal was the second-largest bid ever to fail, after BH Billiton’s attempted takeover of Rio Tinto in 2008.

Horizon Pharma takes over Vidara Therapeutics
Horizon Pharma has grown into one of the most productive independent pharma companies in the US, but once its deal with Vidara Therapeutics is finalised over the summer, it will no longer bear an American postcode. The arrangement is curious. The new Horizon Pharma PLC will primarily market its four products in the US, but it will be based – and taxed – in Ireland, home of the soon-to-be defunct Vidara.

Global-withdrawn-m&a-volume

Though Vidara’s portfolio consists only of Actimmune, a bioengineered protein used to treat granulomatous disease and osteopetrosis, Horizon has shelled out around $660m to incorporate it, $200m of which will be paid in cash. For Vidara, a single-product privately held company, it is a good deal. However, it has since become clear that Horizon’s takeover was more of an inversion deal than anything else. By acquiring Vidara, Horizon has secured the right to base its operations in the extremely favourable tax climate of Ireland. Horizon has maintained that its interest in Vidara was purely motivated by Actimmune.

The Wall Street Journal has quoted an anonymous person close to the deal as saying that should Vidara have been based in the US, it’s price tag would have read something between $300m and $400m. Few countries are as welcoming of foreign takeovers as Ireland, which has carefully crafted generous tax provisions corporations looking to settle on its shores. The savings Horizon will make in tax payments by relocating to Ireland more than make up for the additional $260m it is paying for Vidara to begin with.

As well as Horizon, a number of other medium-sized American pharma companies have made the move across the Atlantic to the Emerald Isle. Actavis bought out Warner Chilcott last year for a 34 percent premium to the value of the stock, but revealed soon afterwards that its effective tax rate would drop from the 28 percent paid in New Jersey to around 17 percent in Ireland.

Deutsche Boerse fails to merge with NYSE Euronext
Plans were well advanced between NYSE Euronext and Deutsche Boerse to merge into the world’s biggest exchange in 2012, before EU governing bodies intervened to put a stop to it. Deutsche Boerse was set to take over NYSE Euronext for $9.5bn, and the new merged company would have had an outright monopoly in European exchange-traded derivatives.

In the final moments, the European Commission intervened and stopped the takeover, claiming that the benefits would not be enough to outweigh the “harm caused to customers by the merger,” according to an EC statement on the matter. The two companies had appealed directly to EC president Jose Manuel Barroso in a last-ditch attempt to salvage the deal, but to no avail.

“This is a black day for Europe and its future competitiveness on global financial markets,” said Deutsche Boerse in a statement. “The decision is based on an unrealistically narrow definition of the market that does no justice to the global nature of competition in a market for derivatives. We therefore regard this decision as wrong.” Though both companies considered an appeal with the EU courts, in the end, they parted ways and pursued individual strategies.

The decision to disallow the merger was momentous at the time, as EU markets were failing and market participants had long been calling for a consolidation of the industry. Though the NYSE Euronext and the Deutsche Boerse are based on opposite sides of the Atlantic, they remain each other’s closest competitors, so it seems unlikely that the EU would ever have permitted such a merger. Joaquin Almunia, the EU’s Antitrust Chief, and Barroso have a long history of ruling against mergers like this one, which would clearly create what they perceive as straightforward monopolies.

Almunia said the deal was blocked “to protect the European economy from the perverse effect of a combination that would have practically eliminated effective competition in the market.” However, it could just as easily be argued that Almunia and Barroso’s trigger happy response to shooting down potential cross border take-overs may actually do more harm to the European markets, which have been stale and sluggish since the financial crisis broke half a decade ago.

£69bn

Pfizer’s failed bid for AstraZeneca

£9.5bn

Deutsche Boerse’s blocked bid for NYSE Euronext

Attempted takeover of Alstom Energy by General Electric
Though Schenectady, New York-based General Electric has not been entirely excluded from negotiations with Alstom’s energy arm in France yet, the local government has taken aggressive steps to prevent any takeover by GE from happening. In yet another act of unabashed protectionism, François Hollande’s government has given itself the power to veto or block foreign investment in key industries such as energy. Though it is an extension of a previous piece of legislation passed in 2005, few doubt the motives behind the timely amendment and the vital powers it gives Hollande.

