Year: 2014

Equity trading in the emerging markets: TradeNet advises

Posted on by Ashton Wenborn

Equity trading when approaching emerging markets can be tricky to navigate. World Finance speaks to Mohammad Attiya, President of TradeNet – a leading equity order management company based in Saudi Arabia – to discuss how to succeed in the area.

World Finance: Well Mohammad you’re a leading provider of equity trading services to emerging markets. So what advice would you give traders who are approaching these markets for the first time, what should they really look out for?
Mohammad Attiya: The nature of trading in emerging markets that we operate in are more retail than institutional, so a lot of retail activities, most customers are individuals who are trying to get rich fast. The volume of retail based trading exceeds 95 percent, and that requires certain ways of dealing with the customers that are not typical to the mature markets.

The other difference is the size of the market and the effect rumours do to this size of the market. The markets are small, and a small rumour can make a big huge change to the market, and that makes the nature of investors more speculators than investors if I may say.

Our system offers multiple rulebooks

World Finance: Well you supply direct access to many Middle Eastern stock markets, so what trends are you currently seeing there?
Mohammad Attiya: Two major trends. The increased footprint of institution investors. We see institutional investors coming into the markets. The other one is the demand by customers to have a single portfolio that they can trade in multiple markets, so they go outside of their traditional comfort zone of just the local market.

World Finance: Well Islamic financial services are also gaining ground, so what do you offer in terms of financial brokerage services?
Mohammad Attiya: The two main differences between Islamic based or sharia compliant brokerage and traditional brokerage is what you buy and how you finance it. What you buy depends on the rulebook that you follow. Our system offers multiple rulebooks. You can define the rulebook that you want to buy according to, so which rulebook is simply a set of criteria to define if a certain stock is sharia compliant or not based on the activity of that company. So for example, companies that deal in alcohol are not sharia compliant.

The other aspect of Islamic brokerage is how you actually give a margin, or how you finance the purchase. There are number of transactions that you have to do in order to finance a purchase or sale of a stock, and we provide support for these different types of transactions to support sharia compliance trading.

World Finance: So for those who are new to Islamic finance, how would you suggest they approach it?

Mohammad Attiya: First you need to know the rules. There is unfortunately no single way of knowing, or single book to read from, or single opinion to listen to, so you need to do a bit of education to yourself as a brokerage company and then implement those principles in your technology platform, or take a platform that can support this.

World Finance: Well finally, what are Tradenet’s plans for future growth?
Mohammad Attiya: Tradenent is focusing on what we see as the main trends in brokerage now, which are mobility, and the use of information. Mobility is not just mobile applications or being able to trade from my mobile. It’s like the move from wired to a wireless environment. Now you move from a core location to dislocated teams. By that I mean yes, the customer can trade online, or from his mobile, but also the broker can do his work from a tablet. The compliance officer can track what’s going on while he’s on the move, so it’s basically moving the whole brokerage industry mobile.

Tradenent is focusing on what we see as the main trends in brokerage now, which are mobility, and the use of information

The other aspect that we see is happening is, if you watch the World Cup, in the past the only piece of information that mattered in a match was the score. Then it developed into how many goals did they miss? But now you see at the end of each half time, you see information like who ran how much, who possessed the ball how much, and who did the proper passes. So this information has always been there. It was not shared and it was not required by customers even. When TV channels started showing these, they got more audience.

The same with brokerage. If you give the customer information that you already have, like your trading today is falling within ten percent of your risk profile in general, of your peer groups, what you are investing in is different from what others are investing in. Without giving information that the regulator will not allow to give, summarised information with grouped information, so I know more about myself with the information that the brokerage company already has.

World Finance: Mohammad thank you.
Mohammad Attiya: Thank you very much.

Does money laundering go up when assets get frozen?

Posted on by Ashton Wenborn

Money laundering is a problem worldwide. The International Monetary Fund estimates that two to five percent of global GDP is laundered each year. World Finance talks to Dennis Cox, author of The Handbook of Anti Money Laundering, to ask what kinds of conditions increase money laundering.

World Finance: Dennis, would it be fair to assume that, when assets were frozen of a list of Russian oligarchs and other expats, the amount of money laundered went up?
Dennis Cox: Not necessarily. The money that was, if it was illegal proceeds of crime and that’s what we were to recognise we’re looking at, would have been laundered already.

In the case of most of those Russian oligarchs, one has to assume that actually it is not the proceeds of crime, there’s no evidence that it was so at this stage, so for the financial institution, as long as they’ve checked the source of funds, and they’ve verified the individuals and the source of funds, it doesn’t fall into those kind of categories. So there is no real reason why that should have been the case.

What did happen was, clearly when they had the Cyprus problem, was that money moved around the system, and that was more to do with confidence in the banking sector than really the money laundering rules themselves.

China shuns ‘dirty’ coal to tackle air pollution

Posted on by Ashton Wenborn

In late September China took a massive step to tackle air pollution announcing it would ban low-quality coal imports in 2015 and switch to clean alternatives such as natural gas, nuclear and renewables. According to its commission’s website, from January 1 China’s government will encourage imports of higher-quality supplies and stray away from imports of ‘dirty’ coal. A blanket ban on domestic mining, sale, transportation and imports of coal with ash and sulphur content exceeding 40 percent and three percent is also being put in place, with utilities and other big consumers having to cut imports. This ultimately comes at a consequence for international traders as China looks at shifting its energy consumption and importation.

As the largest importer and consumer of ‘dirty’ coal in the world, China must ensure a cleaner and less-polluted country. Importing about 300 million metric tons of coal and consuming approximately 3.5 billion tons a year, China depends on the resource for 65 percent of its energy. NRG Senior Analyst Edgar Van der Meer says China’s needs are still visibly and rapidly growing with a new coal power plant commissioned every seven to 10 days, though he believes the impending ban will have a slow effect on China as the world’s top coal importer and consumer. “It will take a little while for policy to trickle down and really have an effect because China is such a behemoth in terms of its consumption of coal and electricity at the moment,” he says. “Coal isn’t going anywhere anytime soon for China at least.”

Analysts say China’s efforts to get rid of ‘dirty coal’ might be in vain

During the last decade, global coal demand has largely been driven by China, however this demand could fall as much as 15 percent to less than 300 million metric tons if the ban goes ahead. Therefore it is unknown whether the effects of the decision will be positive or negative or whether the country’s choice will create a shift in coal trade flows. Reuters states global thermal coal demand will shift away from China in coming years as it switches to cleaner energy and this shift will shake up the Asian seaborne coal trade, which currently focuses on routes between shippers such as Australia, Indonesia or South Africa to established consumers in China, Japan, South Korea and Taiwan.

Whereas some countries will lose out, others will step up in the game. London’s Business Monitor International put together a report released in September detailing China’s pre-emptive ban, concluding that if the ban went ahead in 2015, coal exports from South Africa and Australia would come under pressure, while Indonesia and Russia would emerge as winners with greater room to expand coal exports. Indonesian Coal Mining Association Head Bob Kamandanu told The Wall Street Journal Indonesian coal exports wouldn’t be adversely impacted because the country’s sulphur content is generally less than one percent and ash content is five to seven percent.

