CFI.co Spring 2013

Capital Finance International

Spring 2013

GBP 4.95 // EUR 5.95 // USD 6.95

AS WORLD ECONOMIES CONVERGE

Freeman Hrabowski:

EDUCATION, EDUCATION, EDUCATION also In this issue // World Bank: State’s Role in Finance // USAID: Diaspora Returns EIF: Social Impact Financing // ECB: Banks Not Funding SMEs MIGA: Risky Business in Gulf and Africa // OECD: Income Inequality and Growth

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Crunch Time for the Eurozone

T

he single currency caused convergence in prices and income in eurozone countries irrespective of their relative competitiveness. The catch-up at the periphery has been funded by the North. The newly-found liquidity caused salaries and asset prices to spiral in the PIIGS without the possibility of adjustment through currency depreciation to match productivity and real relative prices. The IMF and Germany have insisted that aid recipients must cut government spending and raise taxes. Now, IMF chief Lagarde is making a U-turn after realising that this approach may be counter-productive. Austerity (cutting government spending and public deficits) does not work during a deep recession but makes it deeper. The Troika (EU commission, ECB and IMF) has for three years pushed a cocktail of austerity on troubled countries promising a cure for their ailments. Now the evidence shows that this bitter medicine is killing the patient. We are at a crossroads. Allow countries to issue bonds backed by the Eurozone or consider a return to national currencies.

St Paul’s Cathedral, London

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CFI.co | Capital Finance International

Spring 2013 Issue

Letter from the Chairman The IMF, the EU complex and national politicians offer contradictory and less than honest policy advice to PIIGS and the Northern European countries alike: “Save your way to prosperity” and impose new increases in taxation and public sector cuts. Of course this policy of fiscal contraction creates unemployment and the economic slack is not picked up by the private sector. Economic experts (including Roubini, Stieglitz and the EPC in this issue) point out that in an economic down turn such counter-to-Keynes fiscal policies will only perpetuate the balance problems - such as increases in public debt.

With the weaker European economies stuck on a path of annual deficits there is no growth strategy to balance out the relative size of debt to economy.

As tax revenues shrink, and the expenditure income transfers grow with new under-employment, the public balance problems perpetuate. Suddenly, a liquidity crisis is on track to become a solvency crisis (see Pettis and El-Erian).

Dear Reader, We are attempting to deliver a worthwhile and informative read that gives you direct access to uncensored perspectives on international business, finance and economics from some of the world’s leading organisations, companies and experts.

Please let us know (email editor@cfi.co) if you think we have succeeded in this objective.

In May 2013, the G8 and G20 will congregate in London to discuss world economics. At the top of their agenda is consideration of ways to create growth and jobs (and you will find several articles on this topic in this issue).

For an economy to create net new jobs, it must have economic GDP growth of at least 2% per annum.

The emerging economies (and the US - just barely) are exceeeding this mark but Europe and Japan are not. Japan has long experience of austerity policies and so is now experimenting with a new more expansionist approach.

Europe has had no agenda for such job creating growth levels for years, and, it seems, has lost its way. The Union is just muddling along and attempting ad hoc crisis patchwork solutions to fundamental problems - such as banking system systemic flaws. And meanwhile the PIIGS cannot devalue their overvalued and uncompetitive currencies (see Dr. Jackson’s article inside).

CAPITALFINANCE I N T E R N AT I O N A L

For the PIIGS, now joined by Cyprus - and quite possibly further Eurozone countries - austerity brings no hope. Their competitiveness is deteriorating in the short run as their financing costs have gone up to offset any benefits from internal devaluations.

Longer term, their labour force and infrastructure is becoming less productive and less innovative.

SMEs (in particular in PIIGS) have little or no access to financing from banks - while the larger (often Northern European) companies enjoy access to cheap loans (see also IMF and EIF editorials).

Again the message to the commercial banks from politicians, regulators, multilateral organisations (EU, OECD, IMF) and central banks (ECB, Fed) is contradictory and even self-serving (funding government deficits). The message is this: repair your balance sheet, increase your reserves, while we the central banks will print you (almost) unlimited free cash (at 0.75% interest per annum in Europe and even less in the US and Japan) for a geared carry trade with government bonds (yielding around 3% to 7% p.a.) which eventually will restore your equity capital (and the required increase in tier one capital ratio).

So how can governments ask the banks to shrink their assets (loan portfolio) and expand them with loans to businesses (while at the same time they also have to buy government debt)? Little wonder

the SMEs are not getting funded. Private enterprise is crowded out. With this monetary policy it is simply disenginous to be surprised that banks do not lend to businesses (with corporate notes and bond issues only part solution for the largest players – and not helping the SMEs, nor helping PIIGS).

Against this toxic cocktail of tight fiscal policies and a lack of bank lending, it is simply not good enough for politicians (think e.g. UK’s Osborne and his counterparts in Spain and Greece) and multi-lateral organisations alike to continually appear surprised (with endless EU/ECB/BOE/OECD/IMF/WB downward growth revisions) that un- and under-employment as well as budget deficits persist and thrive.

The G-20 comes together in an interconnected world where we all need each other (including each other’s markets). There are tectonic power shifts from the Old Developed World towards the Emerging Economies that are booming and creating wealth and prosperity - fuelled by free enterprise and entrepreneurship as well as population and productivity growth. BRICS, Tigers, Africa, LatAm, the Gulf et al are quickly catching up with the Old World’s flat lining productivity.

In Europe, public investments and works should be undertaken immediately (e.g. investing in a reduction of dependence on fossil fuels: see DESERTEC). Funding could come in part from PPPs and project finance. Red tape should be cut and taxes on labour reduced. SMEs must have access to bank financing. Investment and innovation should be encouraged through bold temporary tax break incentives. The resources and opportunities are bountiful. What is needed now is also new optimism, belief in a better plan and a vision that points forward (perhaps along New Deal lines).

Fairer and more equal deals are required between the Europe of the North and the Europe of the South; between people with capital and people who only own their labour; between the financial sector and businesses; between misguided government policies and suffering families; as well as between current and future generations.

Hopefully, we at CFI.co through the insight of the written word can make a modest contribution to the development of such new deals.

Good reading!

Tor Svensson Chairman Capital Finance International

CFI.co | Capital Finance International

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> Letters to the Editor

“ “ “

Your interview with JeanMarc Delpon de Vaux (Winter issue) touched on – but did not do full justice to - Lubna Olayan’s support of women’s rights.

Almost ten years ago, at the Jeddah Economic Forum, Olayan delivered a historically important speech.

She was the first woman to address a ‘mixed conference’ in my country (and yes, by that I mean that women were present as well as men).

Lubna Olayan told of her dream of a time when any Saudi, irrespective of gender, would be able to find a job in a field in which he or she was best qualified. Her vision was that of a Saudi Arabia where citizens, residents and visitors could all live in an atmosphere of mutual respect and tolerance – regardless of social class or gender.

That’s my dream today too.

Name withheld Jeddah

The ‘face of power’ in Africa is certainly changing fast (LEX Africa, Autumn issue) and we are no longer the ‘dark continent’. Your readers may have been surprised to hear that recent gas finds in Mozambique may rival those of Kuwait. Who would have imagined that just a few years ago? And the outlook is equally positive in many other African countries. This continent is going to be turning on lights all over the world very soon.

V. Antonio Maputo

I note that Barclays won the CFI.co UK Banking Award for 2012 in view of the attitude shift insisted upon by ‘new broom’ Anthony Jenkins. May I respectfully ask the new broom to arrange for the texts promised by my branch to be sent out immediately the cash hits my account rather than days after – if at all. Sorry to bring up a practical point during all the excitement. b. jenkins Swansea

Cristina Kirchner (Heroes, Winter issue) is no hero of mine after describing the Falkland islanders as ‘squatters’. This year, in what was probably the only genuine 99.8 per cent poll victory in history, the Falklands

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CFI.co | Capital Finance International

Spring 2013 Issue

people declared their determination to remain British. I heard today that President Kirchner is now calling on Pope Francis to ‘mediate’ over the fate of this British island. Surely Kirchner can find something more useful to do when her country is in such a dreadful mess?

J. Armstrong Plymouth

“ “ “

The sexism surrounding PM Julia Gillard (Heroes, Winter issue) took a further turn when the ‘first Bloke’ got himself into trouble by suggesting that small, female Asian doctors should be the ones to check out prostates. Gillard’s partner apologised for any offence he may have caused but the Prostate Society of Australia was quite relaxed about the whole thing. Although the PM was not best pleased, I believe her partner was making a fair point.

S. Frost Adelaide

Ross Jackson is absolutely right in saying (Sustainability and the Business Community, Winter issue) that, “Many businessmen would prefer to operate within a framework that was protective of the environment and social structures as long as the political leadership could define such a framework that applied to everyone.”

Jackson goes on to suggest that there should be tariffs on foreign imports produced at a lower environmental standards and that world trade rules should better reflect environmental and social needs. I do so agree.

L. Vieira Rio de Janeiro

Congratulations to Cairo Amman Bank upon their award win (Winter issue). I imagine your readers were interested to discover that iris recognition for bank account holder identification was pioneered in our part of the world. I am very proud of this achievement.

R. Abdullah Jordan

I would like to say that - if the winter issue is anything to go by your magazine is a better read than The Economist. Keep up the good work.

C. Dahlager Copenhagen

CFI.co | Capital Finance International

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Editor Chris North

>

Assistant Editor Sarah Worthington

COVER STORIES

Executive Editor George Kingsley Production Editor David Graham

Editorial William Adam David Gough-Price Diana French Jim Pearson Ellen Roland

Editor’s Heroes (118 – 125)

World Bank: State’s Role in Finance (12 – 14)

Distribution Manager Len Collingwood

Subscriptions Maggie Arts

USAID: Diaspora Returns (136 – 137)

Commercial Director Jon Gerben

Publisher Mark Harrison

Chairman Tor Svensson Capital Finance International 43-45 Portman Square London W1H 6HN United Kingdom

MIGA: Risky Business in Gulf and Africa (100 – 101)

OECD: Income Inequality and Growth (48 – 49)

T: +44 203 137 3679 F: +44 203 137 5872 E: info@cfi.co W: www.cfi.co

EIF: Social Impact Financing (24 – 25)

ECB: Banks Not Funding SMEs (28 – 31) Printed in the UK by The Magazine Printing Company using only paper from FSC/PEFC suppliers www.magprint.co.uk

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CFI.co | Capital Finance International

Spring 2013 Issue

FULL CONTENTS 12 – 49

As World Economies Converge World Bank

OECD

IMF

European Investment Fund

European Policy Centre

ECB

Nouriel Roubini

Joseph Stiglitz

PIMCO

Michael Pettis

Ross Jackson

World Economic Outlook

50 – 69

Education, Education, Education: Ten Prominent Business School Leaders

Sir Andrew Likierman

Bernard Yeung

Christine Riordan

John Marinus

Andrey Kostin

70 – 81

CFI.co 2013 Awards: Rewarding Global Excellence

Sergio Caveggia, Ernst & Young

82 – 90

Focus on Europe

Baker McKenzie

91 – 99

Latin American Review

Enrique Gómez Junco

100 – 109

MENA News

Grant Thornton

Luis Gerardo del Valle

Ernst & Young

MIGA (World Bank)

Christopher Baines

DESERTEC

Fady Jamaleddine

Joschka Fischer

Burgan Bank

Shahid Javed Burki

118 – 125

Editor’s Heroes

Ten Men and Women Who are Making a Real Difference

126 – 133

New Africa

PwC

Dideolu Falobi

134 – 146

Global Perspectives

IBM

LEX Africa

Crowd Funding

USAID

PREM (World Bank)

WorldPensionSummit

Grant Thornton

CFI.co | Capital Finance International

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> The World Bank:

Rethinking the State’s Role in Finance

By Martin Čihák and Aslı Demirgüç-Kunt

The State’s role needs to become less direct, as the crisis subsides.

T

he global financial crisis has given greater credence to the idea that active state involvement in the financial sector can be helpful for stability and development.

The crisis has prompted many people to reassess official interventions in financial systems, from regulation and supervision of financial institutions and markets, to competition policy, to state guarantees and state ownership of banks, and to enhancements in financial infrastructure.

But the crisis does not necessarily negate the considerable evidence accumulated over the past few decades. It is important to use the crisis experience to examine what went wrong and how to fix it. Which lessons about the connections between finance and economic development should shape policies in coming decades? In this article, we reassess state interventions in finance, building on the World Bank’s 2013 Global Financial Development Report.

State involvement: balancing the pros and cons For better or worse, state interventions tend to play a major role in modern financial systems.

The state (which includes the government, the central bank, and other public sector agencies) is a financial sector promoter, owner, regulator, and overseer. There are sound economic reasons for the state to play an active role in financial systems, but there are also practical reasons to be wary of the state playing too active a role.

Many of the reasons for the state’s involvement arise from the externalities associated with risk taking.

For the sake of this illustration, imagine a busy road with cars and trucks. If a car or truck goes faster, it can get to its destination sooner, but there is a chance that it will be involved in a crash. The likelihood of a crash is small but it increases with speed. Crashes involving large vehicles are particularly costly to others involved in the crash and very disruptive to traffic in general. Nobody wants to be involved in a crash, but when deciding on how fast to go, a car or truck driver may not take fully into account the costs that a crash might have on others in terms of injuries, damages, time lost in traffic jams, and so on. The state can play a role, for example by imposing and enforcing speed limits, and perhaps imposing stricter regulation of large trucks and other vehicles that pose bigger risks.

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more control over safety and soundness, but it can become quite expensive for taxpayers.

Alternatively, the state could build large speed bumps on the road, so that there are almost no crashes; however, traffic would slow down to a crawl.

“Deposit insurance coverage has increased during the crisis. This, together with other aspects— such as generous support for weak banks—did not improve incentives for monitoring.”

The analogy underscores that correcting for market imperfections is a not an easy task.

State interventions need to be risk-sensitive, but measuring risk properly and enforcing risk-based regulations is not straightforward. The state can try to run parts of the financial system directly, but that approach tends to be very costly. And if the state required banks to hold capital as large as their loans, the risk of failures would be minimal, but it would slow down financial intermediation to a crawl.

Similarly, financial institutions often do not bear the full risks of their portfolios. When a large bank makes risky investments that pay off, bank owners reap the profits. But when such gambles fail, the bank does not always bear the full costs for its clients and other connected banks and firms, in terms of lost value or production, increased unemployment, and so on. A bad gamble by one bank can thus have repercussions for many people with no association to the risktaking decisions of that original institution. This potential for cascading events can be a reason for the state to intervene by imposing “speed limits” on risk taking by banks, and perhaps tougher limits for large banks and other financial institutions that pose bigger risks. The state can intervene instead more directly, for example by providing government-approved drivers for all cars and trucks. That way, the state can have

Reforming regulation and supervision The causes of the global financial crisis are still being debated, but there is agreement that the crisis revealed major shortcomings in market discipline as well as regulation and supervision.

Financial regulation and supervision is also one area in which the role of the state is not in dispute. The debate is not about whether the state should regulate and supervise the financial sector, but about how to best do it to support sound financial development.

Regulation and supervision in crisis and non-crisis countries

Is Tier 3 allowed in regulatory capital?

Is advanced internal ratings-based approach offered to banks?

Crisis Non-Crisis Are minimum levels of specific provisions for loans and advances set by the regulator?

Is there a regulatory requirement for general provisions on loans and advances?

0

10

20

30

40

50

60

70

80

Note: The percentages of countries responding “yes” to these questions. Based on the World Bank’s Bank Regulation and Supervision Survey, covering 143 countries. “Crisis” countries are those that had a systemic banking crisis in 2007-2012; "non-crisis" are the rest.

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100

Spring 2013 Issue

To find out what works in financial regulation and supervision, much can be learned from a recently updated World Bank survey of regulation and supervision (www.worldbank.org/ financialdevelopment), a fourth survey of this kind, and the first one since the crisis began. Our analysis of the survey results suggests that countries directly hit by the global financial crisis had more complex but weaker regulation and supervisory practices compared to those countries that avoided the direct crisis impact. Specifically, they had more complex and less stringent definitions of capital, less stringent provisioning requirements, and relied more on banks’ own risk assessment (Figure).

The survey thus underscores that it is important to address the “basics” first. Emerging markets and developing economies should focus on establishing a basic robust supervisory framework that reflects local financial systems’ characteristics, and refrain from incorporating unnecessary complex elements.

Referring back to the earlier analogy with speed limits for cars and trucks, it may be appealing to have a more sophisticated rule in which each car has its own speed limit, depending on the quality of its brakes and other risk-mitigating features. A case could be made that such a system is efficient (allowing safer cars to go faster) and less prone to failures (because cars get to safety faster, there may be less crashes). However, if the state does not have the capacity to monitor and police such complex rules, the likely result is more speeding and more crashes. Similarly, for example, complex approaches to calculating capital requirements are not appropriate if there is limited capacity to verify the calculations, do robustness checks, and police implementation.

Another important finding from the survey is the need for more incentive-compatible regulations.

Our analysis suggests that while the quality of publicly available financial information was roughly comparable in crisis and non-crisis countries, the former gave much less scope for incentives to actually use that information for monitor financial institutions (for example, they had more generous deposit insurance coverage). We find that during the crisis, countries have stepped up efforts on macroprudential policy, resolution regimes and consumer protection, but it is not clear whether incentives for market discipline have improved. Some elements of disclosure and quality of information have improved, but deposit insurance coverage has increased during the crisis. This, together with other aspects—such as generous support for weak banks—did not improve incentives for monitoring.

The survey suggests that there is further scope for improving disclosures and monitoring incentives.

Against this background, we have been calling for regulatory approach that is focused on proactively identifying and addressing incentive problems and making regulations incentive-compatible to end the continuous need to eliminate deficiencies and close loopholes that are inevitably present in ever more complex sets of regulations. Specifically, we have CFI.co | Capital Finance International

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“Poor regulatory environment and distorted risk-taking incentives are what promote instability, rather than competition itself. With good regulation and supervision, bank competition can help improve efficiency and enhance access to financial services, without necessarily undermining systemic stability.” proposed “incentive audits” as a tool that could help in pinpointing incentive misalignments in the financial sector and identifying reforms that are incentive-robust.

When do direct government interventions help?

During the global financial crisis, as private banks curtailed their lending activities, many countries, from Brazil to Russia and China, used state-owned banks to step up financing to the private sector. These actions reignited the ageold debate on the need for direct government intervention in the financial sector. Supporters of state-owned banks now argue that these financial institutions, in addition to their longterm development roles, provide the state with an additional tool for crisis management. Those opposing government bank ownership point out that agency problems and politically motivated lending render state-owned banks inefficient, prone to cronyism, and ultimately contributing to fiscal liabilities.

A broad review of the evidence suggests that lending by state-owned banks tends to be less pro-cyclical than that of their private counterparts. During the global financial crisis, some state-owned banks have indeed played a countercyclical role by expanding their lending portfolio and restoring conditions in key markets. The expansion of the lending portfolio of state-owned commercial banks (such as PKO Bank Polski in Poland) and state-owned development banks (such as BNDES in Brazil) did mitigate the effects from the global credit crunch and fill the gap of lower credit from the private sector. Also, Mexican development banks supported the credit channel through the extension of credit guarantees and lending to private financial intermediaries. Globally, bank lending is pro-cyclical, growing during booms and falling during downturns, but the lending pattern of private banks is more pro-cyclical compared with their state-owned counterparts.

In high-income countries, state-owned banks even behave in a clearly countercyclical fashion, increasing in downturns. However, because in many cases lending growth continued even after economic recovery was under way, and loans were not directed to the most constrained borrowers, it is not clear that the recent crisis illustrates that state-owned banks can effectively play a countercyclical role. Furthermore, the evidence from previous crises on this issue is mixed. Importantly, efforts to stabilize aggregate credit by state-owned banks may come at a

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cost: particularly through the deterioration of the quality of intermediation and resource misallocation. In other words, a temporary boom in state bank lending has long-term adverse effects by creating a portfolio of bad loans in crises that take a long time to sort out.

Ideally, focusing on the governance of these institutions may help address the inefficiencies associated with state-owned banks. They need to have a clear mandate, complement the private banks, and adopt prudent risk management practices. However, in practice, countries that could benefit from these governance reforms the most are also the ones where such reforms are particularly challenging due to weak institutional environments.

