With renewed economic growth slowly creeping across much of the developed world, alongside it has been a surge in the value of real estate. While the financial crisis, subsequent recessions, and decline in credit severely hampered much of the world’s property markets, real estate has bounced back during the last 12 months.
Investment in real estate across the world has continued to increase considerably over the last year, with volumes rising to as much as $788bn in the 12 months to June as a rate of 17.2 percent, according to a study by real estate consultants Cushman and Wakefield (C&W) released in October.
This year, the IMF launched its Global Housing Watch study that will continually look at real estate markets around the world. Launching the report, the IMF’s Deputing Managing Director Min Zhu said that providing the world with detailed analysis of real estate prices would ensure that some of financial crises that were exacerbated by property prices could be understood better. “Understanding the drivers of house price cycles, and how to moderate these cycles, is important for economic stability. It is only by maintaining an open dialogue on these issues that we will gain a solid understanding of how policies can contain housing booms.”
Contrasting fortunes
Some of the initial findings in the IMF’s study showed that the most expensive parts of the world to buy a house were Belgium, Canada and Australia. Calculating the index by comparing the ratio of house prices to average income in each country, the results show that it is proving particularly difficult for people to acquire property in these regions. By contrast, affordability in Germany, Korea and Japan is particularly low.
Another result of the study was the stark impact of the global financial crisis on the world’s house prices, with a fall of 20 percent on the average price of property in 2009. While prices have yet to return to their 2008 high, some countries are seeing bigger increases than others. These include the Philippines, where average prices rose by 10.5 percent in 2013, and Hong Kong, which saw a 10.3 percent rise. India saw a dramatic fall in prices last year of nearly 9.1 percent, while the troubled economies of Greece and Italy caused prices to fall seven percent and 6.5 percent respectively.
Investment in retail property has also been strong, although has experienced smaller increases in the worlds top 25 cities compared to the wider market, according to C&W. At the same time, office space has grown, but there has been more focus on modernisation and upgrades than a surge in new space. Reduced occupancy has become a global trend, with many businesses looking to scale down their real estate costs.
In the US, foreign investors pushed up real estate activity by nearly 50 percent over the last year, dominated in large part by Canadian, Chinese and Australian buyers, according to C&W. As the US economy strengthens, foreign investors are increasingly looking at the country’s real estate. Pension funds and Asian investors are particularly keen on US real estate, and it is thought this trend will continue into 2015.
The areas that have been of most interest have been near to energy and technology markets, with New York, San Francisco, Boston and Houston all seeing strong investment. At the same time, retail markets have strengthened as a result of the improving economy and falling unemployment.
Asia’s property market has remained strong, with a healthy level of demand and liquidity due to insurance companies and pension funds being eager to invest. However, uncertainty over the regions economy has meant that activity isn’t as high as had been expected, with tougher lending conditions also hampering real estate markets, says C&W.
“Core markets are generally outperforming but the mixed economic picture together with rising new supply has weighed on overall performance. However, while there are occasional scares over the outlook, sentiment is generally firming, with expectations of a modest improvement next year as China’s commitment to rebalancing starts to pay off and as reforms in Japan and India add to confidence.”
Runaway market
London’s runaway property market has shown little sign of slowing down; with house prices in the UK capital surging passed the expected level for 2014. Homeownership has become an increasingly politicised issue within London, as the city’s soaring population struggles to fit into the houses on offer.
Studies suggest that London’s population is growing by roughly 100,000 people each year, and by 2030 will hit 10 million citizens. In order to cater for this there needs to be a rapid increase in house building. Current Mayor of London Boris Johnson has set a target of 42,000 new homes to be built each year, although some commentators believe that figure should be nearer 52,000.
One contentious issue surrounding London property is the number of foreign buyers that are seemingly hoovering up many of the new buildings as soon as they hit the market. Politicians from all sides of the political spectrum have said they intend to do something about this issue, although whether they will be able to genuinely resist this influx of foreign capital remains to be seen. Overseas investors have looked to capitalise on London’s robust property market, pouring money into real estate across the capital over the last year at a rate that far outweighs any other city.
Coinciding with this, the C&W study reports that the level of investment into London has jumped by a staggering 40.5 percent to $47.2bn in the 12 months up to June. London was second only to New York in this respect, which saw $55.4bn invested during the same period, an increase of 10.9 percent.
Another issue is talk of a potential tax on high value property that has been proposed by two of the three main political parties. The so-called Mansion Tax would hit all homes valued over £2m ($3.23). However, there has been much debate over how fair such a tax would be on people in London, and how practical it would be to actually implement such a scheme.
Finally, with interest rates set to be increased – albeit modestly – in the coming year, it is though that the booming property market in the UK could well stabilise.
While few people believe there will be any large collapse in property values, there have been signs of a slowdown recently. Next year will likely see this continue, although there will likely not deter the enthusiasm for UK property seen from people overseas.
Mass urbanisation
Across developing nations, mass urbanisation has led to slums sprawling out of major cities. As jobs become centralised and people flock to the big cities, governments are struggling to build the necessary homes that will cater for their demanding citizens. In places like Brazil, China and India, a lack of affordable homes is hampering growth. According to a study by the Royal Institution of Chartered Surveyors titled Global Affordable Housing: BRICs PLUS Mortar, governments should ensure that a clear strategy is laid out for addressing these problems.
Professor Duncan Maclennan, the reports author, says, “International bodies and lobby groups talk of the looming challenges of population ageing, the environment, worklessness, immigrations and the like. They also need to recognise that there is an emerging global crisis in relation to the provision of decent homes and neighbourhoods.”
C&W say that the global market during the coming year is likely to be stronger still, but also vulnerable to differing strategies towards monetary policy. “Looking forward to 2015, the global economy is anticipated to be firmer but still vulnerable, with trends divergent country by country. One of the most notable drivers for this will be the polarisation in monetary policy, which will be tightening in some areas but remaining loose elsewhere. This points to conflicting trends for real estate globally.”
The report goes on to state that while interest rates are likely to rise during the coming year, the impact on real estate prices is not likely to be too severe as some fear. “Whatever the nature and timing of policy changes, however, fears over higher interest rates are somewhat over done: withdrawal may be painful but investors should be more frightened of stagnation and deflation. Higher rates and reduced quantitative easing will in fact be a welcome sign of ‘normality’ returning and investment strategies should be ready to respond – focusing on the fundamentals which actually look promising in a number of property markets.”
The likelihood for next year is that the increasing competition to acquire property will continue to force prices up around the world. Unless there is a gearshift in house building across the most desirable locations, these prices are unlikely to see any falls in the future. Our Real Estate awards feature those companies best equipped to handle, what can at times, be an unpredictable market.
Time and again sources have spoken about the world’s dwindling fossil fuel reserves and the stress that is, increasingly, being put on what precious opportunities remain. Industry names have suspected that available reserves have come close to the end on more than one occasion – and have said as much – though the rate at which new discoveries are being made and demand for fresh supply is gaining has sparked resurgence in the global energy market. ExxonMobil estimates that global energy demand will continue to rise by approximately 35 percent in the period through 2010 to 2040, and technological developments alongside significant strategic changes made in that same period will no doubt embolden the industry’s cause.
In the case of the US, a shale revolution is lifting the world’s biggest economy out of the doldrums and setting it on the straight and narrow, whereas recent developments in China’s hydrocarbons sector have been instrumental in realising a more sustainable means of prosperity. In Europe, unanswered questions on the dangers of fracking have put the brakes on efforts to tap what reserves lie beneath the surface, and the opportunities and challenges associated with Arctic drilling have made headlines across the globe. Irrespective of an uncertain operational environment, what’s clear is that the oil and gas industry is in the midst of a major transformation.
To celebrate some of the brightest names in the business and bring attention to what we feel are the greatest industry-related achievements of this past year, the World Finance Oil and Gas Awards 2014 offer a glimpse into what advances are being made in the global energy market. Here we take a quick look at some of the most significant developments and how oil and gas companies have acclimatised to a much-changed marketplace.
Changing demographic With emerging markets playing an increasingly important role in driving global economic growth, demand for oil and gas is far and above what it was. “According to the estimates of McKinsey Global Institute, by 2025 440 cities in developing countries will contribute up to half of the global GDP growth. At the same time the levels of consumption will grow,” reads Lukoil’s Global Trends in Oil and Gas Markets to 2025 report. “Urbanisation and growth of the consumer class in developing countries will, in turn, promote demand for real estate, infrastructure, cars, hi-tech goods and, as a result, energy resources.”
This shift in the oil and gas consumer demographic means that companies have had to respond to what is fast emerging as a long-term industry trend, with growth stemming principally from emerging markets. According to the UN, a population of just over seven billion today is forecast to reach 9.6 billion by 2050, with over half of the additional numbers attributable to Africa. What’s more, India’s population is forecast to surpass China’s in 2028 and Nigeria’s is expected to exceed the US’s before 2050. Elsewhere, Europe’s population is tipped to decline, and life expectancy in developing nations is expected to be around 81 years by the end of the century.