Eager not to leave this booming market to Indonesia, other major coal exporters, such as Australia, Colombia, South Africa and the United States, will also compete for new opportunities in countries like Vietnam, Malaysia, Thailand and the Philippines. According to BMI, Australian and South African coal will be worst hit since both countries have an ash content of 23 to 25 percent. The Australian stated Australia exports at least 49 million tons of thermal coal to China each year. About 55 percent of the nation’s thermal coal export mining capacity complies with China’s tough new coal import regulations, 29 percent does not comply and 16 percent partly complies. Van der Meer states Australia has more to lose if it isn’t able to remain cost-competitive.

Despite this, analysts say China’s efforts to get rid of ‘dirty coal’ might be in vain, with the effects on pollution and greenhouse gas emissions yet to be seen. Van der Meer says China has promised a slowing and not necessarily a reduction of pollution. A lot of the expansion is expected to be taken up by alternate fuel resources and renewable energies, thereby slowing the rate of increase and creating a levelling off of greenhouse gases, instead of a noticeable decrease.

There are several knock-on implications that may come from China’s impending move to ban the import and sales of ‘dirty coal’. A notable shift in coal trade flows will produce significant winners and losers, as demand for global thermal coal moves away from China. Indonesia will capture a larger share of the Chinese market, while countries like South Africa and Australia will look to re-direct their coal towards other countries. Seaborne imports will continue and so will competition amongst major coal exporters. Although the anti-pollution move could have significant repercussions for key exporters, straying away from ‘dirty coal’ is indeed beneficial for addressing China’s alarming pollution levels. And it seems the nation definitely has a strong will to tackle the problem.

SME growth key to Africa’s future, says African Guarantee Fund

Posted on by Ashton Wenborn

Small and medium-sized enterprises (SMEs) are widely recognised as big drivers of economic growth, innovation, regional development and job creation. A strong and vibrant SME sector provides a strong foundation to increase standards of living and to reduce poverty. Indeed, Africa’s small enterprises, from trading to farming, contribute more than 80 percent of output and jobs in most African nations. They also offer the best opportunities for growth, diversification and job creation. But SMEs are constrained by limited access to stable energy services, business management, skilled labour and especially finance for investment.

Successful developing countries have seen their SMEs flourish, moving from informal to formal production and becoming the backbone of growth in production and employment. Such processes of development support the creation of a strong middle class and also tend to strengthen democratisation and the rule of law.

80%

of output and jobs from SMEs in Africa

Despite the internationally recognised importance of SMEs, African small businesses often have difficulties accessing financing from the formal financial sector. Almost 50 percent of African companies identify lack of access to finance as a major constraint to doing business. The cost of finance, including investment finance, is higher in Africa than any other part of the world, and the access for SMEs is particularly limited. Very few commercial banks do small-enterprise banking in Africa. Furthermore, SME financing is often considered by many financial sector players in Africa to be a risky activity as promoters quite more often than not, fail to come up with the collateral levels required to secure bank facilities.

Low-level financing
Studies done by the World Bank and other organisations have revealed very low levels of bank financing to SMEs in Africa when compared to other developing countries. It is also often noted that SMEs represent a ‘missing middle’ in African private sectors as these are dominated on the one hand, by (mostly informal) very small (micro) enterprises, and by large companies on the other.

The missing middle is particularly pronounced in sub-Saharan Africa, where the unmet need for credit by all micro, small, and medium-size enterprises (MSMES – enterprises that typically have fewer than 250 employees) is in the range of $140-170bn, approximately 70 percent do not use external financing from financial institutions, although they are in need for it.

These studies have attributed low levels of bank financing to SMEs in Africa to both supply and demand. While the lack of effective business plans and adequate skills within SMEs are a problem on the demand side, the supply is constrained by lack of capacity in the financial sector to do business with smaller companies; inadequate information resulting in high-risk assessments; lack of collateral and collateral registries; poor protection of creditors; and lack of availability of longer term funds.

Rising to the challenge
It is in response to these challenges, the African Guarantee Fund for Small and Medium-sized Enterprises (AGF) was created in by the African Development Bank (AfDB), the Government of Denmark through the Danish International Development Agency (Danida), and the Government of Spain through the Spanish Agency for International Development Cooperation (AECID). AGF was imagined and designed primarily as a response to a development challenge as the need to foster innovation, growth companies and provide employment opportunities in all economies is essential to long-term and sustained growth.

Today, Africa is enjoying unprecedented growth and the world is awakening to the opportunities that the continent offers. AGF’s job is to be part of the effort to ensure that the benefits of that growth are fairly shared at all levels of the society.

Through its guarantee facility, AGF assists financial institutions partially cover the risks associated with SME financing and thus enable them increase their portfolio in that asset class. Its guarantee business also enables financial institutions to raise long-term resources for SMEs long-term needs. AGF also offers capacity development facility enable partners financial institutions enhance their SME financing capabilities and thus to execute their growth strategies in that sector with ease. A combination of AGF’s guarantee and capacity development facilities, allows partner financial institutions to bring their SME financing business to the required scale that would not only enable them bring down transaction costs significantly, but also increase returns on investment. AGF is the missing link that enables partner financial institutions execute their SME financing strategies effectively, while enabling SMEs to play their expected role in fostering African economic development.

Since its official launch in 2012, AGF has gained over $300m of financing to more than 300 SMEs in Africa. Through its partner financial institutions the company operates in more than 20 countries in Africa.

AGF anticipates in its strategic plan that it will guarantee approximately $2bn of new lending in the medium term and enable over 10,000 African SMEs to have access to finance. This would help to secure and create millions of productive and better jobs for the youth across the continent.

How important is America’s economy to the rest of the world? | Video

Posted on by Ashton Wenborn

Treasury Chief Jacob J Lew said the world is looking to America to drive the global recovery. Is this the case? World Finance speaks to Ryan McMaken, Editor of Mises Daily and The Free Market, to discuss how important America’s economy is to the rest of the world

World Finance: Treasury Chief Jacob J Lew said the world is looking to America to drive the global recovery. Ryan, is this the case? How important is America’s economy to the rest of the world?
Ryan McMaken: Even with all of America’s troubles, there are 300 million people in America and they do have money, still. There’s still a lot of capital that was created during the twentieth century in this country and we’re still taking advantage of it, and still able to use it.

So, as a place where you you can sell your goods globally, in terms of a place where there are many investors looking to invest, the United States is still very important, there’s no denying that.

World Finance: Well the US and China could very much be described as “frenemies”, so how much do they need each other?
Ryan McMaken: Well, if we really want to increase the well-being of both people in China and the United States, free trade is always a good way to do that. So as long these two countries can get along and continue to trade, even if it’s not totally free trade, just some trade is certainly better than no trade.

Certainly the better those countries get along, the less they get caught up in foreign policy that’s belligerent, the better that’s going to be, not of course just for the people in those countries, but globally as well.

Actavis moves closer to finalising Allergan buyout

Posted on by Ashton Wenborn

After months of battling it out against Canadian drug firm Valeant and activist investor William Ackman, pharmaceutical giant Actavis looks set to acquire botox-maker Allergan.