State as promoter of contestability and credit information sharing Crisis evidence also suggests that the state needs to encourage contestability through healthy entry of well-capitalized institutions and timely exit of insolvent ones. The crisis fueled criticisms of “too much competition” in the financial sector, leading to instability. However, research suggests that, for the most part, factors such as poor regulatory environment and distorted risk-taking incentives are what promote instability, rather than competition itself. With good regulation and supervision, bank competition can help improve efficiency and enhance access to financial services, without necessarily undermining systemic stability. Hence, what is needed is to address the distorted incentives and improve the flow of information as well as the contractual environment, rather than to restrict competition.

Experience points to a useful role for the state in promoting transparency of information and reducing counterparty risk. For example, the state can facilitate the inclusion of a broader set of lenders in credit reporting systems and promote the provision of high-quality credit information, particularly when there are significant monopoly rents that discourage information sharing.

Conclusions Our overall message is cautionary. The global crisis has given greater credence to the idea that active state involvement in the financial sector can help maintain economic stability, drive growth, and create jobs. There is evidence that some interventions may have had an impact, at least in the short run. But there is also evidence on potential longer-term negative effects.

The evidence also suggests that, as the crisis subsides, there may be a need to adjust the

CFI.co | Capital Finance International

role of the state from direct interventions to less direct involvement. This does not mean that the state should withdraw from overseeing finance.

To the contrary, the state has a very important role, especially in providing supervision, ensuring healthy competition, and strengthening financial infrastructure. i

About the Authors Martin Čihák and Aslı Demirgüç-Kunt work at the World Bank as Lead Economist and Director of Research, respectively.

Martin Čihák

Aslı Demirgüç-Kunt

> Przemyslaw Kowalski, OECD:

State-Owned Enterprises in the Global Economy: New Policy Initiatives State-owned enterprises increasingly compete with private firms in the global marketplace.

S

tate-owned enterprises (SOEs) are increasingly competing with private firms in global markets for resources, ideas, and intermediate and final products.

This is likely driven by a combination of at least four factors: the dynamic growth and trade expansion of some emerging market countries with large SOE sectors; a resurging economic intervention of the state in some economies, including through ownership; deliberate policies supporting foreign expansion of SOEs in some countries; and by deepening global integration via trade and investment.

While data is still scarce, the recent analysis by the OECD has revealed that SOEs are indeed among the largest and most influential world enterprises [1]. For example, among the Forbes Global 2,000 enterprises 10% (204) were majority state-owned in 2011 with aggregate sales equivalent to 6% of world GNI [2], exceeding the GDPs of countries like Germany, France or the UK (Figure 1). Among the Fortune Global 500 firms as much as 19% were SOEs, indicating that state ownership is even more prevalent toward the top of the largest companies list [3]. Moreover, it has grown during the recent decade. The share of SOE revenues among the Fortune Global 500 increased from 6% in 2000 to 20% in 2011, while the share of SOE employment increased from 19 to 30% [4].

“The recent analysis by the OECD has revealed that SOEs are indeed among the largest and most influential world enterprises.”

India (30), Russia (9), the United Arab Emirates (9) and Malaysia (8). The OECD countries with prominent incidence of state ownership include Norway, France, Ireland, Greece and Finland.

Many of the countries with large SOE shares play an important role in global trade and foreign direct investment (FDI). For example, the eight countries where SOEs account for more than a half of country’s largest firms together account for more than 20% of world merchandise trade [6].

As far as FDI is concerned, it is estimated that between 2008 and 2012 SOEs accounted on average for as much as 11% of total international mergers and acquisitions (IM&A), up from 3% during the 1995-2007 period [7].

While it is the cross-border trade and investment

by SOEs that have recently attracted the attention of media and policy makers, typical SOEs are still primarily oriented towards a domestic market. For example, in 2012 the average value of domestic mergers and acquisitions (M&A) investment by

Figure 1: The GDP of the United Kingdom, France, and Germany compared to total sales of SOEs among top 2,000 global firms in 2011. Source: Kowalski et al. (2013) and WDI.

State ownership appears to be most prominent in, but not restricted to, the emerging economies [5]. The 204 SOEs identified among the 2000 world’s largest companies are owned by central or local governments from 37 countries, with China leading the list (70 SOEs), followed by

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SOEs was double the value of their international M&A investment globally. Foreign assets of SOEs constitute on average only 10% of their total assets while foreign revenues constitute 23% of total SOE revenues [8]. SOEs also have relatively fewer foreign subsidiaries as compared to

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privately owned firms [9]. This suggests that the nature of competition between SOEs and foreign private enterprises in SOEs’ home markets—as well as effects of their domestic market position on competition in other markets—might be of particular interest.

Several natural resources, manufacturing and services sectors exposed to international competition have high incidence of state ownership [10]. SOEs are particularly prevalent in mining of coal and lignite and mining support activities, civil engineering, land transport and transport via pipelines, extraction of crude petroleum and gas, and telecommunication and financial services [11]. Since many of these are important upstream sectors, it is important to consider SOEs not only as potential receivers but also conveyors of government-created advantages when thinking of effects of state ownership on global markets.

Is the increased presence of SOEs in the global markets a reason for concern?

The answer would be yes, if these SOEs were to enjoy favourable treatment by their governments.

If this was the case, goods and services would no longer be produced by those who can do it most efficiently but those that receive the greatest advantage. Examples of such advantages include: direct subsidies, concessionary financing, state-backed guarantees, preferential regulatory treatment, exemptions from antitrust enforcement and bankruptcy rules [12]. Even though such advantages may well be justified from a domestic point of view—for example, to correct domestic market failures, provide public goods, and foster economic development—they may be difficult to accept by a country’s trading or investment partners [13]. If their effects extend beyond national borders, they may undermine the case for international trade and investment, which is predicated on the basis of non-discrimination and respect for market principles.

Indeed, the expanding trade and investment

by SOEs have attracted the attention of the media, policy makers and business, many of

Spring 2013 Issue

In Pictures: The Storting, the supreme legislature of Norway, located in Oslo. Norway is one of the OECD countries with prominent incidence of state ownership.

whom are calling for a “levelling of the playing field” in international trade and investment.

The discussions of new SOE disciplines in the on-going Trans-Pacific Partnership (TPP) negotiations and the implementation of stricter national investment screening mechanisms for SOEs in some countries are testimony to this.

Fair dealing by SOEs has also been identified as one of the priorities for the future multilateral trade agenda [14].

At the same time, it is important to ensure that trade and investment by SOEs that operate according to market principles is not hindered or discriminated against. In addition, views as to how to practically ensure the “level playing field” differ across countries. For example, since SOEs and private firms alike can be favoured by the state, some argue for ownership-neutral rules and advocate disciplining the use of stategranted advantages to influence competitive position of firms engaged in commercial activities rather than ownership per se. Yet, paying specific attention to state ownership may also have substantial and practical merits. It is not unconceivable that the triple role of the government as a regulator, regulation enforcer and owner of assets may increase the likelihood of favourable treatment of SOEs in some cases.

Ownership implies a financial interest, which may constitute an additional incentive for favourable treatment. From such a perspective there might be a case for holding SOEs to higher standards, i.e. adopting a state ownershipspecific approach to regulation. It is not yet clear which will be the dominant approach in future trade and investment agreements.

What is the regulatory context and how does it evolve?

Several existing regulatory frameworks discipline some forms of anti-competitive behaviour of SOEs at the national, bilateral and multilateral levels [15]. However, most of them offer only partial provisions relating to SOEs and they differ considerably in their ambition and enforcement capacity.

For example, national antitrust laws can in principle be used to deal with the abuse of dominant position by SOEs, including in the international context, or to prevent anticompetitive effects associated with M&A activities of SOEs. A precondition though is that SOEs are not exempt from competition law, which is the case in some jurisdictions [16].

Furthermore, traditional antitrust laws aim to discipline profit maximising firms and are not

CFI.co | Capital Finance International

aimed at preventing subsidies and artificially low prices—except where these are manifestly motivated by predatory strategies [17]. They also typically apply to situations with “effects in domestic territory”, not foreign markets [18].

Some countries developed more specific competitive neutrality arrangements aimed at mitigating or eliminating competitive advantages of their SOEs in domestic markets, including with respect to taxation, financing costs and regulation. Some of these frameworks refer specifically to state ownership (e.g. in Australia) while others (e.g. in the EU) are ownershipneutral. To assist development of such arrangements, the OECD recently developed a “best practice report”, which indentifies priority areas (e.g. cost transparency, regulatory and tax neutrality, debt neutrality) for policy makers committed to competitive neutrality. Ambitious reforms addressing these priority areas would no doubt go a long way towards establishing level playing field in international markets. Yet, while several countries declare commitment to competitive neutrality[19], countries that fully enforce it or have elements of enforcement in place are still a minority. Learning from peers and the voluntary nature of this process and can be virtuous as it allows countries to pursue

17

reforms they are comfortable with. Yet, for the moment this process falls short of providing the binding rules seen typically in the WTO, free trade agreements (FTAs) or bilateral investment treaties (BITs).

WTO rules are generally ownership-neutral. The disciplines that they impose on government regulations and actions do not distinguish between situations where the provider of the goods or services covered by the regulation or action is a public or a private entity. Yet, several WTO agreements contain concepts related to SOEs (e.g. state-trading enterprises, public monopoly, public body) and thus can discipline some government policies and actions involving them, for example, when SOEs receive tradedistorting state subsidies [20]. Violation of national treatment or most-favoured nation principles, granting of subsidies or other forms of influencing trade by SOEs themselves can also be covered by WTO disciplines if these enterprises can be proven to be “vested with or performing a governmental function”. Yet, certain interpretational ambiguities have rendered application of some these disciplines uncertain [21].

A number of recent FTAs and BITs depart from the ownership neutral approach of the WTO and include SOE-specific provisions. They may explicitly specify that party’s obligations under the agreement apply similarly to SOEs, clarify some of the definitional lacunae in the multilateral context, or include additional SOEspecific disciplines. For example, in NAFTA state enterprises are obliged by the same nondiscriminatory obligations as the governments themselves. US-Singapore FTA has additional transparency provisions, prohibits direct government influence on SOEs, collusion and other anti-competitive activities and foresees a progressive reduction in the number of Singapore’s SOEs. The Singapore-Australia FTA also has extensive references to competitive

neutrality. In addition to including specific SOE definitions, some FTAs contain the so-called “trade +” provisions on intellectual property rights, technical barriers to trade, or investment and competition, which may also be extended to SOEs. Most recently, SOE provisions are one of the key negotiation areas in the on-going TPP negotiations and they have also been flagged as an area for negotiations in the newly-initiated Transatlantic Trade and Investment Partnership negotiations between the EU and the US. In sum, international trade and investment

by SOEs could well continue to increase as countries with significant SOE sectors grow and become more internationalised, or if the renewed intervention of the state in the market place continues. It seems that at this moment a better understanding of the implications of SOEs’ trade and investment for the functioning of international markets—and of strengths and weaknesses of existing regulations—is needed to help governments formulate informed and balanced policy responses. Some of the regulatory frameworks have been designed with domestic objectives in mind or were conceived at times when the state sector was oriented primarily towards domestic markets. There might be a case for their revision. More recent trade and investment policy initiatives, most notably FTAs and BITs, contain more modern SOE disciplines, which however typically concern a small number of countries and are tailored to their specific national contexts. The key challenge for all current and future policy initiatives will be to balance the different national views on the roles of government in the economy with the need for clear and binding rules that ensure effective competition in the international market place among all market participants. i

The view expressed here are strictly those of the author and do not implicate the OECD Secretariat or any of OECD member countries. The topic is an area of on-going policy debate.

About the Author Przemyslaw Kowalski is an economist at the Organisation for Economic Co-operation and Development (OECD) and visiting lecturer at the Institut d’Etudes Politiques de Paris, Sciences Po in Paris. His work at the OECD to-date includes macroeconomic projections, country surveillance, quantitative and qualitative assessments of economic effects of trade and other structural policies and trade policy and trade performance in emerging economies.

Currently he co-ordinates a project on trade and investment effects of state-owned enterprises (SOEs). He graduated with a PhD in economics from the University of Sussex, United Kingdom, and holds an MA and MSc in economics from the University of Sussex and the University of Warsaw, respectively. He has contributed to several articles and books on economics and economic policy.

E-mail: Przemyslaw.Kowalski@oecd.org

References Capobianco, A. and H. Christiansen (2011), “Competitive Neutrality and State-Owned Enterprises: Challenges and Policy Options”, OECD Corporate Governance Working Papers, No. 1, OECD Publishing.

Christiansen, H. (2011), “The Size and Composition of the SOE Sector in OECD Countries”, OECD Corporate Governance Working Papers, No. 5, OECD Publishing.

Gestrin, M. and Y. Shima, (2013 mimeo) “A Stock-taking of International Investment by State-owned Enterprises and Relevant Elements of National and International Policy Frameworks”, OECD Publishing.

Kowalski, P, M. Büge, M. Sztajerowska and M. Egeland (2013), “State-Owned Enterprises: Trade Effects and Policy Implications”, OECD Trade Policy Paper, No. 147, OECD Publishing.

OECD (2012), Competitive Neutrality: Maintaining a Level Playing Field Between Public and Private Business, OECD Publishing.

Zoellick, Robert (2013), “Questions for the world’s next trade chief”, Financial Times, 3 April 2013.

Citations [1] The most recent data collection efforts are: Christiansen (2011); Kowalski, Büge, Sztajerowska and Egeland (2013); and Gestrin and Shima (2013). [2] Kowalski et al. (2013). [3] Gestrin and Shima (2013). [4] Gestrin and Shima, (2013). [5] Kowalski et al. (2013). [6] Kowalski et al. (2013). [7] Gestrin and Shima (2013). [8] Gestrin and Shima (2013). [9] Kowalski et al. (2013). Interestingly, this tendency is weaker in the emerging economies. [10] See Kowalski et al. (2013) for a ranking of sectors with highest SOE incidence. [11] Kowalski et al. (2013) [12] Capobianco, A. and H. Christiansen (2011). [13] In extreme cases, states may simply not consider in their interest to promote competitive neutrality in international markets—i.e. they may pursue strategic or political objectives such as competition for scarce natural resources. [14] Zoellick (2013) [15] Kowalski et al. (2013) provides and detailed survey of these frameworks, considering their relative strengths and weaknesses. [16] See also Capobianco and Christiansen (2011) [17] Op.cit. [18] Seeking recourse on the basis of foreign antitrust law is in principle possible, if the foreign country has effective competition laws and enforcement, but it still may be more difficult to fulfil formal requirements and access evidence. For more see Kowalski et al. (2013). [19] OECD (2012). Also, in 2005 the OECD developed Guidelines on Corporate Governance of SOEs which provide standards and good practices on corporate governance of SOEs. They can be a useful tool for advocacy-oriented approach or can act as a benchmark to assess the quality of potential SOE investors. Yet, they do not explicitly consider nationality of SOE competitors, are voluntary in nature and are not subject to regular assessment of implementation. [20] Services sectors—often with significant SOE presence and potentially important upstream implications—are not disciplined as a general matter by existing WTO subsidy rules. [21] See Kowalski et al. (2013) for a more extensive discussion of SOE-relevant WTO rules.

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CFI.co | Capital Finance International

> International Monetary Fund (IMF):

Strong Growth in Emerging Economies with Weak Recovery in Advanced Countries Executive Summary costly bank financing has boosted bond issuance Financial markets have rallied and near-term by non-financial corporates in both advanced stability risks have eased in response to better and emerging economies. policies, but this is translating to activity very slowly.Decisive actions in the euro area and Background the United States have contained the most During the Great Recession, the global economy 3 experienced its most severe and synchronized immediate threats to the global recovery.

Financial markets have rallied and equity price decline in activity since World War II. World volatility has fallen to pre-crisis levels. However, output declined by 0.6 percent in 2009, sources of investment financing, including financing lead indicators suggest that real activity macroeconomic will compared with an external average growth of aboutand 4.0 local strengthen only gradually, as easier financial percent between 2000 and 2008, and world financing through bank credit and capital markets. conditions take time to transmit to the broader with strong capital inflows or still-elevated trade volumes fell by more than 10 percent. economy. credit growth, supervisory and macroprudential So far, the recovery has been unusually uneven measures should be deployed to curb sectorial across advanced and emerging economies.

Despite an improving economy and better excesses. policies, significant downside risks remain.

• In advanced economies, the recovery has been 3.

During the Great Recession, the global economy experienced its most severe and These relate to the potential for stalled policy Abstract very weak. This likely reflects the legacies of the synchronized in activity since World Warcrisis II. World output declined by 0.6Growth percent in implementation in the euro area, unsustainable Since thedecline great recession, investment has been and ongoing fiscal consolidation. public finances in the United States and Japan, very weak in advanced economies, while of both consumption and investment has 2008, been and 2009, compared with an average growth of itabout 4.0 percent between 2000 and and further growth disappointments in emerging has been strong in many emerging economies, appreciably slower compared to past recoveries. volumes fell byAsia. moreGoing thanforward, 10 percent. far, theemerging recovery economies has been have unusually economies. However, there are also upside world risks trade particularly in emerging • In Socontrast, unevencontinuing across advanced and emerging economies. from better financial conditions and confidence. sluggish investment in advanced performed better than in past recoveries. Overall, economies, and to some extent in emerging emerging economies have witnessed strong Policymakers cannot afford to let up their efforts.

Europe, may weigh down on potential output, has growth, driven by buoyant consumption  In advanced economies, the recovery been verylargely weak.

This likely reflects the While near-term threats have been avoided, and growth, over the medium term. Investment and investment growth, vibrant asset markets, legacieshas of evolved the crisis andinongoing consolidation.

Growth of both consumption important medium-term challenges remain. financing broadly line with fiscal the strong capital inflows, and expansionary policies.

The imperatives remain broadly unchanged. relative economic performance of the G-20slower Emerging Europe istoa past notable exception to these and investment has been appreciably compared recoveries.

Specifically: members. FDI inflows to emerging Europe trends, having suffered a financial shock very • The euro area should proceed towards a declined as corresponding outflows from similar to that experienced by many advanced  In contrast, emerging economies have better than in past recoveries. Overall, genuine economic and monetary union. Rolling advanced economies receded some, but FDIperformed economies. back financial fragmentation is also essential inflows to emerging Asia and Latinwitnessed America strong growth, driven largely by buoyant emerging economies have to improve the transmission of monetary policy. have remained broadly at pre-crisis levels. Total Investment and its Financing consumption and investment asset markets, strong capitalhave inflows, This will require making tangible progress toward bank credit in emerging Asia and Latingrowth, America vibrant Similar to activity, investment developments a banking union with greater fiscal integration. has strongly, but policies. stagnated Emerging somewhat inEurope been markedly different across advanced and andgrown expansionary is a notable exception to these trends, • In advanced economies, fiscal consolidation advanced economies and emerging Europe, in emerging economies, as well as within emerging having suffered a financial shock very similar to that experienced by many advanced needs to continue at a gradual and sustained part due to reduced foreign bank funding. A economies. Investment in advanced economies economies. pace, supported by accommodative monetary “search for yield” and substitution away from fell sharply in the wake of the crisis (by more policy. Fiscal adjustment and targets in most advanced economies are broadly appropriate.

Real GDP growth Global Growth and Trade (Percent; year over year) Consolidation must be supported by the adoption (Percent; year over year) 2012 2011 2010 2009 40 and implementation of concrete medium-term Trade volume (goods and services) 15 6 35 Real GDP growth (RHS) consolidation plans in the United States and Japan, where the recently-announced stimulus 5 30 10 25 makes this even more urgent. U.S. authorities 4 20 should act early and decisively to durably raise 5 15 the debt ceiling and avert automatic spending 3 10 0 cuts. More generally, advanced economies need 2 5 to curtail rising age-and health-related spending.

-5 0 • Policy responses for emerging economies 1 -5 vary. With short-term risks to activity abating, -10 0 -10 the general challenge is to rebuild fiscal space.

Adv. Emg. Latin Emg. Oil Some emerging economies can afford to -15 -1 Asia America Europe Exporters maintain current monetary policy settings, while 00 02 04 06 08 10 12 Source: IMF, World Economic Outlook. others may have to gradually tighten. In countries Source: IMF, World Economic Outlook.

“Policymakers cannot afford to let up their efforts. While near-term threats have been avoided, important medium-term challenges remain.”

