the view of the CIC on Chinese help and Europe

Posted 9.11.2011

Jin Liqun: Europe induces ‘sloth, indolence’

some  hard to hear but quite to the point comments

FSA Approval of directors: a note from the friendly OWL

Posted 17.10.2011

Regulatory Guidance for Non-Executive Directors

The objective of the service is to assist NEDs to obtain the necessary FSA approval for their role, to enable NEDs to fulfil their responsibilities with skill and confidence and to reduce the risk of confrontation with regulators throughout their term of office.

Regulatory challenge

The principal regulatory challenges for a NED are:

  • Obtaining FSA approval for the appointment
  • Interviews with FSA supervisors during ARROW and other visits to the firm
  • Meeting FSA requirements and expectations in the course of their duties

As FSA becomes more intrusive, so it becomes ever more challenging and demanding, especially in relation to the performance of NEDs. The new NED approval interview regime is resulting in one in five potential NEDs not proceeding with the appointment. This high and expensive drop-out rate is one which firms and candidates are increasingly keen to forestall. Sound preparation saves expensive disappointment.

OWL Approach

The OWL approach is in four parts:

  • Preparation for approval and ARROW interviews by mock interviews and guidance on areas of due diligence required and expected
  • Quarterly briefings on regulatory developments, covering changes in regulatory requirements as well as evolution in regulatory practice
  • Half yearly briefings on regulatory obligations for Board members of regulated firms
  • On-call advice on regulatory questions of principle and practice

Through this approach, OWL provides NEDs and regulated firms with a combination of regular and on-demand advice and briefings. Focused on FSA and European regulation, a key aim of the service is to assist directors to keep up to date with their ever expanding and constantly changing regulatory obligations and to determine the best means of fulfilling them.

αpollo liquidity – September update

Posted 14.10.2011

as you may know, part of our activities cover the structuring of alternative investment portfolios. Attached to this post is the September fact sheet of a paper portfolio we run according to our investment philosophy. We will post its performance every month. Should you have any questions, please feel free to contact us. Read more

Views on the Sovereign crisis

Posted 30.09.2011

On Wednesday 21st  at the Invest Forum in Geneva, Patrick Arthus shared with an audience of wealth managers his views on the current market situation and the sovereign crisis. These are some of the points that were discussed.

Solvency cannot be treated as a Liquidity issue

First and foremost the situation of a number of countries, Greece, Portugal and Spain, possibly Italy, has moved from liquidity – financing issue- to an insolvency situation. This means this is not about bridging a temporary situation by providing some financing. It is about the inability of those countries to pay back their debt. This cannot be treated by lending.

There are three steps that need to happen in quick order:

-        A restructuring: basically a right-off of a very large portion of the debt

-        Loans, as the countries have to finance their most urgent needs to ensure stability

-        Structural reforms: state budget reforms, tax changes, infrastructure development, education policy … in order to tackle the roots of the problem.

What makes the situation especially difficult is that the banks  in Europe are heavily invested in Government bonds, as they have been prompted by the states to do so via the liquidity and solvency constraints imposed on them for example via the Basle agreements. So a restructuring would hurt them greatly, with the danger of the liquidity and then eventually the solvency issues spreading inside the whole European financing system.

The key factor to get back under control is the dependency of the state’s finances to the external world, so that the financing can effectively be done by personal savings. That means getting the trade balance back in the green. The only way to achieve this quickly is via a massive devaluation of the currency. This is not an option in the context of the Euro zone; Hence the discussion around a potential exit from certain countries.

The cost and complexity of any exit would be mind blowing, not to mention the risk of contagion and the consequences on the European banking system as a whole. Greek banks balance sheets are loaded with Greek government bonds and owned by foreign banks, typically French. Any solution including a default from Greece will have to make sure that the banking system is protected: because it will allow the Greek economy to function and even more so because it will avoid a disaster in the rest of Europe.

For Ireland and Spain, the situation seems to be on better tracks. Ireland now shows a positive trade balance which means they have time to get their internal finances in order. As a result their 10 years financing rate has gone down 600 bpts in one month. Spain is on the way to achieve the same goal, having already halved their trade deficit. For Greece there are limited hopes they can achieve it, and in Italy the jury is still out.

Critical to restoring public finances is growth. It is therefore risky to deploy an aggressive budget deficit reduction as it would translate immediately into a decline in GDP growth, endangering tax revenues therefore ultimately failing to achieve the desired goal: deficit reduction.

So currently the battle to avoid contagion to Italy.   The EFSF will not solve an Italian problem. The amounts are just too large and the Bundesbank would oppose it.

Market situation

This situation has created a market where valuations are not driven by fundamentals any more, rather by risk factors and fear. There has been, and this is likely to last for some time a loss of influence from fundamental / value analysis. That an asset looks cheap today does not mean it will not look even cheaper tomorrow and this has nothing to do with its intrinsic merits.