The firms are to hold discussions this week to review the cash and stock terms already agreed on – with shares valued between $215 and $220 – according to sources familiar with the case, Reuters reported. That could see the deal close at over $65bn, marking the biggest pharmaceuticals buyout of 2014.

Allergan has shown reluctance to accept
either offer

Allergan has shown reluctance to accept either offer, arguing that Valeant’s tendency to buy out competitors and then reduce spending could negatively impact on its product development. The debate provoked a wider discussion in the industry over how much money should be invested into pharmaceuticals R&D.

Allergan even tried to sue Valeant and Ackman – manager of hedge fund Pershing Square Capital Management – for insider trading. The pair, whose interest in Allergan dates back to April, offered $200 per share in their latest bid. That would value the company at $53bn – significantly lower than the Actavis offer, although they could still raise the bid.

“I think Actavis is going to win,” University of Michigan business professor Erik Gordon told Reuters. “Ackman is going to be content to take his profit on his Allergan shares and go onto the next battle.”

Ackman revealed in April that he held a 10 percent share in the Botox company – meaning he will gain from either takeover.

The deal marks the latest in a string of buyout attempts in the industry, with Pfizer’s AstraZenica bid and Abbvie’s efforts to acquire Shire both falling through in 2014.

The highs and lows of Randall Kroszner’s life at the Fed | Video

Posted on by World Finance

Hard to believe that it was just a few years ago that the US faced economic meltdown. One of thek key decision makers at the time was Randall Kroszner; he speaks to World Finance about the decisions they made, the loss of Lehman Brothers, and the one thing nobody saw coming.

Hard to believe that we were, just a few years ago, facing an economic meltdown in the United States. Now one of the people at the helm, making the big decisions, joins me now – ex-Governor of the Federal Reserve, Randall Kroszner.

Word Finance: Do you think that all of the right decisions were made by Bernanke at the time?

Randall Kroszner: Well, I was one of the fellow Governors, along with the Chairman, making these decisions – so you’re not going to get an unbiased view from me. So we obviously tried to do our best in very difficult circumstances. I think the emergency liquidity policies that we undertook, the various lending programmes, the international swap agreements that helped to prevent meltdown in other countries around the world, that had very strong demand for dollars but didn’t have them – I think those are very helpful in one, fighting off deflation which is something that central banks can do if they’re active about it, but sometimes they’re not as focused on it. And two – avoiding more broadly a kind of repeat of the great depression. The unemployment rate in the US went up by 10 percent during this crisis – during the 1930s it was over 20 percent. So I think we did a lot of things that helped to prevent the crisis from being nearly as bad as it was back in the 1930s.

Word Finance: Now, if you could go back – what would you change?

Randall Kroszner: So one of the things that we didn’t have enough insight into were some of the interconnections in the economy. And so we were focused on regulating banks and focused on banking institutions. Other regulators were focused on other types of institutions. And there wasn’t enough information exchanged between them to see the interconnections, to see those vulnerabilities, those fault lines and weaknesses.
I wish we could have had more foresight to say, well rather than us just look at our institutions and you just look at your institutions, let’s look at the interconnections and relationships between them – and that’s really where the weaknesses were. 

Word Finance: Do you think that there was a bit of naivety in terms of impact the housing crisis played towards the toppling effect of the US system?

Randall Kroszner: So one of the things we were doing was international comparisons, to see how the US housing market was doing relative to other countries. Because obviously housing prices were moving up reasonably rapidly. But we, as well as the IMF, did some of these comparisons and the US I think was even in the top five of the countries seeing housing price increases.
That gave us a false sense of confidence that the US was not an outlier. The challenge was that there was a risk factor in housing around the world and it wasn’t just us in the US, but people in Spain, people in many other countries didn’t see that there were these challenges there also.

Word Finance: Should we be mourning the loss of the Lehman brothers or is the US really better off without it?

Randall Kroszner: Well certainly the Federation, as well as other regulators and supervisors, were trying to find a merger partner for Lehman Brothers – and that didn’t work. There were some challenges with the UK Government and being able to implement a takeover by Barclays, and so we were left that weekend dealing with Morgan Stanley, Goldman Sachs, Merrill Lynch and then there was no merger partner for Lehman Brothers.

The key challenge was what would be the consequences for the markets more broadly? And this goes back to the other answer that I gave you – the consequence was in the money market funds, which we didn’t see because we didn’t regulate those funds. People weren’t looking to see if there was a concentration of Lehman Brothers debt obligations in one particular money market fund, that fund got into trouble and then that triggered trouble throughout that industry. And so if we had been able to see those interconnections more clearly earlier, we might have been able to prevent Lehman Brothers demise from causing such problems throughout the system.

Although I think Lehman Brothers was really much more of a symptom rather than a cause. I mean even if something could have been done to put a band-aid on Lehman Brothers – the vulnerabilities were there in the system. They needed to be addressed much more fundamentally and something like the Troubled Asset Repurchase Programme, the TARP Program, which injected capital into the financial system, was crucial – and without that it would have been very difficult to stabilise the system. We might have seen another institution, perhaps a larger institution, get into trouble.

Word Finance: Do you think the right banks were bailed out?

Randall Kroszner: So we were dealing with the challenges as they were coming, and certainly they were coming quite rapidly, and thinking from a system point of view what would be the best to stabilise the system. Because by doing that we could prevent a meltdown, a repeat of the great depression that would have led to a 20 percent unemployment rate, housing prices falling by 60 or 70 percent rather than only 20 or 30 percent. So we were trying our best trying to try and deal with the challenges as they came along.

Word Finance: We’re now a few years out since this crisis happened. Did you ever expect the US economy to be where it is today?

Randall Kroszner: When I left the Federation in early 2009 I don’t think anyone sitting around the Federal Open Market Committee table, making decisions about interest rates, would have thought that in 2014 the debate was – well when in 2015 would interest rates rise – that they would be so long in coming up. We brought rates down to roughly zero at the end of 2008, and that six or seven years later interest rates would still be at zero – I don’t think anyone really foresaw that.

World Finance: So how are you feeling in terms of progress – where do you think the US stands to go a year from now?

Randall Kroszner: So I think it was very important that the Federation did what it did to prevent a repeat of the great depression. But central banks can do the necessary job to prevent the deflation, or in other periods to prevent high inflation – but they aren’t sufficient for getting the economy going.

Fiscal uncertainly is something that weighs heavily on businesses uncertain of what their taxes are going to look like over time, uncertainly on regulation – a lot of uncertainties surrounding the President’s business healthcare program. And so I think that’s been slowing us down. If we can deal with some of these issues, I think that will help to put us on a more solid foundation.

I wish I could say everything’s solved now – but it’s a little bit too early to tell whether the elections are going to solve problems. But we do seem to be making progress in the labour market – we do seem to be making progress more generally with production. But we need to restore confidence in investment to get productivity to grow, to get wages to grow and really come back more strongly.