II. Background

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III. INVESTMENT AND ITS FINANCING CFI.co | Capital Finance International Investment and Saving

he crisis, as discussed below.

advanced economies have continued to rely on n average, have generated positive net saving. ries as a creasing Current Account Balance elatively 25 (Percent of Regional GDP) Advanced Emerging Asia Latin America Emerging Europe dvanced 20 Oil Exporters of their 15 ge fall— 10 estment, 5 nancing 0 of GDP -5 xceeded -10 to them 00 02 04 06 08 10 12 marked Source: IMF, World Economic Outlook e 2).

Spring 2013 Issue

than 15 percent) and has recovered only very

slowly thereafter due to several including has been more than sufficient to factors, finance high depressed demand, uncertainty, and weak growth ge externalprospects. surpluses.

More recently, strong As a result, it still remains below the pre-crisis level (by about 10 percent), leaving the investment-to-GDP ratio below the pre-crisis level by about 2.5 percentage points. In contrast, investment growth in emerging economies overall has increased during the crisis, largely driven by China. However, there have been appreciable differences in investment performance across regions. Specifically: • In emerging Asia, investment has accelerated since the crisis, on the back of substantial fiscal stimulus, particularly in China. As a result, the investment-to-GDP ratio increased to about 41 percent from about 36 percent of GDP before the crisis.

• In oil exporting countries, investment stagnated with the collapse of the commodity prices in 2009–10, while it declined in Latin America. However, investment recovered strongly thereafter, supported by fiscal stimulus and a recovery of oil prices; and has significantly surpassed its pre-crisis levels.

During the pre-crisis boom, advanced countries as a group relied on external funding to finance increasing investment needs while saving remained relatively stable. The current account deficit for G-20 advanced economies peaked at about 1¾ percent of their aggregate GDP in 2006.

On the back of a large fall—and subsequent slow recovery—in investment, advanced economies’ needs for external financing declined by more than 1 percentage point of GDP after the crisis.

In contrast, saving has exceeded investment in emerging economies, leading to them to export saving abroad. However, there are marked differences across emerging economies.

emerging economies have generally accumulated reserves, largely matched by net portfolio inflows in advanced deficit economies—who remain providers of direct investment abroad.

• Advanced economies continue to export their funding in the form of direct investment.

At the same time, to fill the gap between their saving and investment, they have counted on net portfolio inflows. Partly due to deleveraging pressures in the public and financial sectors, advanced economies’ direct investment flows abroad have declined some, while external deficits narrowed and portfolio inflows declined.

• FDI flows to Latin America remained positive, on net, during the commodity price boom in the mid-2000s, with this trend continuing after the crisis. As the economies in the region recovered strongly, net portfolio investment flows have picked up, while reserve accumulation has also continued.

• Emerging Asia and oil exporters have continued to export their saving largely in the form of reserve accumulation, but at slower pace.

At the same time, there have been steady capital inflows to emerging Asia, mainly in the form of foreign direct investment.

External Financing With respect to the pattern of capital flows, surplus

Financing through Banks and Capital Markets Bank credit in emerging Asia and Latin

From a saving-investment perspective, advanced economies have continued to rely on foreign saving, while emerging economies, on average, have generated positive net saving.

CFI.co | Capital Finance International

America has grown strongly, in line with strong investment.5 While total bank credit in advanced economies and emerging Europe has stagnated, credit in other emerging economies—in particular in emerging Asia and Latin America— has risen significantly.

Borrowers’ reliance on foreign bank credit (upstream exposure) has declined significantly in advanced economies and recovered strongly (or remained stable) in emerging economies.

Direct cross-border claims by foreign banks in emerging Asia and Latin America also fell sizably after the crisis but have since rebounded. In Latin America, foreign affiliates’ claims based on non-local deposit funding have also recently increased, but their share of foreign affiliates’ claims is still lower than in emerging Europe.

Bond issuance by non-financial corporates has increased strongly in both advanced and emerging economies. This has been supported by a search for yield and substitution for bank financing, which become more costly as banks continue to deleverage. In contrast, after some rebound, equity issuance declined significantly in all emerging country regions, while moving broadly sideways in advanced economies.

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Figure 1. G-20 Real GDP and Investment (Index; 2000=100)

Advanced 150

Real GDP

Emerging 700

Real Investment

140

600

130

500

120

400

110

300

100

200

13

90 80

00

02

04

06

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10

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Real Investment

100 0

16

Real GDP

00

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Figure 5: G-20 Equity and Bond Issuance by Non-finanicial Corporate

12

14

16

G-20 Real GDP and Investment. Investment (Index: 2000 = 100). Source: IMF, World Economic Outlook.

(Billions of U.S. Dollars)

700 600

Emerging Asia Advanced Bonds Real GDP

Latin America Emerging

1,600

Equities 1,400 Real Investment

500

240 220

1,200

200

1,000

180

Real GDP Bonds

EquitiesReal Investment 500 400

160

400

800

300

600

120

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100

100

200

600

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60

0 0 000001 02 04 05 07 081009 12 10 111412 16 02 03 04 06 06 08

40 00 01 06 07 09 10 12 00 02 0203 04 04 05 06 08 08 10 12 11 14

0 16

G-20 Equity and Bond Issuance by Non-finanicial Corporate. Investment (Billions of US Dollars). Source: Dealogic.

400 100 EmergingAsia Europe In advanced economies Exporters Emerging LatinOil America Conclusions several factors have Recovery of investment has been uneven across hindered investment after the crisis. Depressed 90 Bonds Equities Bonds Equities 350financial 380 regions. sectors, and weak Source 240 Investment in many emerging economies demand, impaired Real GDP Real Investment Real GDP Real growth Investment has performed well since the crisis, but it has prospects have all weighed on capital Group of Twenty: “Investment and80 its 220 relatively weak in advanced economies.

300 bank credit 340 has declined Financing: A Macro Perspective”. Annex to been spending. Foreign 70 significantly in advanced economies, particularly the G-20 Surveillance Note. Meetings of G-20 200 250 periphery300 From a macro standpoint, emerging countries, in the euro area as cross-border Finance Ministers and Central Bank Governors.

60 180 generally, have shown resilience in investment, deleveraging of European banks has been February 15-16, 2013. Prepared by Staff of supported by good policies but also strong credit pronounced. IMF200 surveillance 260 work suggests that the International Monetary Fund. Does50not 160 FDI flows to emerging Asia and Latin financial fragmentation has hindered credit and necessarily reflect the views of the IMF Executive growth.

40 220 America have remained broadly at pre-crisis raised financing 150 costs in the euro area periphery. board.

140 levels, while net portfolio investment picked In advanced economies more generally, weak 30 180 100and tight lending standards 120on the back of relatively strong growth and bank credit growth up 20 low interest rates in advanced economies. Bond have hurt investment, particularly 140 in small and About the Executive Summary: 100 50 issuance has increased strongly, partly due to a medium size enterprises.

Other factors have also Group of Twenty IMF Note - Meetings of 10 G-20 search for yield.

Total bank credit in emerging played a role, as investment has not been strong Finance Ministers and Central Bank Governors: 100 80 0 0 Asia and Latin America has also grown. However, even for large companies with access to market “IMF Note on Global Prospects and Policy 60 60 00 01 vulnerabilities 02 03 04 could 05 06reemerge 07 08 as09 financing.

10 11 12 01 02to03 05 06 07 09 10Summary 11 12 is from domestic While further work00 is needed pin 04Changes”.

The 08 Executive 00economies 02 are 04 already 06 in 08 10 12 14 causes 16 behind low investment, 00 the 02risk 04a note 06by the 08 Staff10of the12IMF 14 16for several a late-credit down root prepared cycle. Thus, to guard against the associated risks, for these economies is that continuing sluggish the February 15-16, 2013 meetings of G-20 the general challenge for emerging economies is investment may weigh down on potential output Finance Ministers and Central Bank Governors 9 40 Emerging Europe Exporters to rebuild their policy space. and growth over the medium term. i in Oil Moscow.

Source: IMF, World Economic Outlook.

Bonds

Equities

8 7

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5

Bonds

Equities

35 30 25

> European Investment Fund (EIF):

Impact Financing Performance Measurements In Fund Investments

By Uli Grabenwarter

Introducing impact financing The notion that the success of an investment should be measured by financial returns alone has often been contested. There is a growing belief that investments should be judged by their ability to generate both a profit and a positive social impact. This approach is known as “impact investing” as it claims explicitly considering an investment’s social and/or environmental impact in the investment decision process.

In pursuit of such impact focus, impact investors have been trying to identify means of making transparent social impact within the performance of an investment. In other words are there any ways of adequately measuring social impact in the performance of an investment.

Approaches used in the past have been favouring single impact measures seeking to express social impact objectives and results for the entirety of actors and stakeholders in an undifferentiated way. These attempts did not however result in impact measurement methodologies capable of becoming market standards.

The complexity of impact measurement in an investment context arises from the complexity

“In pursuit of such impact focus, impact investors have been trying to identify means of making transparent social impact within the performance of an investment.” and diversity of objectives (motivational spectrum of actors and stakeholders) and the degree of proximity or distance of stakeholders and actors to the concrete social impact activity.

Looking at the various actors throughout the “investment food chain”, it appears relevant to distinguish between: • The social entrepreneurs who are typically interested in the most effective way to tackle a social issue (“how can the social issue be best tackled?”)

• The active social investors/philanthropists who are typically interested in the most efficient way of tackling a social issue (“how can I make best use of my money in tackling a specific social issue?”)

Spectrum of “Mission-Related Finance” Impact Investing Environmental- / Social Impact-Benefits Grant Money

Cost Recovering

“Coincidental” Financial return

Financial Return Because of Social USP

Pos. correlation env./ social impact and financial return

Socially/ Policy Neutral Business Models

Neg. correlation env./ social impact and financial return

Financial-Return-Benefits

Charity/ Philanthropy

Philanthropy

Investors with or without socialand/ or environmental investment objectives

Exclusively Financial-ReturnOriented Investors

Source: U. Grabenwarter (2009) The boundaries of the mission-related investment universe.

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CFI.co | Capital Finance International

• The pay-by results participants who may be interested only in an isolated segment of impacts of an activity that addresses their slice of specific results (“what is the social impact of an activity on my own activity?”)

• The passive social investors who typically look at capital efficiency evidenced by process rigour and quality in funding social impact (“has the reason for my investment materialised or at least complied with?”)

• The policy makers who, depending on the layer of intervention, often seek to influence sector trends, geographical development trends, market failures, and hence have a greater interest in the functioning of a market infrastructure than in individual impacts achieved even if concrete impact at social enterprise level may serve as evidence and justification for policy action (“has my policy support met my policy objective?”).

In the pursuit of common impact indicators it is important to understand that one and the same social impact may be pursued by a multitude of stakeholders and actors for a multitude of reasons. These reasons may be direct or indirect results of the social impact activity and therefore are likely to require different social impact indicators in order to express to what extent such varied interests and expectations are met. As much as the outcomes of a given social impact activity may be positively correlated because they have, at their roots, the same social issue, it is equally evident that these results sought by various stakeholders are not necessarily (and actually very unlikely) the same.

Consequently, any attempt seeking to express the social impact of an activity through one single measure that satisfies the information requirement of the entire spectrum of stakeholders is bound to fail: For instance, a social entrepreneur seeking evidence that his activity contributes to eliminating the negative societal impact of reoffending ex-prisoners (including domestic violence, precariousness of their families, social marginalisation of ex-prisoners and their families etc.) will very unlikely be served with an indicator that exclusively expresses the public cost saving generated by the number of ex-prisoners prevented from returning to prison.

Spring 2013 Issue

“In associating leading European institutional investors who themselves have pioneering activities in the social impact investing sector, EIF seeks to pool knowledge and expertise in a collective effort to define and develop this emerging market space.”

Equally, an investor seeking to identify social investment fund managers that set ambitious impact targets for their investments and have a solid track record in delivering on them will not be helped with the number of people reinserted in the employment market without the framework in which such impact performance has been achieved.

It is obvious that the type of indicators used at the level of a social enterprise such as the number of prisoners reinserted in the employment market, the percentage of decrease in domestic violence in the target population or ultimately the decrease in the rate of reoffenders cannot serve investors as source of information in their investment process

The “gamma model“ as impact metrics for fund investments [U. Grabenwarter/H. Liechtenstein: “In search of gamma – an unconventional perspective on impact investing” (IESE Publishing 2011)] Given the above-described difficulty to serve a variety of actors and stakeholders with a uniform measure for social impact, what is known as the “gamma model” deliberately allows for different types of impact metrics and indicators for different stakeholders along the food chain of a social investment activity.

Investors are keen to know whether their money has been spent “efficiently” in pursuit of a given social impact or at least in compliance with a thorough impact-driven approach. But how would an investor know that for a given amount spent he could not have achieved a better impact result? Or a better blended result of impact/ financial return, if that were his objective?

Put into the context of the social impact pursued by an enterprise working on the reintegration of ex-prisoners into society, such indicators at social enterprise level can monitor a multitude of social impacts including the decrease in domestic violence, the bankability of ex-prisoners, the reinsertion in the employment market or the financial self-sustainability of families of exprisoners.

One indicator resulting from the impacts listed above may then be the decrease in the rate of reoffenders, which may, considering the cost to society of a person returning to jail, reflect the perspective of one isolated stakeholder (the state finance department in this case) that has to find ways of optimising the use of resources in dealing with the cost of reoffenders.

Moving up the chain of social finance, the question arises how social impact indicators can be made meaningful for investors that rely on intermediaries such as social investment funds or fund-of-funds for their impact investing activity.

It appears that for an investor using the intermediation of a social investment fund or fund-of funds, the transparency on how his money has been deployed is more useful than the availability of isolated absolute impact performance indicators that in the absence of a comparative context are without any tangible information value.

EIF’s Social Impact Investing Platform The European Investment Fund (EIF) provides risk finance for the benefit of micro small and medium-sized enterprises (SME) across Europe. Its main mission is to facilitate their access to finance and to support EU policy objectives in terms of innovation, employment, social inclusion, entrepreneurship and regional development. In launching its first pan-European social impact investing platform, EIF seeks to help consolidating efforts in the development of the European social entrepreneurship market, especially with respect to social impact metrics standards. Of course, making investments in largely undercapitalised social investment funds across Europe has made this new activity of EIF a long desired initiative.

However, the ambition of EIF’s platform for investing in social investment funds goes further:

Uli Grabenwarter: Head of Strategic Development, Equity, at the European Investment Fund

In associating leading European institutional investors who themselves have pioneering activities in the social impact investing sector, EIF seeks to pool knowledge and expertise in a collective effort to define and develop this emerging market space. In a true publicprivate-partnership approach EIF will share its own impact due diligence and impact metrics approaches in an open exchange with the platform partners to create more widely accepted market standards. These market standards can guide new investors in their approach to this new asset class and facilitate the interaction between social entrepreneurs, social investment fund managers and investors.

Ultimately, the success of impact investing as an investment space will be decided on the question to what extent intentional social impact as the core differentiator to other asset classes can be made tangible and transparent and communicated in a credible way. EIF’s initiative seeks to be a milestone in paving the way towards an impact investing space accessible to mainstream investors by advocating this new way of a holistic value creation. i

EIF’s central mission is to support Europe’s micro small and medium-sized businesses (SMEs) by helping them to access finance. EIF designs and develops venture capital and guarantees instruments which specifically target this market segment. In this role, EIF fosters EU objectives in support of innovation, research and development, entrepreneurship, growth, and employment. The EIF total net commitments to private equity funds amounted to close to EUR 7bn at end 2012. With investments in over 435 funds, EIF is a leading player in European venture due to the scale and the scope of its investments, especially in high-tech and early-stage segments. The EIF guarantees loan portfolio totalled over EUR 4.7bn in close to 255 operations at end 2012, positioning it as a major European SME guarantees actor and a leading micro-finance guarantor.

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> European Policy Centre on SME Entrepreneurship:

Do It Yourself?

By Hans Martens

O

ECD’s recent Economic Outlook confirms the dark employment situation and outlook in Europe Union and for that matter in most countries in the so-called Western World. Unemployment has increased dramatically since the economic and financial crises started, and for the Euro-area OECD forecasts unemployment rates of 11.9% in 2011 and 12% in 2013. This corresponds well with the economic growth – or rather lack of economic growth – as a negative GDP- growth is forecast for 2013 (-0.1%) and only 1.2% growth is forecast for 2014.

As a general rule, the economy only starts to create employment growth when it expands by more than 2% annually, so there is a long way ahead before employment figures will improve.

This can and has been traditionally offset to some degree by expansions in public sector employment, but these days are also over with the poor state of public finances in most countries.

What about creating your own job then, if nobody will offer a job? Why are we seeing so few Europeans actually counteracting the bleak employment prospects by starting their own business?

A recent survey from Eurobarometer (Flash Eurobarometer 354 from June 2012) shows that only 37% of the respondents in European Union member states said that they would rather be self-employment than work as an employee.

This is remarkably lower than the result of a similar study in 2009, where 45% said that would prefer to be self-employed. So the crises and the rising unemployment have not actually given a drive towards self-employment. Rather the opposite- and quite dramatically.

The reasons given are of course diverse. One understandable argument is that the time and the market conditions are not very good for business, but very often the argument used is that respondents prefer to have the job security and security of a steady income coming from

“The economy only starts to create employment growth when it expands by more than 2% annually.” being employed, and that is perhaps less understandable on the background of the insecure situation many employees have been in over the last three to four years.

Who are entrepreneurial?

The Eurobarometer analysis includes data from the different EU member states (and other countries) and although there are differences between different European cultures, the figures show (again).

Country Sweden Denmark Germany Belgium UK Czech Republic Spain Ireland France Italy Poland Greece India US South Korea China Turkey

Percentage* 22 % 28 % 29 % 30 % 33 % 34 % 35 % 37 % 40 % 44 % 47 % 50 % 47 % 51 % 53 % 56 % 82 %

Table: *who prefer to be self-employed - % of total.

From the survey it is very obvious that Europeans in general are less prone to choosing selfemployment than many of the major economies around us, including both more mature economies like the US and South Korea and rapidly emerging markets, such as India, China and indeed Turkey.

In Europe there seems to be a clear North-South divide, but not in the usual sense, where the North is leading the South. Greece has a very high response in favour of self-employment, so has this increased because of the crises? No, it has decreased by 10% since 2009!

It is also remarkable to see Scandinavians at the bottom of the entrepreneurship list, as they probably have the least difficulties to deal with when setting up companies, whereas establishing an own company is quite burdensome in for example Poland and Greece. It is often argued that making it easier to start own business is the best way to boost entrepreneurship, but this does not seem to be the case in the real world, and bureaucratic hindrances for start-ups is not particular dominant amongst the arguments for not starting your own business amongst the respondents in the survey. This obviously is not an argument for putting up obstacles to entrepreneurship, but more to point out that other means are needed if entrepreneurship is to be increased.

By the way: For those who think that entrepreneurship should be a special virtue for the Anglo-Saxon economies, it might be worth noting that more French people would like to start their own business than is the case in the UK or Ireland!

It is about the money – and about ideas The economic crises has lowered the desire to start own businesses as mentioned above, and the sad thing about this is that we cannot therefore expect entrepreneurship really to help reducing unemployment – unless something is done about it. And something can be done. It

“It is a huge problem that the banking market is more or less frozen when it comes to financing small and medium sized enterprises.”

26

CFI.co | Capital Finance International

Spring 2013 Issue

is a huge problem that the banking market is more or less frozen when it comes to financing small and medium sized enterprises. Unless ample collateral can be provided (and that is most often not the case for new businesses), the banks just don’t give credits.

For start-ups we are most often talking about relatively small amounts, so perhaps we should review micro-credits – also for Europe? Micro-credit schemes have been very popular and very useful in other parts of the world, but are not widespread in Europe, although such facilities could be useful for small-scale start-ups. So one recommendation could be to create microfinance schemes and make them widely available.

A more worrying issue that come out of the Eurobarometer study is not only that respondents fear the market conditions are adverse, but also that they lack the imagination to identify a viable business idea. Obviously the rhetoric about our economy is very negative, but a crisis also provides opportunities, and there are indeed areas that provide opportunities for SMEs. The ICT area is under constant redesign and some of the fastest growing businesses are run by those who got the right idea at the right time. Issues in the area of resource and energy efficiency need to be dealt with, and the same goes for the changes in our societies due to the ageing of our populations. That includes the care sector, innovations to be used by older people and ideas on how to provide some of the traditional public services by SMEs. It also has to be noted that entrepreneurship can flourish in very traditional industries - if new approaches are invented.

The second issue is capital that can help successful start-ups grown and begin to employ more people.