Prices are driven by the news flow and sovereign CDS levels; and by public positions taken by senior politicians across Europe.

As for Gold, the point is its price usually is a function of money supply; worldwide supply has increased over 17% in a year… this plus a number of factors such as central banks reserve policies…

Credit Crunch: biting back?

There is currently limited long term financing available for the banks. It is very difficult to find 2 years and above money; some markets, like the USD for some banks, notably the French banks, are almost closed. This means that there is no long term financing available for Capex, which is not very good news for the economic growth. It also forces those banks from some market segments, threatening their profitability. And this situation will remain until bank spreads come down, which will not happen in Europe as long as the sovereign spreads don’t.  Because of Basle II and also probably government incentives, banks balance sheets are full of Sovereign paper. This makes them especially vulnerable in those circumstances.

Fundamentally, the role of banks is not to finance states. Their role is to finance the economy. States should be financed by much longer term investors like insurance companies and pensions funds.

On the other side of the Atlantic, the situation is for the least unstable. The last “twist” is unlikely to bring any impact. The issue in the US is to stabilize the real estate market which is so important to the individuals as well as to the overall economy. Twist will bring liquidity to banks… which have already USD 1,700 bn in deposit with the FED. Sounds like the repeat of something seen in 2008…

Commercial Real Estate

Posted 23.09.2011

Real Estate investing was also part of the strategies reviewed and more specifically commercial real Estate.

Speakers reached a consensus that most of the capital gain potential are already in the prices. So commercial real estate investing is now mainly about income and yield generation.

This implies heavy involvement in developing/managing/maintaining the assets in order to maintain their marketability. It also makes investors more vulnerable to the economic cycles. This is not yet fully the case in the UK as the legal system is very much in favour of the landlord versus tenants. Speakers mentioned this trend is irreversibly reversing, as demonstrated for example by the shortening of leases. It is likely that the UK market reverts to what is now the norm in continental Europe as well as in the US, which will weaken landlords ‘positions. However, commercial real estate remains historically a safe way to ride cycles over the long term. How that is compatible with mark to market and liquidity ratio constraints remains to be looked into…

Participants were also keen to point out that there was limited interest in trying to bypass the inherent lack of liquidity of that market.

All structure and products linked to real estate, including REITS have demonstrated during the past crisis that a product cannot be more liquid that its underlying market, especially in times of crisis. Some would argue that this is precisely when one really needs it…

Private real estate was briefly touched upon. Consensus was that the only consideration currently holding back pension funds to massively re-enter that market is the potential reputational risk linked to exercising their guarantees in case of default. The unbalance of supply and demand and the current yields create a compelling investment case. Watch that space!

Posted 22.09.2011

I attended on the 20th an NAPF conference in London on investments for Pension Funds. One of the topic touched upon was Infrastructure investing.

The theoretical value of these investments need not be listed again. Let’s just mention their capacity to offer inflation risk hedge. After all they are hard assets generating cash flows… Interestingly though, the years 2007 and 2008 saw record level of investments, creating their own local bubble through excessive valuations supported by even more excessive leverage. Those have reversed to acceptable levels since.

Risks linked to these investments have to be carefully analysed prior to investment.

Liquidity is not to be expected from this market and all participants were deploring the lack of secondary market structure. The “secure” cash flows on which the investment rational is based are always subject to political, tax and /or life style risks, especially in schemes linked to transports and energy. And the major draw issue remains the exit strategy and the difficulty to monetise progress or simply get out of the positions.

That was quite a surprise not to say a shock to hear one speaker mentioning Green-tech investing as a hedge against the risks global warming is creating to pension funds. I would never have believed that politically correctness would reach that far, to the point of trying to pollute the way pension funds should look at their investment strategies. There are no limits to the global warming inquisition forces and this surely is the sign a bubble is forming somewhere.

More seriously, it is not easy to draw a line between what is purely infrastructure investment from private equity. It seems to me that when risk starts to shift to technology and execution risks, we enter the world of private equity and these investments definitely belong to a different bucket. It is not making any favour to that market so desperately in need of private capital to attempt to bundle it with investments with very different risk/return profile.

ESMA ‘threat’ to Remuneration Code

Posted 22.08.2011

ESMA ‘threat’ to Remuneration Code

You may well have seen comments recently about the likely impact of the AIFMD on the implementation of the Remuneration Code for asset managers. This is a question that should be getting rather more attention even than it already is, despite the picture being far from clear. The ‘threat’ is that ESMA, in producing guidelines on the application of proportionality for the Code under AIFMD, might consider itself to be obliged to bring back ‘deferral’ and non-cash bonuses for alternative investment fund managers and their delegates, including anyone managing the assets of an AIF (any non-UCITS fund). There has been press comment suggesting that ESMA had somehow published something about this ‘in the small print’. That is not the case.