“Without financial inclusion, you can’t create a middle class” – David Schwartz at Felaban 2014 | Video

Posted on by World Finance

The power-players have gathered for yet another year at Felaban. With nearly 2,000 representatives from financial institutions from markets around the world present, what are the key themes being explored by developed and developing nations? David Schwartz, CEO of FELABAN’s key partner, the Florida International Banker’s Association, tells all.

The power players have gathered for yet another year at Feleban. Here to tell us about some of the highs and lows of the event – David Schwartz.

World Finance: David, I know thousands of people who are attending this year – bankers from all over the world. Tell me, what were some of the big takeaways for you?

David Schwartz: Well you’re right – what we’ve estimated so far is about 1800 participants from 50 countries around the world. So as you can see this is a central meeting point for bankers from around the globe, to do business in Latin America and I think that’s what underlines the importance of this event.

World Finance: Tell me – how central of a role does this particular event have for the banking sector in Latin America?

David Schwartz: Well for Latin America it’s of the up most importance because what your looking at are banks coming from around the world – Europe, Asia, the US – seeking to advance lines of credit and offer financing here for everything from trade finance to infrastructure projects. And this is what helps boost the economies in these countries, which have been struggling of late.

World Finance: So do you think there was any really big takeaway in terms of what significant steps need to be put in place? For instance from The Finance Minister of Columbia, who was speaking earlier.

David Schwartz: Well I think we heard two common themes. One was of course financial inclusion, which is very important in some of the poorer countries in Latin America, and without that you don’t create a middle-class. I think that was a very important note from the speech of the Minister.

The second was technology, because technology and those advancements will really help bring those people into the financial services industry. Not only to help them bank but also to help them create their own businesses – many of these people have ideas and they want to create them, but they don’t have the means to do it. And this will help them.

World Finance: Next year – Miami. What can we expect?

David Schwartz: Well next year we will be celebrating 50 years of Feleban, so I’m not going to release any secrets or unveil any secrets – but will prepare something very special to celebrate the 50th anniversary.

World Finance: Now reflecting on the Americas in general – as much as emerging markets need some of the developed economies, the developed economies need the emerging markets. Is that going to be a theme that runs through next years conference?

David Schwartz: That will always be a theme in every conference because while we talk about the developed nations, really today it’s only the US and maybe the UK, that have come out of the crisis with any type of future hope, in that the economies will remain stable. We see that Europe is struggling still. Japan today officially announced that they have entered into a recession. So we need trading partners, and Latin America has always been the top-trading partner for the US.

World Finance: Why do you keep going back to Miami – what is it about that community that really reflects the ambitions of the banking sector?

David Schwartz: Well we like to say that Miami is the gateway to Latin America, and in some peoples minds Miami is the capital of Latin America. Don’t say that to the Latin American’s because it could be offensive, but culturally and geographically we are the meeting point.

We are able to have events like Feleban in Miami, speak to them in their own language – people of their own culture are organising these events. In Miami of course it’s sunny all year round – we have the ocean. And most importantly for a lot of them, we have shopping.

World Finance: Ok now one last point – I know FIBA organises quite a few events around the banking sector, the anti-money laundering conference that’s going to be held is personally a lot of interest for me. Can you tell me, what can we expect from it?

David Schwartz: Well this has been a challenging year for the banks when it comes to regulation and compliance. We will be holding the 15th annual anti-money laundering conference on March 5th and 6th.

We have a lot of regulators that have reached out to us, and policy makers, they want to come and discuss the issues at the conference. And that’s always been the most important aspect of it. We have an open, free flowing dialogue between the industry, policy makers and regulators.

And given the current challenges, I think you’ve seen a lot of the rather substantial fines that have been handed out to banks for failures with their money laundering programmes – this is going to be a very important event, a very key event this year. Because we have regulators and policy makers issuing guidance saying banks really need to work better – and you have the banks and the industry of course saying we’re over regulated.

So we’re going to have a very interesting and perhaps controversial discussion on some of the main issues.

World Finance: David Schwartz, thank you so much for joining me today.

David Schwartz: And thank you.

Recession hits Japan; Latin America reacts | Felaban 2014 | Video

Posted on by World Finance

The surprising fall into a recession – that’s how Japan’s current economic situation is being described by market watchers. BTGPactual’s Mauricio Gutierrez discusses Japan’s presence in Latin America’s vital infrastructure sector, and the possibilities that may lay in store as banks react to its new economic reality.

The surprising fall into a recession – that is how Japan’s current economic situation is being described by industry watchers. Here to shed light on what that means for foreign lending, Mauricio Gutierrez.

World Finance: The news has just hit, what do you make of it?

Mauricio Gutierrez: Well I think the financial situation in Japan has impressed us for quite some time. In Latin American markets where the Japanese banks compete, we have seen them to act very aggressively, to have cost of funds that are below zero sometimes, so that allows them to lend money to projects still at home, and I imagine other countries as well.

Very aggressively, we have seen them compete with us in our projects, in infrastructure projects, and we’re very impressed. I don’t think this news that we’ve just had of them going into a recession will change that, because if anything we will still see low interest rates in Japan, and very low cost of funds. So if there’s less activity in Japan, the likely scenario is that this aggressiveness outside of Japan will continue. 

World Finance: Do you see more opportunities coming out of Japan in light of the current destabilising economic situation that’s happening?

Mauricio Gutierrez: I see them very present in the Latin American markets, very aggressive. I don’t see that aiming down, the opposite. A week ago I just saw a very aggressive proposal from a Japanese bank to a project that we’re also approaching. So I think that will continue.

Maybe I’m being optimistic, maybe some of these banks will have problems at home that will affect their appetite overseas, but I think LatAm is a natural market for them to grow, they’re present in the main market. I think they will continue taking advantage of the growth that is coming out of this region. 

World Finance: It sounds like optimism abounds from your perspective. Mauricio Gutierrez, thank you so much for joining me today.

Mauricio Gutierrez: You’re so welcome. Thank you.

How is money laundering hitting markets?

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As one of the most prosperous industries at present, money laundering is one of the most aggressive growth. Here, Dennis Cox, author of the Handbook of Anti-Money Laundering, explains to Jenny Hammond how the industry has taken off – and governments are worried

World Finance: Dennis, money laundering – where are the trouble spots?
Dennis Cox: As crime goes up around the world then clearly people want to try to turn those funds into money they can use. That means everywhere is a trouble spot. The main centres of financial crime deterrents become the UK, America because we’re the centre of the financial markets. So we have to be particularly vigilant in the major markets to try to look out for these kinds of funds.

World Finance: Well you wrote that money laundering is one of the few global growth industries that seem to be prospering at present. How is this industry structured and what is the process?
Dennis Cox: Every time you have something stolen from you or you have some trying to extract money from you in some way, they are going to try and place it into a source so they can actually get true value from it. As crime goes up, and we were discussing things like terrorist financing in the book, but obviously drug trafficking, human trafficking and other types of crime – they’re all growth industries, with regret.

Money laundering tends to stay ahead of the regulations

And of course if they’re growth industries then by consequence money laundering itself becomes a growth industry. Very much organised crime – a lot of organised crime is involved in this kind of process. Although there is a difference between what I would call amateur money laundering, which when the single person who has just stolen from a flat is trying to sell a TV or something. As opposed to professional money laundering, which is more attached to the organised criminals who are doing drug trafficking, human trafficking, terrorist financing and those kinds of matters.