Here we are talking about larger amounts, and as the banks are still reluctant to take the risks, instruments like venture capital seem to be the option. The general impression, however, is that European venture capital is underdeveloped and less efficient than say the US venture capital market. There have been some suggestions recently that US venture capital is becoming more interested in Europe, but generally speaking initiatives need to be taken to increase availability of risk capital for SMEs in Europe.

So the dark mood in itself prevents entrepreneurship, and this again calls for a major and large scale political initiative to kick start our economies.

Psychology and expectations for the future are extremely important, so apart from taking initiative to a massive effort at the European level to inject new dynamism in the economies, our political leaders should urgently work to develop schemes of making capital available for start-ups and for developing SMEs and they should in addition help making it much more acceptable and even desirable to become self-employed and grow small companies into larger and successful ones. i

There are two sides to this: One is the capital needed for start-ups, and the second is the capital needed to grow.

“So the dark mood in itself prevents entrepreneurship, and this again calls for a major and large scale political initiative to kick start our economies.”

The European Policy Centre (EPC) is an independent, not-for-profit think tank, committed to making European integration work. The EPC works at the “cutting edge” of European and global policy-making providing its members and the wider public with rapid, high-quality information and analysis on the EU and global policy agenda. It aims to promote a balanced dialogue between the different constituencies of its membership, spanning all aspects of economic and social life.

In line with its multi-constituency approach, members of the EPC comprise companies, professional and business federations, trade unions, diplomatic missions, regional and local bodies, as well as NGOs representing a broad range of civil society interests, foundations, international and religious organisations.

About the Author Hans Martens has been Chief Executive of the European Policy Centre since 2002.

Born in Denmark, Hans studied Political Science at Aarhus University and went on to become Associate Professor in international political and economic relations.

In 1979, he joined the Danish Savings Bank Association as Editor-in-Chief and Head of Information. From 1982 to 1985, he was Head of the International Department of the Salaried Employees Federation, a Danish trade union, where he took charge of the organisation’s international relations, including with the OECD and the ILO. In 1985, he joined the Copenhagen Handelsbank, initially in charge of the Economic Department and later as Head of the International Private Banking Department. There, he was responsible for economic analysis and forecasting, and for developing the bank’s investment and capital market products. In 1989 he set up Martens International Consulting.

Hans is a regular lecturer at Universities and Business Schools in Europe and in the US. He is an expert on European competitiveness issues, monetary and macroeconomic issues, demographics and the Digital Economy, including eGovernment.

CFI.co | Capital Finance International

27

> European Central Bank’s Eurosystem:

Printing Money Helped Offset Banking Crisis The ECB’s expansionary monetary policies have partly offset the negative effect on GDP growth from contracting bank lending. However, the ECB’s policies have fallen short of helping companies obtain financing, in particular for small firms in distressed PIIGS countries. Recently, new ECB policy initiatives have attempted to make credit available for SMEs. ABSTRACT The Euro area economic activity and banking sector have shown substantial fragility over the last years with remarkable country heterogeneity.

Using detailed data on lending conditions and standards, we analyse how financial fragility has affected the transmission mechanism of the single Euro area monetary policy during the crisis until the end of 2011. The analysis shows that the monetary transmission mechanism has been time-varying and influenced by the financial fragility of the sovereigns, banks, firms and households. The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress. This amplification mechanism, moreover, operates mainly through the credit channel, both the bank lending and the non-financial borrower balance-sheet channel.

Our results suggest that the bank-lending channel has been partly mitigated by the ECB non-standard monetary policy interventions. At the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers have not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to SMEs, we infer that the policies adopted until the end of 2011 might have fallen short of reducing credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress.

SUMMARY The financial crisis that started in 2007 has had a strong overall impact on the economy of the euro area, but different effects across the euro area countries. While earlier on financial integration and an appropriate functioning of macro-financial linkages had ensured that the monetary policy of the ECB would transmit homogeneously to the whole area, since 2008 the interconnections between market segments have largely broken, also across borders, and the

28

“The impact of monetary policy on aggregate output is stronger during the financial crisis, especially in countries facing increased sovereign financial distress.”

ECB has operated in a context of heterogeneity and segmentation in the money and financial markets.

Based on this framework, it is possible to study the extent to which a reduced ability of banks to provide credit to the private sector – this is how bank financial fragility is defined here – or the fragility of firms and households – impaired access to credit – can amplify the impact of monetary policy on the real economy (and on inflation).

The analysis suggests that the effect of the bank lending channel has been partly mitigated especially in 2010-2011 by the policy actions.

By providing ample liquidity through the full allotment policy and the Longer-Term refinancing Operations (LTROs), the ECB was able to reduce the costs arising to banks from the restrictions to private liquidity funding by effectively substituting the interbank market and inducing a softening of lending conditions. At the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers has not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to Small and Medium Enterprises (SMEs), we infer that the policy framework until the end of 2011 might have been insufficient to reduce credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress.

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The analysis therefore supports the complementary actions that have been put in place successively, and in particular those specifically targeted at increasing credit to small firms to reduce their external finance premia and credit rationing. In fact, the decision to enlarge the collateral framework of the Eurosystem – in particular by accepting loans to SME as eligible collateral – had the explicit objective of meeting the demand for liquidity from banks in order to support lending to all type of firms.

INTRODUCTION The crisis has had a strong overall impact on the Euro area, but with substantial heterogeneity across the various member countries. The problems in the aggregate Euro area economy and banking sector hide a considerable degree of country heterogeneity, in terms of credit developments, financial fragility of borrowers, lenders and sovereigns and real activity. The single monetary policy has been the key policy implemented over all member countries to overcome the negative effects of the banking crisis and financial fragility. Therefore, a key question arises: what are the effects of the single Euro area monetary policy on a heterogeneous set of economies?

While we argue that the bank balance sheet problems relative to liquidity might have been mitigated by the ECB interventions, at the same time, when looking at the transmission through banks of different sizes, it seems that, until the end of 2011, the impact of credit frictions of borrowers have not been significantly reduced, especially in distressed countries. Since small banks tend to lend primarily to SME, we infer that the policy framework until the end of 2011 might have been insufficient to reduce credit availability problems stemming from deteriorated firm net worth and risk conditions, especially for small firms in countries under stress. This conclusion therefore supports the

Spring 2013 Issue

Figure 1c Credit Default Swaps across Euro area countries (difference from the median) 7400 1000

complementary actions undertaken in successive periods, in particular those specifically targeted at increasing credit to small firms in order to reduce their external finance premia and credit rationing.

MOTIVATION AND AIM Financing conditions became particularly tight in 2007, when the problems in the subprime markets in the US came to surface. However, conditions worsened dramatically later on, to reach a minimum after the bankruptcy of Lehman Brothers.

1000 800

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France

Credit Default Swaps across Euro area countries (difference from the median). Note: The credit default swaps (CDS) are calculated for 10-

Central banks reacted swiftly by lowering policy rates and, in the Euro area, by changing the terms for the liquidity provision to the banking sector. Liquidity provision moved to a fixed rate full allotment policy – banks could come at the Eurosystem liquidity operations and ask for unlimited amount of liquidity at the policy rate.

Financing conditions remained nevertheless tight, since the liquidity provided by the operations could fill only very short-term liquidity needs.

While differences in the perceived country risks in the Euro area became particularly evident

Source: Thomson Financial Datastream

year senior sovereign debt. The CDS for Greece, Ireland, Italy, Portugal and Spain are above the median and they define the group of

Note: The credit default swaps (CDS) are calculated for 10-year senior sovereign debt. The CDS for Greece, Ireland, countries under sovereign stress. The CDS for Austria, Belgium Finland, France, Germany and the Netherlands are below or equal to Italy, Portugal and Spain are above the median and they define the group of countries under sovereign stress. The CDS the median (Belgium) and define the group of other countries. The CDS for Greece is plotted on the same scale only until 2011:Q2. for Austria, Belgium Finland, France, Germany and the Netherlands are below or equal to the median (Belgium) and Source:the Thomson define groupFinancial of other Datastream countries. The CDS for Greece is plotted on the same scale only until 2011:Q2.

in 2010 and 2011 with the unfolding of the sovereign crisis, already in 2008 the credit risk of the single Euro area countries started to be Figure 1d Long-term central bank effectively priced, as evident for example by the divergent patterns in the credit default swaps (CDS) of the sovereign year. Starting from (as percentage of bank10 assets) this observation, we divide the countries in two groups, the countries under sovereign stress 1.2 (Greece, Ireland, Italy, Portugal and Spain) and 1.0

the other countries (Austria, Belgium, Finland, France, Germany, Luxembourg, Netherlands).

liquidity Standard

and non-standard measures of monetary policy affect the willingness and ability of banks to grant credit to the corporate and household sector. Figures show that lending conditions and standards, measured by the 1.2 BLS, diverged significantly since the start of the 1

“The single monetary policy0.8has been the key policy implemented over all member 0.8 countries to overcome the negative effects of the banking crisis and financial fragility.�0.6 0.6 0.4 0.2

CFI.co | Capital Finance International

0.4

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0.2

Figure 1d Long-term central bank liquidity (as percentage of bank assets) financial crisis in the two groups of countries, with more tightening of lending conditions and standards in the countries under stress. At the same time, demand for business loans started to decline in all countries already at the beginning of the crisis. However, only in the very last period of our sample the demand for loans in the two groups of countries significantly departed from each other.

1.2

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RESULTS In sum, results suggest that on average the effect of a (single) monetary policy shock on GDP growth has been time-varying during the years of the crisis and became stronger and faster in 2008-2009. Differently, not much variation is shown for impacts on inflation. Moreover, the impact has been substantially stronger for the sovereign stressed countries, in particular after May 2010.

0.2

0.2

THE BROAD CREDIT, BANK AND NON-FINANCIAL BORROWER BALANCE SHEET CHANNELS All in all, the impulse responses suggest that the impact of a monetary policy shock on GDP growth is amplified by changes in the credit conditions and standards – the broad credit channel is active. In other words, the amplification reflects the underlying problems in credit markets as implied by the credit channel theory. The amplification is stronger in the countries under stress and is significant throughout the crisis period. The banks from the most distressed economies accessed massively the long-term liquidity provided by the Eurosystem and were able to relax the liquidity constraints on their balance sheets. In other words, the financial frictions affecting firms and households in stressed countries continued to be relevant in the last two years of our sample and, therefore, reductions of the monetary policy rates are important in softening the lending conditions for non-financial borrowers.

We can conclude that the impact of monetary policy shocks has changed during the crisis in a heterogeneous way across countries and across the different credit channels.

The amplification effect of a standard monetary policy shock has been more pronounced in distressed countries through the broad credit channel for the entire period. Transmission through the bank-lending channel of monetary policy has been important only in 20082009 whereas the transmission through the nonfinancial borrower balance sheet channel remained important and statistically significant for the whole crisis period for countries under stress. This implies that in 2010-2011 the reductions of the monetary rates have affected positively GDP by reducing the external finance premia and credit rationing for non-financial borrowers. At the same time, further EONIA shocks seem not to be able to significantly affect

30

0.0 Dec-02

0 Dec-03

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other countries

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countries under sovereign stress

Long-term central bank liquidity (as percentage of bank assets). Note: The chart plots the liquidity given by the ECB to banks of euro are countries at refinancing operations with maturity from 3-month to 1-year. The group countries under sovereign stress is composed by

Source: ECB, authors’ calculations

Greece, Italy, Ireland, Portugal and Spain. The other countries are Austria, Belgium, Finland, France, Germany, Luxembourg and the

Note: The chart plots the liquidity given by the ECB to banks of euro are countries at refinancing operations with maturity from 3-month to 1-year. The group countries under sovereign stress is composed by Greece, Italy, Ireland,

Netherlands. The amount of liquidity is scaled by the total assets of the banking sector in each country.

Source: ECB, authors’ Portugal and Spain.calculations The other countries are Austria, Belgium, Finland, France, Germany, Luxembourg and the

Netherlands. The amount of liquidity is scaled by the total assets of the banking sector in each country.

the bank lending capacity (channel), as banks can get unlimited (in exchange of collateral) liquidity from the refinancing operations of the ECB at different maturities, paying the MRO policy rate.

we explore the variation during the crisis of credit frictions linked to size. As noted by the literature, the transmission of monetary policy through the credit channel may differ according to the heterogeneity of borrowers and lenders, notably in firm size and in bank size. In particular, monetary policy shocks should affect more the credit granted by smaller banks to smaller firms, typically more financially constrained.

THE IMPACT OF BANK (AND FIRM) SIZE If financial frictions in credit markets have been important in this crisis, a key question is whether bank and firm heterogeneity with respect to size matters the credit standards channel of monetary In distressed frictions for Figure 2a forLending for business loanscountries, in Eurofinancial area countries policy, as, in general, smaller firms and banks small banks have significantly been reduced as have worst access to credit. In this subsection suggested by the lack of economic and statistical

33

(net percentage of banks tightening standards) 100

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countries under sovereign stress

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Dec-10 euro area

Lending standards for business loans Banks, in Euro area countrie (net percentage of banks tightening standards). Note: Lending standards are Source: ECB, National Central authors’ calculation the net percentage of banksare in each group of countries have lending standardsthat in response to Question 1 of the euro Note: Lending standards the net percentage ofthat banks intightened each group of countries have tightened lending standards Bank Lending Survey: 1 Over have your bank’sOver creditthe standards as applied to the approval loansbank’s or inarea response to Question of the thepast eurothree areamonths, Bank how Lending Survey: past three months, how have ofyour credit as applied to theThe approval of loans or credit lines enterprises changed?

The figure reported forasthe credit standards lines to enterprises changed? figure reported for the euro area is ato weighted average (using total bank assets by country euro areaofisthe a weighted average (using The totalgroup bank assets by country as weights) of the net by country.

The weights) net percentages by country. countries under sovereign stress is composed by percentages Greece, Italy, Ireland, Portugal group countries under sovereign stress is composed by Greece, Italy, Ireland, Portugal and Spain. The other countries and Spain. The other countries are Austria, Belgium, Finland, France, Germany, Luxembourg and the Netherlands. are Austria, Belgium, Finland, France, Germany, Luxembourg and the Netherlands.

Source: ECB, National Central Banks, authors’ calculation

Figure CFI.co 2b | Demand for business loans in Euro area countries Capital Finance International

Spring 2013 Issue

significance of the bank lending channel, but not the credit frictions of their borrowers, which are mainly small firms. That is, the low net worth of smaller firms and their higher risk make loans to these borrowers relatively unattractive to banks, notwithstanding the impact of central bank liquidity provisions on bank balance sheet capacity. The policies implemented until the Fall of 2011 may have not been comprehensive enough, and our analysis would support targeted policies aimed at increasing credit availability for small firms – especially in countries under stress. On this basis, policy initiatives specifically aimed at increasing lending availability to the non-financial sector, like the ones implemented by the Bank of Japan and more recently by the Bank of England, could prove to be particularly beneficial, although these programs have different explicit linkages to the monetary policy operations.

The Bank of Japan (BoJ) introduced in June 2010 a program to boost economic growth by providing funds to banks that are lending for or investing in growth areas. The program was extended in duration and size in March 2012. The BoJ also setup another lending facility in June 2011 specifically geared towards promoting equity investments and asset-backed lending, which the BoJ believes will allow small businesses and startups to seek loans and investments from financial institutions without real estate collateral or guarantees. In July 2012 the Bank of England (BoE) and the HM Treasury announced the launch of the Funding for Lending Scheme (FLS). Under FLS banks are able to borrow UK Treasury bills from the BoE for a period of up to four years against eligible collateral (including loans to households and businesses and other assets) for a fee. The provision of T-bills (rather than liquidity) is meant to stress that the operation should be seen as distinct from the regular monetary policy operations of the BoE. The BoE borrows the T-bills from the UK government debt management office and the scheme does not lead to an increase in the government debt outstanding.

THE ROLE OF NON-STANDARD MEASURES Bank balance sheet problems have been mitigated and the banklending channel in great

part “neutralized” by the ECB interventions which have targeted almost exclusively banks’ liquidity; furthermore, the non-financial borrower balance sheet channel is still economically and statistically significant in distressed countries, therefore the current policy may still be insufficient if not targeted to increase credit availability for small firms (due to the firm channel) especially in the countries under financial stress.

The overall lesson to draw from our results is in line with the general principle that non-standard measures are most effective when they are designed specifically to address the prevailing impairment occurring at any point in time. The Eurosystem policy measures have been effective in mitigating bank liquidity problems, thus in great part neutralizing the bank lending channel.

However, the firm balance sheet channel was still operational until end-2011, especially for smaller firms, and, therefore, financial frictions for small firms may still be binding.

That is, there is still substantial heterogeneity in bank loan conditions and standards for nonfinancial borrowers between distressed and other countries, and these differences are even stronger for small firms. From this analysis one can infer that policy measures specifically targeted at increasing credit availability to small firms could significantly stimulate economic activity, by mitigating these frictions.

All in all, these results also support the decision to enlarge the collateral framework of the Eurosystem – in particular by accepting loans to SME as eligible collateral – with the explicit objective of meeting the demand for liquidity from banks in order to support lending to all type of firms.

CONCLUSIONS We have analysed how financial fragility has affected the monetary policy transmission mechanism, in particular through the credit channel, placing emphasis on heterogeneity at different levels.

The transmission mechanism of monetary policy has changed with the crisis, with a strong amplification effect of the credit channel in

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countries under sovereign stress. For these countries, the fragility of banks has been especially important in 2008-2009, whereas the firm/household balance sheet channel of monetary policy has been significant during the whole period, especially for small firms.

With all the necessary caveats that such a nonstructural analysis may entail, results indicate that the effects of common monetary rates on GDP growth are significant and heterogeneous across countries. We argue that the bank balance sheet problems might have been partly mitigated (and the bank-lending channel partly “neutralized”) by the ECB interventions – which have targeted almost exclusively banks’ liquidity – while the non-financial borrower balance sheet channel is still significant, especially in financially distressed countries.

For this group of countries, the results suggest that more central bank liquidity has helped in fostering better credit conditions for borrowers.

However, our results also suggest that the policy framework until the end of 2011 might have fall short of increasing credit availability for small firms especially in distressed countries.

This in turn would support the complementary policy actions that have taken place after the period analyzed in this paper, in particular the 3-year LTROs (Longer Term Refinancing Operations) and the enlargement of the collateral framework to include loans to SMEs as eligible collateral for central bank operations. The latter was targeted precisely to address the problem of credit availability for SMEs. i

Source Abstract from: “Working Paper Series, No 1527 / March 2013 – Heterogeneous Transmission Mechanism. Monetary Policy and Financial Fragility in the Euro Area.”

Authors: Matteo Ciccarelli, Angela Maddaloni and José-Luis Peydró Note: These excerpts from the should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the authors and do not necessarily reflect those of the ECB.

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> Nouriel Roubini’s World-Wide Status Report:

Myriad Challenges Facing the Global Economy

I

n Europe, the tail risk of a eurozone breakup and a loss of market access by Spain and Italy were reduced by last summer’s decision by the European Central Bank to backstop sovereign debt. But the monetary union’s fundamental problems – low potential growth, ongoing recession, loss of competitiveness, and large stocks of private and public debt – have not been resolved.

Moreover, the grand bargain between the eurozone core, the ECB, and the periphery – painful austerity and reforms in exchange for large-scale financial support – is now breaking down, as austerity fatigue in the eurozone

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periphery runs up against bailout fatigue in core countries like Germany and the Netherlands.

Austerity fatigue in the periphery is clearly evident from the success of anti-establishment forces in Italy’s recent election; large street demonstrations in Spain, Portugal, and elsewhere; and now the botched bailout of Cypriot banks, which has fueled massive public anger. Throughout the periphery, populist parties of the left and right are gaining ground.

Meanwhile, Germany’s insistence on imposing losses on bank creditors in Cyprus is the latest symptom of bailout fatigue in the core. Other

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core eurozone members, eager to limit the risks to their taxpayers, have similarly signaled that creditor “bail-ins” are the way of the future.

Outside the eurozone, even the United Kingdom is struggling to restore growth, owing to the damage caused by front-loaded fiscal-consolidation efforts, while anti-austerity sentiment is also mounting in Bulgaria, Romania, and Hungary.

In China, the leadership transition has occurred smoothly. But the country’s economic model remains, as former Premier Wen Jiabao famously put it, “unstable, unbalanced, uncoordinated, and unsustainable.”

