Author: Ashton Wenborn

Bitcoin’s biggest backers post-MtGox

Posted on by Ashton Wenborn

Coinbase
The San Francisco-based exchange facilitates various bitcoin transactions and is home to 990,000 consumer wallets and 24,000 merchants. The organisation’s objective is to simplify the complex business of cryptocurrency.

Kraken
The virtual currency exchange, which went live in September 2013, partnered with Fidor Bank late last year, which has since allowed conventional banking activities to be conducted via bitcoin.

Bitstamp
“Bitcoin is working and still has a bright future,” according to the UK-based bitcoin exchange, which has long stood as the European alternative to MtGox and is now one of the largest exchanges worldwide.

BTC China
BTC China boasts the highest trading volumes in China and claims to offer the most liquidity of any bitcoin exchange. The platform was rocked last year due to tighter restrictions, although it’s back to business-as-usual as of this year.

Blockchain.info
The most popular bitcoin wallet and block explorer worldwide, Blockchain.info regularly racks up 200m page views per month. The site’s security policy is to hold as little data as possible to protect against any breaches.

Zach Witton on the health of the eurozone economy | Moody’s Analytics | Video

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The health of the eurozone economy is often called into question. Economist Zach Witton discusses what the European Central Bank’s latest round of assessments indicate about confidence in the eurozone banking system, what challenges lie ahead, and how a culture of secrecy is affecting banks’ willingness to lend

World Finance: Zach, we’ve taken some time to talk about the stress tests, but I also want to hear about the overall health of the eurozone economy. In particular, you say in your report, “European banks’ balance sheets lack transparency, making the banks less willing to lend to one another.” Now can you tell me, do you think this culture of secrecy in Europe differs all that much from their American counterparts?

Zach Witton: The key aspect for European banks is that we don’t know which ones hold sovereign debt, and amid the eurozone crisis, that was a major issue. And that made banks particularly reluctant to lend to each other.

A good point coming out of the ECB’s comprehensive assessment is that for the first time they’re going to be quantifying what sovereign debt the banks are holding on their books. So hopefully that will increase confidence and inter-bank lending. The European Central Bank is also for the first time going to quantify illiquid assets and hard-to-value assets, so that’s another positive for the economy.

[F]or the first time they’re going to be quantifying what sovereign debt the banks are holding on their books

World Finance: Why does this matter across the region?

Zach Witton: I think the eurozone is different from other countries such as the US, because the eurozone economy relies on credit from banks a lot more than in the US. And so if banks aren’t lending in the eurozone, it matters a lot more than if they’re not lending in the US.

Now another observation of yours is that “Total outstanding loans from banks to households equated to more than 50 percent of GDP last year; well above 19 percent in the US.” Now tell me, why does that matter?

Zach Witton: I think in the situation in Europe, households and businesses have high debt loads. They’re in a situation where they have to pay off that debt, so rather than buying goods and services in Europe, they’ll just be paying the bank. Whereas in the US, their debts aren’t as high, so they’ll be able to run out and buy consumer durable goods such as cars and the like. So the prospects in that regard are better for the US economy than the eurozone.

World Finance: The ECB report of course covers 120 of the most significant banks in the eurozone, but do you think that the balance sheets of smaller banks matter in terms of evaluating the overall health of the region?

Zach Witton: I think they’ve actually taken the right approach. They’re looking at the banks that are really systemically important. Smaller banks can fail, they do collapse, but they might be more of a one-off problem. Whereas if one of these systemically important banks fails, then basically you could have a problem with the whole economy being in peril. So I think they are correct to focus on the larger banks.

I think banks should really focus on lending as much as they can to households and businesses at the moment

World Finance: In your opinion, what is the best way for a bank to hold its assets?

Zach Witton: That’s a very good question! I’m not a banker, I’m an economist; I think banks should really focus on lending as much as they can to households and businesses at the moment, to get credit flowing through the economies. Banks will benefit from that; greater economic activity will support their profit margins. So yeah, I would encourage banks to lend as much as they can.

Regarding what assets they should hold or should not hold, I think their holdings of sovereign debt are very high at the moment. But of course the uncertainty about how the European Central Bank in the stress tests is going to treat that; I think they should be very wary of taking on additional sovereign debt, and if possible they should try and get rid of what sovereign debt they’ve got.

World Finance: And finally, what are the major challenges ahead for the ECB?

Zach Witton: The ECB has a mountain to climb. What they’re doing is unprecedented in scope and scale. Another major challenge at the moment is that if they identify a bank as needing to be recapitalised, and that bank is unable to do it from private sources such as issuing debt, there’s a big question mark about how the public funds will step in.

European officials haven’t agreed at the moment for a public backstop, and it would be a catastrophe if banks had these capital gaps that were identified, and they couldn’t be filled. So basically, European officials need to agree some mechanism before the stress test results are released in October.

Is Europe’s stress testing too hard on the banking system? | Moody’s Analytics | Video

Posted on by Ashton Wenborn

Moody’s Analytics has unveiled its report on the latest round of assessments by the European Central Bank. How will the stress tests affect the banking system and the economy? Moody’s Analytics economist Zach Witton discusses how stress testing could restore confidence in eurozone banks.

World Finance: Can you tell me how the stress tests will help restore confidence in the eurozone banking system?

Zach Witton: Okay, well we have a system where banks at the moment aren’t willing to lend to each other. They’re scared that other banks hold bad assets, bad debts, on their balance sheets. And so, if the stress tests are credible, if people believe them, they will restore banks’ confidence to lend to each other. And that in turn will allow banks to ease credit conditions and to increase their lending to households and businesses; which will strengthen Europe’s economic recovery.

World Finance: You called the latest round of stress tests more rigorous than the earlier ones, can you tell me why?

Zach Witton: That’s correct. Okay, there’s two aspects. First, they’re looking at 120 banks – actually more than 120 banks – this time. Previously the European Banking Authority looked at around 90 banks, so you’ve got an extra 30 or so that are being covered.

Also the threshold that banks have to pass or fail this time is 5.5 percent, whereas previously it was five percent. So that means it’s that little bit harder for banks to pass it. We had this situation with the EBA tests, where some banks actually passed the stress tests but they subsequently in real life collapsed. So that’s why we really need the higher threshold, and the increased number of banks being examined, to increase confidence.

World Finance: Do you think it’s fair to have rigorous stress tests in the eurozone versus Asia as well as the US? Which are perceived as not having as strong a regulation in place?

I think it’s very crucial that Europe has rigorous stress tests. The reason is that Europe’s economy relies a lot more on bank credit than the US and other economies

Zach Witton: When you look at the US stress tests going at the moment and compare it to the European Central Bank’s comprehensive assessment, the ECB’s threshold is higher than the one that the US Federal Reserve uses, so, it is more stringent in that sense. You’ve also got the number of banks: the Federal Reserve looks at about 30 banks, whereas as I mentioned before, the European Central Bank is looking at more than 120.

I think it’s very crucial that Europe has rigorous stress tests. The reason is that Europe’s economy relies a lot more on bank credit than the US and other economies. You’ve got at the moment, banks aren’t lending to each other. That credit isn’t going through. So basically we need the tests to be rigorous so that banks lend to each other, and get the credit flowing again.

World Finance: And does the perception of the banking system in general then change because of these more stringent reforms?

Zach Witton: I think it really depends on the results. If the results are credible, I think the perception will improve. I think it’s important to remember that the US did some quite rigorous stress tests earlier on in about 2009, and the important thing was, they actually had a backstop. So some banks were identified as needing recaptalisation, and they weren’t able to get the money privately. And that government-backed backstop really reassured everyone that those banks wouldn’t fall over; they wouldn’t collapse. Unfortunately in Europe at the moment, we don’t have that same backstop, so that’s the major question mark over the whole tests.

World Finance: So what do you think will be the likely, or most likely, outcome of the EU stress tests?