The planet’s rising population means that oil and gas companies must look to new frontiers if they are to capitalise on emerging opportunities and negotiate the ever-changing tides of the global economy.
Developed markets
This is not to say, however, that existing market powers are of any less importance. In the US, for example, oil and gas still accounts for approximately 60 percent of the country’s energy mix, and the so-called shale revolution has set the nation on the road to self-sufficiency. Increased oil and gas production, therefore, has created additional jobs and given the country a much-need measure of economic stimulus. Not excluded to unconventional sources of energy, however, US crude production is closing in on the country’s historical high of 9.6 million barrels per day, and imports as a percentage of total energy use are plummeting.
Crucially, increased oil production has stopped short of sparking a global oil price collapse, supported primarily by the costs associated with increased production and the continued depreciation of the US dollar.
“Looking at the bigger picture, some of the changes which are taking place are quite fundamental. It was already evident that worldwide flows have significantly changed over the past few years, with the US currently being an exporter rather than an importer and an ongoing increased demand from countries such as India and China, to name just a few changes,” writes Jeff Sluijter, Ernst & Young BeNe leader of Energy and Natural resources in the company’s Oil and Gas Industry Forecast 2014. “These are interesting times, with many changes and challenges still ahead of us.”
In Europe, production has declined, due in large part to more competitive alternatives in both Asia and the Middle East, and the public’s reluctance to embrace fracking in quite the same way they have across the Atlantic is stifling the region’s potential. However, many industry analysts anticipate that the coming years will mark a turning point for the continent’s gas market, as supply of LNG takes an upturn and prices dive. In preparation for a new competitive landscape, many of the region’s biggest players have decided on an LNG-first strategy and looked to improve their technological and infrastructural proficiency wherever they can in order to better capitalise on new opportunities (see Fig. 1).
New opportunities
To satisfy increasing levels of consumption, greater efforts must be made by those in the industry to exploit what recoverable reserves remain in the ground. Perhaps the most important aspect of this goal, therefore, is technological improvement and innovation, as firms look to increasingly hard-to-find, and so expensive, findings.
Perhaps the clearest indication of this quest to unearth barely recoverable reserves is the race to tap billions of tonnes worth of oil and gas in the Arctic. Unsurprisingly, the costs of setting up shop in the world’s most inhospitable climate are high, though the rewards for successfully doing so have lured a number of major international names to the fold. Rosneft and its Arctic project partner Exxon Mobil, for example, completed the drilling of the northernmost well in the world in September and took another step closer to realising the true extent of Arctic oil and gas.
Source: AT Kearney. Notes: Asia Pacific includes Singapore, Thailand and Pakistan
In response to record high demand, major industry names have to look to unconventional, and so costly, methods of drilling. However, more important than that is the fact that companies must today look to the long-term if they are to occupy a greater share of the market.
Though the industry is so often associated with short-term gains, the technological demands associated with exploiting unconventional oil and gas deposits and setting up shop in difficult geographies means that companies will have to wait years before they see a return on their investment. Whereas in years passed money has been spent primarily on exploration, many are now moving towards infrastructural developments and taking a step closer to production. Evidence of this trend can be seen with increases to midstream and downstream capital spending, according to Deloitte, as well as a drop in M&A numbers, as companies look to focus on existing operations.
As the complexity of and expense tied to projects takes an upturn, those in the oil and gas market must take greater care to protect against uncertainties, whether they be regulatory, financial or technological in nature. Both oil and gas are still key energy sources for the global economy, even in today’s environmentally conscious society, and those responsible for satisfying demand play a key part in driving socio-economic development on a global scale.
The importance of the 2014 World Finance Oil and Gas Award winners, therefore, should not be underestimated, taking into account the work they have put in to improve the lives of countless individuals across the globe. Having each played an important part in spearheading industry developments and in making a difference to the many communities in which they work, the award winners represent the cutting edge of the energy market.
As part of the country’s two-year anti-corruption drive, Chinese authorities imposed an upper limit on executive pay in September and, in doing so, looked to rectify a number of employment market inefficiencies. In keeping with the ruling administration’s commitment to clamp down on state corruption and restore balance to the labour market, the world’s number two economy has agreed to legislation that its European counterparts could not quite stomach.
For instance, in 2013, a popular proposal to limit executive pay was taken to a Swiss referendum. However, the overwhelming majority (65.3 percent) rejected the motion that executive compensation should be no greater than 12 times that of what the lowest paid employee earns. And although the Swiss public voted in favour of outlawing ‘golden hellos’ and ‘golden goodbyes’ (signing and leaving bonuses) earlier that same year, the 1:12 referendum proved too radical a proposal for the voting public.
In China, however, the Assets Supervision and Administration Commission and the Ministry of Human Resources and Social Security have announced that executive pay at state-owned enterprises (SOEs) will be capped at 10 times the salary of any employee at the same firm.
Power should be restricted by the cage of regulations – President Xi Jinping
The measures are surprising, given that China is typically viewed as more susceptible to corruption than its Western counterparts. Nonetheless, a closer look at what reforms have been introduced in months passed shows that the country’s ruling powers are working hard to right a muddied reputation and silence its critics.
Crackdown on corruption
The crackdown on corporate pay is only one facet of President Xi Jinping’s programme to arrest concerns of overly excessive government spending and instances of corruption. In the lead-up to his instatement as President, Xi vowed to expose any misdeeds and clamp down on untoward business leaders and bureaucrats.
“We must uphold the fighting of tigers and flies at the same time, resolutely investigating law-breaking cases of leading officials and also earnestly resolving the unhealthy tendencies and corruption problems which happen all around people,” he said in a speech broadcast by Xinhua in the January preceding his term. “Power should be restricted by the cage of regulations.”
According to figures cited by the newly created Central Commission for Discipline and Inspection, more than 182,000 party officials were punished in 2013, and eight of the 31 high level officials contained in the sample are currently facing legal prosecution. Whereas the ruling parties of old have succeeded only in the ridding of political rivals and currying favour among the masses, Xi’s corruption drive is closer to a sustained solution to what has been a long-running problem in Chinese politics. The party’s pledge to outlaw the “extravagance and hedonism” of years gone by, therefore, has been well received by the Chinese public and earned the president a favourable reputation among an emerging – and increasingly influential – middle class population.
Since 2012, the CPC Commission has introduced a raft of measures to stamp out corruption at every conceivable level, beginning with new powers for the party’s Discipline and Inspection Committee and ending with drink restrictions at company-sponsored dinners.
Crucially, the decision to impose a ceiling on SOE executive pay signals the party’s willingness to engage with what concerns Chinese individuals the most, and hone in on the prevailing issue of widening income inequality. “From an economic perspective this may not be optimal. But the state has to weigh up its ability to attract/retain the best talent against concerns regarding growing income/wage inequality,” says Alex Bryson, Head of Employment Group at the National Institute of Economic and Social Research (NIESR).
China leading the way
China is set to cap its CEO to average worker pay ratio at 10:1. But the inequality pay gap exists across the world, and has done for quite some time.
10:1
1983
195:1
1993
301:1
2003
331:1
2013
Source: Yahoo! Finance
Competition and comparisons
As it stands, executive pay among China’s SOEs is far short of those in the developed west, although the rapid rate at which the figures have been growing of late has given some cause for concern. A recent report, authored by Bryson, his NIESR colleague John Forth and University of Nottingham Ningbo China professor Minghai Zhou, shows that executive pay at SOEs has effectively doubled in the period through 2005 to 2010. Add to that the fact that any increases to Chinese executive compensation were closely in keeping with firm performance in the period through 2001 to 2010, and it appears that the similarities between Chinese and western markets number in the many.
“Despite differences between China and the west in the composition of the public listed sector and the governance of market relations, its executive labour market resembles executive markets elsewhere,” reads the report.
“There appears to be something about executive jobs and how they are managed, which transcends national economic, political and cultural differences.”
Nonetheless, despite the rate at which executive pay has risen in China, the actual amount pales in comparison to similar-sized western firms. For example, Industrial and Commercial Bank of China Chairman Jiang Jianqing was paid $185,000 of the bank’s $38.5bn in 2012 net profits, whereas Goldman Sachs’ chairman Lloyd Blankfein was awarded over 100 times that amount, according to the Financial Times. The comparison, of which there are many like it, shows that executive pay has failed to keep pace with performance in China, though the ratio of executive to worker pay is still a cause for concern.
“There is such pressure for the simple reason that, as in any economy that is becoming increasingly developed, China relies on a fully functioning and efficient labour market where individuals are paid a rate that is commensurate with their skills,” says Bryson. “There are many instances of exploitation associated with monopoly firms that militate against this. The government is beginning to promote independent trade unionism, much of it in the foreign owned sector, to help redress these imbalances.”