Spring 2013 Issue

China’s problems are many: regional imbalances between its coastal regions and the interior, and between urban and rural areas; too much savings and fixed investment, and too little private consumption; growing income and wealth inequality; and massive environmental degradation, with air, water, and soil pollution jeopardizing public health and food safety.

The country’s new leaders speak earnestly of deepening reforms and rebalancing the economy, but they remain cautious, gradualist, and conservative by inclination.

Moreover, the power of vested interests that oppose reform – state-owned enterprises, provincial governments, and the military, for example – has yet to be broken. As a result, the reforms needed to rebalance the economy may not occur fast enough to prevent a hard landing when, by next year, an investment bust materializes.

In China – and in Russia (and partly in Brazil and India) – state capitalism has become more entrenched, which does not bode well for growth. Overall, these four countries (the BRICs) have been over-hyped, and other emerging economies may do better in the next decade: Malaysia, the Philippines, and Indonesia in Asia; Chile, Colombia, and Peru in Latin America; and Kazakhstan, Azerbaijan, and Poland in Eastern Europe and Central Asia.

Farther East, Japan is trying a new economic experiment to stop deflation, boost economic growth, and restore business and consumer confidence. “Abenomics” has several components: aggressive monetary stimulus by the Bank of Japan; a fiscal stimulus this year to jump start demand, followed by fiscal austerity in 2014 to rein in deficits and debt; a push to increase nominal wages to boost domestic demand; structural reforms to deregulate the economy; and new free-trade agreements – starting with the Trans-Pacific Partnership – to boost trade and productivity.

“Meanwhile, Germany’s insistence on imposing losses on bank creditors in Cyprus is the latest symptom of bailout fatigue in the core.”

But the challenges are daunting. It is not clear if deflation can be beaten with monetary policy; excessive fiscal stimulus and deferred austerity may make the debt unsustainable; and the structural-reform components of Abenomics are vague.

Moreover, tensions with China over territorial claims in the East China Sea may adversely affect trade and foreign direct investment.

Then there is the Middle East, which remains an arc of instability from the Maghreb to Pakistan. Turkey – with a young population, high potential growth, and a dynamic private sector – seeks to become a major regional

CFI.co | Capital Finance International

power. But Turkey faces many challenges of its own. Its bid to join the European Union is currently stalled, while the eurozone recession dampens its growth. Its currentaccount deficit remains large, and monetary policy has been confusing, as the objective of boosting competitiveness and growth clashes with the need to control inflation and avoid excessive credit expansion.

Moreover, while rapprochement with Israel has become more likely, Turkey faces severe tensions with Syria and Iran, and its Islamist ruling party must still prove that it can coexist with the country’s secular political tradition.

In this fragile global environment, has America become a beacon of hope? The US is experiencing several positive economic trends: housing is recovering; shale gas and oil will reduce energy costs and boost competitiveness; job creation is improving; rising labor costs in Asia and the advent of robotics and automation are underpinning a manufacturing resurgence; and aggressive quantitative easing is helping both the real economy and financial markets.

But risks remain. Unemployment and household debt remain stubbornly high. The fiscal drag from rising taxes and spending cuts will hit growth, and the political system is dysfunctional, with partisan polarization impeding compromise on the fiscal deficit, immigration, energy policy, and other key issues that influence potential growth.

In sum, among advanced economies, the US is in the best relative shape, followed

by Japan, where Abenomics is boosting confidence. The eurozone and the UK remain mired in recessions made worse by tight monetary and fiscal policies. Among emerging economies, China could face a hard landing by late 2014 if critical structural reforms are postponed, and the other BRICs need to turn away from state capitalism. While other emerging markets in Asia and Latin America are showing more dynamism than the BRICs, their strength will not be enough to turn the global tide. i

About the Author Nouriel Roubini, a professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

Source: project-syndicate.com

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> Joseph Stiglitz:

Europe’s Toxic Austerity is Destroying Human Capital

T

he European project, as idealistic as it was, was always a top-down endeavour.

But it is another matter altogether to encourage technocrats to run countries, seemingly circumventing democratic processes, and foist upon them policies that lead to widespread public misery.

While Europe’s leaders shy away from the word, the reality is that much of the European Union is in depression. The loss of output in Italy since the beginning of the crisis is as great as it was in the 1930’s. Greece’s youth unemployment rate now exceeds 60%, and Spain’s is above 50%.

With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy.

The economy’s doctors say that the patient must stay the course. Political leaders who suggest otherwise are labelled as populists. The reality, though, is that the cure is not working, and there is no hope that it will – that is, without being worse than the disease. Indeed, it will take a decade or more to recover the losses incurred in this austerity process.

In short, it is neither populism nor short-

34

sightedness that has led citizens to reject the policies that have been imposed on them. It is an understanding that these policies are deeply misguided.

Europe’s talents and resources – its physical, human, and natural capital – are the same today as they were before the crisis began. The problem is that the prescriptions being imposed are leading to massive underutilization of these resources. Whatever Europe’s problem, a response that entails waste on this scale cannot be the solution.

The simplistic diagnosis of Europe’s woes – that the crisis countries were living beyond their means – is clearly at least partly wrong. Spain and Ireland had fiscal surpluses and low debt/ GDP ratios before the crisis. If Greece were the only problem, Europe could have handled it easily.

An alternative set of well-discussed policies could work. Europe needs greater fiscal federalism, not just centralized oversight of national budgets.

To be sure, Europe may not need the two-toone ratio of federal to state spending found in the United States; but it clearly needs far more

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European-level expenditure, unlike the current miniscule EU budget (whittled down further by austerity advocates).

A banking union, too, is needed. But it needs to be a real union, with common deposit insurance and common resolution procedures, as well as common supervision. There will also have to be Eurobonds, or an equivalent instrument.

European leaders recognize that, without growth, debt burdens will continue to grow, and that austerity by itself is an anti-growth strategy.

Yet years have gone by, and no growth strategy is on the table, though its components are well known: policies that address Europe’s internal imbalances and Germany’s huge external surplus, which now is on par with China’s (and more than twice as high relative to GDP). Concretely, that means wage increases in Germany and industrial policies that promote exports and productivity in Europe’s peripheral economies.

What will not work, at least for most Eurozone countries, is internal devaluation – that is, forcing down wages and prices – as this would increase the debt burden for households, firms, and governments (which overwhelmingly hold

Spring 2013 Issue

“With the destruction of human capital, Europe’s social fabric is tearing, and its future is being thrown into jeopardy.” to accept the necessity of a banking union that includes common deposit insurance. But the pace with which they accede to such reforms is out of kilter with the markets. Banking systems in several countries are already on life support.

How many more will be in intensive care before a banking union becomes a reality?

Yes, Europe needs structural reform, as austerity advocates insist. But it is structural reform of the Eurozone’s institutional arrangements, not reforms within individual countries that will have the greatest impact. Unless Europe is willing to make those reforms, it may have to let the euro die to save itself.

The EU’s Economic and Monetary Union was a means to an end, not an end in itself. The European electorate seems to have recognized that, under current arrangements, the euro is undermining the very purposes for which it was supposedly created. That is the simple truth that Europe’s leaders have yet to grasp. i

“Internal devaluation, combined with austerity and the single-market principle (which facilitates capital flight and the hemorrhaging of banking systems) is a toxic combination.”

“The Germans, will do everything except what is needed.”

euro-denominated debts). And, with adjustments in different sectors occurring at different speeds, deflation would fuel massive distortions in the economy.

If internal devaluation were the solution, the gold standard would not have been a problem in the Great Depression. Internal devaluation, combined with austerity and the single-market principle (which facilitates capital flight and the haemorrhaging of banking systems) is a toxic combination.

The European project was, and is, a great political idea. It has the potential to promote both prosperity and peace. But, rather than enhancing solidarity within Europe, it is sowing seeds of discord within and between countries.

Europe’s leaders repeatedly vow to do everything necessary to save the euro. European Central Bank President Mario Draghi’s promise to do “whatever it takes” has succeeded in providing a temporary calm. But Germany has consistently rejected every policy that would provide a longterm solution. The Germans, it seems, will do everything except what is needed.

About the author Joseph Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank.

His most recent book is The Price of Inequality: How Today’s Divided Society Endangers our Future.

Of course, the Germans have reluctantly come

Source: www.project-syndicate.org

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>

Mohamed El-Erian, PIMCO:

The Quest for Global Growth

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hat is the most urgent economic priority shared by countries as diverse as Brazil, China, Cyprus, France, Greece, Iceland, Ireland, Korea, Portugal, the United Kingdom, and the United States?

For both theoretical and practical reasons, this is a challenge that will not be met easily or quickly.

And, when it is met, the process will most likely be partial and uneven, accentuating differences and posing tricky coordination issues at the national, regional, and global levels.

sometimes almost irrespective of underlying fundamentals. Still others (China and Korea) exploited seemingly limitless globalization and buoyant international trade to capture growing market shares. And a final group rode China’s coattails.

It is not debt and deficits; and it is not dealing with the aftermath of irresponsible lending and borrowing. Yes, these are relevant and, in a handful of cases, urgent. But the number one challenge facing these countries is to develop growth models that can provide more ample, well-paid, and secure jobs amid a secular realignment of the global economy.

The last few years have highlighted the declining potency of long-standing growth models. Some countries (for example, Greece and Portugal) relied on debt-financed government spending to fuel economy activity. Others (think Cyprus, Iceland, Ireland, the UK, and the US) resorted to unsustainable surges in leverage among financial institutions to fund private-sector activities,

Recent data from the International Monetary Fund highlight these models’ simultaneous loss of effectiveness. Global growth averaged only 2.9% in the most recent five-year period, well below the level for virtually any such multi-year period going back to 1971. While emerging economies have out-performed developed countries, both have slowed. Growth has been

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virtually flat in developed economies and, at 5.6% in the emerging world, is well below the 7.6% average in the previous five-year period.

Highly leveraged systems in finance-dependent economies were the first to hit a wall, surprising many who had uncritically bought into the “Great Moderation” – the idea that macroeconomic and asset-market volatility had eased permanently.

The bold policy action that countered the initial disorder prevented a global depression, but it encumbered public-sector balance sheets.

As a result, highly indebted governments were the next to hit the wall. Some were pushed there by the high cost of containing the damage from banks’ irresponsible behavior. Facing immediate credit rationing and large output contractions, they could be stabilized only by exceptional official financing from abroad, and, in some extreme cases, by defaulting on past commitments (including to bondholders and, most recently, bank depositors).

For other countries, including the US, mediumterm issues came to the fore. But, rather than catalyzing sensible policy discussions, these issues played into polarized and polarizing politics, creating new and more immediate headwinds to economic growth.

Meanwhile, a highly interdependent and (now) less dynamic world economy has been limiting the scope for external growth drivers. Accordingly, even countries with sound balance sheets and manageable leverage have experienced a growth slowdown.

In the process, inequality has risen further. And yet, despite the urgent need for major policy adaptations at the national level, and much better regional and global coordination, progress has been disappointing.

With the political context undermining the right mix of short- and longer-term measures, national policymaking has stumbled into partial approaches and unusual experimentation. The focus has been on buying time, rather than on implementing a sensible transition to a sustainable policy stance.

And potential national outcomes would be less uncertain if excessive inequality were not treated as an afterthought.

“The number one challenge is to develop growth models that can provide more ample, well-paid, and secure jobs amid a secular realignment of the global economy.”

The regional and multilateral dimensions are similarly inadequate. The absence of wellarticulated common analyses and policy coordination has accentuated legitimacy deficits, encouraging leaders and publics to opt for partial narratives and eroding confidence in existing institutional structures.

Given these trends, the search for more robust growth models will take much longer and be more complicated than many recognize – especially as the world economy pivots away from unfettered globalization and high levels of leverage.

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We should expect countries like the US to benefit from dynamic bottom-up entrepreneurship and traditional cyclical economic healing.

Notwithstanding a dysfunctional Congress, the private sector will increasingly convert a paralyzing uncertainty premium, which impedes much investment, into a less disruptive risk premium. But, without a short-term economic turbo-charger, the recovery in growth and jobs will remain gradual, vulnerable to political and policy risks, and disproportionately beneficial to those with favorable initial endowments of wealth and globalized talents.

Governments’ role will be different in countries like China, where officials will guide a shift from dependence on external sources of growth to more balanced demand. As this requires some fundamental domestic re-alignments, the rebalancing will be both gradual and non-linear at times.

The outlook for other economies is more uncertain.

Undermined by a lack of policy flexibility, it will take a long time for countries like Cyprus to overcome the immediate shock of crisis and revamp their growth models.

Left to their own devices, these multi-speed dynamics would translate into higher global growth overall, coupled with larger internal and cross-country disparities – often exacerbated by demographics. The question is whether existing governance systems can coordinate effective intervention to counter the resulting tensions.

Simultaneous progress on both substance and process is needed. Parliaments and multilateral institutions must do a better job at facilitating cooperative policy implementation, which will require a willingness to reform outmoded institutions, including political lobbying.

No one should underestimate the growth challenge facing today’s global economy. The stronger sectors (within countries and across them) will continue to recover, but not enough to pull up the global economy whole As a result, weaker sectors risk being surpassed at an ever-faster pace. These trends will become more difficult to reconcile and keep orderly if governance systems fail to adjust. i About the Author Mohamed A. El-Erian is CEO and co-Chief Investment Officer of the global investment compamy PIMCO, with approximately $1.4 trillion in assets under management. He previously worked at the International Monetary Fund and the Harvard Management Company, the entity that manages Harvard University’s endowment. He was named one of Foreign Policy’s Top 100 Global Thinkers in 2009, 2010, and 2011. His book When Markets Collide was the Financial Times/ Goldman Sachs Book of the Year and was named a best book of 2008 by the Economist.

Source: project-syndicate.com

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> Michael Pettis:

When Do We Call It a Solvency Crisis?

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t a London conference earlier this year, some were a little shocked that the buoyant bond and equity markets are being interpreted as if the worst of the European crisis is behind us. The euro, the market seems to be telling us, has been saved, and peripheral Europe was widely seen as being out of the woods.

Some share my scepticism - including a very senior and experienced banker whose name is likely to be recognized by anyone in the industry.

After I finished explaining why I thought the Euro crisis was far from over, and that I still expected that absent a serious effort from Germany to boost domestic spending – an effort likely to leave the country with rapidly rising debt – at least one or more countries would eventually be forced off the currency, he told the group that he had not made as gloomy a presentation only because he considered it impolitic to sound as pessimistic as I did.

Neither of us, in other words, (and few in the meeting) felt that the recent market enthusiasm was justified. Never mind that the Spanish economy, to return to the country I know best, contracted again in the fourth quarter of last year. It is expected to contract again this year.

Unemployment is still rising and the ruling party is involved in yet another scandal which has driven its popularity down to 20%. Never mind that young Spaniards are emigrating (20,000 a month net), that the real estate market continues to drop, that businesses are still disinvesting and popular anger is extraordinarily high.

“If only I could find even one case in history of a sovereign solvency crisis in which the authorities did not assure us for years that we were facing not a solvency crisis, but merely a short-term problem with liquidity.” from policymakers in both the creditor and the debtor nations that the problem can be resolved with time, confidence, and just a few more debt rollovers.

To take one possibly illuminating example, I started my trading career during the Latin American debt crisis, which officially began in August 1982. I joined the market in 1987, when bankers and policymakers were still assuring everyone that the problem Latin America was facing was a liquidity problem. As long as we could keep rolling loans over, they earnestly explained, the problem would eventually resolve itself at little to no relative cost (well, Latin America was struggling with unemployment, capital flight, hyperinflation and political turmoil, but I guess that doesn’t really count).

The European Central Bank, it seems, is willing to pump as much liquidity into the markets as it needs, so rising debt levels, greater political fragmentation, and a worsening economy somehow do not really matter. This crisis continues to be just a liquidity crisis as far as policymakers are concerned – and not caused by problems in the “real” economy – and the solution of course to a liquidity crisis is more liquidity.

It wasn’t until 1990 that the first formal debt forgiveness took place – known as the Mexican Brady Bond restructuring – and before the end of the decade nearly every country except Chile and Colombia had their own Brady bonds. Even those two countries, and all the others, had managed to obtain for themselves a significant amount of informal debt forgiveness through debt-equity swaps and debt repurchases at huge discounts from face value (some legal and some not quite legal).

But is peripheral Europe really suffering primarily from a liquidity crisis? It would help me feel a lot better if I could find even one case in history of a sovereign solvency crisis in which the authorities did not assure us for years that we were facing not a solvency crisis, but merely a short-term problem with liquidity. A sovereign solvency crisis always begins with many years of assurances

Why did it take so long for bankers and policymakers to recognize the truth, that this was not just a liquidity problem? Actually it did not. Most bankers knew by 1985-86 that the region was actually suffering from a generalized solvency problem, and among the big banks JP Morgan had been taking substantial provisions all along. No one could formally acknowledge

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the possibility of insolvency, however, because to have done so would have required that all of banks take much greater provisions than they already had. This would have created a problem.

Of the top ten banks in America, only JP Morgan would not have been technically insolvent had the banks been forced to mark their Less Developed Countries (LDC) loan portfolios to market.

In May 1987 Citibank, after many years of replenishing its capital, was able to announce suddenly and to the great surprise of the entire market that it had decided to take a huge amount of provisions against dodgy sovereign loans. By 1989-90 the rest of the big American banks were also able to accept the write-offs without becoming technically insolvent. That is when everybody formally “discovered” that in fact the LDC debt crisis was a lot more than just a liquidity crisis.

This is the key point. The American bankers were not stupid. They just could not formally acknowledge reality until they had built up sufficient capital through many years of high earnings – thanks in no small part to the help provided by the Fed in the form of distorted yield curves – to recognize the losses without becoming insolvent.

And this matters to Europe. There is simply no way European banks, especially in Germany, can acknowledge the possibility of sovereign insolvency until they, too, have built up enough capital to absorb the losses. They have, unfortunately, been painfully slow to do so, even with yield-curve help from the ECB, and so I suspect that this is going to remain a “liquidity” problem for many more years. While it does, the debt-burdened countries of peripheral Europe are going to suffer a decade of weak growth, high unemployment, and contentious politics, all the while the debt growing faster than the economy.

The new gold bloc Or the peripheral countries can regain competitiveness quickly by leaving the euro, in which case after a year or so of confusion growth would return almost immediately, especially in countries like Spain that have managed to put into place a number of very important labour market reforms. The historical precedent is clear.

Crisis-stricken countries that have forced through robust reforms to address their comparative lack of competitiveness will continue to struggle under the burden of high debt and an overvalued

Spring 2013 Issue

“In Spain, you are not really supposed to talk about abandoning the Euro if you want to be taken seriously.�

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currency, but once they directly address both, growth usually returns quite quickly.

And there have been real reforms in Spain for all the grumbling. Several Euro-optimists have pointed out that unit labour costs in Spain have dropped substantially relative to Germany, by as much as 6 or 7 percentage points. So this whole reform process is working, they claim, and if we can just wait it out another year or two Spain will be fully competitive again.

I am not so sure. Although I agree that there have been real economic reforms, I am a lot less sanguine about the ability of these reforms to stave off the crisis. First, the reforms have come at a huge social cost, and it is not obvious that people can suffer much longer than they already have. After all we know how to force down unit labour costs. It is really quite easy. High unemployment usually does the trick.

The problem is that Spain, after four years of punishingly high unemployment, has only clawed back in labour competitiveness about one-third of what it needs to claw back in total, and Madrid has already picked most of the low hanging fruit.

As brutally difficult as this has been, this was the easy part. For Spain to claw back other 10-15 percentage points in unit labour costs, and it may need more, may well be beyond the capacity of the population to endure.

Second, labour is only one factor in international competitiveness. Capital is the other, and everyone is in a hurry to forget this. It is hard to calculate the appropriate trade-off, but while relative labour costs in Spain have certainly

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“The bankers just could not formally acknowledge reality until they had built up sufficient capital through many years of high earnings – thanks in no small part to the help provided by the Fed in the form of distorted yield curves – to recognize the losses without becoming insolvent.” declined, the relative cost of capital has just as certainly risen, and probably by a lot more (to the extent that businesses can even get capital).

At best we can say of the combination of lower labour costs and higher capital costs that there has been a transfer of resources from the capital-intensive parts of the economy to the labour-intensive parts. Aside from the fact that this probably does not bode well for future productivity growth, it suggests that for all the pain of reform Spanish businesses still cannot compete.