You’ve got a situation where the tests have got to be credible. If no banks fail, their credibility will be brought into question

Zach Witton: That’s the $64,000 question! You’ve got a situation where the tests have got to be credible. If no banks fail, their credibility will be brought into question. So I think you’re going to have a number of banks failing. At the same time, if you have a large number of banks failing, you’ve got the risk of that triggering concern about the stability of the banking system in Europe. So the ECB has to really walk a very fine line between having some failures, but not too many. And I think in that sense, they’re really going to have a rigorous stress test, but one that isn’t too tough, or too onerous.

World Finance: Was there anything particularly surprising that you found in putting together this report?

Zach Witton: There’s really more information to come out from the ECB. They have to release their asset quality review details, and that’s going to be at the end of this month. And then at the end of April they’ll be releasing the details of the stress tests. Now that is going to provide a lot more information, and that could have a few surprises in them.

For instance, how sovereign debt is treated: at the moment, sovereign debt on banks’ balance sheets is treated as risk-free, but they might actually penalise banks for holding sovereign debt. There’s also a question over whether banks that have taken a lot of liquidity from the European Central Bank are going to be penalised. So there’s still a lot of unanswered questions, and things that will be revealed in the coming months.

Pirelli’s commitment to governance and sustainability

Posted on by Ashton Wenborn

Pirelli is the world’s fifth-largest tyre manufacturer based on revenues and one of the oldest Italian multinational companies. Over the years, the company has prospered not only because of its commitment to innovation and technological excellence, but because of its attention to its responsibilities as a member of the communities in which it operates, to the stakeholders with which it interfaces and an awareness of its global responsibilities. In other words, it also pursues excellence in corporate governance and sustainability.

At the end of 2013, Pirelli introduced its new industrial plan for the period 2013-17. The plan represents the strategic evolution of the company’s previous industrial plan, which began in 2011, and arrived in a very different macroeconomic context than its predecessor.

Foreseeing the market’s trend, Pirelli in 2011 had already identified the premium (high performance) tyre segment as the one with the best prospects. That segment, even in a difficult economic climate, continues to grow at a rate three times faster than the non-premium and, thanks to its high margins, has been one of the factors that most contributed to the company’s positive recent results. Overall, premium tyre sales (sizes equal 17 inches and above) represents over 53 percent of car business revenues and over 80 percent of profitability, which is seven percentage points higher, both in terms of revenues and profitability, compared with only two years ago. From 2011 to today Pirelli has:

  • Consolidated its partnerships with car makers, building a market share in ‘prestige’ original equipment;
  • Increased its weight within the premium segment of the car industry;
  • Achieved ‘best in class’ position in the industrial segment in terms of profitability, with an EBIT margin over 13 percent;
  • Consolidated its position in rapidly developing economies. Activities in these countries today represents over 56 percent of total revenues and more than 63 percent of profits;
  • Developed a structure suited to the implementation of a new business model focused on the shift from a logic of ‘volumes’ to one of ‘value.’

Pillars of governance
Pirelli has evolved in terms of its shareholder structure and governance. With regard to the shareholder structure, the weight of foreign institutional shareholders has grown from 16 percent in 2009 to 36 percent today; the free float has gone from 49.3 to 73.8 percent as a consequence of the dissolution of the Shareholder Block Agreement. Meanwhile, Camfin, with 26.2 percent, remains Pirelli’s biggest shareholder (see Fig. 1).

The system of governance at Pirelli is built on six key pillars: (i) the central function of the board of directors, responsible for the strategic guidance and supervision of the company’s overall business; (ii) the central role of independent directors, who represent the majority of the members of the board of directors; (iii) an effective internal control system; (iv) a pro-active risk management system; (v) a remuneration system; and (vi) strict discipline concerning potential conflicts of interest and solid principles of conduct to execute transactions with related parties.

For the execution of its activities, the board of directors has the support of four special board committees, two of which are entirely composed of independent directors. The other two committees are composed of all executive, non-executive and independent directors. Among its duties, the nominations committee has the task of examining the corporate processes relating to the identification, management and development of ‘talents’, which ensures the group has a ‘natural source’ of in-house growth over time, thereby ensuring a constant generational change.

Alongside its product range and the value of its name, the group’s corporate governance and sustainability have always contributed to value generation and responsible growth. Pirelli’s efforts were acknowledged in 1999 when it became one of the first Italian companies to fully comply with the recommendations of Borsa Italian’s Corporate Governance Code for Listed Companies. Since then, Pirelli has always aimed to be up-to-date with governance best practice.

An advanced sustainability governance system allows Pirelli to effectively manage the economic, social and environmental impact of its processes, products and services, with a constant focus on innovation and risk prevention. Pirelli has developed its sustainability model in accordance with the United Nations Global Compact of which Pirelli has been an active member since 2004, and the ISO 26000 guidelines.

With a vision for 2020, Pirelli’s sustainability plan was developed in accordance with the ‘value driver’ model inspired by the UN PRI (Principles for Responsible Investment) and UN Global Compact to encourage dialogue between investors and firms on sustainability issues. The key business metrics used to determine the return on investment of corporate sustainability activities in the 2013-20 plan include revenue growth from sustainability-advantaged products, savings and cost avoidance from sustainability-driven productivity initiatives and the reduction of sustainability-related risk exposure.

Revenues from ‘green performance’ products represented 42 percent of Pirelli’s tyre revenues in 2013, reduction of the injury frequency indicator was reached two years ahead of time and the recycling of production waste is in line with the targets of the 2011-13 plan. The company’s 2014-17 sustainability plan, which sets a number of targets for 2020, foresees:

  • Revenues from ‘green’ products in 2017 equal to 48 percent of tyre revenues;
  • 90 percent reduction in the injury frequency indicator by 2020 compared with 2009. This target will be reached thanks to investments in increasingly safer equipment, as well as programmes to reinforce the culture of security among employees;
  • 15 percent reduction in CO2 emissions by 2020;
  • 18 percent reduction in the specific energy consumption ratio by 2020;
  • 58 percent reduction in the specific water use ratio by 2020;
  • Recycling of production waste above 95 percent by 2020;
  • The maintenance of investment in research and development, equal to seven percent of premium revenues, dedicated to the development of safer products with low environmental impact.

Risk management model
Pirelli has adopted a proactive risk management model, based on a risk management process that permits a prompt and complete identification of risks, addressing risks in advance, rather than simply reacting. The model is built on three risk families, as outlined below.

[T]he company has prospered not only because of its commitment to innovation and technological excellence, but because of its attention to its responsibilities

Risks associated with the external environment in which the company operates, the occurrence of which is outside the company’s control. This category includes the risk areas related to macroeconomic trends, the development of demand, strategies adopted by competitors, technological innovations, the introduction of new legislation and the risks associated with the country (economic, political and environmental). The risk management objective is to monitor risk and mitigate potential impact. The control model is based on the adoption of internal/external tools to identify and monitor risk, stress tests to assess the robustness of the plans, the construction of alternative scenarios to the ‘base’ scenarios, business cases to assess the impact of significant changes to the environment conditions, and others.

The second type of risk is strategic risks; namely, risks characteristic of the reference business, the correct management of which is a source of competitive edge, or otherwise the cause of failing to achieve planned targets. This category includes the risk areas associated with the market, product and process innovation, price volatility of raw materials, production processes, financial risks and risks associated with M&A operations. The risk management objective is to manage the risk using specific tools and safeguards designed to reduce the probability of risk or to limit the impact if something occurs. The control model is based on identifying and measuring profit/cash flow/risk when preparing strategic/management plans; defining the risk appetite and the risk tolerance for the main risk events; introducing key risk indicators in group reporting; and monitoring the mitigation plan in relation to significant risk events in the absence of specific business safeguards that are already operational.