China has an aversion to risk, and so, excessive compensation has kept a lid on executive pay, at least in comparison to those living in developed economies. Likewise, the fact that most of the country’s largest organisations are owned by the state means that excessive pay could be seen as contradictory to the stated purpose of the company. And, while efforts to close income inequality are well placed, the decision to limit executive pay has raised concerns about the ability of SOEs to attract international talent and compete on a global basis.
“The issue, of course, is that it seems as though the limits will only apply to state-owned firms. All other things equal, that it is going to limit their ability to recruit high-quality executives,” says Forth. “But pay is not the only thing that attracts people to state-owned firms – recruits may be attracted by career paths.”
Without a history of strong corporate leadership experience in China, many firms have been forced to look beyond their own borders
As the size and profit-making potential of leading Chinese SOEs has grown, so too has the need to bring in the appropriate personnel. Without a history of strong corporate leadership experience in China, many firms have been forced to look beyond their own borders; a practice that has put extraordinary pressure on what remains comparatively low executive pay. However, inflated executive wages may well be a necessary evil if the country is to attract experienced names, despite the ruling party’s efforts to enforce strict controls on pay. The danger is that the 1:10 executive pay limit could stifle Chinese talent at a time where international appointments are becoming a necessity.
“I wonder whether the impact of the move may go further though, because we know that the state plays a role in executive appointments beyond the state-owned sector,” says Forth. “So the state may be able to limit executive salaries beyond the state-owned sector, even if only indirectly, if it is sufficiently determined. There is also the question of whether state-owned enterprises set a ‘norm’ that other firms wish to follow in order to gain favour in the market. If either of these happens, then the impact on the competitiveness of state-owned enterprises is going to be limited, because the playing field won’t be so uneven.”
The implications
After months of speculation about how a crackdown on state largess might compromise China’s competitiveness, it seems the country’s political differences have buffeted what implications the measures might have had in a western market. “In a western developed economy one might worry about any measures taken which might inhibit firms’ ability to attract and incentivise their top executives,” says Bryson. “However, in the case of China, many of those incentives derive from political preferment and opportunities to move within the communist party. This incentive system also has strong economic benefits.”
The proposal to introduce a pay ceiling could also have far-reaching implications for those looking to enter the labour market for the first time. As of 2013, two-thirds of Chinese graduates set their sights on a government position or a role at a major state-owned firm, despite the part private companies have played in powering the economy onwards and upwards in years passed. Whereas, historically speaking, foreign firms paid far and above what the state did, the amount has more recently levelled out and the added perks have tipped the scales the state’s way.
Assuming the 1:10 proposal holds, positions at SOEs might not hold the appeal they have done, and the country’s top graduates might be tempted instead to look further afield and to China’s growing number of private companies. Though the decision to limit executive pay might stifle the ability of state enterprises to reel in proven international expertise, the positive impact this could have for the labour market far outweighs the risks taken.
In the midst of the on-going dispute between Argentina and the ‘vulture funds’ that hold its bonds, a broad consensus has emerged concerning the need for sovereign-debt restructuring mechanisms (SDRMs). Otherwise, US Federal Judge Thomas Griesa’s ruling that Argentina must pay the vultures in full (after 93 percent of other bondholders agreed to a restructuring) will give free rein to opportunistic behaviours that sabotage future restructurings.
Most recently, the International Capital Market Association (ICMA) recommended new terms for government bonds. Though the ICMA’s proposal leaves unresolved the hundreds of billions of bonds written under the old terms, the new framework says in effect that Griesa’s interpretation was wrong and recognises that leaving it in place would make restructuring impossible.
The ICMA’s proposed contractual terms clarify the pari passu clause that was at the heart of Griesa’s muddle-headed ruling. The intent of the clause – a standard component of sovereign-bond contracts – was always to ensure that the issuing country treated identical bondholders identically. But it has always been recognised that senior creditors – for example, the International Monetary Fund – are treated differently.
High interest stakes
Griesa did not seem to grasp the common understanding of the clause. After Argentina defaulted on its sovereign debt in 2001, vulture funds bought defaulted bonds in the secondary market at a fraction of their face value, and then sued for full payment. According to Griesa’s interpretation of pari passu, if Argentina paid the interest that it owed to creditors that accepted the restructuring, it had to pay the vultures in full – including all past interest and the principal.
After Argentina defaulted on its sovereign debt in 2001, vulture funds bought defaulted bonds in the secondary market at a fraction of their face value, and then sued for full payment
The vultures’ business was enabled in part by litigation over the so-called champerty defense – based on a longstanding English common-law doctrine, later adopted by US state legislatures, prohibiting the purchase of debt with the intent of bringing a lawsuit. Argentina is simply the latest victim in the vultures’ long legal battle to change the rules of the game to permit them to prey on poor countries seeking to restructure their debts.
In 1999, in Elliot Associates, LP vs. Banco de la Nacion and the Republic of Peru, the Second Circuit Court of Appeals determined that the plaintiff’s intent in purchasing the discounted debt was to be paid in full or otherwise to sue. The court then ruled that Elliot’s intent, because it was contingent, did not meet the champerty requirement.
Though some other courts accepted the Second Circuit’s narrow reading of the champerty defense, the vultures were not satisfied and went to the New York state legislature, which in 2004 effectively eliminated the defense of champerty concerning any debt purchase above $500,000. That decision contradicted understandings according to which hundreds of billions of dollars of debt had already been issued.
Investors who acquire defaulted sovereign debt at huge discounts should not expect repayment in full; the discount is an indication that the market does not expect that, and it is only through litigation that one could hope to receive anything close to it.
An important change in the legal framework, such as the elimination of the champerty defense, is de facto a change in ‘property rights’, with the debtors losing, and creditors who purchase the bonds intending to sue if they are not paid what they want – the vultures – gaining. The vultures were thus unjustly enriched, doubly so with the novel and unjustified interpretation of the pari passu clause.
Circling the prey
Will so-called collective-action clauses (CACs) – another aspect of the ICMA ‘reform’ aimed at de-beaking the vultures – save the day? In many countries, CACs stipulate that if, say, two-thirds of the investors accept a company’s (or a country’s) restructuring proposal, the other investors are bound to go along. This mechanism prevents speculative holdouts from holding up the restructuring process and demanding ransom. But CACs do not exist for sovereign debt written in many jurisdictions, leaving the field open for the vultures.
Moreover, CACs are no panacea. If they were, there would be no need for domestic bankruptcy law, which spells out issues like precedence and fair treatment. But no government has found CACs adequate for resolving domestic restructuring. So why should we think that they would suffice in the much more complex world of sovereign-debt restructurings?
In particular, CACs suffer from the problem of aggregation. If a CAC required, say, 75 percent of the holders of each bond class, vultures could buy 26 percent of only one bond class and block the entire restructuring. The recent Greek debt restructuring had to confront this issue. The ICMAs new framework seems to provide a way out: the supermajority would be defined by the acceptance of the aggregate principal amount of outstanding debt securities of all of the affected series. The supermajority’s decisions would be binding on all other investors.
CACs are no panacea. If they were, there would be no need for domestic bankruptcy law
But this, too, poses a problem. The more junior creditors could vote to have themselves treated in the same way as more senior creditors. What recourse would the senior creditors then have? In bankruptcy court, they would have grounds for objecting, and the judge would have to weigh the equities.
These issues are especially important in the context of sovereign-debt restructurings, because the claimants to a country’s resources include not only formal creditors; others, too – for example, pensioners – might not be paid if bondholders are paid in full. Chapter nine of the US Bankruptcy Code (which applies to public entities) recognises these rights – unlike Griesa and the vultures.
Today, the international community faces two challenges. One is to deal with the hundreds of billions of dollars of debt written under the old terms, which cannot be restructured under Griesa’s ruling. The second is to decide on the terms that should be imposed in the future. The investing community has made a serious proposal. But changes of this magnitude must be based on discussions among creditors and debtor governments – and more is needed than tweaking the terms of the agreements.
An initiative at the United Nations to encourage the establishment of SDRMs is receiving the support of prominent academic economists and practitioners. Global efforts are good first steps to remedy the damage to international financial markets that the US courts have inflicted. For the sake of a healthy global economy, the vultures must be grounded.
In part two of our series on Iran, we talk to President of the National Iranian-American Council, Trita Parsi, about whether sanctions posed on Iran to hinder the government’s nuclear programme will have a progressive or damaging effect.