Some people might argue – and do – that the sharp contraction in Spain’s current account deficit, from 5% of GDP in 2008 to around 1%

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today, shows that Spain has indeed become more competitive, but this of course is not at all obvious. Much of the “improvement” seems to have occurred because of a drop in imports, which suggests greater export competitiveness has not played much of a role here – which it should not have done if I am right about the impact of higher costs of capital in eroding the benefits of lower labour costs.

Unemployment levels well above 15-20% (and I assume official unemployment of 26% is probably overstated by the failure to account for the “black” economy) are an incredibly effective way of forcing a trade deficit to contract, because when people cannot buy anything, they also cannot buy tradable goods. As they stop purchasing those tradable goods however these goods would necessarily have been diverted to exports, even without any improvement in the country’s overall competitiveness.

This might imply that whatever increase in exports we have seen may be no more than the export of goods that Spaniards used to buy but no longer can. This kind of export performance is not a consequence of improved competitiveness. It is simply a consequence of rising unemployment.

What is more, if Spain is ever going to repay its very rapidly rising debt, it needs a lot more than a lower trade deficit. It needs a very high trade surplus to fund net capital outflows (unless we are expecting an unlikely surge in net private capital inflows). Actually to be technically correct I should say that in order to repay its debt Spain needs a very high current account surplus, and given Spain’s huge interest burden, this actually

Spring 2013 Issue

Madrid: Royal Palace

means it needs a whopping trade surplus since the trade surplus has to exceed the interest outflows before it can be used to pay down debt.

If unemployment is the best tool to get us there, I am not sure the Spanish population can bear the burden needed to get us the necessary high trade surplus.

So in spite of the good news in the Spanish bond markets, I still do not think we can pop the champagne corks. Except for the debt refinancing costs, the underlying fundamentals have not gotten better in the last six months. At best they are unchanged, and probably they are worse.

How long must Spain hold on to prove how serious it is about staying the course? A lot longer, I think. After all it was not until around 1931-32 that France began suffering from its

membership in the gold bloc, but they doggedly held on until 1936 when they finally threw in the towel and devalued. The Spaniards are proving tougher than the French were, possibly because among the older generation (although not so much the younger) there is a tremendous residual worry (and shame) that Spain might not truly be European, and this is creating much of the loyalty to Europe, of which the Euro is the great symbol.

But the Spanish still have a lot of pain to absorb.

By the way, if we were to see an intensification of the debate in France about the Euro, I suspect that this will give a green light to Spanish public intellectuals, for whom France is the North Star, to discuss the prospect themselves. Until then, in Spain you are not really supposed to talk about abandoning the Euro if you want to be taken seriously. It is a little like England in the

1920s, when for much of the policymaking elite abandoning the country’s free trade principles and leaving gold were unmentionable – until many years of unemployment suddenly made both policies very “mentionable” in the first years of the 1930s.

In my opinion the happy bond markets are, as they have so often been under similar circumstances in history, a little premature.

I think the phrase “there is light at the end of the tunnel” was popularised by Herbert Hoover around 1931, when the US stock markets staged a strong rally, convincing him and others that the crisis was over. Of course it was not and the buoyant markets gave back everything and more over the next three years. i

Source: www.mpettis.com. Edited extract from Michael Pettis Newsletter of March 21, 2013.

About the Author Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is also Chief Strategist at Guosen Securities (HK), a Shenzhen-based investment bank.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt.

Pettis has been a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University.

He can be contacted at michael@pettis.com

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> Ross Jackson, PhD:

Tackling the Global Crisis With crisis all around us at this critical time in history, it is time to start asking ourselves some hard questions that are not normally part of the daily political discourse. Let us step back for a moment and take a realistic look at the global status quo. he very first thing that requires recognition is the fact that the current economic/political world order today is totally dysfunctional - ecologically, economically and socially. The system is simply not working for the great majority of world citizens. It is time that we seriously ask ourselves why this is happening to us. The latest example is the Cyprus crisis, which is a direct spinoff of the southern European economic crisis, which in turn is a spinoff of an even greater systemic problem.

In many European states, the same underlying causes are slowly destroying our welfare states and social cohesiveness. If we do not soon come to grips with the underlying causes, we can look forward to further deterioration of our society and our environment.

T

The Underlying Cause It is my thesis that all of these crises are a direct and predictable result of major changes in the global economic/political structures, which were introduced roughly thirty years ago without any public debate. The new structures - which were a reversal of the previous, widely successful economic policies of what many have called the “Golden Age” from 1945-1980 - go under the name of “neoliberal economics”. The major instruments of the changes were the three international organizations, the World Trade Organization (WTO), the International Monetary Fund (IMF) and the World Bank, all three more or less under the control of the USA. All three reversed their policies and original mandates without any public debate during the regimes of President Ronald Reagan in the USA and Prime Minister Margaret Thatcher in the UK. “Neoliberalism” was from the beginning a political project having nothing to do with economic science, a plan purposely designed to further the interests of a very small, wealthy elite, who control the great majority of multinational corporations. In 2010, the top 1% in the USA owned 64.4% of all American financial securities, and 62.4% of all business equity.

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“The underlying economic philosophy, which Joseph Stiglitz, former chief economist of the World Bank has called “more religion than economics”, has dominated international relationships for the last thirty years.”

The project was carried out purposely, cleverly, and with great success from the point of view of its promoters, resulting in an enormous transfer of wealth from the middle class and the nonprofit sectors of society—the environment, communities, and social welfare— to the already wealthy. Among other things, it was specifically designed to destroy the European welfare state, and is well on its way to doing so. Susan George, honorary president of ATTAC, calls it “one of the greatest hold-ups of ours or any generation.”

The results of the neoliberal experiment are now clear to everyone after thirty years: 1. Unprecedented degradation of the environment; 2. Increasing inequalities between rich and poor countries and within all countries as the rich have become richer and the poor have become poorer; 3. No increase in well-being in spite of substantial economic growth.

The underlying economic philosophy, which Joseph Stiglitz, former chief economist of the World Bank has called “more religion than economics”, has dominated international relationships for the last thirty years. Neoliberal economics was specifically designed to benefit the strong over the weak, capital over labour,

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creditors over debtors and the wealthy over the poor, but was cynically and cleverly packaged as a way to benefit all world citizens. Its claim was that all would benefit from its recommended economic policies: the free flow of goods without tariffs; the free flow of capital across borders; deregulation of corporations; and the privatization of public monopolies. It is a system designed to meet the wildest dreams of multinational corporations who wish to be able to operate in any country as they please without restrictions and with no democratic or moral responsibility to anyone.

Naturally, corporate interests in all countries are attracted by this concept as they stand to benefit, and they lost no time telling their politicians so in 1994. That was what made it possible to dupe an unsuspecting public into acceptance of a WTO that is now the major hindrance to achieving a sustainable future for this planet and a threat to our very survival. All of the premises of neoliberal economics are demonstrably false, yet it has been marketed cynically and successfully. Most of the allies of the USA and the UK bought into the concept, not realizing that it was a recipe for the destruction of both the environment and democracy. American philosopher and former professor of politics at Princeton University Sheldon Wolin is one of the USA’s leading political theorists. He calls the political system which has evolved in America “inverted totalitarianism... the political coming of age of corporate power and the political demobilization of the citizenry”.

John Gray, professor of European Thought at the London School of Economics puts it this way: “Those who seek to design a free market on a worldwide scale have always insisted that the legal framework which defines and entrenches it must be placed beyond the reach of any democratic legislature.” Gray shows that “democracy and the free market are rivals, not allies.” The WTO and IMF are both excellent examples of such undemocratic institutions.

Spring 2013 Issue

“Neoliberal economics was specifically designed to benefit the strong over the weak, capital over labour, creditors over debtors and the wealthy over the poor, but was cynically and cleverly packaged as a way to benefit all world citizens.”

Source: www.footprintnetwork.org

Among other things, neoliberalism is a threat to our very survival as a species. Anyone in doubt should listen carefully to James Hansen, former director of the NASA Goddard Institute, and probably the most knowledgeable person on global warming, who stated recently that if Canada and the USA implement their current plans to fully exploit the Alberta tar sands and shale gas, then “it will be game over for the climate”, meaning irreversible out-of-control warming.

From the viewpoint of our politicians, they see little choice. “Reforms”, they claim, are necessary to meet the competition from abroad if we are to maintain jobs in our country, meaning lower wage growth, cuts in welfare even for the poorest segments of society, and tax breaks for corporations to meet the competition. But this way of defining the problem takes the neoliberal model as given—a model, which was designed to force precisely these austerities upon us, and for the benefit of foreign commercial interests.

The Political Dilemma Globally, we are currently consuming roughly 50% more renewable resources each year than nature can replenish, as shown by the most recent report from the World Wildlife Fund and illustrated in the chart above. This situation is untenable, potentially suicidal, and totally removed from any public debate, where politicians still imagine they are operating in a world that existed 60 years ago, when the global ecological footprint was only about 50% of world biocapacity, and more economic growth was a reasonable goal. In a world of 50% overconsumption, that goal has become absurd.

The Race to the Bottom The international playing field is not level. In a world of free markets and unrestricted capital flow, no country, and especially not a small developing country, has the slightest chance of competing with sociopathic multinational corporations that are often larger than most countries, that exploit Asian sweatshops with near slavery conditions, that minimize their tax contribution to society with the use of tax havens and transfer pricing, which use their considerable muscle to obtain all kinds of financial concessions wherever they operate, and are under no pressure to be either socially or environmentally responsible. A local company that wants to compete successfully with the multinationals under WTO rules has little choice but to leave its home country and try to follow the same policies, in what is a race to the bottom, environmentally, socially, and economically.

Those with a higher moral standard that stay behind and try to develop more environmentally friendly production technologies are penalized

by WTO rules that reward those who are best at exploiting the environment.

“In 2010, the top 1% in the USA owned 64.4% of all American financial securities, and 62.4% of all business equity.”

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But, you might say, can the local government not put tariffs on foreign imports produced under lower environmental standards and protect leading edge innovative domestic industries?

Surely that is the logical solution if we want to become sustainable? No, they cannot, under WTO rules, which were written by corporations for corporations, without regard for the consequences for the environment, the welfare state or social considerations, and which just about every major country accepted in 1994 or since, against the wishes of the developing countries and without any public debate. This WTO rule is, in my opinion, the single most important barrier to a sustainable future, and the major reason why insufficient progress is being made in the technological innovation that is necessary if we are ever to live in a sustainable world. This rule also explains why the EU CO2 emissions quota system has never worked and will never work as intended. If the quota costs were high enough to have a real effect on technologic research, major European companies would be forced either to leave the EU to survive or stay and lose market share to foreigners with lower standards. It is as simple as that.

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The EU leadership, under the influence of its corporate sector, has also bought into the dysfunctional neoliberal philosophy. It was reflected in the charter of the European Central Bank established in 1998 with the sole objective of keeping inflation down without consideration of the effects on unemployment. It was also reflected directly in the subsequent proposal for a formal EU constitution that would have institutionalized neoliberal economics as EU policy, but which was fortunately rejected by referenda in France and the Netherlands in 2005. It is also central to the current eurozone crisis, as the political leadership forces austerity on its citizens in an effort to protect creditor banks from absorbing their speculative losses.

What can We Do? The opposition to change in the status quo is so massive that totally new thinking is required for those who want to put an end to it. While a vast majority of world citizens is dissatisfied and would support radical change, no imaginable initiative from civil society can do the job, as NGOs are fragmented into too many separate parts that cannot realistically act together without outside help in what must be a global initiative to

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succeed. But there is another possibility.

In Occupy World Street, I have put forward a concrete design for a radically new global political/economic world order that is more in keeping with what the vast majority wants, and a strategy to get there. I can only touch on it briefly here. The key is to show the world that a sustainable and just alternative to neoliberalism is not only possible, but exists on the ground. To do so requires cooperation between a few small countries who are prepared to take the initiative to form a new international organisation among their members, and civil society around the world that will give their backing once the new organization is established. This is a strategy of leading by example, the only kind of leadership worthy of the name; an example of what Mahatma Gandhi called “being the change you want to see in the world”.

The most important thing required to bring it about is the courage of a small number of visionary political leaders who are prepared to stand up and say to the world, “We have had enough. From now on we are going to do things differently. Please join us.” i

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about the author Ross Jackson is chairman of the charitable association Gaia Trust, Denmark, major shareholder of organic foods wholesaler Urtekram, and author of Occupy World Street: A Global Roadmap for Radical Economic and Political Reform.

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tly in the third supportive financial market environment and the growth turnaround in the housing market have helped to n sources of improve household balance sheets and should Outlook: onomies, underpin firmer consumption growth in 2013. The > IMF World Economic pected,Gradual and projections, however, are During predicated on the Upturn in Global Growth 2013 sed on the assumptions in the October 2012 WEO that the Bond spreads spending sequester will be replaced by back-loaded lobal growth is projected to increase because the effects of temporary factors, ile prices during for2013, as the factors measures andeuro thearea pace of fiscallived withdrawal (at the “The continues underlying such as the car subsidy and disruptions to trade soft global activity are expected to with China, will subside. And a sizeable fiscal to pose a large downside stimulus package subside. Policy actions have lowered government level) in 2013 further monetaryat easing se globally. general willandremain acute crisis risks in the euro area and the risk to the global outlook. will give growth at least a nearterm boost, with States. But in the euro area, the return to from a pickup in external demand and mained United strong.

1¼ percentInofparticular, GDP. risks of support recovery after a protracted contraction is delayed. a weaker yen.

G

prolonged stagnation Growth in emerging market and developing in the euro area as a economies is on track to build to 5.5 percent in The near-term outlook for the euro area has been 2013. Nevertheless, growth is not projected to whole will rise if the rebound to the high rates recorded in 2010–11. revised downward, even though progress national policies have in underpinned much momentum for reform is Supportive of the recent acceleration in activity in many not maintained.”

But weaknesspolicy in advanced economies adjustment and a strengthened economies.

EU-wide

While Japan has slid into recession, stimulus is expected to boost growth in the near term.

At the same time, policies have supported a modest growth pickup in some emerging market economies, although others continue to struggle with weak external demand and domestic bottlenecks. If crisis risks do not materialize and financial conditions continue to improve, global growth could be stronger than projected.

However, downside risks remain significant, including renewed setbacks in the euro area and risks of excessive near-term fiscal consolidation in the United States. Policy action must urgently address these risks.

urther in the ad set of ion and trade will weigh on external demand, as well as on the outlook for euro the euro area has beencrisis revised terms of trade of commodity given and the engthen response term to the area reduced tailexporters, risks downward, even though progress in national assumption of lower commodity prices in 2013 and a strengthened EU-wide policy in this Update. k in global improvedadjustment financial conditions for sovereigns in the response to the euro area crisis reduced tail risks and improved financial conditions for sovereigns Moreover, the space for further policy easing has ctors, periphery.

Activity now expected tosupply contract in the periphery. Activityis is now expected to diminished, while bottlenecks and by policy Economic conditions improved modestly in the contract by 0.2 percent in 2013 instead of uncertainty have hampered growth in some third quarter of 2012 (Figure0.2 1), with global expanding 0.2 percent.instead This reflects delays economies (for example, Brazil, ation (mainly percent inby2013 of expanding

by India). Activity growth increasing to about 3 percent. The main in the transmission of lower sovereign spreads in Sub-Saharan Africa is expected to remain emerging market and improved bank liquidity to private sector robust, with a rebound from flood-related d and sources newof acceleration were 0.2 percent.

This reflects delays in the transmission economies, where activity picked up broadly as borrowing conditions, and still-high uncertainty output disruptions in Nigeria contributing to an and the United States, where growth about the ultimate resolution of the crisis despite in overall growth in the region in area expected, of lower sovereign andacceleration improved bank surprised on the upside. Financial conditions recent progress. During spreads 2013, however, these 2013. stabilized. Bond spreads in the euro area brakes start easing, provided that the planned declined, while prices for many risky policy to addresssector the crisis continue to Against this backdrop, the projections implyand that d, withperiphery some liquidity to reforms private borrowing conditions, assets, notably equities, rose globally. Capital be implemented. global growth will strengthen gradually through emerging markets remained strong.

2013, averaging 3.5 percent on an annual basis, kness flows to tothe The near-term growth outlook for Japan has not a moderate uptick from 3.2 percent in 2012. A Global financial conditions improved further in been downgraded despiteGDPG renewedrowth recession. further strengthening to 4.1 percent is projected Figure 1.

G lobal cted further in of 2012. However, a broad Activity the fourth quarter is expected to expand by 1.2 percent for 2014, assuming recovery takes a firm hold in (Percent; quarter over quarter, annualized) set of indicators for global industrial production and trade suggests that global growth did not strengthen further. Indeed, the third-quarter uptick in global growth was partly due to temporary factors, including increased inventory accumulation (mainly in the United States). It also masked old and new areas of weakness.

Activity in the euro area periphery was even softer than expected, with some signs of stronger spillovers of that weakness to the euro area core.

In Japan, output contracted further in the third quarter.

h in the United in 2013, rising ear (Table 1). from the Turning to the updated outlook, growth in the States is forecast to average 2 percent nomicUnited in 2013, rising above trend in the second half the year. In particular, a supportive financial ar, a ofmarket environment and the turnaround in the housing market have helped to improve household balance sheets and should underpin firmer consumption growth in 2013. The near-

in 2013. The recession is expected to be short-

8 7 6

Emergingand developingeconomies

5 4 3

World

2 1

Advancedeconomies

2011

12

Figure 1: Global GBP Growth (Percent, quarter over quarter, annualised). Source: IMF staff estimates.

Source: IMFstaff estimates.

46

the euro area economy.

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0 -1 -2 13: Q4

Spring 2013 Issue

Policy Action Is Needed to Secure the Fragile Global Recovery The policy requirements outlined in the October 2012 WEO remain relevant. Most advanced economies face two challenges. First, they need steady and sustained fiscal consolidation.

Second, financial sector reform must continue to decrease risks in the financial system. Addressing these challenges will support recovery and reduce downside risks.

The euro area continues to pose a large downside risk to the global outlook. In particular, risks of prolonged stagnation in the euro area as a whole will rise if the momentum for reform is not maintained. Adjustment efforts in the periphery countries need to be sustained and must be supported by the center, including through full deployment of European firewalls, utilization of the flexibility offered by the Fiscal Compact, and further steps toward full banking union and greater fiscal integration.

In the United States, the priority is to avoid excessive fiscal consolidation in the short term, promptly raise the debt ceiling, and agree on a credible medium-term fiscal consolidation plan, focused on entitlement and tax reform.

In Japan, the priority is to underpin the renewed emphasis on raising growth and inflation with more ambitious monetary policy easing, adopt a credible medium-term fiscal consolidation plan anchored by the consumption tax increases in 2014–15, and raise potential growth through structural reforms. Absent a strong mediumterm fiscal strategy, the stimulus package carries important risks. Specifically, the stimulusinduced recovery could prove short lived, and the debt outlook significantly worse.

In China, ensuring sustained rapid growth requires continued progress with market-oriented structural reforms and rebalancing of the economy more toward private consumption. In other emerging market and developing economies, requirements differ. The general challenge is to rebuild macroeconomic policy space. The appropriate pace of rebuilding must balance external downside risks against risks of rising domestic imbalances. In some economies with large external surpluses and low public debt, this entails a lower, more sustainable pace of credit growth and fiscal measures to support domestic demand. In others, fiscal deficits need to be rolled back further, while monetary tightening proceeds gradually. Macroprudential measures can help stem emerging financial excesses. In the Middle East and North Africa region, many countries will need to maintain macroeconomic stability under difficult internal and external conditions. i

Source IMF World Economic Outlook. Released: In Washington, D.C., January, 23, 2013

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> OECD:

Fiscal Consolidation, Growth and Income Inequality – How to Get It Right

T

he crisis affecting OECD economies is now in its sixth year, yet sizeable efforts are still needed to put government finances back on a sustainable base while preserving growth. At the same time, pressure is mounting to tackle the deepening social problems with policies to reduce exclusion and inequality. It is a difficult balancing act, which few countries can ignore. Indeed, the two largest OECD economies, the US and Japan, are among those countries requiring the most fiscal consolidation of all, of the order of 10% of GDP. Consolidation requirements are also large in troubled countries of the euro area and the UK. What impact will such prolonged and significant policy efforts have? Fiscal consolidation strategies, however important, have been questioned for adding to the woes of already struggling economies, and leading to even higher unemployment and more social hardship. We can gauge this by looking at the so-called fiscal multipliers–the decline in economic growth for every 1 percentage–point reduction in the government’s fiscal deficit. Though there is some debate about the size of these multipliers, which vary widely across countries and at different times, it is clear that their size was underestimated. They are higher than usual, largely because low or zero interest rates are making it harder for monetary policy to offset the adverse impact of austere fiscal policies.