The grounds for concern are that, whereas when CEBS dealt with CRD3 on this at the end of last year, it was covering a wide spectrum of sectors, including banks, the AIFMD remuneration requirements relate only to fund managers and their delegates. Consequently, with CRD, it was possible to apply the key measures only to the high risk sectors; with AIFMD, there is much less scope for differentiation and consequent selective application of those same key measures, all of which appear in the AIFM Directive itself (i.e. in Level 1).

However, the optimists take the view that ESMA would be unlikely to overturn what was done by CEBS (now EBA) only a few months ago, especially since the directive explicitly requires ESMA to work with EBA on this point. ESMA will recognise the damage that it would do to the new structure of European supervisory authorities if it brought about such an early u-turn. Consistency and acceptability will be high in their priorities.

The reason that the position on this remains unclear is that, while ESMA is working on Level 2 of AIFMD, it will not start on the guidelines. That means that we will not see any pronouncement from them on this until November at the very earliest, and more likely in January next year. However, that does not mean that it is too early to talk to them about it. With the Level 2 Public Hearing coming up on 2nd September, there should be opportunities to raise the point with them. If you would like to discuss this, give me a call.

Oliver Lodge

020 7389 7028

note from OWL fresh from the FSA meeting last week

Posted 27.06.2011

Suitability: reaction from the FSA meeting

As those who were present will have heard, at the FSA’s Annual Public Meeting this morning, Margaret Cole showed that she was unable to answer a straight forward question about Suitability. When I asked whether variations in regulatory standards in different countries should be taken into account when making the Suitability judgement, she would only say that FCA expected to be ‘compatible with Europe’ and therefore the issue should not arise. As the FSA has made it quite clear that FCA may well be taking a much more robust approach than other regulators, particularly in relation to Product Intervention, that was a  pretty unhelpful answer. If the FSA wants to shine the spot light on Suitability and to take firms to task for failures, it will need to be clear about what is expected.

Our friends at OWL comment on Suitability

Posted 26.06.2011

The Suitability Standard

If you have not received the FSA’s Dear CEO letter on its wealth management review, you are either lucky or have an incompetent postman. Those who are not so fortunate would be unwise to ignore the obvious warning implicit in it. Courteous it may be; subtle it is not. FSA is raising its standard; it wants these colours to be visible from coast to coast. And it definitely expects firms to raise their standards too.

However skewed their sample may have been, with findings of 79% failure, the FSA cannot now let up on this suitability campaign. It will soon be showing on a street near you. Note also that it is Margaret Cole who has signed the letter. Read into that what you will.

It would be churlish to ignore the FSA’s invitation to assess the suitability of your client files. Acts of brave defiance are best reserved for another day. And be sure to be ready to explain how you have applied Principle 6 to your findings.

The challenge is to be able to demonstrate compliance; that is going to be the hardest part for many. Note the comment ‘a high risk of unsuitability or the suitability could not be determined’. It is a fair bet that the latter group is by far the larger. And it is worth recognising the added dimension: if investments go belly-up and you cannot demonstrate their suitability, a tricky client may choose to sue.

Although the findings include inconsistencies with client objectives, it is clear that the greater problem is failure to take proper account of clients’ attitude to risk. Inadequate risk management systems get an honourable mention too.

Note also their concern about non-conformity to the ‘house model’. As with all procedures, the easiest charge is failure to stick to the letter of your own law. If the house model is not mandatory, be sure to be clear about that.

Remember that compliance with the letter of the rule is the barest minimum; questioning will quickly revert to a principles basis, focusing largely on skill, care and diligence. But you will also have recognised the letter’s unattributed quote from Principle 3.

The quality of firms’ responses will help FSA to prioritise their further reviews. This is not a time to be glib, unless, of course, you find your supervisor irresistibly attractive.

The FSA invites responses by 9th August.

What needs to be done? What needs to be done by 9th August? What should the letter say? How big is this exercise?

OWL advises and supports the investment industry.

Oliver Lodge

Europe, Regulations and Hedge Funds… It is time to make plans, the clocks are ticking

Posted 28.03.2011

Europe, Regulations and Hedge Funds…

It is time to make plans, the clocks are ticking

UCITS, AIFMD, Private Placement rules in Europe are very topical subject at the moment. And many people find it quite a daunting task to try to understand what the options are, what the implications are and quite simply which path to follow in the mine field of ever changing regulations.

Bottom line is it is going to be extremely difficult to avoid all kind of regulation in Europe; this is if the fund intends to be distributed in Europe. The good news is that it will clarify the limbo in which many funds stand at the moment, and which distribution capabilities relay in pretty obscure and imprecise private placement rules. So give or take, in 2 to 3 years, every single fund in Europe will be regulated. And if it has found a way not to be, it will in any case have a very hard time being distributed; so very likely, AUM will suffer. Read more