World Finance: So how profitable an industry would you say it is for those that are doing the dirty washing?
Dennis Cox: The person who is trying to get the proceeds so they can use them legitimately, is willing to take a discount on the funds, which is sometimes quite substantial. They know that they want clean funds that they can use, and they’re willing to pay for that privilege.

That means that there’s a lot of money to be made – there’s a lot of funds that can then be moved around in those ways. And that creates the advantage, that creates the preference – and that means that we actually have new things coming through all time. Money laundering tends to stay ahead of the regulations – the challenge with anything in this space is trying to stay ahead of the money launders.

World Finance: How are governments cracking down and are there any traps legitimate businesses can fall into unwittingly?
Dennis Cox: Increasingly there are new sets of rules coming in in terms of the way you have to verify your staff, including people like contractors, to see that they are legitimate – and that’s focusing particularly on the financial services industry. One of the key areas has been within the taxation market, and thinking about taxation – if you under pay tax then clearly that is ill-gotten gains from the evasion of taxation. And where this line comes between avoidance and evasion is clearly a very difficult line to tread.

World Finance: How do international standards differ and what challenges do these pose?
Dennis Cox: We do have some global standards primarily promulgated by the financial actions task force, although there are other principles around like the Wiseberg principles and we have the European directives. But everyone seems to want to have there own derogation, and then of course you have to align it to the laws of the country.

And so you walk into things on data privacy for example which can make life quite difficult sometimes – what am I allowed to connect, what data and I allowed to hold – and once you start to have restrictions on the data then it makes it much harder to identify and really identify either the corporate or the person.

World Finance: Well considering that illegal activity is now counted towards GDP, surely cracking down is actually going to hit economies?
Dennis Cox: Does money laundering create employment? I’m not convinced it does. Does it add value to society? I’m not convinced it does that either. So the elimination of it terms of improving economy, making it feel like a good place for people to do business, where you can do business safely – I think that creates greater growth than anything we could possible lose by some loss of numbers on a fictitious GDP figure.

[C]hild pornography and child exploitation are seen as being areas where quite small payments may turn up

World Finance: Well there is a general understanding that the authorities are more interested in large amounts of money. So when it comes to small amounts, do these slip through the net?
Dennis Cox: I think they do. And this is what we call something like the plumber. Is it plausible that your plumber might take cash, and is it plausible that your plumber might then not disclose all of that cash to the tax authorities? And is that exciting, in terms if finding organised crime? Well the answer is – no it’s not. So clearly at that end it’s to an extent allowable. Now we in the UK have set up the rules of zero de minimis – that’s because child pornography and child exploitation are seen as being areas where quite small payments may turn up.

World Finance: So how easy is it to prosecute and how many people get away with it in reality?
Dennis Cox: The number of prosecutions is not high enough, and I think everyone would agree with that. There’s a lot of work done in terms of producing suspicious activity reports and sending them to the relevant authorities. But in many countries – there are almost no prosecutions. Here, we are slightly better within the UK market – the US is doing slightly better too. But from other countries you find hardly any prosecutions at all. It doesn’t mean there isn’t money laundering – it just means it isn’t prosecuted.

United Real Estate Company expands economic strategy in the Middle East

Posted on by Ashton Wenborn

Much has been made of the Middle East’s real estate market in recent years, as the region’s wealth and easy access to capital has created an accommodating growth climate – presenting a wealth of opportunities for those in the sector. Nonetheless, the characteristics fail to offset the fact that demand far outstrips supply, and it is here above all else that the Middle East’s status as a still-immature market is best seen.

In a region still characterised by a lack of transparency and inadequate government policy, the real estate sector represents a means by which the Middle East could perhaps realise a more diverse and sustainable economic strategy. Real estate developers, therefore, have been tasked with the responsibility of leading the region’s social and economic development, as the Middle East looks to move away from its dependence on oil and gas, and expand upon the diversity of its economic make-up.

Governments in the Middle East must start incentivising developers

“I personally view the role of a developer as the key player in facilitating this growth and in un derstanding the responsibility they have towards the built environment,” says Renimah Al-Mattar, Executive Vice President of United Real Estate Company (URC). “First and foremost, it is a real form of diversification away from oil.”

Addressing needed reforms
Al-Mattar is acutely aware of the opportunities and challenges facing the industry, as well as the unique qualities it takes to succeed in what remains a problematic marketplace. The relative immaturity of the market she says, does mean however, that there is a great deal of growth still to be realised; although there are many challenges, and require far-reaching structural reforms before the real estate sector reaches its potential.

“I think the role of developers has changed because they are no longer builders or contractors,” says Al Mattar. “We still have a tendency to call companies or investors ‘developers’ when they are not, and this does not happen only in the Middle East but actually all over the world.” Al Mattar continues to outline the importance of governments contributing to this same growth and treating real estate as more than an investment market, by acknowledging its contribution to social and economic growth. Governments in the Middle East, says Al-Mattar, must start incentivising developers by streamlining the process of approvals required and by creating further development guidelines, as opposed to simply reverting to subsidies.

Developing responsibly
Unlike construction companies, real estate developers must manage the entire value chain, starting with land acquisition onto overseeing valuations, developing and analysing financial feasibility studies, and, most importantly, creating development strategies. “A developer must not only choose the appropriate construction companies, consultants and architects,” says Al-Mattar, “developers are the entity that oversee the whole project and make sure the final product stays true to the development’s strategy, and that is something that we do at URC.” The challenge of realising untapped potential in the region’s real estate sector, however, is easier said than done. “Following the Arab spring, there are still uncertainties arising from political transitions and social unrest, and issues of unresolved public policy or private sector legal framework affect all industries, including the real estate sector.” What’s more, research shows that the majority of real estate activity in the Middle East is centred on land acquisition and residential units, given that there is an artificial shortage of land triggered by that being reserved, either indirectly or directly, for oil-based activities.

Taking into account the challenges that exist for real estate developers, only those with a focus on sustainability and a commitment to responsible development will succeed. With projects such as the Abdali Mall in Amman, Jordan and another sustainably minded project in Shuwaimiyah, Oman, has URC been working towards satisfying the demand for real estate and participating in the region’s wider social and economic development.

URC demonstrates how, with a commitment to responsible growth and a wealth of experience in the market, developers can skirt the complications that exist for those working in the real estate sector. “I want to continue working with my CEO, Mohammed Al-Saqqaf, who has been instrumental in driving many of our visions. Strong leadership and supportive shareholders are what will allow us to develop projects that we feel contribute to the built environment,” says Al-Mattar, on speaking of the company’s future. “My ambitions for URC are to continue to attract and retain talent that allows us to be the leading real estate developer in the region.”

Is the US economy ready to end QE? | Felaban 2014 | Video

Posted on by World Finance

As the US prepares to end its monetary easing programme, what potential financial stresses should the federal government keep an eye on? Former Fed governor Randal Kroszner talks unemployment, manufacturing and the tricky question of whether the US people have confidence to invest again.