Moreover, when many countries that interact together tighten policy at the same time, the negative impact is exacerbated as the chill wind of austerity in one country is felt among trading partners. Yet governments have little choice but to forge on with consolidation, given very high levels of public debt and the need to restore financial market confidence. Indeed high and growing debt ultimately depresses growth and increases fragility.

A major policy concern is how this austerity will affect income inequality. A trend increase

“According to current consolidation plans, most governments aim to improve the budget primarily via spending restraint. ” in income disparities was already a concern in many OECD countries prior to the financial crisis, but it has likely widened since. The Gini coefficient for disposable income–this measures income distribution, whereby a value 0 means all households receive the same income, and 1 means just one household receives all income– has risen from an average of around 0.25 in the mid-1980s to around 0.3. Moreover, the financial crisis has drawn attention to excessive and distorting incentive pay in the financial sector, which many people believe to be a key culprit in the crisis.

There is real risk that fiscal consolidation will worsen this inequality, sparking more social anger that can threaten even the most carefully designed and legitimate consolidation programmes, or even destabilise public institutions, including the EU. There is also some discussion as to whether widening inequality can in turn undermine growth too. For instance, the concentration of income and wealth among the few can spur reckless financial decision making to the detriment of growth. Also, there is a danger that declining incomes or a rise in poverty will affect productivity.

The situation is grave. According to current consolidation plans, most governments aim to improve the budget primarily via spending restraint. Social security transfers are planned to decline in cyclically-adjusted terms in about half of all OECD countries, while adjusted household income taxes will increase in most of these countries. The net redistributive effect of all

measures combined is likely to be negative. This has to be avoided.

Fortunately, despite all the tightening to date, there is still scope for countries to adjust their fiscal consolidation efforts and redesign them in such a way so as to achieve more fiscal sustainability, more growth and more equity too.

To do this, governments must act on both sides of the fiscal equation, while also introducing structural reforms.

On the expenditure side, cutting benefits and other cash transfers often significantly increases inequality. However, cuts can be designed to have less impact on lower earners, and be supplemented by structural measures in a way that minimises, or even eliminates, any adverse effects on wealth distribution.

For instance, cuts in unemployment-related benefits tend to hit poorer people most, particularly when weak economic activity prevents an offsetting rise in employment. Such cuts might not be desirable during deep and protracted downturns such as the present one.

Moreover, there is still considerable scope among OECD countries to improve benefit-tax systems, including disability benefits, to encourage higher employment and greater equity. Such measures should be reinforced by structural reforms, for example, to support unemployment policies that keep the unemployed in touch with the labour market, and by making it easier to set up and run businesses, so generating revenue and creating jobs.

Raising the effective retirement age would be another good place to take action. Many people still retire young, compared with today’s robust life expectancy, and this often means a drop in income. Later retirement has the potential to raise earnings and so reduce income inequality, as well as giving economic activity a boost.

True, acting on this will not produce immediate budgetary savings, but addressing it should at

“Fiscal consolidation strategies, however important, have been questioned for adding to the woes of already struggling economies, and leading to even higher unemployment and more social hardship.”

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Spring 2013 Issue

0.50

Scenario

Benchmark 0.45

0.40

0.40

0.35

0.35

0.30

0.30

0.25

0.25

0.20

0.20

0.000

SVN DNK NOR CZE SVK FIN SWE BEL AUT LUX FRA NLD IRL DEU ISL CHE POL EST ESP CAN NZL JPN AUS ITA GBR PRT ISR USA CHL

0.45

C. Absolute change in Gini due to an increase in direct household taxes of 3% of GDP

0.035 0.030

-0.010

0.025

-0.015

0.020

-0.020

0.015

-0.025

0.010

-0.030

0.005

-0.035

0.000 SVN DNK NOR CZE SVK FIN SWE BEL AUT LUX FRA NLD IRL DEU ISL CHE POL EST ESP CAN NZL JPN AUS ITA GBR PRT ISR USA CHL

-0.005

least reassure financial markets that the longterm fiscal outlook is in safe hands.

Education and health care reforms should also rank highly on the policy agenda since these areas are both big-ticket spending items and vital for social well-being and progress. Most countries have substantial margins to improve the efficiency of health and education provision, allowing for large savings without compromising equity or service quality, and possibly improving both. However, such gains might take several years to fully materialise and could lower employment growth in the near term.

The revenue side of fiscal policies merits particular attention, since cutting certain tax expenditures can increase both equity and economic growth. Many tax expenditures have been introduced without serious welfare considerations, although there are exceptions like income tax credits and payroll tax rebates

Scenario

SVN DNK NOR CZE SVK FIN SWE BEL AUT LUX FRA NLD IRL DEU ISL CHE POL EST ESP CAN NZL JPN AUS ITA GBR PRT ISR USA CHL

Benchmark

B. Gini of disposable income before and after a reduction in transfers of 3% of GDP

D. Absolute change in Gini due to a reduction in transfers of 3% of GDP

SVN DNK NOR CZE SVK FIN SWE BEL AUT LUX FRA NLD IRL DEU ISL CHE POL EST ESP CAN NZL JPN AUS ITA GBR PRT ISR USA CHL

0.50

A. Gini of disposable income before and after an increase in direct household taxes of 3% of GDP

“Meanwhile, tax hikes that can bolster equality and have relatively little impact on longterm growth, such as on real estate, should be considered.� for low-wage workers. The value of many other tax reliefs - including tax breaks for health and child care, education, owner-occupied housing and various saving schemes -often increases for earners in higher tax brackets. This is costly and hardly helps improve equity, and should be addressed.

Meanwhile, tax hikes that can bolster equality and have relatively little impact on long-term growth, such as on real estate, should be considered. However, serious consideration must first be given to the state of the housing market,

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which has been struggling in many countries.

Moreover, to be effective, additional measures, such as carrying out proper (and possibly costly) valuation of property, might be needed.

Meanwhile, hikes in capital income taxes would be positive for equity and do not necessarily distort growth, while shifting tax burdens away from labour and towards green consumption taxes for instance would also bring benefits.

Though fiscal consolidation must continue for a while, progress especially in Europe has been substantial as many countries, are taking the right steps. If more similar reforms had been made in the past couple of years, the benefits may already be starting to lift the economy.

Hopefully we have seen the bottom of the crisis but there is still time for policymakers across the OECD area to carry out reforms and give more weight to the tax expenditure side of the fiscal equation, for the sake of restoring sustainable growth and improving equality too. i

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> Spring 2013 Special: Ten Prominent Business School Leaders

T

he global demand for business education continues to grow apace and the challenges and opportunities businesses face are becoming increasingly more complex and intertwined. At CFI.co we take the view that there has probably never been a more exciting time to be the dean of a business school. We have selected ten business school leaders who are currently helping shape the changes taking place in business education. We noticed after deciding on the educators to be included in our list that we had omitted quite a few of the usual suspects.

This probably reflects our view that the ranking system that now influences the way the quality of business education is perceived is not always helpful or even constructive. This really is a debate for another day but it does appear that the management of many schools now need to keep one eye on ranking metrics when making important decisions. It is unclear that this results in any real and lasting benefits. We hope you enjoy our list as we believe that each of the business school leaders featured here is playing an important role in encouraging and nurturing strong future business leaders.

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Spring 2013 Issue

> Professor Doug Guthrie George Washington University School of Business Prof. Doug Guthrie is the dean of the George Washington University School of Business. Of course he is a most accomplished academic but interestingly also an expert on China. Guthrie has sometimes come in for criticism as being too proChina but we would suggest that he is a business school leader well worth listening to. He has a deep understanding of China’s development and how its culture impacts that development and has brought this knowledge to the School.

With the ever-growing importance of the Chinese

economy and the country’s increasing political influence, the guidance Prof Guthrie provides should put George Washington University right at the top of the list for business students who truly want to understand China. Not just what is happing in the first tier cities but also how China’s development is creating opportunities right across the country. There is far more to Doug Guthrie than his China expertise but we feel that the Dean’s deep political and economic knowledge of the country is having a real impact.

> Professor Sally Blount Kellogg School of Management Prof. Sally Blount is the dean of Kellogg School of Management. Kellogg is very much seen as a competitor to some of the big names in business education and as such has always needed to be an innovator. Blount is certainly continuing in that tradition. Her academic background is not that of an economist (she is a social psychologist) but given that perhaps the most important skill you can learn at business school is how to build effective organisations it does seem surprising that there are not more deans with Prof. Blount’s academic background. Since becoming dean in 2010, she has been continuing to lead Kellogg in its innovative tradition - positioning the school to understand and teach the skills required by management in the 21st Century. Prof. Blount is an academic who understands the need for pure research and how to apply and pass on that knowledge. The role of a leader in a school like Kellogg is very much that of identifying the big questions concerning business interactions with society and in Prof. Blount the School has a leader who can efficiently focus that research and help teach the benefits of its findings.

> Professor Alice Guilhon Skema Prof. Alice Guilhon is the dean of Skema, the new business school created through the merger of Lille School of Management and Ceram, in Sophia Antipolis, France. Under her leadership Skema has opened campuses on two technoparks, one in China (Suzhou) and the other in the United States (Raleigh, North Carolina). She is practising what she preaches as a professor of strategy and entrepreneurship. With the globalisation of education the strategy of merging is a clear way forward meeting the demand from students for truly international education and CFI.co | Capital Finance International

Skema has firmly established itself as a brand in the business education market place. Under Prof. Guilhion Skema is taking shape not only as new educational force in Europe but on the global stage too. This charismatic dean has set a benchmark on how business education can globalise but - just as importantly - she recognises that there is limit to how large even an international school can become and still remain coherent. While many others have been discussing how to internationalise, Prof Guilhon has reached the implementation stage.

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> Professor Samir Barua Indian Institute of Management Prof. Samir Barua’s tenure as Director of Indian Institute of Management, Ahmedabad will have ended by the time you read this piece. Under his leadership, IIM-A has firmly established itself as one of the world’s leading Business Schools.

Prof Barua is rare among heads of business schools in that his whole career has been spent at IIM-A (having signed up for his PhD in 1976 he never left). His deep understanding of the institution has paid dividends over the past five years of Barua’s leadership. The increasing international recognition is due in no small part

to his management of the school’s faculty. Never an easy task, Prof. Barua has quietly moulded the faculty and IIM-A is increasingly seen as an important centre for thought leadership.

Research is blossoming with its inevitable feedback into teaching. Prof. Barua helped build on almost 50 years of strong foundations at IIM-A when he took over the reigns in 2007 and he paved the way for the school to be consistently ranked among the world’s leading institutions for business and management.

> Dr. Maria de Lourdes Dieck-Assad EGADE Dr. Maria de Lourdes Dieck-Assad is the rector of EGADE, one of Latin America’s leading business schools. It is always worth taking note when business school leaders spend a significant part of their career outside academia.

In Dr. Dieck-Assad’s case her experience goes to the heart of Mexican government as she was an ambassador and also served as chief of the Mexican Mission to the European Union. Her understanding of cross-sector relationships between business, government and academia is helping drive the school forward. Under her guidance EGADE is becoming recognised not just as a leading Latin American school but as a true centre of excellence providing Mexican and international students with a real understanding of global business. Of particular interest is the work being done on project adaptation and how it can help mitigate risk - and more importantly, the effort put into creating real world solutions and spreading the knowledge to stakeholders in particular those running SMEs.

> Professor Colm Kearney Faculty of Business and Economics at Monash University

Prof. Colm Kearney is currently dean of the Faculty of Business and Economics at Monash University. With many Asian students now looking to Australia for their higher business education as an alternative to US or European schools, Prof. Kearney’s international experience and 52

business and finance expertise further enhance Monash’s reputation as an important centre of academic excellence. The Monash objective is triple crown accreditation over the next few years and the engagement of strong new faculty.

Prof. Kearney’s academic reputation, undoubted CFI.co | Capital Finance International

leadership skills and personal experience of accreditation matters are going to help push Monash to the elite level of business schools.

Prof. Kearney is one of a generation of deans whose mobility and broad experience is part of the global convergence of education.

Spring 2013 Issue

> Sir Andrew Likierman London Business School The London Business School benefits enormously from Prof. Likierman’s broad experience. Unlike many deans, Sir Andrew has spent much of his career outside academia working in both the private and public sectors with appointments that have included running a textile factory in Germany and heading up the government’s accountancy service. This business experience has helped maintain the School’s sense of intellectual freedom and diversity. Prof. Likierman’s return to academia as dean has undoubtedly further enhanced the reputation of the School. By all accounts, he is a stickler for academic integrity and this suits the ethos of the London Business School which is not to take a fixed view on the world (in contrast to many of their American counterparts). This has helped maintain a strong faculty against competition from better endowed rivals. With his academic rigour, management experience and strong leadership and a characteristically British style the School has managed to expand to what must be close to full capacity. Rather like London’s international hub Heathrow, Prof.

Likierman has taken the School to the point where without physical expansion the School has reached its limit.

> Professor Bernard Yeung National University of Singapore Business School It seems rather appropriate that Prof. Bernard Yeung, dean of National University of Singapore Business School is truly a global citizen. He holds three nationalities and is part of the growing trend that has seen top academics returning to their native Asia. Under his stewardship, NUS is attracting top faculty from across the globe and recreating the concentration of academic talent found in leading western institutions. This concentration of talent is key because - given the need for the development of the region - it is not going to be possible to rely on existing text books. New ideas and better understandings must be nurtured as rapidly growing Asia takes full advantage of the industrial, scientific and economic knowledge that has been build up over the past hundreds of years. Prof. Yeung is at the forefront of creating the kind of academic institution that Asia needs and it is clear that NUS will be producing graduates that can take full advantage of the opportunities that abound and avoid the pitfalls as Asian economies converge with those of the developed world.

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> Professor Christine Riordan Daniels College of Business - University of Denver Prof. Christine Riordan is a perfect example of a dean who practices what she preaches. Riordan has a reputation as an expert in leadership and ethics and under her own leadership, Daniels has blossomed into an internationally recognised academic community. Prof. Riordan has strengthened all aspects of Daniels but of particular interest to us is the way in which she has increasingly engaged the school with the local community. The approach Daniels has shown is really paying dividends - not just in terms of boosting endowments but also in helping strengthen faculty and, most importantly, driving the educational and career opportunities open to students. More and more, Daniels is seen as a centre of excellence and is an integral part of driving the local economy.

Prof. Riordan has shown what strong and focused leadership can achieve: when she took over as dean, Daniels did not feature in the rankings but has now established itself as a top ranked school. Her leadership stands out as an example of what is possible to deliver given focus and determination.

> Andrey L. Kostin St. Petersburg University GSOM Andrey L. Kostin is the Dean of the St. Petersburg University GSOM. He fits this role around an already very busy business life. For most business school deans the role is full time but GSOM rather than engage a full time dean elected Dr Kostin. This was an interesting decision given that Dr. Kostin already has a demanding job as the chairman and president of VTB Bank. The advantages of electing a well-respected and active business leader to lead the school has bought with it several key advantages. There can be no doubt over Dr. Kostin’s leadership experience having been instrumental in leading VTB over the past decade through both major acquisitions and organic growth turning VTB into one of Russia’s leading universal banks.

Part of the business schools mission has been to help turn Russia into a market economy and the contacts and knowledge that Dr. Kostin has built up helping turn VTB into an internationally respected bank are sure to help drive the business school towards the goal of being seen as one of the global centres of excellence for business education.

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Spring 2013 Issue

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> Sir Andrew Likierman, Dean of London Business School:

Adapting to the Evolving Business Landscape Sir Andrew Likierman, Dean, London Business School talks about the biggest challenges facing the world of business, the rise of entrepreneurship in the School and how the School is adapting to the ever evolving business landscape.

T

he biggest business challenge facing Europe in the next decade is to resolve the instability and imbalances arising from the operation of the Euro. For three years, the continent has lurched from one crisis to another. It has held together through the realisation of the major countries that the breakup of the Eurozone will be worse than keeping the weaker members in the Euro. But Europe will not be able to sustain permanent disequilibrium, so a major priority is finding the new balance which maintains the Eurozone as a whole, while putting less pressure on the citizens of each country, particularly those with the greatest economic problems.

At a company level the biggest challenge is to resolve the ability of industry and commerce to operate in a world where the engine of growth is Asia and there is a resurgence of the United States as an industrial power, boosted by its newly found energy reserves. This will be a continuation of the uncomfortable adaptation already undertaken over the past 40 years by the loss of a great deal of manufacturing to Asia. As India and China mature as economies, there will be different imbalances. Some cost pressures may ease, but the competition will be of an increasingly sophisticated variety of goods and services. European business will need to meet this challenge.

London Business School is at the frontline of addressing these global economic and business challenges. The School continues to remain distinct and relevant amidst the changing and

“Entrepreneurship and innovation are important to a growing economy and play a much larger part of traditional business education than ever before.”

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challenging business landscape. In a competitive global marketplace, amongst a variety of top business schools, London Business School distinguishes itself through quality and its global approach.

Many business schools round the world pride themselves on their quality. However, it is difficult for any business school to be good at research, to make that research relevant and then to translate it into teaching. So many business schools split cutting edge research from teaching. London Business School is acknowledged (through league tables and government measures) to be a world-leading research school. But being in London, one of the world’s great business centres, it also encourages its faculty to reach out to the business and wider community and to include the practical application in teaching.

This is helped by a number of faculty being actively engaged as non-executive directors in public and private organisations. I myself am Chairman of the UK Government Auditor, the National Audit Office.

With London, itself a global city, as our home, we mirror its diversity and its world outlook. We have faculty from 30 countries and students from 100 countries on our degree programmes, with no dominant nationality – we have significant numbers of students from not one but four countries - the UK, the US, India and China.

Our approach to knowledge is global in that we look for good examples all over the world, without assuming there is a single “way of doing things”.

Entrepreneurship and innovation are important to a growing economy and play a much larger part of traditional business education than ever before. There is an increasing focus on smaller and medium size enterprises. At London Business School, our latest major research centre is the Deloitte Institute for Innovation and Entrepreneurship. The work of the research centre focuses as much on the process of creating and developing smaller enterprises as it does on what happens in large companies. In part this

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reflects the interests of students themselves, an increasing number of whom leave at the end of their degrees to start their own businesses. It also reflects the acknowledgement of the importance of such enterprises in the economies round the world.

As for how the space is created, at London Business School we have introduced entrepreneurship as part of the core curriculum, introduced far more case studies relating to smaller businesses and started a summer school for those who want to develop ideas. Two years ago we went a step further than teaching and research by starting an incubator for graduating students who want time to develop their plans before taking them to market.

In the future, technology will obviously play a greater part in the way degree programmes are delivered. We will embrace all the elements of technology that help the students. But we also

Spring 2013 Issue

“At a company level the biggest challenge is to resolve the ability of industry and commerce to operate in a world where the engine of growth is Asia and there is a resurgence of the United States as an industrial power, boosted by its newly found energy reserves.� believe that our students gain a huge amount from learning together, being together outside the classroom and taking part in the many activities in our clubs and societies. So we see ourselves as using technology to get closer to the students, not further away!

Adapting to the current marketplace is vital to London Business School and we know that our degree programmes have to change all the time.

Since we are determined to continue to be a leading business school, we know that other top schools are changing and we need to reflect the best of those changes. Finally, I should say that our students are very bright people and are not slow to tell us if we are lagging behind!

We undertake fundamental reviews of all our degree programmes every five years. This is an essential discipline which includes bringing in outsiders to assess what we are doing. We have just completed a five year review of the MBA. This has resulted in a number of changes, just one of which is the Global Business Experience which allows students to choose from one of five cities in five countries in which to undertake a field course with 80-100 of their classmates.

As the world continues to evolve, London Business School evolves with it. The MBA has to be a reflection of the world as it is and since that changes all the time, so must the MBA. i CFI.co | Capital Finance International

Sir Andrew Likierman

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> Bernard Yeung, Dean of NUS Business School:

The Best Laid Plans in China Co-authored by Randall Morck

I

n a single generation, China has transformed itself from one of the poorest places on Earth into a rising industrial superpower.

Yet despite the speed and scale of the transformation, China’s economic miracle remains a “work in progress”: many stress points have developed and some pose serious threats to its continued success.