Third: operational risks. Specifically, those risks generated by the organisational structure, by the processes and by the group systems, assuming these risks do not produce any competitive edge. The main risk areas in this category refer to information technology, security, business interruption, legal and compliance, health, safety and environmental. The risk management objective is to manage these risks through internal control systems.

Finally, Pirelli’s incentive plan is designed to align top management’s pay with shareholders’ interests in order to generate value in the medium- to-long-term. Under the latest plan, payment of a part of the annual incentive is delayed and made subject to achievement of the group’s three-year targets, establishing a direct link between pay and sustainable long-term performance. In fact, more than 70 percent of the variable portion of management’s pay is link with medium- to long-term goals and a portion is also linked to total shareholder return, strengthening the link between management work and the generation of value for shareholders.

That segment, even in a difficult economic climate, continues to grow at a rate three times faster than the non-premium

Pirelli has taken its respected brand into over 160 countries. It has 22 production facilities located on four continents and counts about 36,000 employees. It is one of the leading producers of high-end and ultra-high-end tyres, segments in which it aims to become world leader by 2015. The company has a great commitment to research and development, an area in which it invests three percent of its total revenues and seven percent of its top-of-the-range revenues, one of the highest levels in the sector. In pursuing its goals, Pirelli has always aimed to combine economic profitability and social responsibility. And in line with its generations’ industrial tradition, Pirelli continues to invest in international expansion projects while at the same time maintaining strong local roots.

The group has more than 1,200 researchers and a number of R&D centres around the world. It also has research agreements with 14 universities worldwide and continues to attract talented people, both as employees and external collaborators, because of its ability to innovate, the quality of its products and the strength of its name. In fact, the Pirelli brand has been valued by independent analyst Interbrand at more than €2.2bn. That value stems primarily from the consistent quality of its products over the years, but is supported by a number of other high level and related activities, such as the Pirelli calendar, its involvement in motorsports, particularly Formula One, and, more recently, its return to industrial design applied top fashion.

The company has been active in sporting competitions since 1907 and this culminated two years ago with its return to F1 as sole supplier after an absence of 20 years. When Pirelli was awarded the F1 contract for the three-year period 2011-13, it came with the challenge of making the sport more exciting. This was done by providing the teams with a selection of tyres which, while performing optimally in terms of speed, grip and braking, was deliberately designed to degrade more quickly than regular tyres. This was no small technical challenge and its successful realisation has brought the tyre strategy to centre of the overall race strategy, further enhancing the company’s reputation.

Renewable energy in Saudi Arabia | ACWA Power | Video

Posted on by Ashton Wenborn

Increasingly, renewable energy is being pushed to the forefront of government agendas. Paddy Padmanathan, Thamer Al Sharhan and Rajit Nanda, from Saudi developer ACWA Power, discuss the future for renewable energy in the GCC region, the challenges and opportunities, and how their business is developing its portfolio

Energy, and more specifically renewable energy, is at the forefront of most governmental agendas, including oil rich nations like Saudi Arabia. I’m here with Paddy Padmanathan, Thamer Al Sharhan, and Rajit Nanda to speak about how and why this major policy change is going to be implemented.

World Finance: Well Paddy, let’s start with you, and of course Saudi Arabia is a leading oil producer, but there has been talk of it embracing its renewable energy policy. How likely is this to happen?

If we can develop this as a new source, we have an unbeatable opportunity to create a new industrial platform

Paddy Padmanathan: Firstly, we have abundant resources, and we have land that is available to deploy renewable energy. Secondly, we actually have the demand in our part of our world of electricity. Demand is growing at about nine percent per annum, so we need more and more new energy capacity. Provided we price fossil fuel, which is the alternative that we have available to generate electricity at the market price, already renewable energy is the most competitive solution for a segment of the demand curve. And of course, finally, we have a very young population that we need to provide employment opportunities and economic value creation strategies. If we can develop this as a new source, we have an unbeatable opportunity to create a new industrial platform.

World Finance: So Thamer over to you now, and how developed are renewables in the GCC region?

Thamer Al Sharhan: Currently not that much, we are having a lot of potential, we have the highest radiation in the world. Also, we are blessed with a lot of wind potential, geothermal, and we are waiting for this to get developed.

World Finance: So what are the major challenges for renewables in the region today?

Paddy Padmanathan: A lack of understanding of the true cost of producing electricity using what we use today, fossil fuels, not only by the public, but also even by some of the important policy makers. When you have got electricity retailing at 3 cents per kWh, and the cheapest cost of producing renewable energy is 12 US cents per kWh, of course common sense says how on earth is this going to be affordable, why do you think this is ever going to happen? Well the reality is that we are producing and dispatching electricity at three cents per kWh, only because we are consuming our own oil at $4.40 a barrel, instead of the world market price of $100, and we are consuming gas at 75 cents per mn BTU compared to whatever you want to take as a gas price.

[T]here is a solid case for moving into renewables, reduce oil consumption, and therefore diversify the energy mix

Rajit Nanda: What the policymakers have recognised is that obviously the demand for energy is growing at about nine percent, and therefore the consumption is also going to grow concomitantly, and therefore there is a need to look at alternative ways to save this fuel. At the same time, it coincides with a decline in the cost of producing renewable energy. So all of this put together, what it means is that there is a solid case for moving into renewables, reduce oil consumption, and therefore diversify the energy mix.

Thamer Al Sharhan: There is a healthy debate in the region about the use of renewable energy, from economical viability, technical suitability, and reliability for our market. We at ACWA Power encourage these healthy debates, and also participate in an educational campaign

World Finance: Well Rajit, ACWA Power set quite an ambitious target three years ago, that five percent of your portfolio would be renewable energy within the next five years. How is this going?

[M]ore than 30 percent of energy will start to get generated using renewable energy in the MENA region

Rajit Nanda: Today we’ve managed $23.5bn of generation and desalination water portfolio. Of this, about $1.5bn is in the renewables sector. Now what is happening is essentially all the procurers and generators in our target market have realised that renewable is an important component of the energy mix going forward, and there has been an escalation in terms of the requirement for energy coming from the renewables sector. Currently, over the next 12 months we are preparing investments to the tune of $15bn, of which about 50 percent is in the renewables sector.

Paddy Padmanathan: What’s interesting also from the experience you are seeing just with us is that it’s perfectly plausible, as you can see from this anecdotal evidence, if you extrapolate it, that within the next two decades, more than 30 percent of energy will start to get generated using renewable energy in the MENA region.

World Finance: Paddy, Rajit, Thamer, thank you.

All: Thank you.

The privatisation of electricity in Saudi Arabia | ACWA Power | Video

Posted on by Ashton Wenborn

It was not so long ago that governments owned and operated most infrastructure assets and delivered utility services such as electricity, water, telecoms, and sewerage management. But it is becoming more and more common for the private sector to take on this responsibility. ACWA Power is a company that has rapidly emerged from Saudi Arabia as a leading operator of electricity generation and desalinated water production. Paddy Padmanathan, Thamer Al Sharhan, and Rajit Nanda from ACWA Power discuss their successful business model.

World Finance: So Thamer, if I might start with you, who is ACWA Power and what’s your business model?

Thamer Al Sharhan: In 2004, the Saudi government encouraged the private sector to participate in huge investment in infrastructure, and utilities, power and water [were some] of the high cards on the agenda. The shareholders of ACWA Power saw this opportunity, and today ACWA Power is owned by eight large Saudi private companies and two government shareholders.

Paddy Padmanathan: Our business model is to sell electricity and desalinated water on bulk long term offtake contracts. We do that by developing our own power and desal water plants, or by acquiring and integrating them.

Rajit Nanda: We do that by basically getting together a multidisciplinary team, various specialists, who come together and formulate a business case, get the best partnership, the most value-adding partnership, structure competitive technology solutions, procure lump-sum turnkey construction contracts, and the most competitive cost-solution, and of course structure debt and equity around it to deliver the most competitive tariff.