World Finance: Are the Iranian sanctions as debilitating as we saw in Cuba for example? Trita Parsi:In many ways no. First of all, the sanctions that have been quite debilitating have only been imposed on the country for the last couple of years, and already you are starting to see that that initial sting has started to wane off a bit, which is really typical. Sanctions tend to very harsh in the beginning, and then after a while, workarounds are found and other ways to pursue trade are found. But in the case of Cuba it’s a bit different, because the Cubans never really had a strong economy to begin with, they didn’t have natural resources and other things that the outside world was in dire need of, whereas the Iranians sit on a tremendous amount of oil as well as gas, which the world is in dire need of, and as a result they’re in a much stronger negotiating position.
I’m personally very unfavourable towards the idea of sanctions, mainly because it tends to hit the weak
World Finance: How do you feel about sanctions on a country? Trita Parsi: I’m personally very unfavourable towards the idea of sanctions, mainly because it tends to hit the weak and those in society that actually have very little to do with the decision making of whatever policy it is that the sanctioning countries are trying to change. It is, in essence, collective punishment, particularly when it comes to countries such as Iran that are not true democracies, where the people have very limited ability to impact a policy. Moreover, there’s not a lot of evidence for sanctions truly working, meaning not that they impose pain, that they can do, but that they can translate the pain into a shift in policy, and a desired shift in policy. There’s very little evidence for that. The last point I would say about it, some of my hesitations about sanctions is that, the way sanctions tend to work in really hurting the middle class, is a very negative development when it comes to the prospects of democratisation. By harming the middle class in developing countries, we’re also harming their ability to move towards democracy.
Taiwan is one of the leading countries in the world when it comes to insurance penetration rates, and one of the largest markets in the Asia-Pacific region. World Finance speaks to Executive Vice President of Cathay Century Insurance, Longman Pin-Yao Lin, about how the industry is developing and the company’s place within it.
World Finance: Well Longman, the insurance sector in Taiwan is well established, so where does Cathay Century Insurance fit in and what services do you focus on?
Longman Pin-Yao Lin: In 2013, non-life insurance premium income was $4.2bn. We got a 3.7 percent increase over previous years. The growth rate of my company, Cathay Century Insurance, was nine percent.
We are committed to providing new products to meet the demands of the public and insurance customers, and we also focus on loss prevention and risk management.
World Finance: You have a strong presence in China and other parts of Asia such as Vietnam. How different is the insurance sector in these different countries and what challenges do these differences represent?
Longman Pin-Yao Lin: China’s non-life insurance market developed very rapidly under the privatisation of motor insurance pricing, and the opening to foreign insurers of the compulsory liability market.
Chinese non-life insurance will become attractive and more efficient. But it is not easy for insurers to get into the Chinese insurance market.
Chinese non-life insurance will become attractive and more efficient
The East Asian insurance market such as Vietnam is emerging – not a well-developed market. It offers a big opportunity to do business there.
The first challenge here is you should raise up the importance of insurance, and the second challenge is the laws or regulations relevant to non-life insurance is still immature. Thirdly, you would face the shortage of human resource.
We have set up our service network there for about three years now. I hope that we can acquire the recognition of the local clients through our excellent operation.
World Finance: As a relatively new insurance market, what opportunities does the Asia-Pacific insurance sector offer?
Longman Pin-Yao Lin: The penetration and the density of insurance is lower than in the other areas, but the increase in demands from middle-class societies and insurance customers is continuously growing.
World Finance: How do you safeguard policy holders’ equity?
Longman Pin-Yao Lin: We set up many kinds of risk management measures and tools, and we’re developing another programme to improve the service efficiency to protect the equity of the policy holder.
We focus on improving our managing skills, and we aim to be the leader in Taiwan’s non-life insurance market
World Finance: Now you have a strong corporate governance policy; what initiatives do you have in place and how are they aiding social development?
Longman Pin-Yao Lin: We have operated this company based on two policies. One is steady growth, and the other is keep a good performance both in quality and quantity. We maintain a good performance of underwriting, we earn reliable profits, and we set the integrity, accountability and creativity to our core value.
World Finance: Finally, where are you targeting for growth?
Longman Pin-Yao Lin: In 2013 it is our 20 year anniversary, and we enter a new stage of operation. We face challenges, we face severe competition; we will continue to develop an outside channel and we will extend our sales force. We focus on improving our managing skills, and we aim to be the leader in Taiwan’s non-life insurance market.
By November 24, a historic deal may be struck to resolve the Iranian nuclear standoff, but what would that mean for the country’s economy and, in turn, the west? World Finance speaks to Trita Parsi, President of the National Iranian-American Council, to discuss
World Finance: Well Trita, as the deadline for a nuclear agreement with Iran and the permanent member of the United Security Council, plus Germany, draws closer, who needs an agreement more, Iran or the west?
Trita Parsi: Both sides will be much better off if there is a deal, and both sides will face rather dire consequences if they fail to reach some form of a compromise, and that balance of interests is probably one of the key reasons as to why the negotiations have been this successful thus far.
[B]oth sides will face rather dire consequences if they fail to reach some form of a compromise
World Finance: Well the sanctions were intended to prevent Iran gaining the technology to develop its nuclear programme and punish the government members whose assets are frozen. So how much has this impacted Iran?
Trita Parsi: Well, the sanctions have impacted the general economy in a very very negative way, and has made the life of average Iranians quite miserable. It has, however, not affected the access to supplies, etc. for the nuclear programme in a particularly strong way. The Iranian nuclear programme has proceeded throughout in spite of all these sanctions, and officials in the government actually have a much easier time getting around the sanctions than the average Iranian citizen.
World Finance: You published a study this year looking at how much sanctions on Iran had actually cost the United States, so what figures are we looking at there?
Trita Parsi: We did an econometric analysis, looking at the lost export revenue, not just the United States but other European countries suffered as a result of these sanctions, and the number we reached, which is a very conservative estimation for several different reasons, was somewhere between $135 and $175bn. The Europeans only have had sanctions since 2010, but during the first three years of those sanctions the Europeans lost twice as much money as the US did during that same period. But of course, since they’ve had sanctions during shorter periods, they haven’t lost as much. The US has had very strong sanctions on Iran at least since 1994.
World Finance: Considering that this standoff has been bad for both Iran and the west, what are the real reasons behind the Iran-US stalemate?
Trita Parsi: It is a geopolitical conflict that is at the root of this, the nuclear programme in many different ways is just a symptom of a deeper problem. But that problem has now become so deep that if they didn’t resolve the nuclear issue, it could actually have spilled over into a hot conflict, a military confrontation. That is not something that would be to the benefit of the United States, the west or Iran, and I think that is one of the reasons as to why the two sides have come to the table and negotiated in a much more serious way than they’d done before, because they both realised that they really needed an exit ramp out of this escalatory dynamic that they had found themselves in.
World Finance: Well if the talks on the 28th do not end with an agreement, what will this mean for Iran and the rest of the world?
[T]he two sides are speaking much more comfortably and more confidently about the deal than they did before
Trita Parsi: If it ends in such a way that they’re going to have to have another extension a couple more months, then the crisis may be able to be postponed. If it ends in such a way that it’s clearly not going to be able to come back to the table, then it’s going to very much depend upon who the rest of the world blames for the failure. If the failure falls around the responsibility of the Iranians, then you’re going to see an intensification of sanctions and a ratcheting up of other threats as well. In fact, Wendy Sherman the American lead negotiator put it this way, she said “if there’s a failure, the name of the game on both sides is going to be escalation. The US is going to try to intensify sanctions, the Iranians are probably going to escalate their nuclear activities. There’s no one who will be winning from that scenario.
World Finance: So finally, how likely is an agreement?
Trita Parsi: Some of the problems that existed in earlier rounds appears to have been resolved, the two sides are speaking much more comfortably and more confidently about the deal than they did before, and also their messaging to the domestic audiences has shifted, and that’s a very critical point, because neither side was going to go on a campaign of selling the deal until they had at least a very likely deal, and since they have started that selling campaign, I draw the conclusion that they’re much closer a deal than many people may have thought.
After a disastrous 17 months under modern retail guru Ron Johnson, recent times have seen a renewed focus for American department store JCPenney – with sales rising under incumbent CEO Myron (‘Mike’) Ullman. But a quick glance at the rise masks the darker side, and despite optimistic forecasts, incoming CEO – Home Depot executive Marvin Ellison, set to take the helm in August 2015 – has a lot of work to do before the struggling, 1,100-store retail giant can return to profitability. A large part of this comes down to whether he can learn to tread the fine line between tradition and innovation – that is, whether he can strike a balance between Johnson’s forward-thinking approach and Ullman’s successful pricing strategies.
In its prime, middle-market department store chain JCPenney was one of the retail industry’s biggest players. “You could certainly compare them to businesses like Macy’s,” says Dwight Hill, partner at American retail consulting firm McMillan Doolittle. The retail giant was floating up there in the dizzy heights of other $18bn department stores in the 1990s and early 2000s, when American consumers were hungry for red-tape deals and convenient, all-in-one shops. But as the age of the internet got into full swing, shopping habits began to change.