The French government has made no secret of its distaste for GE’s proposed takeover of Alstom’s energy operations, and has openly favoured Germany-based Siemens’ proposed bid, in an attempt to keep control of the company within the EU. Alstom’s board has openly backed GE’s proposed takeover, but Hollande himself has deemed the terms of the agreement “unacceptable” as they fail to provide sufficient protection for French workers. “It is for the government to ensure that its legitimate objectives are fully taken into account by foreign investors, whether from within the European Union or other countries,” Minister for the Economy and Industry Arnaud Montebourg said in a statement. “This new power will naturally be applied in a selective and proportionate manner.”

GE has openly stated that it will protect French jobs and open new sites in the country but there are fears that the rail section of Alstom’s business might not be able to stand alone after the energy business is sold off. Alstom is one of France’s most traditional companies, and as well as its more profitable energy arm, it runs the country’s iconic TGV rail service. Alstom and TGV were bailed out by the government only 10 years ago, and might not be strong enough independently.

France is also a powerhouse in the global energy market, and the government is fearful that a takeover by a foreign company could harm its standing in the industry. It is understood that Siemens’ proposal would ring-fence Alstom’s steam turbine used in nuclear plants, thus protecting France’s exports in the atomic power market.

The power grab by the French government could be setting a dangerous precedent for cross-border takeovers in France, and Europe as a whole, and it is especially troubling when taken alongside the European Commission’s tough stance on antitrust legislation. It could put the future of cross border takeovers into Europe is in jeopardy.

3D printing cannot completely replace traditional manufacturing, say experts

Posted on by Ashton Wenborn

Cited by some as ‘the next industrial revolution’, 3D printing is slowly reshaping the traditional supply chain, and could conceivably be the single most disruptive breakthrough since progressive assembly. “The fundamental economics of manufacturing changes with additive manufacturing,” says Terry Harrison of the Supply Chain and Information Systems Department at Pennsylvania State University.

Additive manufacturing has only recently come into mainstream use, and companies are beginning to question how the technology could factor into their processes and improve backward integration. Provided the technology addresses a number of areas still in need of improvement, where once the onset of globalisation gave rise to globe-spanning supply chains, additive manufacturing could spark a return to highly localised manufacturing environments.

Some analysts have pointed out, however, that 3D printing won’t replace traditional manufacturing in its entirety; it will only improve upon a select few components of the traditional supply chain

The traditional supply chain, though it has been much improved over the years, still carries with it a number of glaring inefficiencies, namely: long lead times, high transport costs, complex distribution networks and a dependency on economies of scale. However, a 3D printing alternative represents quite the opposite, in that goods can be locally printed and distributed, with low transport costs to match, leading some commentators to speculate overly enthusiastically about the changing dynamics of traditional supply chains.

Changing supply chains
Additive manufacturing, according to a Goldman Sachs report entitled The Search for Creative Destruction, is one of eight major technologies that will drive companies and business models in the future to either adapt or die. However, 3D printing is still very much in its infancy, and fails to match the requirements of big businesses aiming to improve upon existing products and processes. Should some of the technology’s creases be ironed out, however, the process could well emerge as a viable alternative for organisations seeking to streamline and localise their supply chains.

“Many articles in the popular press lead one to conclude that these large impacts are very near term,” says Harrison. “Our view is that there is significant work ahead before additive manufacturing will realise the kind of potential that is forecast.”

Beginning in the late 1980s and early 1990s, early iterations of 3D printing – or rapid prototyping – were used to create prototypes within a relatively short amount of time. However, the high costs associated with doing so meant the process was off-limits to most, and it is only in the past five years or so that the technology has become affordable for SMEs and even consumers.

Since the technology’s migration to the mainstream – and in particular since 2010 – industries have introduced additive manufacturing to various day-to-day processes. For instance, those working in architecture, construction and industrial design enterprises often utilise 3D printing for prototyping, as do those in the fashion, food and medical industry, to a much lesser extent.

The area in which additive manufacturing will have the biggest influence in the near-term, as has been the case for the past 30 years, is in prototyping. “The biggest advantage of 3D printing is the ability, as I put it, ‘to move from design for manufacturing to manufacturing the design,’” says Pete Basiliere, Research Director at Gartner. “‘Design for manufacturing’ leads to compromises that enable highly efficient and cost-effective mass production, but does not always result in what the consumer or marketer originally requested. ‘Manufacturing the design’ means the ideal design can now be produced, even in lots of one unit, just as the buyer wanted.”