World Finance: So what has ACWA Power achieved so far?

Within nine years we have consolidated a portfolio of 15,500 mW of electricity, and 2.45mn cubic metres of desalinated water per day

Paddy Padmanathan: Within nine years we have consolidated a portfolio of 15,500 mW of electricity, and 2.45mn cubic metres of desalinated water per day. In terms of investment, that portfolio represents about $23.5bn. We today, from our hub in Saudi Arabia, operate in the MENA region.

Thamer Al Sharhan: Part of ACWA business model, in 2005 we managed successfully to create our operating company, which is called First National Operation and Maintenance Company, which is NOMAC. NOMAC has the operating capacity for 2.2mn cubic metres desalinated liquid per day, and over 10,000 mW.

World Finance: So Paddy, obviously ACWA Power has gone from strength to strength, so what would you say the key to success is?

Paddy Padmanathan: By relentlessly focusing on our core mission, which is to reliably deliver desalinated water and electricity at the lowest possible price. We have consistently, transaction after transaction, achieved this, typically at about a twenty percent level, the tariff difference between the tenders that we have offered and that offered by the second bidder.

Rajit Nanda: The lowest competitive tariff solution is all based about staying engaged with different facets of the supply chain, and cultivating with them a trust-based partnership, so that all of them work towards a common goal of delivering a most competitive elements of the tariff solution.

World Finance: Well Paddy, ACWA Power has developed a large portfolio, is there anything noteworthy that happened in 2013?

Paddy Padmanathan: The real noteworthy stuff in 2013 is probably the two renewable energy plants that are both in construction, a 160 mW concentrated solar power plant, with three hours of storage in Morocco, and a 50 mW plant with nine hours of storage – that’s probably the longest storage in that technology in the world that’s under construction today, of concentrated solar power.

World Finance: Gentlemen, thank you.

All: Thank you.

Japan’s disappointing growth calls Abenomics into question

Posted on by Ashton Wenborn

News of Japan’s disappointing growth stats in the middle of February sparked further unrest among analysts and led many to believe that Prime Minister Shinzo Abe‘s aggressive fiscal and monetary measures will fall short of their intended effect. Granted, the short-term results with regards to inflation are encouraging, given that the BoJ looks on course to meet it’s two percent inflation target by 2015 and consumer prices grew at their fastest rate in five years late last year. However, having exhibited early signs of growth owing largely to exports, it’s now up to consumers to take the reins and lead the Japanese economy to long-term stability.

Japan’s last quarter

Up 1.7%

Exports

Up 0.5%

Household spending

Abenomics has succeeded in reeling the economy from impending collapse, although the vast majority of growth has come by way of exports, which picked up just 1.7 percent last quarter after a 2.7 percent annualised fall in the third quarter. For Japan to level out at the desired two to three percent annual growth outlined by Abe, internal consumption must see something of an uptick in the coming months and years ahead.

Household spending during the October to December quarter expanded just 0.5 percent, which, given that analysts expected 0.7 percent, illustrates just how cautious Japanese consumers are when it comes to spending. In order to boost private consumption and dispel the lingering air of caution, higher prices must be coupled with higher wages so as to lessen the squeeze. And whilst cash earnings saw an annualised rise of 0.5 percent in November, the ever-so-slight boost follows four months of consecutive decline and, when excluding bonuses, means that Japanese wages overall remain unchanged.

Whilst the economy this coming year looks on course to exhibit levels of growth unseen since 2010, rising costs alongside falling wages will see public support for Abenomics plummet for as long as this remains the case. As such, the government is pushing for companies to boost their wages come spring, although many will be hesitant to do so until they’re convinced of the economy’s emboldened prospects of long-term prosperity.

To compound problems in the consumer space, Japan’s sales tax is scheduled to rise to eight percent from five in April, in order to reduce the world’s highest debt burden. Not only will the tax hike impact growth on a short-term basis, but also serve to deter consumers from spending further still. The timing comes at an especially inopportune time here in light of Japan’s lacklustre growth, and the repercussions could serve to push consumer confidence to new lows.

Expect an uptick in private spending in the months ahead as consumers race to beat the rise, however, once the eight percent rate is put in place, Japan will be forced to contend with even lower sales, and the prospect of additional stimulus measures looks likely to say the least.

Can new CEO Erez Vigodman inject life back into Teva?

Posted on by Ashton Wenborn

The world’s largest generic medicines group, Teva, has in the last few months suffered such stark divisions among its board of directors that it has now appointed its fourth CEO in just seven years. After the sudden dismissal of previous head, Jeremy Levin, in October, Teva began searching for an agent of change to lead the company.

When it was announced in January that board member, Erez Vigodman would be ushered in as the new CEO in late February, broader questions about the company’s future came into focus. With a divided crew and rough seas ahead, appointing the man with a reputation for turnarounds hinted at a hole in the bottom of the ship.

Despite dealing in generic drugs, Teva’s most profitable product remains its patented product, Copaxone. The multiple sclerosis treatment brings in over half of the company’s annual profit and with its impending expiry in May 2014, its future has come under great scrutiny from its directors and shareholders. If the pharmaceutical giant is to stay afloat, its new man at the helm will have to find innovative solutions to fend off the increasingly hungry competition.

Supply and demand
Generic drug companies’ profit comes from launching less expensive versions of drugs whose patents have just expired. In recent years, an increased demand for cheaper drugs from governments and health insurers has benefited the generics industry. As one such company, Teva understands the implications of patent expiries, and the looming fate of Copaxone has faint echoes of poetic justice.

Growing tensions among the board of directors regarding the company’s future resulted in paralysing managerial decisions. Its chairman, Phillip Frost, was in favour of moving the company in the direction of specialty pharmaceuticals while other board members wanted to continue the focus on the generic drugs industry.

A managing partner at Sphera Global Healthcare Fund, a company whose own assets are invested in Teva, Ori Herschkovitz told Reuters of the state of the company. “[T]his division has wreaked havoc on the company in the last couple of years. It’s by far the worst positioned company in the pharmaceutical sector.”

Over the last two years, Teva’s shares have underperformed by nearly 40 percent, while its stock trades at eight times the forecast 2014 earnings.

The greatest conflict of opinion was between chairman and largest shareholder, Frost, and Levin. Rather than clashing over policy, tensions stemmed from the two men’s struggle for authority. In October last year, Teva’s executive committee pleaded for calm.

With a divided crew and rough seas ahead, appointing the man with a reputation for turnarounds hinted at a hole in the bottom of the ship

The committee wrote that it “respectfully urges the board to reassess their involvement in the ordinary course of business matters that in our opinion has been prevalent in recent months and hindered management’s ability to effectively manage Teva and implement the approved strategy”. Two days later, the board dismissed Levin.

Insiders have reported that Levin’s dismissal was not solely based on his differences with Frost and that he had irritated other board members by demanding greater autonomy and transparency. For Levin, this meant disclosing Frost’s annual compensations, including a $900,000 salary, $700,000 for use of his private plane and $412,000 for rented office space in Miami, where he is based.

Before his departure, Levin had announced plans to make 5000 employees redundant, 10 percent of Teva’s total workforce. Immediately following Levin’s removal, shares fell by a sharp 12 percent.

Investors, like the board, were split on Levin’s administrative decisions. Levin not only antagonised the board, but spent heavily on consultants, failed to meet earnings targets and threatened the company’s historic Israeli base by deciding to cut jobs. Furthermore, he failed to secure profitable acquisitions that would boost the company’s pipeline of new pharmaceutical products.

Over the last two years, Teva’s shares have underperformed by nearly 40 percent, while its stock trades at eight times the forecast 2014 earnings

Others thought his strategy logical, agreeing that Teva was ill-prepared for Copaxone’s patent expiry. Disappointing acquisitions, such as the $7bn purchase of the international biopharmaceutical company Cephalon, also contributed to dissatisfaction among investors. Its purchase was intended to reduce Teva’s reliance on Copaxone revenue, but Cephalon products failed to take off.