As the US prepares to end its quantitative easing program, many question what is going to happen to the economy in the days, months, years to come. Former governor of the fed reserve Randall Kroszner joins me now. Thank you so much for joining me today.

World Finance: So as I said, what is going to happen, do you think the US is really ready to end this program?

Randall Kroszner: Well I think the fed felt that there had been enough progress in the labour market. The US economy was sturdy enough to stop the additional asset purchases. We have to remember that the fed’s balance sheet is now $4.5tn. It had been $800bn, so it’s dramatically larger. Even though they’re not purchasing more asset, they’re still providing a lot of support for the economy. 

World Finance: Absolutely. Now you were in charge when the 2008 financial crisis hit. Bernanke, many say, was quick to respond. Do you think that he put in the measures that needed to be taken at that time?

Randall Kroszner: We tried to act very quickly. One of the things that really haunted us was what happened in the 1930s when the shocks came and the fed did nothing. Milton Friedman, one of the great University of Chicago economists, had said that the depression became the Great Depression because the fed didn’t act, and so we were certainly not going to make that mistake. We undertook a lot of programs to avoid a deflation, avoid a repeat of the Great Depression. Was everything perfect? Certainly not. But did we avoid the worst outcomes? I think we did a reasonably good job.

World Finance: Do you think the labour market was hit too hard by the measures that were put in place?

Randall Kroszner: We were trying to provide support for the economy and for the labour markets. The shocks hit very hard across large and small financial institutions, people who owned homes, and in the US the main savings vehicle for people are their homes and they fell dramatically in value, so consumption was down, and it was a challenge overall. So we’ve had a slow recovery, but we’ve had a steady one. It hasn’t been as robust as we would like, but fortunately it’s been a bit stronger than many other major countries around the world. 

World Finance: So do you think that the US labour market is now poised to continue the slow but steady growth that we have been seeing?

Randall Kroszner: So I think that’s likely. There could be so many shocks that come in, there are so many geo-political uncertainties, whether it’s the Middle East or the Ukraine. We see what happened Vladimir Putin storming out of the G20. That doesn’t suggest that everyone’s working perfectly together. So there are lot of risks out there, but if there’s no major shock that comes in, it’s likely that the labour market will continue to recover, but we’ve still got a long way to go. There are a lot of people who are not in the labour force who would like a job, there are a lot of people working part time that would prefer to be full time.

World Finance: The precarious balance that we face right now, a lot of focus has been on what is it going to do to the wider economy? But as you and I know, a lot of American money that comes in is fuelled by a stable currency, but the currency rising, what is that going to do to manufacturers who rely very heavily on exports?

Randall Kroszner: We’ve had a lot of productivity growth in manufacturing in the US over time, and I think the manufacturing sector in the US will be reasonably robust to these changes in the exchange rate. The main challenge is going to be weak demand in much of the rest of the world.

World Finance: How do you think the US can stave off the impact of that in addition to the end of the monetary stimulus programs?

Randall Kroszner: So it’s challenging times, and as I mentioned, there could be a lot of geo-political shocks that come in. But it seems that there’s a gradual restoration of confidence, a gradual willingness to hire and hire full-time rather than part-time, although we still haven’t made as much progress there as we would like, and as those trends continue we should be on a reasonable path, not an incredibly robust path. The US is much less of a manufacturing economy than it once was, so we’re not as dependent upon manufacturing in our core growth, but it’s still an important contributor.

World Finance: Do you think we’re looking at a different USA, different qualitatively in terms of the mood, the willingness, risk projections. Do you think that people are really ready to take that next step to invest, to buy homes, that sort of thing?

Randall Kroszner: I think that’s a very important point, because there’s a lot of uncertainty, particularly on the fiscal side. People are not quite sure what taxes are going to look like, they’re not quite sure what the level of government expenditures are going to be, and we haven’t really lifted that cloud of fiscal uncertainty either in the short run or the long run, and that’s something that’s really been holding back investment, particularly by firms. 

If firms aren’t investing, they’re not going to be hiring as much, and if they’re not hiring as much and they’re not giving the capital goods for the workers to work with, we’re not going to see wage growth to be that strong, so I think that’s the major gap in US policy right now, is that fiscal uncertainty both in the short and long run. 

World Finance: And what impact is political divisions going to play in the future of the US economic system?

Randall Kroszner: If we’re optimists, we could say well this is what happens in the last few years of the Clinton administration, a Democratic president, Republican congress, and they actually got a lot of things done.
 
I’m not as optimistic now to be able to restore that kind of working together relationship, but I think both the Republicans as well as President Obama want to get some things done, and I think we’ll be able to make at least some progress on some small things. I don’t think the big issues related to fiscal uncertainty, the long term unsustainability of our spending trajectory, that’s not going to be resolved before the next presidential election, but I’m hopeful that we can make some contributions. We’ll see. 

Basically, if we can get a few small things done that will be a good sign, but if by the end of the year we can’t get anything done, then unfortunately it’s going to be business as usual.

How ready is Latin America for Basel III? | Felaban 2014 | Video

Posted on by World Finance

Banking regulation is tightening worldwide, and Basel III is at the head of these changes. Ricardo Anhesini, Head of Financial Services for Latin America at KPMG, discusses the outlook for Brazil, Argentina, and the region as a whole in light of the tougher demands.

Banking regulation is tightening worldwide and Basel III is at the helm of those changes. Here to tell us whether Latin America is ready for the wave of change that’s upon it is Ricardo Anhesini of KPMG.

World Finance: Ricardo we know that Brazil of course was able to benefit from the commodities boom a few years ago. Now the economy has slowed down, the banking sector is going to play a key role is shoring up any sort of economic development. Do you think that the country is going to be able to build on the capital shortfall that has existed in the past and be able to draw investors in the future?

Ricardo Anhesini: Yes Kumutha, absolutely. Listen, the situation in Brazil is complex. I think Brazil has under delivered over the last couple of years, with respect to a measure of momentum, which was the general election. So we now have a new government, which happens to be the former government re-elected. But in general what we see is that the new government will look at what is necessary for the economy to catch up. The banking community will play a very important role in this catch up.

We have several things that need to be addressed. We need to look at infrastructure finance. We need to look at credit for consumption, especially because credit for consumption was pretty much the basis for keeping momentum in previous years in Brazil. And we also have to look at the global regulation, and the implications of global regulations in Brazil – as Brazil is normally following BIS guidance on that particular set of rules.

World Finance: So do you think Brazil is ready for these changes, as you discussed some of them that need to be made?

Ricardo Anhesini: I don’t think Brazil is ready – I think Brazil will be ready. You know, there’s a lot of expectation that came out from what happened in the election. But from what I heard this morning for example when we debated here at Felaban, the Brazil economy perspective from 2015 – 2020, it was quite encouraging. We heard from the economists a number of positive things about the current structure of the Brazilian banking system and how that can play a role in the future.

Over the last, lets say five to six years, the central bank was quite keen in being present, dictating and adapting the Brazilian rules to the global regulations. And that created some sort of protection to the Brazilian system and the Brazilian banks, and we had quite a consistent level of capital, getting ready to comply with Basel III. We have credit at a level that has grown a lot, as I said, but it’s still below average of the developed world.