Then-CEO Ullman continued to draw in value-conscious customers on the hunt for a bargain. His strategy was to flood customers with coupons, slash prices with constant sales and fill the shop floor with red pen markdowns. He also formed unprecedented partnerships with the sophisticated likes of cosmetics retailer Sephora, fashion designer Ralph Lauren and clothing line Liz Claiborne. When news of a 10-year exclusive deal with the latter was released in 2009, the design company’s stocks shot up by 28 percent and JCPenney’s reached a 52-week high; Ullman was creating buzz in the nationwide chain.
Sources: Valuewalk, JCPenney, Nomura. Notes: Figures for 2014, Nomura estimate
Catastrophic decline
Ron Johnson, the entrepreneurial mind behind Apple’s innovative retail strategy as its Senior Vice President between 2000 and 2011, believed JCPenney’s reputation was dwindling – its former golden days losing out to images of dowdiness. Sales had only risen 0.7 percent from December 2010 to 2011, against a 2.7 percent increase the year before, while in the same year competitor Macy’s enjoyed a 5.4 percent rise.
Replacing Ullman after seven years at the helm in 2011, Johnson spotted an opportunity and ran with it – a little too rapidly. He decided to apply Apple’s experiential approach, including its signature empty stores and quirky in-shop features like the Genius Bar, which he was the brain behind, to JCPenney. His vision, as declared in the company’s annual report that year, was to “return to the golden age of department stores, when retailers offered truly special experiences that customers loved.”
“He had a grand plan that he was going to turn JCPenney into some sort of upmarket store,” says Neil Saunders, Managing Director of retail research agency and consulting firm Conlumino. Scrapping discounts in favour of everyday low costs, Johnson slashed prices by around 40 percent, restricted sale tags to a few select items and introduced two dedicated discount days per month. He also implemented specialty shop-in-shops, introduced designer brands like Levi’s and got rid of staff formal dress codes in favour of a far more casual approach.
Q2 sales, 2014
$2.8bn
JCPenney
$6.27bn
Macy’s
$119.3bn
Walmart
The transformations came at a hefty cost; he projected a monthly expenditure of $80m on the ambitious project, which included plans to open new stores and introduce monthly services such as free haircuts and ice cream giveaways in the summer, mirroring Apple’s emphasis on the experience. His aim was to capture a younger target audience and bring the store in line with a technologically advancing world. “One of the key challenges is, how do you take a 110-year-old company and make it relevant?” he asked in the 2011 report.
However, ditching the coupon-based strategy Ullman had implemented, while reducing stock to create a more minimalist atmosphere, backfired and the company fell into decline and revenue loss. “The unfortunate reality was that he underestimated the level of addiction the American consumer has to sales and discounts,” says Hill. “When you factor down the prices and the promotions, the prices were probably about the same. But it was the psychological factor.”
JCPenney saw its former customer base fade into the midst of its competitors and its losses hit almost $1bn, with revenue plunging by nearly 27 percent to $12.99bn between February 2011 (when Ullman was still CEO) to February 2012 (see Fig. 1).
The situation was so dire that Johnson, the same man so fervently celebrated for his Apple successes, was ousted in April 2013, just 17 months into his term. Shares had dropped 51 percent, its market capitalisation had plummeted from $6.84bn to $3.49bn according to a report by CNBC, and its comparison store sales slumped (see Fig. 2). “He just tried to turn JCPenney into something it wasn’t, and the result was catastrophic,” says Saunders.
According to a report by Yahoo!, investors didn’t hesitate to celebrate when Johnson was fired; stock shares saw a relatively sharp increase (almost 13 percent) in after-hours trading following the news. JCPenney was forced into making a quick decision, and former success story Ullman was called upon to step in and save the ailing department store. His strategy was to destroy everything that Johnson had implemented and take Penney “back to the future”.
“There was a complete backlash against what Ron was attempting to achieve, and there was very much a focus on going back to the way JCPenney was before,” says Hill. Other former Apple executives left, he got rid of the brands that weren’t working and hauled back the discounts – much to the temporary damage of the business’ margins.
JCPenney continued to suffer and in May 2013 resorted to a five-year $2.25bn loan from Goldman Sachs in order to secure essential funding for the business; the move assured investors that the store would avoid defaulting on its $200m bond debt repayment due for October 2015.
In early 2014 the crisis continued. The company closed 33 stores and made 2,000 staff cuts as part of the turnaround strategy. Ullman started to implement a second layer of initiatives including a renewed emphasis on the retailer’s private brands, a reinvigoration of the home department (which suffered under Johnson) and increased online activity.
Sources: Valuewalk, JCPenney, Nomura. Notes: Figures for 2014, Nomura estimate
The turnaround
After months of slogging away to restore the retail chain’s former glory, through a (somewhat uniquely) regressive process, the market began to refocus its attention on the business. Reuters said in May 2014 that the CEO’s turnaround strategy was paying off, with the company reporting a 6.2 percentage point increase in same store sales in the first quarter of the year. That marked the second consecutive quarter rise after nine quarters of falling sales. Going back to the pre-Johnson model saw JCPenney’s shares rise by over 25 percent in after-hours trading.
In August this year JCPenney reported a six percent rise in second quarter same store sales, with total sales amounting to $2.8bn. The Financial Times reported that while competitor Macy’s suffered from a six percent decline in shares in one week in mid-August, JCPenney had the smallest fall at 1.8 percent. Gross margins grew, from 30.8 to 33.1 percent year on year, as a result of a reduction in the number of discounted items. “Clearance sales were less than 15 percent of the total sales for the quarter, in line with historical rates,” the company’s CFO Ed Record said in a conference call to discuss JCPenney’s second quarter performance, stating his belief that they were “on track to re-establish JCPenney as a leading moderate department store in America.”
Then in September 2014 the business struck a $400m unsecured bond. Reuters reported that JCPenney would have been able to pay off its three outstanding debts (totalling $685m) without it, with credit rating agency Moody’s stating that the firm had $847m available cash as of August 2014. A source said the deal was a positive move to prove the company’s ability to draw on debt capital.
Despite the excitement surrounding JCPenney, that bond highlighted the company’s continued reliance on debt. Add that to the fact the company reported a net loss of $352m in May, and in October lowered its third quarter sales guidance, and the picture isn’t quite so rosy. Although some praised Ullman on his strategy, his reputation wasn’t completely without its flaws. When it was announced that he was returning as CEO in 2013, stock dropped 21 percent in after-hours trading and Hill says Ullman was a last resort.
Innovation is key if JCPenney wants to gain further ground in an increasingly competitive and technologically focused market
There are further flaws. As Saunders points out, the supposedly strong rates of sales growth over the past three quarters are relative to sales figures that plummeted to an all-time low. “It’s very easy to see strong sales growth when you’ve had a 20 or 30 percent decline,” he says.
“Analysts have got very excited about these numbers… and I’m a bit more cautious. I think we’ll start to see some pretty weak levels of performance, maybe as we move into next year and come up against strong comparatives.”
JCPenney indeed continues to fall behind the big names it once contended with. Macy’s $6.27bn second quarter sales this year dwarf JCPenney’s celebrated $2.8bn – and that’s before someone like Walmart is even considered (boasting sales of $119.3bn for the same quarter). “Ron’s effects are still being felt because it did a lot of damage and it’s going to take a lot of time to win back customers and get them spending,” says Saunders.
JCPenney aimed to cut capital expenditures to a tight $250m in 2014. That’s an ambitious goal given that capital expenditures amounted to $1bn back in the golden days of 2007, and Saunders believes a continuation of those cutbacks in the long-term would have a negative impact. “It’s fine to cut that capex in this period of transition when the business is trying to swing back into profitability, but unfortunately the price of doing business in retail at the moment is that you do need to spend money to innovate,” he says. “Over the medium and long term if you maintain a lower level of investment it eventually catches up with you and you will pay – it will cost in terms of sales.”
Innovation is key if JCPenney wants to gain further ground in an increasingly competitive and technologically focused market, but it’s also what brought the business down in the first place. Like other retailers, the company is caught between a rock and a hard place. It needs to strike a balance between maintaining convention and embracing innovation; between recapturing a more traditional demographic and attracting a younger and more technologically advanced one. JCPenney’s success hangs on Ellison’s ability to walk the line between the two.
Striking a balance
Johnson’s failure went some way in showing the risks a tech giant can take that a non-tech one can’t. Available funds are first and foremost the make or break. While Apple had strong gross margins, Penney didn’t; while tech shoppers are driven to a store for a specific product, department store customers aren’t; and while Apple can empty its shop floors to create a pristine, design-driven brand, JCPenney can’t.