However, some analysts believe 3D printing will have more fundamental consequences for manufacturing. “We are seeing more and more manufacturers extend beyond product development to using 3D printed parts to augment their manufacturing lines and processes,” says Basiliere. “While not a ‘self-replicating printer’, Stratasys’ subsidiaries MakerBot and Solidscape use their parent’s Fortus 3D printers to make the jigs and fixtures used to assemble their own 3D printers. And certainly there are manufacturers who are making finished goods, ranging from Asda’s 3D printed figurines to BMW’s valve stems for its high-end, limited production engines.”

Even so, the technology is still seen as the remit of high-end manufacturing and tech-savvy entities targeting very specific segments of consumers, and with a high price tag to boot. While some predict that the technology will change the way in which certain products are manufactured, most stop short of the opinion that 3D printing will fundamentally reshape global supply chains on a universal basis. “3D printing is ‘a’ new tool ‘in’ manufacture, but not ‘the’ new tool ‘for’ manufacture. 3D printing is great as it requires no tooling, but it is inherently a more expensive, lower quality way of making a part,” says Nick Allen, founder of 3D Print UK. “3D printing will help a lot in the prototyping market, meaning that products can get to market quicker and can be updated faster… so what is being supplied might change quicker, but how it is being supplied probably won’t change much in the near future.”

Opportunity for change
Proponents of the technology argue that 3D printing will play a major part for a much broader base of consumers and could potentially reshape supply chains in the not-too-distant future. Admittedly, 3D printing for certain applications, such as circuit boards and similarly intricate components, is some way off the quality of existing processes, but it could, in theory, play a significant part should accuracy improve and costs fall.

Alongside technological breakthroughs such as advanced robotics and open source electronics, 3D printing is making its way onto the agendas of business leaders seeking to optimise manufacturing and distribution processes. “To compete in this fast-approaching future, companies and governments must understand and prepare for this new software-defined supply chain,” says one IBM report, entitled The New Software-defined Supply Chain.

What’s key in the adoption of 3D printing is that the technology eliminates the need for high-volume production and reduces the waste product that comes with it. Whereas the traditional supply chain relies on the efficiencies of mass production and requires a high volume of assembly workers, additive manufacturing needs little more than the necessary raw material to fulfil any one order and the necessary blueprint to produce it.

As the technology develops, the impact in terms of inventory and manufacturing could be vast, in that a product could be printed immediately on demand and need no longer be stacked on store shelves prior to an order. “These effects are likely to be different for different firms. For some, the effects will be large and for others, not nearly so much,” says Harrison. Clearly there is an opportunity here for SMEs with small order quotas to fill, ridding enterprises of the pressures that come with maintaining a suitably sized inventory at any given point.

The potential for small-scale production runs also means that SMEs will no longer have to pay for expensive moulds, and that smaller orders will not necessarily prove more costly per unit than larger ones.

On the other hand
Some analysts have pointed out, however, that 3D printing won’t replace traditional manufacturing in its entirety; it will only improve upon a select few components of the traditional supply chain.

“Complete replacement will never happen because there are too many items that are made in such high volumes, without any changes from item to item, that traditional, highly efficient, long run manufacturing technologies will always be more efficient and cost-effective than 3D printing,” said Basiliere. “On the other hand, 3D printing revolutionises certain industries, as well as short run and custom production in almost all industries.”

Eliminating the need for mass production also means that companies needn’t look to emerging markets for a more cost competitive workforce. This development marks perhaps the biggest game changer for 3D printing in that it could reshape the global supply chain of today into a new hyper localised model. A tighter supply chain and reduced transportation costs will also limit carbon emissions, meaning that companies looking to improve upon their CSR offerings will be eyeing 3D printing as an attractive alternative.

“3D printing’s impact on supply chains will be evolutionary, not revolutionary,” says Basiliere. “Supply chains consist of multiple functions (plan, source, make, deliver, service) so 3D printing’s application will vary across those functions as well as by the different supply chain types and the segments in which a company operates.”