Levin may have been sacked, but he left behind pre-existing governance problems. The drug giant has grown exponentially while retaining a large, Israeli-focused board of directors, many of whom are without experience in the wider pharmaceutical industry. This view was reaffirmed by Benny Landa, an Israeli entrepreneur and one of Teva’s directors, who expressed his views to other investors.

“[T]he board is comprised – apart from chairman Phillip Frost and those on his payroll or who are otherwise beholden to him – entirely of local directors, none of whom have any pharma experience.” Landa had been fighting the battle for change, proposing to cut the board down to 12 members while reducing the influence of Frost and his allies over company decisions.

Frost joined the board when Teva acquired his generics company Ivax in 2006. He became chairman in 2010, after which the 16-member board has failed to demonstrate any great diversity of opinion. Preparing for demands by investors to shake up the board room, Frost told analysts during a conference call reported by the FT, that “the board has never attempted to manage the company; is not managing the company now; and is fully co-operating with the management with respect to their respective roles.”

New management
Following Levin’s dismissal last year, the board of directors has looked outside the company – and industry – for a new head. After Vigodman’s emergence as the favoured candidate for CEO, Teva’s previously disappointing stocks rose 3.4 percent. With a reputation for restoring companies’ profits, Vigodman has his work cut out for him. After taking over the role of CEO of the world’s biggest generic agrochemicals company, Makhteshim Agan Industries in 2010, Vigodman restored the company’s profitability by closing production lines, improving product offering, renewing research and development strategies, and pushing the company into new markets. From 2009 to 2012, MA Industries’ net income grew by 55 percent, a trend which continued well into 2013.

Erez Vigodman: ‘Turnaround Specialist’

3.4%

Amount Teva’s stocks rose when Vigodman was appointed CEO

55%

Amount MA Industries’ net income grew between 2009 and 2012, under Vigodman’s leadership

Analysts have, however, been quick to point out the gulf of differences between the pesticide and pharmaceutical industries. If Vigodman is to be successful in any of his endeavours, he will have to learn the ropes quickly while restoring investors’ confidence, many of whom remain unconvinced that such measures would offset Copaxone’s patent expiry. Prior to heading up MA Industries, Vigodman worked as President and CEO of Strauss Group, a food and beverage company. He turned Strauss into a global player by moving the company into emerging markets – Brazil in particular. Under Vigodman, Strauss doubled its sales from 2002 to 2008.

These accomplishments position Vigodman as a promising CEO. With Copaxone’s imminent patent expiry, the company needs a complete revival. Amir Elstein, Vice Chairman of the board and head of the committee leading the search for the company’s new CEO, was pleased with the result. “Erez is the right person to lead Teva. We evaluated a comprehensive list of internal and external candidates as part of our rigorous search and board process, engaging the international search firm Egon Zehnder.

“Erez stood out due to his impressive track record in transforming global and complex corporations and delivering breakthrough results. He is a change agent with an impressive strategic mindset and a proven ability to execute restructuring programmes, build organisational momentum, expand successfully in emerging markets, and work with the capital markets.”

At the request of Elstein, Landa met with Vigodman to discuss the company’s future challenges. After their four-hour meeting, Landa released a telling statement. “As critical as I am of Teva’s board, I think this time they got it right. Erez Vigodman is made of the right stuff to succeed. He is a strategic thinker with excellent managerial skills. My sense is that he has the courage to make tough decisions.”

Arguably, Vigodman already has some useful insight into the company’s management structures, having sat on its board since 2009. His first assignment will be to heal existing divisions in the board while initiating a series of cost cuts. With dwindling business opportunities and growing competition in the generics business, Vigodman will have to reduce reliance on ‘copycat drugs’.

With a reputation for restoring companies’ profits, Vigodman has his work cut out for him

Teva has difficulties with emerging markets, which casts further uncertainty over the company’s future. Hershkovitz told Reuters that the company will need to completely restructure its management, replacing existing executives with those experienced in turning around pharmaceutical companies. He then continued to say that as CEO, Vigodman will have to boost branded business through partnerships and acquisitions in the specialty drug sector, which is in keeping with chairman Frost’s vision for the company.

Despite Teva’s promising new management, it remains an undeniable fact that the company’s most profitable source of income is soon to become public property. It is unlikely that Vigodman’s short-term actions will differ greatly from those proposed by Levin, with cost cuts planned in preparation for Copaxone’s revenue loss. As the company’s new CEO, Vigodman will have to weather the storm before determining whether it has a future afloat, or if it is destined to sink.

Credit Suisse phases out its remuneration scheme

Posted on by Ashton Wenborn
Credit Suisse are phasing out their current bonus scheme, and replacing it with two bonus plans that will shift the bank's emphasis onto collective, rather than individual, performance
Credit Suisse are phasing out their current bonus scheme, and replacing it with two bonus plans that will shift the bank’s emphasis onto collective, rather than individual, performance

Credit Suisse has notified its employees that they might have to wait until 2021 to cash in on bonuses awarded two years ago. Under revised regulations, millions of pounds worth of rewards that were expected to mature by 2016 may be deferred for a further five years.

Bringing the bank’s reward scheme one step closer to getting rid of a reward system that was too closely linked to risky assets. Though the move was prompted by changes in capital regulations, it is certainly a step in the right direction for Credit Suisse.

By linking employees’ bonuses to the bank’s performance overall and in specific areas ensures that bankers work for the bank rather than for their bonuses

The bonus scheme being phased out was originally offered to around 5,500 senior bankers in 2012, all of whom must now chose a replacement plan. According to a memo sent to staff at the bank’s Canary Wharf outpost, the scheme was ‘linked to a portfolio of the bank’s credit exposures, and provided risk offset and capital relief to the bank. Due to regulatory changes, this capital relief is no longer available and accordingly, [bonuses] will be amended in accordance with its terms’.

Credit Suisse will offer two replacement bonus plans; a Contingent Capital Award (CCA), in which their bonuses would be awarded as bonds of sorts, which would be wiped out if the bank’s levels of capital drop below a certain point. “Settlement would occur either by a cash payment of the fair value of the CCAs at a time or a physical delivery of an actual contingent capital security able to be held thereafter or sold in the market,” explains the memo.

The second option is linked to a Capital Opportunity Facility (COF), in which bonus payments are linked to the a seven-year facility ‘that is linked to the performance of a portfolio of risk transfer and capital mitigation transactions chosen by the PAF management team,’ explains the memo.

By linking bonuses to performance and by deferring payments for several years means that these payments become more like rewards that must be earned rather than a negotiated part of a pay package. Though deferred pay is already widely practiced by most major banks, remuneration remains a contentious issue in the wake of the global financial crisis.

By linking employees’ bonuses to the bank’s performance overall and in specific areas ensures that bankers work for the bank rather than for their bonuses. Furthermore, by separating bonuses from risky derivatives employees are less attracted to these tools, and that can act as a powerful disincentive to overindulge in this type of activity.

Other banks like UBS in Switzerland and Barclays have already moved to paying bonuses in this type of scheme, but it is still far from the norm. Unfortunately.

Japan files criminal complaint against pharma giant

Posted on by Ashton Wenborn

On January 9, the Japanese Health Ministry filed a criminal complaint against pharmaceutical company Novartis, calling for an investigation into the drug company’s local unit. It is suspected that falsified data was used in the clinical trial of Novartis’ best selling drug Diovan. Japanese pharmaceutical affairs law strictly prohibits exaggerated advertising and this particular incident is a first for Japan.

The complaint has wider implications not only for the Japanese pharmaceutical industry, but also for the company’s international reputation. The Japanese scandal has drawn further attention to Novartis’ broader misconduct, following allegations of bribery in both the US and China. It also coincides with Diovan’s patent expiry in Japan.