World Finance: Is it the right type of capital to move the country forward?

Ricardo Anhesini: Absolutely. Brazil needs to get more investment, a higher level of investment either by local savings or getting investment from abroad. It’s absolutely imperative that Brazil, we meet leverage and delivery expectations, finance infrastructure, and be able to move from where we currently are manufacturing to a higher level, if we get higher levels of investments.

So you’re absolutely right, we need to get more capital and better capital. Now as far as it relates to capital movement in the financial institutions, in the financial system – this seems to be quite right. Our tier one level in Brazil remains high. From a Basel III point of view Brazil is one of the most prepared countries in the region. So we have to deal with other issues coming from different regulations. But on capital I think either on financial institutions, financial systems in general, I think we’re quite right.

World Finance: Let’s go from specific to general. Latin America as you said – robust economies, still there are some issues that riddle these economies. Anti-money laundering, anti-fraud – these are regulations that any country that wants to move forward, is going to have to make sure it is very responsive to the changes that Basel calls for, as well as the other regulatory partners. Are they ready?

Ricardo Anhesini: When you talk about anti-money laundering, when you talk about anti-corruption, owing that to the conduct codes and fair lending – all those strengths are already present in Latin America. Either because the national banks that play an important role in the region, or because the local central banks from Brazil, Mexico, Argentina, are looking at those regulations in a very relevant way, and putting them quite high at the top of their agendas for the banks to deal with.

If we talk about the humour of the banks and the regulations – we are ready now. What it takes to get there, what it takes to implement in terms of technology, in terms of restructuring the governance of the financial institutions that is still to come. And an important piece on that is also about what we just said, about the appeal to make further investments in building the infrastructure of those financial institutions, to get it delivered.

World Finance: Now let’s look at another significant economy – Argentina. We know Argentina is still grappling with some significant issues, trying to control inflation, reduce the exchange rate. How likely is it in the next few years, to be able to be responsive enough to the changes that are required at the Basel level, international regulation?

Ricardo Anhesini: Argentina has of course gone through its issues and problems, but it cannot be ignored. When we look multiple years ahead, Argentina needs to find a way to solve its internal problems, its political issues, its inflation issues and be prepared to absorb and realise the potential the country has. And financial institutions and financial institutions are looking at Argentina with the expectation that those issues will be solved, and Argentina will deliver on those expectations. Now the big question is, how long is it going to take? And I have no answer to that.

World Finance: I wish we all had that crystal ball, but in trying to prove the virility of any banking sector and the potential for future mergers and acquisitions – how much of a role is Basel III playing in those conversations? 

Ricardo Anhesini: The two discussions are quite connected – Basel III implementation and the consolidation of the market in the region. M&A in the region is going to be big in upcoming years. There is no way that the change on the business models, how the banks are operating – they need to control costs, they need to leverage capital to make sure that we get the proper levels under the required regulations.

So I see, without question, that under the financial service M&A is going to be big. Now, to finish on Basel III and how that’s connected. I think that, you know, it’s absolutely necessary that you employ your capital in the best way possible to comply with the regulations. It is a lot more effective if you can combine capital, manage liquidity levels and manage regulatory capital levels, when you are bigger and focused on the larger slice of the region where you operate. I think those two things will really connect as we move forward.

World Finance: Do you think that we are going to see a new flourishing of banking products that are more in line with what Basel III and the international standards are calling for?

Ricardo Anhesini: In general banks the response is yes. I think we will see a lot of innovation in banking products. We need to deploy capital properly and we need to control costs. My response to that is yes. Now I don’t have the crystal ball here either, to tell you what those products are going to be – but a lot of innovation is coming into this industry in the coming years. 

Banco Puente ‘very optimistic’ about Argentina’s investment opportunities

Posted on by Ashton Wenborn

Banco Puente, which is based mainly in Argentina, is one of the leading investment banks in Latin America. World Finance speaks to its Capital Markets Director, Marcos Wentze, about how the investment banking industry has remained strong, despite the country defaulting for the second time in a decade on its sovereign debt repayments.

World Finance: Marcos, you operate throughout Latin America, but are primarily based in Argentina. Earlier this year the country defaulted for the second time in a decade on its sovereign debt repayments; how has this felt in the Argentinian investment banking industry?
Marcos Wentzel: I would say it’s totally different, what happened in the last default. It’s more a legal problem. At the end, what happened is that some kind of the debt that Argentina had put it in a situation of default.

What’s happened in the market, we see it mainly as a stop from outside investment, outside inflow, and what we still see is a lot of interest of all investors around the world in Argentina; a very good medium and long-term picture. But we must struggle through the next couple of months until this situation comes through.

World Finance: Now how has this posed opportunities or challenges for Banco Puente?
Marcos Wentzel: Well yes, it’s always for us a challenge, because the economy here has given us constant challenges!

We are very optimistic. We are going to have a couple of months more volatility, but with a good future view

On the wealth management side, we see a lot of clients looking for more conservative investments. They don’t only go to Argentina, they go to corporate investments. So, looking for good yields and better credits in this situation.

What’s going on in the rest of the LatAm region is, the economies are getting slower; Argentina’s getting slower. But at the end we see a lot of potential for Argentina.

I think the expectation of everybody to investments here is very high. As you probably know, next year we’re going to have elections – there is no possibility for this government to continue. And we see at this point different alternatives, different candidates, and they’re all very open to international investment for different projects, infrastructure projects the country has.

We are very optimistic. We are going to have a couple of months more volatility, but with a good future view.

World Finance: So for the next 12 months, would you say there are investment opportunities in Argentina? And then as you said, in the longer-term when the new government arrives, which sectors would you target for growth?
Marcos Wentzel: After 12 months, for sure energy. The energy sector is one of the sectors that has been in need of investment, and the growth of Argentina over the last 10 years has been on average six percent. And from being an exporter of gas 10 years ago, we are importing gas at this point. So Argentina has the reserves; what is needed is the funding and investment to have this gas in the local market, and put Argentina again in an exporting situation.

So energy, for me, is one of the places that for sure is going to be an ace today, in the view of international investors. Not for the short-term, because for sure you will have this volatility because of what’s going to happen mainly in the political environment.

[E]nergy, for me, is one of the places that for sure is going to be an ace today, in the view of international investors.

World Finance: So is there anything you’d like the new Argentinian government to do, to help attract new investors to the country?
Marcos Wentzel: The issue that the last government had was that Argentina today’s debt over GDP is one of the lowest in the region. So I think that’s something very positive for the next government. It will give them the opportunity to go on the capital markets internationally.

What’s going to be really important for me and for all investors, is that the target of these funds really goes to investments that will support the continuous growth of Argentina for the next 10 years. And that’s the main challenge this government will have.

World Finance: Let’s talk about Banco Puente in the context of this volatility, then. How do you manage your investment risk?
Marcos Wentzel: Well, as the main investment bank in Argentina, we diversify our risk through different locations. We cover the southern cone from Argentina, but we have offices in Uruguay and in Paraguay, where we do not only get the flow of investment coming to Argentina, or from Argentina going to these countries; we’re also involved in local businesses.