But Hill believes that such innovation combined with the right pricing strategy – something Johnson is widely conceived to have got wrong – could take JCPenney to the next level. “The key issue with the Johnson administration was not that they came up with these innovative approaches to retail. It’s the fact they did not test.” He cites simple moves such as providing wi-fi so customers can search merchandise information in-store as the way forward, and believes experiential shopping could sit well with clothing stores. “With Apple you get to immerse yourself in the experience – that could certainly live within a department store environment, particularly in the home area.”
That’s a reality big-name retailers are starting to realise. British store Marks & Spencer recently opened an e-boutique in the Netherlands, where customers can view clothing samples in the shop on a digital clothing rack via a life-sized screen and then order products online. Sunglasses brand Chilli Beans launched a flagship concept store in Brazil, where customers can try the brand’s full range in a modern environment that also offers quirks like breakfast, a beer machine and stage shows.
Other large retailers are, like JCPenney, struggling in a changing consumer market; British supermarket chain Morrisons has hit the news repeatedly this year for its decline, while global player Tesco has likewise struggled. Tesco saw a 2.4 percent drop in sales last Christmas from the previous year in like-for-like sales and, according to recent reports, overstated its first and second quarter profits this year by around £250m ($405.8m). These retailers need to adapt their business model in order to regain consumer trust and survive at a challenging time.
Ullman was starting to implement basic innovation through a multi-channel strategy that combined online and store-driven sales; that seemed to be having some effect, with CFO Ed Record reporting a 16.7 percent increase in online sales in the second quarter compared to the previous year. Those sales were still in the negative, however, and those initiatives need to be accelerated by Ellison when he steps in next year if JCPenney is to return to profitability.
Moving forward
Both Hill and Saunders are optimistic about JCPenney’s future in the long-term. But Ellison needs to go beyond the back to basics strategy taken by Ullman and use the type of experiential and technologically advanced approaches promoted by Johnson, to bring the business forward in an increasingly innovative market. If he can combine them with the right pricing strategy and testing to avoid the pitfalls of both his predecessors, then he may be able to bring Penney back to profitability.
Even then, Saunders believes the era of department stores is over. “They’ve had their heyday and they’re a shopping format that was very relevant to American consumption and we’re not at that point any more,” he says.
But according to Hill, department stores still account for around $180m of a US retail market worth over $4bn, and online sales still only make up approximately 10 to 12 percent of retail sales in the US – which means in-store continues to represent around 90 percent of all transactions. With that in mind, a market surely remains for ailing retailers like JCPenney – the challenge is how to approach it.
The recapitalisation wave continues among Greece’s banks. One of the latest and biggest institutions to grab headlines is Eurobank. World Finance speaks to Stavros Ioannou, Senior General Manager, to discuss more.
World Finance: There have been recapitalisation efforts across southern Europe, can you tell me about the impact they’re having?
Stavros Ioannou: When we talk about the Greek banking system, we talk about four systemic banks, actually, today. All these banks have raised more than €8.9 bn, and they have perfect core Tier 1 ratios, that they rank from 14-15 percent to 17.8 percent. Actually, Eurobank is having the highest core Tier 1 ratio, and this was a tremendous opportunity for institutional investors to visit Greece and come to Greece and invest money which of course has given a big boost to the Greek banking sector. I can give you three or four examples just to understand how well this recapitalisation has affected the economic situation in Greece. One is that we are noticing lately a big deposit boost. Actually we used to have deposits of a €215 bn once upon a time, then this has dropped to €150 bn, and then this back to €164 bn. So the deposit sentiment is coming back, it’s rebalancing. The second one could be the de-leveraging. We have in the last two or three years experienced a very steep de-leveraging, which again is coming back now from the worst that we could have, which was -9.3 percent, as we speak we are at around minus three percent. So this shows that at least the people have again the courage to borrow money. And the last thing which is also important for the Greek banks is about the transparency that is coming out through the AQR tests, because I’m sure you know that the ECB is taking control of the situation, and so we feel also that this transparency will boost even more this kind of markets.
When we talk about the Greek banking system, we talk about four systemic banks, actually
World Finance: There is the average Greek person. Tell me, how have they been responding to some of these efforts?
Stavros Ioannou: What are the things that someone could see and could understand that faith is coming back, is that, of course, their deposits are increasing back, which I said earlier, which means that they have more trust in the banking system that they used to have in the past. The other part that is very important for them is that unemployment is coming down, so we have unemployment from 27.6 percent to come down to 27.1. It’s not a big decrease, but as you know unemployment rates are decelerating steeply when growth is there, when six or 12 months from growth have come down. Still in Greece, as you know, we are experiencing a minus GDP, but what I have to say, you know very well that the contraction of GDP in the last five or six years was almost 25 percent, which was big. Lately, in the first quarter of 2014, we had only -1.1 percent, in the second one we have -0.3 percent, and hopefully all the macro-economists, and the macro-economists of the bank as well, foresee that the third quarter may be and should be the first positive quarter on GDP.
World Finance: Now I now that Moody’s has recently lifted its outlook on the Greek Banking sector form negative to stable. How has that contributed to your ongoing momentum?
Stavros Ioannou: Moody’s are changing positively their evaluations, and for us it was really extremely important to see this kind of thing. Don’t forget that when the crisis came into the picture, we had a big deceleration of our levelling in these kind of companies. For Moody’s, I have to tell you that they were even in some instances much more optimistic than what the Greek situation was, which seems that they have faith, they have trust. Of course, these kinds of organisations, as you know, they base always their valuations on real data, and what I have referred earlier on in saying about unemployment, about consumption, about these kind of indicators which are extremely important indicators, I think they have been checked thoroughly by Moody’s and they have arrived to that result.
Moody’s are changing positively their evaluations, and for us it was really extremely important to see this kind of thing
World Finance: Now I know you’re not going to stay stagnant, of course you’re going to continue to keep growing. Can you tell me about some of the large scale restructuring efforts that are on the horizon?
Stavros Ioannou: One of the things that we have touched upon and we will continue to touch upon is the troubled assets. Troubled assets are for us a very important sector. What we have done in Eurobank is that we have consolidated all the non-performing and the remedial management together, so we are focusing on that. We have very noticeable results in the second quarter, which we have already published, and we feel also that in the months to come, in the quarters to come, we’ll be able to do even more good things.
World Finance: Well certainly an exciting time for Eurobank. Stavros, thank you so much for joining me today.
Listed on the Forbes Middle East Top 500 companies in the Arab world, Jordan’s Capital Bank has cemented its place at the centre of commerce in the region. World Finance speaks to its CIO, Mr. Yezan Haddadin, about the maturation of Jordan’s local banking sector and how these trends impact the investment field.
World Finance: Now 2013 of course has brought healthy growth in the banking sector, with total assets of all banks at about $60.5bn. How’s growth today?
Mr. Yezan Haddadin: Well, growth continues to be healthy in 2014, with the most recent IMF estimates for real GDP growth for the year estimated at about 3.5 percent versus 2.8 percent, which is the level we realised in 2013. Growth has been supported by government spending, by an accommodating monetary policy by the Central Bank of Jordan, and by the increase in the number of people who are seeking refuge in Jordan as a result of some of the regional instability surrounding us. With the equity capital markets not fully recovered in Jordan, the banking sector continues to be the primary source of financing and has benefited from this growth, with the increase in the level of asset for the first six months of 2014 up three percent.
World Finance: Has that growth positively impacted the investment arm of your bank?
[T]he past three years have proven that Jordan is a safe haven. We are seeing a recovery in the investment environment
Mr. Yezan Haddadin: In general terms, the investment environment in the region has been challenging over the past few years as a result of the political and security instability in the surrounding countries. Jordan, despite having a stable political environment, has been impacted by what’s happening in the region. However, the past three years, I think have proven that Jordan is a safe haven. We are seeing a recovery in the investment environment.
World Finance: Now your bank has been involved in a number of very innovative projects, particularly the Tafila Wind Farm drew a lot of headlines in the region. Why is it important for you to get involved in such projects?
Mr. Yezan Haddadin: The Tafila Wind Farm project represents the first utility scale wind farm in the Middle East. It also represents a big step in terms of securing energy independence for Jordan and securing a local source of energy at attractive prices. It puts Jordan on the map in terms of renewable energy, and the successful financing of Tafila wind farm bodes well for what we see as a robust pipeline of additional renewable energy projects that are expected to come online in the next few years.
World Finance: You’ve also been in Iraq since 2005. Tell me about some of the companies that you’ve built investment portfolios around.
In Iraq there is generally strong demand for basic infrastructure and goods and services
Mr. Yezan Haddadin: In Iraq there is generally strong demand for basic infrastructure and goods and services as a result of 30 years of under-investment due to periods of wars and economic sanctions. So if you look at the investment landscape in Iraq you will find a need and an interesting investment opportunity in almost every sector, including healthcare, education, construction and housing, and of course oil and gas, which has attracted the bulk of investment activity in the country, and the sheer size of the oil and gas sector in Iraq has attracted investors to come in and set up ancillary businesses such as logistics, drilling, equipment leasing, lodging and hospitality services for people working in the sector. So those are the sectors that we’re actively looking at, those are the sectors that we’re focused on. I would add to that the basic infrastructure projects that we’re seeing implemented there.