Although it’s easy to speculate how 3D printing could radically reshape the traditional supply chain, the benefits of the process will only really reap major rewards for smaller companies with a design focus and manageable order base. As far as larger, manufacturing intensive firms are concerned, the technology is some way yet from replacing global supply chains.

Pension funding gaps cause turmoil throughout America

Posted on by Ashton Wenborn

Once an economic powerhouse of American industry, the city of Detroit is today little more than a hulking shell of its former self. This is a city that, in its heyday, was America’s fifth-largest, home to 1.8 million citizens and the birthplace of the American auto industry. Six decades on, however, one in five residents were without a job. The once prosperous auto industry – fresh from a 2009 bailout – was struggling for a solid footing, and an estimated 78,000 buildings stood unoccupied.

Having accumulated $18.5bn of debt over 60 years of steady decline, the city’s mayor, at the mid-point of 2013, said that without reverting to extreme measures, spiralling bills would claim 65 cents of every dollar earned. And so, on July 18, 2013, Detroit filed for chapter nine bankruptcy, becoming the largest urban administrative division to do so in US history, and another name on the long list of states and cities to have fallen foul of insurmountable pensions liabilities (see Fig. 1).

The circumstances have brought to light the consequences that pension funding gaps can bring if left unchecked, and have called into question America’s ability – or lack thereof – to protect state pensions in the event of a collapse. “It is a scandal in government management that should be addressed,” says John Turner, Director of the Pension Policy Centre. “However, I am sceptical that it will be, at least within the next year.”

Broken promises
According to data published this year by the Pew Charitable Trusts, American state and local government pension obligations – as of fiscal year 2012 – surpassed $1trn. Beginning in 2008 at a humble $452bn, unfunded state liabilities grew to $757bn by 2010, and bulged by another $158bn over the next couple of years, despite a string of strong investment returns. As a consequence, almost every state in America has fallen short of its predictions, and, as of 2012, only 17 states managed to better the 80 percent fulfilment quota. Jagadeesh Gokhale, Senior Fellow at the Cato Institute, is critical of a long-standing failure to address the crisis, and believes the principal reasons for the state’s runaway finances to be twofold.

Total pension assets and liabilities across all 50 states

$2.6trn

Actuarial assets

$3.6trn

Actuarial liability

$6.7trn

Market valued liability

Source: Business Insider

“The first has to do with what’s permissible under the Government Accountability Standards Board (GASB) accounting rules,” he says. “Those rules allow valuing pension liabilities by discounting future pension payments at the rate of return expected on fund assets – at least, until existing funds are not depleted.”

Leslie Papke, Professor and Director of Graduate Studies at Michigan State University, echoes Gokhale’s concerns, and questions the integrity of those promising lofty payouts, irrespective of the costs. “This is misguided from an economic perspective,” she says. “The size of the pension liability should be valued independently of how assets are invested. The pension liability should be discounted at a rate that reflects its risk – in this case, risk comes from any uncertainty that the payments will actually be paid. Generally a risk-free rate would be around three or maybe higher at four percent, if we think there is some likelihood, as in Detroit’s case, that the entire promised benefit won’t be paid.”

The funding gap that exists for many US states and cities is due largely to irresponsible politicians in years past who have chosen not to fulfil their pension promises, but to pass the buck on to later incumbents. By assuming that investments will yield sky-high returns in the future, states and cities have been allowed to effectively write off any shortfalls for the immediate term, and avert disaster at the expense of future generations. Fast-forward to today and yesteryear’s overly rosy assumptions have landed some states with gaping holes in their public finances.

“The other major contributing factor is political,” says Gokhale. “Reducing the discount rate to correctly reflect the certainty and high protections accorded to benefits would increase unfunded liabilities and increase pressure to make annual pension fund contributions. Politicians want rather to spend on their constituents’ wishes for public services rather than salt funds away for future pension payments. So fund rates are set high by investing in riskier assets. These incentives ensure that liabilities are ‘safe’ but investments are risky – a perfect recipe for [the unfolding] disaster!”

Whereas the worst of the financial crisis subsided some time ago, the funding gap that opened in the immediate aftermath has continued to rise – albeit by a lesser degree – since. “State and city pension funds have invested a higher percentage of their portfolios in the stock market than have private sector funds. This appears to be fine when the stock market is going up, but many people think they have taken on excessive risk,” says Turner. “Furthermore, they have used unrealistic assumptions for determining the value of their liabilities, causing a considerable understatement.”