For the other side, we are in Peru, where we cover all the Andean corridor. And we are also in investments in Peru, Colombia and Chile, from our office in Peru.

And we cover all the central Caribbean from our offices in Panama. So our diversification goes not only in the kinds of business; it goes also in the countries we’re in, so that 100 percent of our income is not only from Argentina.

World Finance: So what’s the outlook for the Latin America region?
Marcos Wentzel: I would say on the whole, the main challenge for emerging markets, the Latin American countries, they will mainly have an infrastructure growth challenge to continuously grow their GDP for the next couple of years.

Commodities will not always be as high, will give the economies a backwind situation so that economies will grow. So it’s really important for all economies that they really start investing so that their infrastructure projects can be developed. And the real challenge is to get this funding and projects going on. And that’s the point today that everybody’s focusing on.

World Finance: A very hopeful outlook. Marcos Wentzel from Banco Puente, thank you so much for your time.
Marcos Wentzel: Thank you very much.

OTC confusion gives rise to cross-margining revolution

Posted on by Ashton Wenborn

In June, Eurex, the clearing house of Deutsche Borse Group, announced it would be introducing new risk-management systems for its clients in Europe, including the possibility of cross-margining between interest rates swaps and fixed income futures. The announcement was greeted with measured enthusiasm in the industry; there was a lot of interest in the potential efficiencies to be made, but there was some trepidation – many wondered why Eurex should bother to clear these products at all when it was not required by regulatory authorities to do so.

The flagship Eurex Clearing Prisma can, as of September, use a plethora of new tools in order to drastically reduce its margining and risk management costs. Though there appears to be demand within the industry for these services, not a lot has happened – probably because the European Securities and Markets Authority (ESMA) released yet another draft proposal for the implementation of key regulatory framework as agreed by the European Parliament in 2012, leaving banks and clearing houses struggling to find their feet in an increasingly convoluted environment.

However, Eurex’s desire to remain ahead of the regulators speaks volumes about the current tense market in Europe. The fact that no other exchanges have yet launched similar products, speaks of the insecurities.

Rising costs
Products such as the ones Eurex Clearing Prisma is launching are already common in the US, where the regulations requiring the central clearing of OTC swaps are already enforced through the Dodd-Frank Act. As similar regulation is set to make it across the Atlantic, the cost of execution of OTC swaps has already risen in Europe, creating a market for swap futures contracts such as Eurex’s new launch. There, the (still relatively small market) for cross-margining swaps is dominated by the CME Group, a futures company and one of the largest options and futures exchanges. However, CME is yet to launch cross-margining products in this side of the pond.

The US has been leagues ahead of Europe when it comes to regulating
OTC swaps

“The Euro-Swap Futures provide our participants with a cost-effective product which tracks the risk of the underlying with the margin efficiency of a standardised futures contract and makes it possible to offset risk with our liquid benchmark government bond futures. The entire European interest rate market will benefit from this offering,” said Mehtap Dinc, a member of the Eurex Executive Board, in a statement made at the time of the launch.

Though Eurex remains confident that the uptake will be significant once the implementation period is over – actual clearing will not start for several months yet – it is a tough sell for many big businesses that will not be required to execute this type of clearing until 2016 under ESMAs new guidelines.

Published in the beginning of October, ESMAs latest draft – still pending approval from the various trade repositories and the European Parliament – declares that so-called ‘Category Two’ counterparties, those of the financial distinction, will need to fulfil stringent clearing obligations for all OTC trades, but not until at least the first quarter of 2016. A definitive date for this regulation to be enforced is still pending.

There are plenty of potential benefits to adopting a cross-margining system for OTC interest rate derivatives trading before the regulatory mandate stipulates. In its documentation Eurex cites higher capital efficiencies as well as more accurate netting effects for listed and between listed and OTC positions. However, because the facilities with which to execute this type of margining is still extremely limited, the cost in terms of time and facilities as well as money, is still relatively high.

Clients are hedging their bets
Cross-margining is not a new concept. Prime-brokerage houses have been offering this type of service for years. But it has not ever been applied to clearing assets before now. It works by factoring in correlations between cleared products – in this case interest rate swaps and fixed income futures – when calculating margin requirements, instead of determining collateral on each individual product. If the risk in each product is reasonably offsetting, which is the case when futures are used to hedge a portfolio of interest rate swaps, a lower net margin amount is possible. Efficiencies can be as high as 70 percent, though savings are highly dependent on the structure of listed and OTC portfolio, and how clients prefer to hedge their investments. So Eurex is hoping that despite high initial investment costs, the potential savings will be enough to push buy side firms to become early adopters.

Without the legal requirement for this type of clearing, the incentive for clients to start clearing these products has been drastically reduced. This type of clearing activity is likely to increasing in the coming months, as front-loading requirements stipulated by ESMA are more clearly defined. In the latest RTS, ESMA indicated that once its mandate was enforced, it would expect trades occurring in the months leading up to its implementation to already have been cleared through the new system – a process known as front-loading.

As with everything else in its latest release, ESMA has not released a date from when traders are expected to adhere to these demands. There will be some reaction in the market as people prepare to clear in order to avoid the confusion that front-loading causes. Clearing voluntarily ahead of the regulatory mandate is a way to avoid that, market participants suggest.

Cross-margining remains a fairly simple principle, however, in order to be put in practice, dealers and clients will potentially need to rethink the entire structure of their clearing apparatus. More often than not, clients will see their portfolios reorganised from top to bottom in order to achieve the type of efficiencies Eurex are promising. The implementation process for this type of clearing is going to be dependent on each individual client. Because mandatory clearing is still relatively in its infancy, banks and buy side clients are often still struggling with myriad operational issues and many may not yet be at the stage where they are ready to consider how to increase efficiencies.

Despite ESMAs decision to push back the deadline yet again, it seems as though Eurex and its partner banks will carry on offering the service as before. That may be mainly to do with the need to front-load clearances, but also partly because of the considerable cost savings the process can offer. In short, the future of the OTC market in Europe is still uncertain. ESMA and other relevant authorities are still clearly struggling to strike a balance between the widespread regulatory reform mandated by the European Parliament in 2012 and the laissez-faire approach the industry often favours. Going by their constant re-drafting of the proposed rules and dates for implementation, it appears as though regulators might be losing confidence in their own mandates.

This is turn leaves dealers and clients struggling to adapt their systems to impending regulatory changes in time. And, perhaps more dangerously, fosters a climate of uncertainty in the industry that can be lethal. In the meantime, the US has been leagues ahead of Europe when it comes to regulating OTC swaps, as the Dodd-Frank Act requiring these types of trades to be cleared and margined has been in force since May 2012.

According to Risk.net, early adopters in the US have suggested that their choice of clearing counterparty would largely be affected by the ability to cross-margin in-house would, alongside the significant potential savings, be factors when choosing OTC clearing providers. Mandatory clearing as a principle in itself is still relatively new to the international market, and companies are still struggling to find adequate systems through which to execute their trades, there is still some way to go before they start examining ways in which to make more significant efficiencies in this type of clearing. When it comes to clearing and cross-margining, the market and the regulators need to learn to crawl before it can run.