World Finance: Now, with regard to political instability, can you tell me how recent events in Iraq have in any way impacted investor sentiment?
Mr. Yezan Haddadin: In some areas there’s been a complete halt to whatever projects that we were looking at and considering. In other areas there has been a delay, things are still moving at a much slower pace. Fundamentally we believe that the macroeconomic picture in Iraq has not changed and therefore the investment sentiment with respect to the long term potential of the country has not changed. Iraq today is going through a very serious process of state building. Iraq represents a very unique opportunity in the form of a hydrocarbon led growth story, similar to what we witnessed in Saudi Arabia in the 1960s and 1970s, similar to what we saw in Russia in the 1990s. Our view, it’s not a matter of if, but a matter of when, and we’re very bullish on the medium to long term prospects in Iraq.
World Finance: Lots of exciting developments to watch out for. Mr. Haddadin, thank you so much for joining us today.
The Dodd-Frank Act was signed into law by the Obama administration in the summer of 2010. The aim was to try and curtail extreme risk-taking that had become rife in the over-the-counter (OTC) derivatives market and, in so doing, attempt to prevent a repeat of the financial crisis two years prior. The legislation established a number of new government agencies, such as the Stability Oversight Council and Orderly Liquidation Authority, which now work to ensure institutions that are deemed ‘too big to fail’, don’t.
Another key provision from Dodd-Frank was the ‘Volcker Rule’. Paul Volcker argued that more red tape must be placed around banks and financial institutions in order to stop them making high-risk, highly leveraged, speculative investments. Without it, he claimed, not only would financial institutions continue to act in a manner that was to the detriment of their customers, but also that such reckless behaviour would continue, remaining a threat to the stability of the entire US financial system.
Financial regulation such as Dodd-Frank, along with other regulatory proposals in the pipeline, aimed at curbing casino-style banking in the OTC derivatives markets, has made its mark. So far, the reforms have managed to mitigate the risk that naturally arises when transactions are made outside the supervision of regulators, and it has helped to instil “confidence in the financial markets by boosting transparency and liquidity, reducing the opacity of sell-side trading operations and mitigating counterparty concentration,” according to Ebbe Kjaersbo and Justin McBride, chief business consultants at SimCorp.
End of the Wild West Before the crisis hit in 2008, many financial institutions had managed to build up a ton of unrealised losses by placing highly leveraged, speculative positions within the OTC derivatives market, and because of the lack of oversight – unlike that offered on exchanges – it was impossible to calculate the level of exposure participants had acquired. To counteract this, recent reform has reduced risk by authorising central clearing and pushing for greater levels of capital to act as collateral in derivative trades in a bid to turn the previously unregulated Wild West of OTC markets into something a little more tame. Dodd-Frank also includes a provision that requires market participants to begin executing trades on regulated exchanges or trading screens, which necessitates prices be made public knowledge, allowing regulators to more accurately quantify the level of exposure in the market at any given time.
The need to hedge risk will not change and has not changed
But increased regulation in OTC markets has left a vacuum that must be filled. Traders are always looking for better returns and increased exposure, leading many to shift their focus and move to exchange-traded futures. To help facilitate this mass migration, exchanges have created fresh financial products that offer similar risk profiles to their OTC counterparts, but that are not subjected to the increased regulatory scrutiny brought on by increased regulation.
Products ranging from bundle futures, which allow investors to buy a predetermined amount of futures contracts within each quarter delivery month over the course of two or more years, to future block trades and swap futures have all helped make the transition into exchange-traded futures a no brainer. According to Lael Campbell, Associate General Counsel at Constellation Energy, a subsidiary of US electrical company Exelon, the transition has been smooth: “Everybody in our sector has been very happy with the transition to futures. It has given a lot of people some compliance and allowed them to breathe a little sigh of relief.”
Lack of liquidity
However, not all end-users are quite so happy about the market moving away from OTC trades in favour of exchange-traded securities, because exchange-based products simply do not cater for the nuanced requirements of those with a vested interest in the underlying. Not only do the products fail to meet the demands of end-users, but also, with huge sways of investors scurrying away from OTC markets, as a result of regulatory uncertainty, those who are left are concerned about the lack of liquidity, which is essential for end-users to effectively hedge.
“I hope uncleared OTC derivatives will continue to be an alternative available to end-users,” says Thomas Deas, Vice President and Treasurer of FMC Corporation, a chemical company that hedges its exposure to natural gas prices. “But there are certainly enough regulatory uncertainties that you’d have to say, at this point, it’s in question.”
The real disadvantage of exchange-traded futures for market participants with a stake in the underlying product, who are looking to mitigate fluctuations in price, is the products are standardised: they lack the specialisation afforded in OTC instruments, which have the advantage of being fully customisable. As a consequence, many end-users tend to remain in the bilateral market, but, as a result of the regulatory mandate, these market participants are subjected to increased costs.
The mutualisation of risk
The futurisation of financial markets has also been driven by financial institutions in the US wanting to avoid the clutches of the Commodity Futures Trading Commission rules on OTC derivatives. With so many large firms migrating to exchange-traded futures, it is bound to affect the volumes in the OTC market, again limited end-users capacity to mitigate their exposure.
“What Dodd-Frank required is the mutualisation of risk,” says Chris Scarpati, principal in the financial services regulatory practice at PwC. “So to reduce bilateral relationships is to neutralise risk by requiring certain OTC products to be traded on exchanges and cleared through derivative contract markets or derivative clearing organisations [and] the only way to do so, is with [financial] products that are very standardised. Today, simple vanilla interest rate swaps and simple credit default swaps are relatively straightforward and offer standard terms, which lend themselves to be cleared. However, some of the more bespoke products out there continue to remain bilateral and quite frankly will remain that way. Clearing those instruments would present a challenge to the clearing house.”
This is not to say end-users are left without an effective means of hedging their portfolios. A derivative instrument is used to protect against a certain risk profile and, whether that is someone who is looking to buy credit protection by purchasing futures to limit their exposure in the market place or by through acquiring an OTC forward contract, both are merely tools for hedging risk.
The real challenge comes when moving OTC products onto exchanges, which requires standardising those products, making the task of hedging with one financial instrument almost impossible. This leads to market participants who have a stake in the underlying tending to rely on the bilateral market provided by OTC derivatives. However, as mentioned, with the new regulatory framework driving up the cost of doing business in such markets, along with increased capital and margin requirements needed to safeguard the incidences of risk-taking, both liquidity and volatility are bound to be negatively affected.
“I think the regulations have caused firms to take a deeper look at their businesses and they are probably providing less liquidity, as I am sure they have got out of certain businesses,” says Dan McIsaac, Director of Financial Services, Regulatory Risk Practice at KPMG and former chairman of the SIFMA capital committee.
“Before, they would have done them, possibly as a loss leader, but as the margins get smaller, you have to make some decisions about what markets are not profitable to be in. I think you will see firms that may back away from providing everything, to providing what they are most specialised in and, in doing so, provide less liquidity in the market. End-users benefit from centralised clearing, but I think that it comes at the cost of liquidity and finding that perfect hedge. I think there is a trade off and I think the jury is still out on whether the benefits outweigh the cost. It’s a new landscape and it will take time for [market participants] to figure out how to mine this landscape.”
Compare and contrast
The new products made available in exchange-traded futures have been introduced to offer OTC alternatives for market participants deterred by the heavy regulation imposed on the once-unfettered OTC markets. But it is important to not only think about the issue from the perspective of financial institutions and end-users, but also the fact that there is such inconsistency between the way both markets are regulated, despite both OTC and exchange-traded products being so similar in nature.
“The need to hedge risk will not change and has not changed,” says Scarpati. “Whether or not that hedging instrument is done via a cleared or exchanged product or a bilateral OTC product really comes down to the economics of each instrument and the specific risk one is looking to hedge. Has volume in one market outshone volume in another market? The answer is that it depends from market to market. But what I have seen is a continual general uptick in cleared products, both from an interest rate swap perspective as well as a credit default swap perspective.”
The need for customisable products means OTC products will always be in demand because of the flexibility they offer, making them a great tool for those participants that are looking to hedge against a very specific risk profile. Since the inception of Dodd-Frank – the implementation of which has been swift – there has been significant change to the regulatory landscape, leading to uncertainty from those involved in OTC-traded derivatives on both the buy and sell side. This, combined with stricter rules and the rise OTC alternatives has seen flocks of investors fleeing to exchange-traded futures in order to arbitrage the regulatory inconsistencies present in both markets, rather than purely to avoid the regulation in its entirety.