Buoyed by a stint of better-than-expected returns, some states were too eager to anticipate similarly impressive returns in the years to come. Once the crisis awoke, however, many proceeded to skirt their responsibilities and allowed the gap to widen, sometimes to unmanageable degrees.

Passing the buck
At the end of 2013, Illinois had the highest unfunded pensions liabilities in America at $100bn. Due to unrealistic expectations and years of legislative inactivity; the state has been landed with the lowest credit rating in all of America, pushing borrowing costs to unprecedented heights. As a result, and to the dismay of the public sector, at the tail end of 2013 Illinois proposed a number of radical reforms to overturn the state’s runaway fiscal problems.

By cutting retirement benefits for state workers and forcing the state to make good on its pension promises, Illinois authorities estimated that it would save approximately $160bn over the next three decades. While the proposed cuts would trim Illinois’ unfunded liabilities by 21 percent to $79bn, many believed that by passing the bill on to state employees, the financial implications were grossly unfair for public employees.

Whereas most business groups backed the legislation, public workers were less than enthusiastic about the proposal. “This is no victory for Illinois, but a dark day for its citizens and public servants,” wrote one coalition of union workers acting under the name of We Are One Illinois. “Teachers, caregivers, police, and others stand to lose huge portions of their life savings because politicians chose to threaten their retirement security.”

Source: The Washington Post 2014 figures
Source: The Washington Post 2014 figures

As such, the plans to stabilise the state’s pension system have come undone after unions challenged the constitutionality of the proposed legislation.

The central fact still remains, however, that taking the necessary funds from any one party will come up against stiff opposition. Illinois’ proposed reform package highlights one of the more important considerations when tackling state pension-funding gaps; that is, who will foot the bill? Opinions differ dependent on the individual questioned, but the vast majority believes the gap will be plugged by a combination of tax increases and broken pension promises.

“The bill for the funding gap will be borne in part at least by workers and retirees through reduced benefits and reduced wages,” says Turner. “Taxpayers may be affected through higher taxes, or more likely by reduced services. Bond ratings will be affected, which increases the cost of borrowing, which is borne by taxpayers.”

One report by the Centre for State and Local Government Excellence entitled State and Local Government Workforce: 2014 Trends reveals the extent by which retirement plans have changed over the past year. The report found that 27 percent of respondents had increased employee contributions, 18 percent had decreased pension benefits, 16 percent increased eligibility requirements and eight percent had reduced or eliminated cost of living adjustments.

What’s arguably more important for the debate moving forwards, however, is whether or not state pensions will enjoy the same protection rights they historically have done. Detroit, therefore, is an especially important case in that anything less than a guarantee could have huge ramifications for the way in which state pension promises are managed. “It could go either way as the crisis unfolds,” says Gokhale. “Shortfalls may lead to stripping existing protections in some cases. But, given recent experience with poor pension fund management and plan conversions in so many places, public pension beneficiaries may begin lobbying for even stronger protections in the future.”

The worst affected states have so far chosen to focus on making adjustments to existing retirement plans as opposed to changing state legal protections, and some believe that the central problem is not necessarily the guarantee, but the fact that obligations were allowed to go on unpaid for so long. “The real lesson is a need for greater transparency,” says Dean Baker, Co-Director of the Centre for Economic and Policy Research. “If politicians had made required contributions year by year, then no pension would be in any trouble. The problem was that it became a sport to skip these contributions in places like Chicago and New Jersey.

Cause for optimism
Although the funding gap in certain instances has strained public finances close to breaking point, many are in agreement that the worst of the crisis is now over. Provided that taxpayers and employees accept the resulting concessions, most states and cities should see their funding gap steadily decrease over time. “If pension plans meet their investment return targets and government sponsors make recommended contributions to their retirement systems, states can expect to see funding levels start to rise in future years,” reads a Pew Charitable Trusts report.

“There will be little or no funding gap to pick up in the vast majority of cases,” says Baker. “Most of the gap came about because the market plunged in 2008 to 2009. Because of averaging, the 2009 valuations still appear in most state and local pension funds’ measure of assets. Assuming there is no collapse in the market this year, funds will look considerably better when we have next year’s valuations [2014 valuations replace 2009 valuations]. Instances of serious shortfalls have come about almost entirely because states have gone years without paying required contributions. If the parties approach this problem in good faith, in most cases the gap will be manageable.”