Clinical trials of the hypertension drug were carried out at five Japanese universities. The accuracy of the university-led studies was brought into question last year after several medical journals retracted the findings of two Japanese universities, Kyoto Prefectural University of Medicine and Tokyo’s Jikei University School of Medicine.

Kyoto Prefectural and Jikei lost confidence in the drug’s supposed efficacy in preventing heart disease and strokes, both coming forward to suggest that the data used in the Diovan studies had been falsified.

Misleading advertising backfires
It transpired that a Novartis employee had assisted on all these clinical trials, the findings of which were cited in pamphlet advertising distributed to doctors across the country. The Novartis employee had failed to reveal his affiliation to the pharmaceutical company in published papers and it is suspected that Novartis continued to use advertise the benefits of the drug after discovering that the data had been manipulated.

It is suspected that falsified data was used in the clinical trial of Novartis’ best selling drug Diovan

Novartis Pharma KK has since accepted responsibility for its employee’s involvement, cutting the pay of its top executives in the company’s Japanese arm for allowing the ‘conflict of interest’ to occur. The company has also promised to improve oversight and training procedures.

In a late September 2013 news conference, the president of Novartis’ Japan operations, Yoshiyasu Ninomiya held up his hands. “We feel a heavy responsibility for creating a situation that may have allowed data manipulation to occur.” Nevertheless, Novartis continues to deny any intentional misconduct, arguing that it had no access to data, and consequently could not confirm if the findings had been manipulated and who might be responsible.

However, the Japanese Health Ministry found evidence to contradict the drug giant’s supposed ignorance. The Ministry panel discovered that Novartis had donated funds to two of the universities participating in the trials. A total of 570m yen – the equivalent of $5.4m – had been donated to Kyoto Prefectural and Jikei for ‘running classes’. However, it is expected that these funds were also used in the drug trials, making Novartis a sponsor of its own research. Chiba University denied such allegations of intentional data fabrication, yet failed to mention the 91m yen in scholarship donations it had received from Novartis from 2007 to 2009.

Novartis spokeswoman Yumi Ishii responded to the controversy. “Since last year, we’ve been saying in our news conferences that we need to regain any trust we’ve lost from the issue. That position does not change.” Attempts by Novartis to reinstate confidence in its brand might prove more effective were it not for its behaviour in other leading markets.

Questionable donations

570m ¥

Amount Novartis donated to Kyoto Prefectural and Jikei for ‘running classes’

91m ¥

Amount Novartis donated to Chiba University for scholarship donations between 2009 and 2010

In January, several US states sued Novartis for their kickback scheme relating to Exjade, the iron-reducing drug. The New York Attorney General filed a civil lawsuit against Novartis’ US unit after it was unearthed that the drug company was bribing specialty pharmacy BioScript in order to boost sales. Novartis allegedly paid BioScript to recommend refills of Exjade to its patients, some of whom had stopped using the drug. When doing so, BioScript often failed to warn patients about the potentially fatal side effects, including kidney failure and gastrointestinal haemorrhaging.

New York Attorney General Eric Scheniderman was forthcoming. “This arrangement between Novartis and BioScrip was dangerous for patients and is against the law. Our lawsuit against Novartis and our agreement with BioScrip sends a clear message: Drug companies cannot pay pharmacies to promote drugs directly to patients.” The complaint was filed in the federal court in Manhattan.

BioScript has already agreed to pay $15m to settle charges, reimbursing the tens of millions of dollars in false claims made to Medicare and Medicaid. Novartis disputes these allegations and will defend itself in litigation.

In another example of Novartis’ propensity to operate ‘above the law’, the company was accused of bribing doctors for its eye care unit Alcon in China. Novartis announced in September 2013 that it would investigate such allegations, which had been published in 21st Century Business Herald. The Chinese newspaper cited a whistleblower “Zorro”, who said that Alcon bribed doctors in over 200 Chinese hospitals to push sales of lens implants. The paper also alleged that Alcon had conducted bogus clinical trials on the lens using third party researchers and calling it a ‘patient experience survey’. The doctors subsequently received ‘research fees’. This was the second time in two months that Novartis had been accused of bribery in China alone. Investigations are still being carried out.

The future of Novartis
One of the world’s largest drug companies, Novartis, introduced Diovan to Japan in 2000 to treat hypertension, two years after it was approved in the US. The drug is currently licensed for use in over 100 countries. Diovan’s patent expired in Europe in 2011, followed by the US in 2012. The patent in Japan expired in September 2013, the same month in which Novartis KK were forced to investigate exaggerated advertising allegations.

sales still strong?

558.9bn ¥

Novartis’ revenue from Japan in 2013 – 9.5 percent of total global revenue

Diovan suffered a 28 percent drop in global sales following its patent expiry last year. This has greater implications on the Swiss drug giant; with one of its most important assets now open to competition from generic drug labels, Novartis stands to lose more than its reputation. In the quarter ending 30 September 2013 it experienced the biggest quarterly fall since January-March 2011, dropping to 22.03bn yen from 26.14bn yen the year before, and 28.9bn yen the year before that.

Japan is an important market for the pharmaceutical company. In October 2013, Novartis head David Epstein issued a statement saying that the scandal would not have a significant impact on Diovan sales. Prior to the controversy, Japan’s market accounted for a quarter of Diovan’s global sales, topping 100bn yen in annual sales since 2005. In 2012 alone, 558.9bn yen, 9.5 percent, of Novartis’ global revenue came from Japan, according to a Bloomberg study.

The future of Novartis’ sales in Japan stands to be effected by the exaggerated advertising allegations, but also points to a wider problem in the industry. The controversy has drawn attention to the problem of integrity in clinical research. Hospitals, universities and pharmaceutical companies are so closely linked that research into drugs has become increasingly lax.

Professor of Clinical Pharmacology of at the Graduate School of Medicine at University of the Ryukyus in Okinawa, Shinichiro Ueda told the Wall Street Journal that, “the filing of criminal complaints is a symbolic move. It not only hurts Novartis’ reputation, but also indicates how the Japanese medical community needs to raise the quality of its clinical research.”

[W]ith one of its most important assets now open to competition from generic drug labels, Novartis stands to lose more than its reputation

Although the results of the clinical trials in Japan were similar to those found in the US and 24 other countries, the severity of the matter stems from Novartis’ repeated willingness to cut corners and ignore laws in order to boost sales. Despite the results’ apparent accuracy, Japan does not recognise foreign clinical trials. The subsequently slow drug approval process continues to cause dissatisfaction with international pharmaceutical manufacturers.

They claim that Japan’s available treatments lag behind foreign competitors, thus handicapping Japanese businesses. Contributing to these concerns is the growing importance of the Japanese pharmaceuticals market with the nation’s aging population. These problems need to be dealt with head on to avoid unethical and illegal quick-fix solutions.

Masahiro Kami, professor and medical governance expert at the University of Tokyo had underlined a wider issue, stating, “You can’t take steps for prevention unless it becomes clear who did this for what kind of reason… This is really an issue for the broader industry.”

Legal proceedings
After months of leading their own investigations, the Japan Health Ministry filed the complaint with the Tokyo District Public Prosecutor’s Office, hoping their increased investigative powers would yield more information. If the prosecution does accept the claim and subsequently finds Novartis Pharma guilty of exaggerating the advertising of Diovan, the pharmaceutical company could face a fine of 2m yen and any employees involved could receive a prison sentence of up to two years – light punishments given the fraudulent nature of the crime.

Director of the Health Ministry’s Compliance and Narcotics Division, Jiro Akagawa told reporters that they had filed a criminal complaint with Tokyo prosecutors because its own investigations, aided by Novartis, had failed to expose who was involved in the alleged data manipulation.