International Container Terminal Services Inc has been operating for more than two decades, and has become a leader in port management on an international scale. World Finance speaks to Martin O’Neil from the company about how the industry is developing.
World Finance: Well Martin, maybe you can start by telling me, how is the container port business structured?
Martin O’Neil: For a private operator like ICTSI, the basic structure is a concession lease. Port authorities are reluctant to actually let go of ownership of these assets for understandable reasons, and what they do is give us a 25 year lease to work on the facility, operate it, take responsibility for all the capital investment, the maintenance of the equipment, and to generate an efficient service. At the end of the 25 year lease, what the contract will say is that actually all the assets revert to the port authority, so we’re really a long term tenant and operator of these facilities.
World Finance: You’ve really grown into a global company, so how do you negotiate the different port authorities and regulations, what challenges do these pose, and what do people need to know when they’re approaching this?
Martin O’Neil: Fortunately, although we operate in a lot of locations, the issues are common across many of these ports, so we’re often solving a problem we’ve solved somewhere else, which helps. There is a local component, it’s very important. In most of our locations we prefer to have a local national as the resident CEO. That I think is much easier for facilitating whatever arrangements you have to make with the local port authority, being perceived to be a good corporate citizen. But overall, if you’re operating efficiently and you’re investing in the facility and improving the general efficiency they’ll be happy.
There is a local component, it’s very important. In most of our locations we prefer to have a local national as the resident CEO
World Finance: Trade sanctions are of course prominent at the moment, what challenges do these pose and do foreign policies such as this push up costs?
Martin O’Neil: There are probably two components to it. The biggest impact we see from trade sanctions is it restricts markets that we can go into. So if there are countries that are subject to enough sanctions it’s just not actually viable to really operate there. Once we’re in a market, we actually have to deal with other issues such as currency weakness that causes the central bank to want to make imports difficult so that they can hoard foreign exchange reserves. We’re seeing that in Argentina today, and to a certain extent in Ecuador, and that will effect the business. But that’s a bigger issue on an operating business than the sanctions.
World Finance: You’ve been working on some very prominent projects such as the port of Melbourne where innovation played a strong role, so how is technology changing the face of the business?
Martin O’Neil: I think there are probably three impacts. What people don’t probably see is there’s a very significant and growing IT component in our business. I think our terminal in Manila has 12 cranes, room for 29,000 containers in the yard, they get something like 60 ship calls per month, and actually each ship call may have 800 to 1000 containers taken on and off. It’s grown to a point where you can no longer do this on index cards in order to get a ship turned around in 12 hours. We receive electronic data that tells us what ships on the vessel to load and unload, we know where the boxes are stored because of our IT systems, and that trend I think is going to continue. The second one in automation is it’s an opportunity for cost reduction. It’s more important in high labour cost countries, so I think where you see automated terminals in the world, you’re more likely to see it in Northern Europe. I think the London gateway here has actually undertaken a fair amount of automation and we’ll be doing that in Melbourne as well. So all of that’s leading to just more efficient operations which generally will probably spread around the globe as time goes on.
World Finance: Your company has quite a unique approach to project finance, what is that exactly and how does it impact your clients?
I don’t think the clients are actually interested in how we finesse the terminal, they view it as our problem
Martin O’Neil: Hopefully it has minimal impact on the clients. I don’t think the clients are actually interested in how we finesse the terminal, they view it as our problem. Firstly, we actually start with the premise that we would fund it ourselves on a corporate basis. That having been said, there are always exceptions. Anywhere we have a joint venture, it becomes advantageous just to use project finance rather than the two partners disagreeing over what the right cost should be. And there are other locations like Poland and Ecuador where we are already very well established, and the local financial community was quite eager to actually lend money to the company, which we took advantage of. So, we do it selectively. There are costs, there are constraints when you do it, and we always look at the alternative of just funding it with ICTSI corporate balance sheet funds.
World Finance: The shipping container business can sometimes be linked to illegal activity such as human trafficking. I know in the UK the Tilbury Docks was the most recent example, so how do you ensure security?
Martin O’Neil: It’s a challenge. The two big components of security, believe it or not, most container ports, if you actually put a proper fence around the perimeter, with good lights, and then you control gate access tightly, you’ve probably eliminated 50 percent of your security problems just doing those basic blocking and tackling things. The second component is many of facilities following the events of September 11, there was a heightened scrutiny put on security issues, and at many of our facilities we actually weigh and scan each container that comes in to the facility. Many cases you can’t even load that container on to a ship if you haven’t actually done that. That will catch a lot of things. Nothing’s perfect. We are in the somewhat uncomfortable position of we don’t actually know the contents of each container, that’s not really our business, that’s between the shipper and the shipping line, we’re just told “we want to load 600 containers onto this vessel by such and such a time”. But we do make an effort and, as I said, some very basic measures can catch most of it, but there’ll always be that two percent that’s hard to completely tighten up on.
World Finance: Finally, what’s your strategy for future growth?
Martin O’Neil: I think we’re particularly happy with our position in Latin America, we see continued opportunities in Africa, where there’s been a real lack of investment in these type of facilities. And then there’s some fantastic market opportunities like Turkey and Indonesia that we’ve either missed the early rounds or the regulatory regime is not yet favourable for us as an international operator, and we patiently wait and lobby for that to change.
Created with a view to rivalling the world’s leading financial institutions, big plans are in the pipeline for the soon-to-be-established Asian Infrastructure Investment Bank (AIIB). The bank, which was proposed in October 2013 by Chinese president Xi Jinping, will provide financing for much-needed infrastructure development projects across Asia, beginning in 2015.
But not everyone is welcoming the banking scene’s newest arrival with open arms. Speculation that the AIIB is set to take on the IMF and World Bank is rife and at the AIIB’s inauguration in October the US’s closest allies in the region: Japan, Australia and South Korea, were among the notable absentees. The New York Times reported that the AIIB has met resistance from US officials, who have allegedly deemed it a deliberate effort to undercut other international financial institutions, and a political tool to draw Southeast Asian countries closer.
The bank is part of China’s efforts to expand its regional influence, which has so far not been achieved through membership of the existing Asian Development Bank (ADB), based in Japan. The bank’s creation appears to stem from China’s disappointment at how little participation and influence it has within the World Bank and the IMF, US-based institutions largely dominated by US powers. China is also backing the New Development Bank, or BRICS bank, founded in July 2014 as an additional alternative to existing international financial bodies. In a joint statement, its member nations voiced their dissatisfaction: “We remain disappointed and seriously concerned with the current non-implementation of the 2010 IMF reforms, which negatively impacts on the IMF’s legitimacy, credibility and effectiveness.” The reforms promised in 2010 included giving fast-growing emerging market countries a bigger say on operations within the institution and doubling the financial resources it makes available to its member countries – so it’s not entirely surprising that one of those member countries would eventually take matters into its own hands.
Among the notable absentees were the US’s closest allies in the region: Japan, Australia and South Korea
While the bank’s launch is provoking quite the reaction, Asia’s growing infrastructure gap is surely not up for dispute. Countries such as India, Thailand, Vietnam and the Philippines will likely be the main beneficiaries of the bank, as these are where the gap between developed and developing areas is widest, and domestic private capital lowest.
The most extensive research on the topic was conducted by McKinsey & Company in 2011, and put the continent’s infrastructure costs over the next decade at a whopping $8trn. In light of this, it’s clear that the funding currently provided by the state, the ADB, IMF, World Bank and various other institutions and private investors is just not enough.
“Though several Asian economies will see a high growth in the next few years, the government alone cannot fill the entire funding gap,” said Alka Banerjee, Managing Director of Equity Indices at S&P Dow Jones Indices. “The existence of a public-private partnership is a must and that can be met by creating a transparent and tradable infrastructure market with an efficient and standardised secondary market, with a regulatory framework that incentivises long-term investments.”
If sufficient funding was provided to sectors such as transport and energy, supply could finally begin to meet demand
Asia’s emerging markets are key contributors to the global economic recovery and the tourism potential of many of these countries is enormous. Although the infrastructure required to attract tourists en masse is lacking in many areas at present, if sufficient funding was provided to sectors such as transport and energy, supply could finally begin to meet demand.
According to McKinsey & Company, the deterioration of housing, energy, transport, communications and water facilities in Asia has restrained economic growth by between three and four percent of GDP since the early 1990s. For these reasons alone, it would surely make sense that the international community would support, rather than oppose, the AIIB.
Resisting the AIIB, and therefore resisting infrastructure developments in Asia, is a somewhat backward concept and the bigger picture, which encompasses Asia’s desperate needs for funding, must be considered. Plus, there’s nothing wrong with a bit of healthy competition, and other institutions should see the new arrival as an opportunity for collaboration, rather than a looming threat. Perhaps now is the time for those IMF reforms that were promised back in 2010; giving fuel to China’s fire is the last thing they want to do right now.