In New Mexico, for example, state legislators and unions agreed on a plan to plug one of the country’s largest funding gaps, which in fiscal year 2012 came to $12.5bn. However, beginning last year, certain plan members are required to make larger contributions, and the minimum retirement age for young workers and new hires has been raised. Together, the reforms have offset the vast majority of the state’s projected funding gap, and significantly reduced the strain on public finances.

“If other states follow this sort of model, it is likely that the gaps can be filled in even seriously troubled systems without too much pain. However if you have politicians who want to score political points by inflicting pain of public sector workers then we see serious problems,” says Baker.

US states hit by the pension reforms

Illinois

Owing to years of unpaid pensions promises, Illinois’ liability was close to $160bn in 2012. Only 40 percent of the state’s fulfilment quota was met that same year, and a series of stop-start reforms since have inspired little in the way of confidence that the state will return to fiscal stability anytime soon.

Kentucky

Kentucky’s funded ratio (as of 2012) came to 47 percent, amounting to the second highest in America. Funding for the state’s principal government worker pension system is currently under one quarter funded, and a number of filed bankruptcy cases of late have seen various parties exit the system altogether.

Connecticut

With liabilities of $48.2m and an unfunded gap of $24.5m as of 2012, Connecticut’s public finances have been severely strained by years of unpaid promises. Stemming back to the mid-1990s, the state has by-and-large failed to meet its obligations, leaving it with a funded ratio of 49 percent in 2012.

Alaska

Even through a period of surplus, Alaska has succeeded only in paying a fraction of what it has promised, leaving it with a mountain of unfunded liability to make up. As a consequence, the state now looks to take on a raft of legislative changes in a last ditch attempt to
plug the gap.

Louisiana

Although major pension reforms were enacted in 2009 and 2010, the state still has one of the biggest funding gaps in America. The government proposed yet another legislative change in 2012, however, unions have blocked its passage and many appear unwilling to pick up the bill for years of missed payments.

Legg Mason Asset Management on Asia’s investment opportunities

Posted on by Ashton Wenborn

Asset management is a multi-billion dollar industry, but navigating the market can be tricky – especially in emerging economies. One institution that has successfully established itself in the region is Legg Mason Asset Management. World Finance speaks to Lennie Lim and Freemason Tsang from the firm to find out about the challenges of working in Asia, and the opportunities open to investors.

World Finance: Now Lennie, Legg Mason has over $700bn of assets under management worldwide, so how well positioned would you say Asia is to drive the company’s growth forward?

Lennie Lim: It is quite rare for a firm of our size and given our history, to be so new in the market. We first carried the brand of Legg Mason into Asia when we acquired Citibank Asset Management in 2006. Since then we have weathered the global financial crisis very well, and now we are in the growth stage. We are firmly establishing our business throughout Asia.

For mutual funds, Asia is the fastest growing region in the world, relative to the US and relative to Europe

World Finance: How would you say asset management is developing in Asia, and what challenges do you face in that region?

Lennie Lim: For mutual funds, Asia is the fastest growing region in the world, relative to the US and relative to Europe. What’s driving this growth is very strong economic growth from various Asian countries, at the same time as a strong culture within Asia in terms of savings, and the sheer size of the population.

It can be seen in the amount of wealth that is being created in Asia, but it is also important to keep in mind that many of the Asian countries are still very young in terms of its mutual fund history.

Take China for example; there is less than 15 years of history in mutual funds. As such, in terms of challenges, you will see that Asia is very dynamic in its changes. New regulations are coming in all the time, as the industry goes through its growing pains.

This market is therefore very fast paced, the environment changes frequently and it is rather complex, with so many countries at different stages of growth, and each with their own regulations. But in Asia we always say; in every adversity lies opportunity. And that is how we see Asia right now.

World Finance: Freeman, in a competitive market such as asset management in Hong Kong, what differentiates you from other asset managers in the region?

Freeman Tsang: Hong Kong is one of the mature markets within Asia in terms of mutual fund.

The size of our firm offers a global platform to provide a range of products. And of course, we have to have the local people, to have the local touch, with the local distributors.