After the ministry filed the complaint, a statement on the company’s website read: “Today, a criminal complaint was filed by the Health, Labour and Welfare Ministry against us over doctor-led clinical research on Diovan for alleged exaggerated advertising banned under the pharmaceutical law. We apologise deeply for causing tremendous worries and trouble to patients, their families, medical workers and the public. We take this incident extremely gravely and will continue to cooperate fully with the authorities.”

Novartis has a big year ahead, with the outcomes of its various international scandals eagerly awaited by the wider pharmaceutical industry. Its damaged reputation, in conjunction with the patent expiries of its best selling drug, puts Novartis in an extremely fragile position, both legally and financially. The bad behaviour of Novartis’ leading markets’ arms will soon add up, and what might have had a ripple effect on sales and brand integrity could reach tidal proportions.

India to inject $1.2bn into state-run lenders

Posted on by Ashton Wenborn

“Banks are under strain owing to rising non-performing assets,” said India’s Finance Minister Palaniappan Chidambaram in a speech announcing the government’s interim budget for the year to March 2015. “Bankers have assured me that as the economy turns they will be able to contain the nonperforming assets and record more loans.”

These were the reasons given by the finance minister to justify his announcement that 112bn rupees, or $1.8bn, of capital will be injected into state-owned financial institutions over the next fiscal year.

[N]onperforming assets, particularly loans that have gone bad, are the biggest strain on India’s banks

“In 2014-15, I propose to provide 112bn rupees for capital infusion in public sector banks,” said Chidambaram in his speech. “They have opened 5,207 branches so far, against the target of 8,023 branches, and are near the goal of installing an ATM at every branch.”

The bank has already infused close to 140bn rupees in public sector banks so far this year, so the new announcement does not represent much change from current policy. For the finance minister, nonperforming assets, particularly loans that have gone bad, are the biggest strain on India’s banks as the country’s economy continues to struggle. Typically, the central bank injects capital into state-run institutions by buying shares.

Bad loans have long since been a drag to India’s economy. Raghuram Rajan’s, governor of the Reserve Bank of India has already vowed to cleanse the country’s banks of the scourge, and individual lenders have also been taking steps to mitigate their losses. United Bank of India, the state-run institution with the highest percentage of loans is likely to receive a further government capital injection to boost its risk buffer, according to Finance Ministry Banking Secretary Rajiv Takru, though he declined to specify how much that is likely to be worth or when it might occur.

Bad loans have increased to 4.2 percent of total credit as of September 2013, the highest number is close to six years. It was a significant increase from an average of 34 percent the pervious March, according to a central bank report published in December.  The total amount of nonperforming assets has more than doubled since March 2011.

How can Europe regain its former competitive glory? | Video

Posted on by Ashton Wenborn

Despite a huge and educated population, and massive wealth, the European Union has been stifled by rigid labour laws and crippling tax systems. Damian Chalmers from the London School of Economics discusses what challenges lie ahead for the continent, the lessons that can be learned from Germany, and whether economists have focused too much on failure rather than success.

World Finance: Well Damian, let’s start with the situation on the ground. How competitive is Europe compared to the rest of the world?

[T]here’s a danger on focusing on what Europe doesn’t do well, rather than what it does do well

Damian Chalmers: You have to bear in mind that as a proportion of world trade, the EU still does very well. If we look at something like the World Economic Forum, and its views of competitiveness – a liberal measure if ever there was one! – one finds European states very well represented in the top 10. Particularly north European states.

So there’s a danger on focusing on what Europe doesn’t do well, rather than what it does do well.

World Finance: What are the major challenges it now faces?

Damian Chalmers: One of the things is that many of Europe’s traditional sources of competitive advantage have eroded. That other companies from non-European states, for example, are used to applying European standards now. It’s something that used to give us a first-mover advantage – that’s rapidly disappearing. Europe perhaps had cheaper access to finance than many other parts of the world. I think the differential there is also disappearing.

World Finance: Onto Germany now, and it’s a country that’s often criticised others for accumulating too much debt. But it’s now under investigation by the EU Commission to see if its huge trade surplus can threaten the rest of the block. Do you think this could be the case?

Damian Chalmers: Well it is under investigation by the EU Commission. There’s this argument that the surplus now exceeds what Germany is allowed to have for the purposes of the macroeconomic imbalance procedure.

It’s seen as a problem within the EU because there is so much intra-EU trade. And if some of the newer states in southern Europe are to, if you like, grow their way or export their way out of the current economic predicament, then one of the biggest markets would be Germany.

It’s seen as a problem within the EU because there is so much intra-EU trade

That said, this internal surplus vis-a-vis other Euro-area states can’t be seen in isolation. It is surely a good thing for the EU that one has an engine of growth and an engine of competitiveness in Germany, which is exporting not just to other EU states, but around the world.

World Finance: Germany is the strongest economy in the EU, so what can other countries learn from it?

Damian Chalmers: I think one has to be very careful about this. Certainly since the beginning of the Euro-area crisis, Germany has tried to suggest the model which has served it well should exist for the rest of Europe. Now, it’s not clear to me how easy it would be for others either to fit into this model, or whether the costs of fitting into this model would just be too severe.

Germany is a capital-intensive economy with strong resources in terms of its educational and skills base. This is just not there in certain other Euro-area states.

World Finance: How does the gap in competitiveness between the north and the south impact the overall picture?

Damian Chalmers: I don’t know is the answer to that. If one was looking at somewhere like the US, one probably wouldn’t be talking about it in quite the same terms, as saying “Does the gap in competitiveness between this state and that state affect the US competitiveness?” But of course there is a difference. The US is a single state, it’s a federal state, and the EU is not. And that means the EU is more politically turbulent, it means that different parts of the EU have to account for this relative gap of competitiveness, while the centre of course will put ever greater controls, as happened in the US, to check the less competitive parts of the EU, if you like, up their game. So what is likely to happen is increasing political centralisation, I would guess.

World Finance: Are there any policies that have been implemented that you’ve really thought, you know, “Oh no!” and is there anything that you would have done differently?

I do wonder whether we fight yesterday’s wars

Damian Chalmers: I do wonder whether we fight yesterday’s wars. So this commitment to constitutionally entrench structural balances, or modest structural deficits. I wonder if in a few years’ time we’ll be looking at that as the next great mistake. It is introducing an inflexibility into the system that is perhaps not a great thing, and I think we might also look at the controls that are currently put on the European Central Bank as the controls of a past era.

World Finance: Well what single piece of advice would you give business leaders in the EU if you could make changes?

Damian Chalmers: I think one of the big challenges for business leaders – and they could tell you this across the EU at the moment – is getting access to capital on competitive terms. And that to my mind is probably a bigger challenge than some of the other restrictions that more attention is paid to, such as labour laws and tax laws.

World Finance: Damian, thank you

Damian Chalmers: It was a pleasure.

EC’s new late payment directive grossly overlooks the buyer

Posted on by Ashton Wenborn
The European Commission's updated directive on late payments is geared towards protecting SMEs, and woefully overlooks the buyer
The European Commission’s updated directive on late payments is geared towards protecting SMEs, and woefully overlooks the buyer

After a long consultation period, the European Commission has finally updated its directive on late payments. Though the document came into force in May last year, EC lawyers and economists in charge of the document are still doing the rounds, visiting European capitals to discuss the document with local business leaders and the press.

It is a lengthy, comprehensive document that builds on some of the loopholes left in the preceding directive published in 2000. In it the EC defines the acceptable time a company or a public office has to make a payment for goods and services received. It also details penalties, fines and costs that a buyer might accrue if it fails to make timely payments, and how the courts in each country can deal with the issue, if it comes to that. The directive offers valuable guidance but encourages member states to adapt the code to fit their own needs.

[The Late Payment Information Campaign] is suitably dramatic

The slogan the Late Payment Information Campaign has chosen to advertise its conference and efforts is ‘Time for Change’. It is suitably dramatic. According to the campaign’s literature, late payments can cause ‘companies [to] go bankrupt waiting to be paid. Jobs are lost. Dreams die.’