We often visit local distributors to talk to them, to see what they need. And then we find the best solution, and consistently and precisely deliver this solution to the bankers, the trainers, and the product people.

World Finance: How do you identify investment opportunities for your clients and what are the main investment opportunities in Hong Kong and China?

Freeman Tsang: The beauty of Legg Mason is that it represents six individual asset management companies.

They provide the investment view to us and we provide the solution to the bankers. So when we go to an individual affiliate they can provide us with the individual asset class investment view and the product idea.

This market is therefore very fast paced, the environment changes frequently and it is rather complex, with so many countries at different stages of growth

Alongside this we also have a small cap dedicated manager, a large cap dedicated manager, and one of our largest affiliated fix income managers. In order to provide the best investment opportunities, we are committed to delivering the message from the investment professionals of Legg Mason, to all the bankers around the world.

World Finance: Lennie, from a regional perspective now, is there any notable difference in how your team meets clients’ needs across Asia?

Lennie Lim: We are unique in the sense that we are able to bring our multi-affiliate model to our Asian clients, and with this some of the best-of-breed managers that we have within the Legg Mason fold. My clients deal with a single point of contact on client service, and that’s true of all of us. And therefore my responsibility to ensure we bring a high level of client service to our clients, that’s able to deliver the investment objectives of our clients.

World Finance: Freeman, what trends do you see arising in Hong Kong and China, and how do you think this is going to affect the industry in the coming years?

Freeman Tsang: I would say there is going to be more integration between country and country, like the ASEAN Passport in Southeast Asia, and in north Asia between Hong Kong and China we will see more mutual recognition. This will mean that more funds can be brought forward to China from the Hong Kong registration perspective, or vice versa.

For us, more integration means more opportunity, and when we deal with that, we do see more opportunity, if we can provide a solution. In terms of trends in product development, it’s one of the key trends for Asia, because Asia is a low interest rate, high inflation environment.

Investors are looking for high-income products. Previously, during the crisis, they were looking for stable income. But after the crisis, they’re looking for high-yield fixed income.

Nowadays, we are seeing that they are more willing to take more risks, but they still want that income. So as a service provider when we talk to our bankers or distributors, they do need some kind of income theme but with the equity theme. So we do see a trend developing of people looking for more income but with a higher risk element.

World Finance: Freeman, Lennie, thank you.

Brazil hangs up its boots to prepare for the sixth BRICS summit

Posted on by Ashton Wenborn

The World Cup is over but Brazil will now turn its attention to banking as it hosts the sixth BRICS summit. The leaders of Brazil, Russia, India, China and South Africa will meet in the north-eastern city of Fortalez in their sixth meeting without western powers.

The summit is an annual diplomatic meeting with emerging economies around the world. In the past, little progress has been made, leading many to question if the BRICS can deliver anything better than a catchy acronym – but real progress is on the agenda this time around. The economic powerhouses hope to get the ball rolling on their long-awaited development bank and emergency fund – with initial capital of $50bn.

The development of the BRICS is seen as crucial for Russia as it struggles with visa bans and asset freezes after its annexation
of Crimea

This will be the emerging markets version of the World Bank and the IMF. It sets an implicit philosophical statement that the BRICS are dissatisfied with their role in global political and economic debate. Russian President Vladimir Putin told Russian news service ITAR-TASS that he wants the emerging markets to have a stronger voice on the world stage and provide opposition to US influence on foreign policy. He said: “Any attempts to create a model of international relations where all decisions are made within a single ‘pole’ are ineffective, malfunction regularly, and are ultimately set to fail.”

The development of the BRICS is seen as crucial for Russia as it struggles with visa bans and asset freezes after its annexation of Crimea. For President Xi Jinping of China, the summit is an opportunity to gain more responsibility on the global stage. As the most prominent superpower present, China will want to demonstrate it can promote the rights of the developing world.

Speaking on BBC Radio 4, economist Jim O’Neill – who coined the term “BRIC” – described the three-day summit as a “statement of intent” from nations that feel left out of global democratic discourse. He summarised their attitude as: “If you don’t include us, we’ll do our own thing.”

There is plenty to iron out before plans for a new world bank can be put in motion. Most pressing is the fact that the nations are at loggerheads over where the bank’s headquarters will be. Shanghai, New Deli and Moscow are tipped as the most likely candidates.