Small and medium companies are the worst hit. It is often the case that they have neither the time nor the resources to chase up late payments, and they are often the ones that are the most susceptible to the harms lateness can cause.

And while the EC is absolutely right to try and mitigate the damage late payments can cause to businesses, there was a woeful lack of provision to protect buyers’ rights. The onus of the new directive is entirely on companies collecting late payments, and there is very little room for buyers to protect themselves.

If the EC is so adamant that late payments kill small businesses – and they do – they need to be at least as clear that slapping enormous fines and compensation charges further delay payments.  A minor but significant change from the previous directive is that companies can now charge interest and collect compensation costs on delayed payments worth less €5. It means that a small business can be burdened with hundred of euros of additional costs for a charge worth less than the cost of an employee’s lunch.

During the presentation, constant allusions were made to the European crisis and how it has indeed caused companies to delay – and possibly miss – more payments. But surely if it is an issue for the seller, unpredictable economic conditions must also be an issue for the buyer. Though the EC is right to issue a directive in order to protect businesses, it must be more inclusive than what it is right now.

Negotiation must be at the heart of late payment collections in order to protect the integrity of the supply chain, otherwise the balance will remain tipped in favour of those with resources to prosecute, and sadly, that will never be the small businesses owner.

Comcast snaps up Time Warner

Posted on by Ashton Wenborn

After six months of takeover rumours, Time Warner Cable – America’s second largest pay-TV operator – has finally succumbed to its suitors. However, despite the aggressive pursuit of the company by smaller rival Charter Communications, Time Warner will in fact be joining forces with the country’s largest provider Comcast.

The deal, worth $45.2bn, is likely to face huge opposition from smaller players

The deal, worth $45.2bn, is likely to face huge opposition from smaller players, as well as intense scrutiny from regulators worried about a monopoly forming in what has been a relatively fragmented market. However, if approved by the FCC, it will see an industry giant created that will hold over a third of both the video and broadband subscriber markets.

Comcast was spurred into action by offering $158.82 a share, after months of speculation that Charter would merge with Time Warner. Charter has made a series of bids over the last six months, the largest of which came in January for a reported $60bn. However, the Time Warner board was not in favour Charter’s bid, describing it at the time as “grossly inadequate.”

With a $144.5bn market capitalisation, Comcast is the industry leader in the US, but the market has been seen as fragmented for years now. There had been speculation that Comcast would join forces with Charter to buy Time Warner, but it later emerged that the smaller firm would need to complete a hostile takeover if it was to be successful.

In separate, but potentially significant, news, Time Warner was today this week rumoured to be close to doing a deal with Apple to provide content with a new version of its Apple TV set top box. Such a deal could have proven persuasive for Comcast, seeing as there are an increasing number of people signing up to internet-based TV platforms. As part of the deal, Comcast will gain a series of popular TV channels, including HBO, as well as Time Magazine.

Are transport forecasting models accurate enough?

Posted on by Ashton Wenborn

A frequent topic of this column has been the difficulty – or impossibility – of predicting the future state of the economy. This is true for macroeconomic quantities such as inflation or GDP, but it also applies to things like predicting the economic benefits of particular projects. A good example is transport forecasting.

Forecasters have long been building sophisticated mathematical models of the transport system, which are supposed to predict everything from the flow of traffic in a city in a decade’s time, to the impact of an individual project such as building a bridge or a railway.

Overestimating the figures
While such models are useful tools for thinking about the transport system, their results when compared with outcomes show that accurate transport forecasting remains elusive. A 2006 study by the team of Danish economic geographer Bent Flyvbjerg – who is currently at Oxford University’s Saïd Business School – looked at over 210 projects in 14 countries, and found striking discrepancies between passenger forecasts and measured results.

For rail projects, passenger numbers were overestimated in 90 percent of cases, with an average overestimation of 106 percent

For rail projects, passenger numbers were overestimated in 90 percent of cases, with an average overestimation of 106 percent. Transport forecasts were more accurate for road projects, but half had a difference between actual and forecasted traffic of more than +/-20 percent, and in a quarter of cases the difference was more than +/-40 percent. Nor had forecast accuracy improved with time, or with more advanced models or computer power.

The forecast error is due to a number of factors. For rail projects, it seems that politics is important – passenger demand is overestimated because stakeholders want the project to go ahead. A safe prediction, based on past experience, is that projected numbers for England’s HS2 high-speed rail will turn out to have been significantly overestimated.

Road projects do not show the same systematic bias, so the error is more likely due to model limitations, such as inaccurate estimates of trip generation (based on incomplete data) and land-use development (based on uncertain plans and projections); as well as phenomena such as ‘assumption drag’ – maintaining assumptions even after they have lost their validity.

The assumption drag
As an example of assumption drag, Flyvbjerg et al noted that in Denmark, the energy crises of 1973 and 1979 led to increases in petrol prices and decreases in real wages. As a result, traffic declined markedly for the first time in decades. Believing that the trend would continue, Danish traffic forecasters adjusted their models accordingly. Instead, once the effects of these shocks had worn off, traffic boomed again in the 1980s, ‘rendering forecasts made on 1970s assumptions highly inaccurate.’

Of course, it isn’t just transport forecasters who are affected by assumption drag. As an example, the figure compares the price of oil with forecasts from the US Energy Information Administration (EIA), which are based on their World Oil Refining, Logistics, and Demand (WORLD) model. In the 1980s and 1990s, the forecasts consistently overestimated the price of oil, probably because the model similarly retained a memory of the 1970s energy crises (assumption drag).

The forecasts eventually learned that prices were not going to return to previous levels, and flattened out; but almost as soon as they did, prices spiked briefly to $147. As with travel forecasts, huge improvements in modeling and computational abilities over almost 30 years have had little impact on predictive accuracy.

As Flyvbjerg et al note, the lack of progress in predictive accuracy in recent decades suggests that ‘the most effective means for improving forecasting accuracy is probably not improved models but instead more realistic assumptions and systematic use of empirically based assessment of uncertainty and risk.’ So what alternatives exist, and what is the role of models?

One alternative to traditional model-based forecasting is the method known as ‘reference class forecasting’, which was developed in the 1970s by Daniel Kahneman and Amos Tversky in order to compensate for the cognitive biases which affect economic forecasting. Given a particular project, the first step is to identify a reference class of similar projects; establish a probability distribution for whatever is being predicted, such as changes in behaviour; and finally compare the new project with the class distribution.

A drawback of studying the future is that we don’t have much in the way of data for it

The reference class method relies on the existence of comparable data, which might apply to individual projects, but works less well for bigger questions such as how a city’s economy and infrastructure will evolve in the future. A drawback of studying the future is that we don’t have much in the way of data for it.

Another approach which also attempts to correct for cognitive biases, is the method known as scenario forecasting. Its use in business was pioneered by Shell, who credited it with preparing them for the oil price shocks of the 1970s, and it is becoming increasingly widely used. Usually a small number of scenarios – two to four – are chosen to represent extreme cases.

This helps separate the scenarios from each other (and also accounts for the fact that the future often does turn out to be extreme). Mathematical models can also be used to flesh out the details of the scenarios and check for consistency without masquerading as predictions.

As an example, one project I took part in used this technique to create scenarios for the US Department of Transportation that described what the US transport system might look like in 30 or 40 years time. However, such scenario methods are probably better suited as a way of thinking about general possibilities, rather than for forecasting the success of a specific project.

For those, it may be better to remember John Maynard Keynes’ admission that: ‘If we speak frankly, we have to admit that our basis of knowledge for estimating the yield 10 years hence of a railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing.’ Of course that is no excuse to stop building railways or inventing medicines – but we should be open about the uncertainties involved, and remember that forecasts tend to rapidly go off the rails.