Widening income disparity, worsening pollution, serious product quality scandals, artificial entry barriers to many sectors and regions, severe resource constraints, an aging population, and the often chaotic and discretionary administration of laws and regulations are just some of the issues that have come to the fore.

Approved by the National People’s Congress in March 2011, the 12th Five Year Plan recognises these stress points, and proposes goals aimed at transforming China into an advanced market economy.

The Plan’s long list of objectives will take years to complete. Rather than being attained by decree, achieving most explicitly require a switch from central to decentralised planning: changing the government’s role from that of economic engineer to economic referee.

The need for this decentralisation is evident in plans to professionalise China’s bulky stateowned enterprises, banks, regulatory bodies, and other institutions. The Plan envisions this process largely eliminating corruption and cronyism, with important economic decisions made on the basis of economic principles rather than connections.

However, efficient decentralisation and delegation are easier planned than implemented.

Managers of banks and other financial institutions for example will allocate resources in accordance with the economic logic of these objectives only if appropriately incentivised to do so. If bankers’ careers are advanced by allocating loans politically, to gain favour with cadres, loans will be allocated politically. Similarly businesses will invest to upgrade their productivity only if this proves better for their top managers than investing in political rent-seeking (i.e. doing favours for politically powerful individuals or their families).

These unfortunate truths arise because large, dynamic economies are inherently so

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“First, connections tend to be passed along through families, so a connection-based economy quickly becomes an economy controlled by a powerful hereditary elite composed of a few old-moneyed families.“ complicated that even the most diligent and energetic honest overseers cannot possibly monitor all the millions of decisions people in banks, businesses, and government offices must make. Moreover, government agents will use their powers to promote the Plan’s goals only if they benefit more from doing so than from doing otherwise.

Even before 1978, in a vastly simpler Chinese economy, the direct government control system worked poorly and often created serious economic and political problems. In the China envisioned by the 12th Five Year Plan, reform by decree and exhortation invites catastrophic failure. Other developed countries have found that only well-crafted incentives can generate broadly efficient decision-making.

The goals listed in the Chinese plan demonstrate that central government officials appreciate that the fundamental economic underpinnings of an advanced market economy are strong institutional foundations that make it economically rational for people to work hard and use resources efficiently. These include laws, regulations, customs, and morals that lay down the expected scope of people’s self-interested actions.

Rule of law One of the most important institutions in advanced market economies is the rule of law – the generally correct expectation that most people obey laws and regulations, which are enforced even-handedly. The expectation that most people will act this way makes doing business dramatically easier than it is where such institutions do not constrain behaviour.

Certainly, there are exceptions. Wealthy American financers may violate the rules and get away with it by bribing politicians. But if such things happen too often – as perhaps in Italy or Greece – the economy suffers. Likewise politicians who

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use public monies to bail out ill-run or corrupt businesses deemed “too big to fail” often put their future careers in grave peril. People in advanced market economies genuinely value the rule of law.

This reasoning can gel into a self-sustaining cycle. If the law is enforced fairly and without regard for personal or family connections, people accept the rule of law; and this includes the people charged with enforcing it. Obeying the law becomes a source of personal and family pride.

But the circle can also be self-defeating. If the law is administered selectively or for private gain, the rule of law cannot become established. Instead, people look to family or close associates, rather than public officials, for protection or retribution.

Successfully evading the law can even become a source of personal and family pride.

Because officials have discretionary power to allocate resources and economic opportunities, businesses expecting “help” from high-up government officers invest in connections in ways that enrich those officials, their families, or their associates. This gives officials incentives to gain further powers, making connections an even more essential investment. And businesses that have already invested money in official connections encourage this because it makes their past investments even more useful.

The result is that the economy becomes mired in - at best - middle income levels, and can easily slip back into poverty and backwardness, as has been the unfortunate story of some Latin American countries.

We view the “institutional reforms necessary for the successful realisation of the 12th Five Year Plan goals” as basically those necessary to achieve the rule of law – to transform China into a huge Germany, rather than a huge Peru.

Obviously this is not easy: the world has many economies like Peru and only a few like Germany.

Unfortunate cycle The challenge is the stability of the unfortunate cycle. In the absence of rule of law, the only people who can run businesses are those able to draw on strong political connections.

Without such connections, a successful business entrepreneur risks losing everything to corrupt

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officials, or to rivals with friends in high places.

This situation encourages those without political influence to keep their businesses small and invisible to the politically powerful.

Because of these problems, most large businesses in poor countries are either SOEs or are controlled by politically powerful elite families. This severely limits economic growth in the long run for several reasons.

First, connections tend to be passed along through families, so a connection-based economy quickly becomes an economy controlled by a powerful

hereditary elite composed of a few old-moneyed families. The founders of these dynasties may once have been the country’s most talented and patriotic people, but their descendants need not be.

best advanced by obeying the powerful insiders and reducing the impotent outsiders’ profits to zero through demands for bribes, or through adverse regulatory decisions against those who refuse to pay bribes.

In such economies, people unaffiliated with politically powerful families can generally not deal with government officials, and any outsider with a business idea can only implement it by coming to an accord with one of these families.

The result is a sclerotic economy. Markets are plugged by regulations designed to protect established firms and extract bribes for officials.

And ordinary peoples’ savings are channelled into ill-run elite-controlled firms that lose all their outside investors’ money in periodic crises – while politically connected elite families are typically bailed out by the government.

Rational government officials in such a country soon appreciate that their careers and wealth are

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The Latin American equilibrium This situation unfortunately describes much of Latin America, the Middle East and South Asia. We call this situation the Latin American equilibrium because the history of that region, more than any other, displays repeated brief bouts of energetic economic growth punctuating centuries of relative stagnation.

No country escapes these problems entirely, but the world’s current high income countries have all found ways to limit these problems sufficiently to encourage private entrepreneurship and historically unprecedented wealth creation for most of their populations. These solutions all involve subjecting their government officials to the rule of law.

Our fear for China is that, unless the rule of law takes root, a very real danger exists that only those with political connections will be able to run large Chinese businesses. This risks wasting the talents and discouraging the effort of a billion plus unconnected Chinese people.

To avoid this, China needs reforms to make its officials enforce the law even-handedly and predictably so that honest and well-intentioned people can obey the law without any need for government connections. In other words, government officials must themselves be unequivocally subject to the rule of law.

Our worry is that China’s current situation risks imparting stability to this unfortunate circle described above. At present senior officials who gain wealth and power by using their discretionary powers stand to lose much if the rule of law prevails. Likewise, those who have spent time and money developing valuable connections resent reforms that make those investments worthless.

In these circumstances, senior government officials cannot realistically expect a decree to be effective that lower level officials refrain from abusing their discretionary powers. The officials might want to do so from a personal moral standpoint, but they cannot because failure to honour their connections invites disclosure of

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their past sins and the consequent termination of their careers.

This circle effectively prevents the development of the rule of law in many developing countries.

Instead, what has happened is that senior officials, some well-meaning and others cynical, enact ever more complicated, confusing, and convoluted rules and regulations – ostensibly to attack corruption, but effectively to cause confusion and ultimately augment the value of connections with officials who can help bend or break those regulations and laws. This is the Latin American equilibrium that we very much hope China can avoid.

Separating government from business To develop the rule of law, advanced market economies therefore find the fundamental separation of business from government essential.

This entails making the legislative and regulatory process open, so that officials who favour particular businesses risk exposure and disgrace, as well as making businesses transparent so that illegal government favours become visible.

This is why, in many jurisdictions, business leaders and their families must disclose their incomes and wealth, as must government officials and their families. This is also why wealthy people who become government officials must place their wealth in a” blind trust” - surrendering control of their businesses and investment portfolios to unrelated and independent trustees until their government careers are ended. It is also why public officials exposed as having favoured their friends, relatives, or associates earn disgrace in most high-income economies, as do those they have favoured.

No country has achieved this situation perfectly, but higher standards of living correlate closely with proximity to this ideal.

The successful implementation of the laudable objectives in China’s 12th Five Year Plan thus requires resolving a paradox. Professionalising business and the civil service necessitates

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separating business from government. But this requires limiting the discretionary power of government officials, because otherwise business leaders will continue to see official connections as essential. And limiting the discretionary power of government officials challenges longstanding Party principles.

Elephant in the room The problem of subjecting officials to the rule of law is not unique to China.

The British, for example, have not yet clearly decided whether their parliament can pass a law limiting its powers because, if it could pass such a law, it can surely also repeal that law.

Nonetheless, the country’s common law courts effectively subject the government to the rule of law by deriving limits to official power from longstanding judicial traditions.

The Americans solve this problem, to an extent, with a system of checks and balances: people in one arm of government can gain by highlighting any misdeeds in other arms. Enough of this creates pressure on everyone to be passably honest.

But the conundrum is especially difficult in China because the constitution gives the Chinese Communist Party a leading role. Many interpret this to mean that the CCP has the final say – a factor we see as the real “elephant in the room”.

Retaining the CCP’s leading role, yet subjecting government (and Party) officials to the rule of law, is not beyond the ability of creative legal experts. In Canada, a 1980 constitutional reform preserved the traditional supremacy of the Canadian parliament while simultaneously subjecting parliament to the rule of law.

Parliament can enact a law “notwithstanding” that the country’s Supreme Court deems the law unconstitutional, but only in certain situations and amid open public debate. Few governments have employed this process, and it has acquired an unpropitious aura through disuse.

In such ways, other advanced market economies have found ways of coming to terms with

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historical legacies of unlimited state power while imposing effective rule of law. So China is clearly not alone in confronting this issue.

Critical transition But as China nears the end of its early “catchup” growth phase, in which direct government planning still works to an extent, the need for a transition to efficient decentralised planning is correctly raised by the 12th Five year Plan. This transition cannot be effected unless businesses can be run without government connections.

We see this transition as critical to the plan’s success.

For example, we support calls for sound financial regulations, but note these can only be as good as financial regulators’ respect for the rule of law.

We agree with the need for modern regulatory agencies charged with safeguarding the environment, product safety, and fulfilling many other such legitimate roles.

But we fear that they can only work if officials throughout these agencies, and throughout the Party and government, are themselves all constrained by the rule of law. We also support greater reliance on markets, but this too will go wrong without the rule of law.

“To develop the rule of

law, advanced market economies therefore find the fundamental separation of business from government essential.”

Five Year Plan are laudable, their successful implementation requires the rule of law, which is in turn preconditioned on the political will to separate government from business Finally while praise must also be given to the Plan’s emphasis on promoting innovation, one must also note that innovations are, by definition, “new things” that were not planned. Advanced market economies depend on successive innovations for their continued prosperity, and so must accommodate things that simply cannot be planned.

In short, while the objectives of the 12th

The continued success of advanced market economies requires accepting intrinsically unplannable innovations as the engine of the growth; and dealing with the ensuing uncertainty with social security programs, unemployment

about the author

Bernard Yeung is the Dean and the Stephen Riady Distinguished Professor in Finance and Strategic Management at the National University of Singapore Business School (NUS Business School). Before joining NUS in June 2008, he was the Abraham Krasnoff Professor in Global Business, Economics, and Management at New York University Stern School of Business.

He was also the Director of the NYU China House, the honorary co-chair of the Strategy

Department of the Peking University Guanghua School of Management, and Advisory Professor at the East China Normal University.

Professor Yeung’s research covers topics in international corporate finance, corporate strategy, foreign direct investment, and the relationship between institutions, economic development, and firm behaviour. His research articles have appeared in top rated journals in Economics, Finance, Strategic Management, International Business and Accounting.

Professor Yeung was a member of the Economic Strategies Committee chaired by Mr Tharman Shanmugaratnam, Singapore’s Minister for Finance. The committee aimed to develop

strategies for Singapore to build capabilities and maximise opportunities as a global city.

He is also a member of other committees including the Management Advisory Committee (SPRING Singapore) and Financial Research Council (Monetary Authority of Singapore).

Professor Yeung is on the International Advisory Board of the Korea University Business School as well as the Boards of the Intellectual Property Office of Singapore and the Strategic Recruitment Advisory Committee at NUS.

He is a Director on the Graduate Management Admission Council (GMAC) Board and a member of the Finance and Audit Committee of GMAC. He sits on the Maintenance of Accreditation Committee (MAC) and Asia Advisory Task force (AATF) of the Association to Advance Collegiate Schools of Business (AACSB). He is also an elected Academy of International Business (AIB) fellow.

Professor Yeung received his Bachelor of Arts in Economics and Mathematics from the University of Western Ontario and his MBA and PhD degrees from the Graduate School of Business at the University of Chicago.

insurance, education, vocational training, and so on. Oddly, these programs, once seen as socialist intrusions, have come to be essential to developed market economies.

Fortunately, China is well-placed to overcome all these challenges. The success of the current economic engineering model has delivered enough taxable economic activities to provide the government revenues for the enhanced social security, health care, and other social services that let people cope with the uncertainties of an innovation-driven economy.

This gives today’s China an immense advantage, for which the country’s leaders can justly take credit. But the long-run sustainability of that success is what ultimately concerns us, for we see this depending on the successful implementation of the Plan’s call for professionalised governance across all sectors, which, in turn, requires the rule of law.

The 12th Five Year Plan sets great goals; and presents a golden opportunity for the CCP to lead China past the mid-income traps that have limited development in other once promising emerging economies in Latin America and elsewhere, and to take the country through a successful long march to an advanced, innovative, and efficient economy with harmonious sustainable growth. i

This article was co-authored by Randall Morck, Stephen A Jarislowsky Distinguished Chair in Finance and University Professor at the University of Alberta School of Business. It was first published on the National University of Singapore Business School’s Think Business portal (thinkbusiness.nus.edu).

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> St. Petersburg University Graduate School of Management:

20 Years in Search of Global Excellence

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his year St. Petersburg University GSOM, the leading Russian business school, is celebrating its 20th anniversary and its work for the achievement of excellence in business education.

have seen first-hand the great value that the selfevaluation at the root of the accreditation process can bring to a school”, says Sergey P. Kushch, Deputy Dean of GSOM SPbU.

It was started from scratch in 1993 as the first business school inside a major Russian university, to support the country’s transition to a market economy. Established in partnership with UC Berkeley’s Haas School of Business, the School has followed its strategic priorities of academic excellence, international outlook and corporate connections. Since its inception, GSOM has been determined to create an atmosphere where future national and global leaders through knowledge and experience help each other to grow, both personally and professionally.

By combining world class education standards with our international recognition, partnerships and first-class corporate links, GSOM has established itself as one the most internationally recognized Russian business schools and is well on its way to becoming a major player on the international stage.

As the Faculty of Management of Russia’s top research university, GSOM aims to set the standard for the country’s academic business schools. Since 1993, the School has developed an extensive research-based teaching programme that includes a Bachelor’s, pre-experience Master’s, Doctoral, Executive MBA and nondegree executive courses.

All of the school’s programmes share a strong international focus, which is supported by strategic links with a number of prominent academic institutions with which it conducts joint educational and research projects. These include HEC Paris, the Fuqua School of Business at Duke University in North Carolina, Vienna University of Economics and Business, and the Aalto University School of Economics in Helsinki.

GSOM has earned the international EFMD EQUIS accreditation, the EPAS accreditation for its Bachelor’s programme, and is AMBA accredited for its Executive MBA. St Petersburg University GSOM was the first school in Russia and CIS awarded EQUIS accreditation for three years and EPAS accreditation for the maximum five years,. “I

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As the only Russian member of the leading business education networks CEMS (the global alliance of leading business schools) under which the top-ranked CEMS Master of International

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Andrey L. Kostin

“Strong corporate connections have been one of the strategic pillars for the development of the school – in its earliest days assisted in no small measure by its Advisory Board - chaired by P&G’s former CEO John E Pepper.”

Management is offered at GSOM, and the Partnership in International Management (PIM), which gives its students access to high quality opportunities for international study abroad.

GSOM has also won global recognition in a host of international case competitions. The school’s student teams have claimed victory in such business games as L’Oreal’s ‘R U HR?’ coming first in the world in 2011 and claiming the national top spot in 2012, and the «Henkel Innovation Challenge» coming second in the world in 2013.

Strong corporate connections have been one of the strategic pillars for the development of the school – in its earliest days assisted in no small measure by its Advisory Board - chaired by P&G’s former CEO John E Pepper.

Today’s 33-member Advisory Board is one that many top business schools would envy. There is strong governmental representation, including Russian Deputy Prime Minister Sergei Ivanov and the heads of some of world’s leading companies

such as Vladimir Yakunin, President of Russian Railways, as well as deans of top international business schools.

Sergey P. Kushch explains: “We work with an impressive network of global corporate partners.

Our links with leading national and international companies are important not just for their strategic and financial support but also for the very direct impact that they have on the life of our school by taking active part in the development of our programmes”.

In fact, all of the school’s pre-experience Master’s programmes have corporate partners, such as Citi, IBM, Rusnano, Sberbank and the Sistema business group. And several of GSOM’s research centres have direct corporate support, such as the PricewaterhouseCoopers Center for Corporate Social Responsibility and the Deutsche Bahn and Russian Railways Center for International Logistics and Supply Chain Management.

On December 3, 2012 Andrey L. Kostin, President and Chairman of the Management

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Board, Member of the Supervisory Council, JSC VTB Bank was elected Dean of the St. Petersburg University GSOM. Dean Kostin has been the Member of the Advisory Board for the Graduate School of Management SPbU since 2006, and Professor of the GSOM SPbU Department of Finance and Accounting since May 2012.

“The election of Andrey L. Kostin as the Dean of the St. Petersburg University GSOM is an important stage in the development of the School. We believe that the credibility of Dean Kostin in the business community will facilitate the realization of the ambitious targets that have been set by GSOM SPbU. Our recent EQUIS accreditation is very important, but we will continue to strive to be the top Russian business school and an important international player by to further internationalising our faculty, increasing our already strong international alliances, and improving our position in international rankings.

Today we try to capitalize on what we have achieved and to become a major player on the international stage”, says Sergey P. Kushch. i

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> Christine M. Riordan, PhD:

Reimagining Business Education Developing Leaders for a Connected World A New Leadership Paradigm Today’s organizations face challenges greater than ever faced before. The accelerated pace of technological change, the pressure of competing in a global market, and the complexity of a diverse yet networked world have forced organizations to change their structures and styles of business and leadership.

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o compete successfully in this demanding, fast-paced environment, organizations need leaders who can satisfy day-to-day demands, build strength and flexibility for the future, and create an atmosphere of growth and service.

Leaders must create and infuse value into every facet of the organization. In addition to technical knowledge, today’s leaders must understand basic ethical principles, think strategically, accept and work with ambiguity, understand global economies, communicate effectively and persuasively, and work well with teams of people from diverse backgrounds. Today’s business climate also calls upon leaders to invent and support new organizational forms that foster innovation, empowerment, agility, and continuous improvement at all levels. At the same time, stakeholders have sounded a call for organizations to evolve into socially responsive and caring communities.

This new leadership paradigm is global, principlecentered, collaborative, and fluid.

Reimagining Business Education As business schools lean forward and reimagine how to develop this new form of leadership, their focus and activities are shifting. Below, I discuss five of these shifts: 1. Focus on world economies. Business schools are making a deliberate and concentrated effort to equip future leaders with knowledge about the world’s economic environments. To achieve this goal, business schools offer course and project work about and partnerships with firms in established economies (e.g., United States), growth economies (e.g., China), and early emerging economies (e.g., Africa).

Business schools now recognize the need to give

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“This new leadership paradigm is global, principle-centered, collaborative, and fluid.” their students a mastery and understanding of how business is conducted differently in the various economic environments. For example, Vodafone subsidiary, Safaricom, introduced the mobile banking service M-Pesa in 2007. A truly innovative technology that bypasses much of the need for traditional banking infrastructure, M-Pesa offers many millions of Africans access to banking services and thus setting the stage for a global banking revolution. As a Californiabased mobile banking executive put it: “Africa is the Silicon Valley of banking. The future of banking is being defined here. The new models for what will be mainstream throughout the world are being incubated here. It’s going to change the world.” Many Western multinationals are now scrambling to catch up.

According to a report by McKinsey & Company, CEOs at most multinational firms view emerging markets as critical to their long-term success.

The world is calling for a more globally oriented education, which means that business schools have to find ways to facilitate students’ interactions in the world, providing them with opportunities to experience different cultures and develop different perspectives about business in general - emerging markets in particular.

2. Creation of global learning communities. In conjunction with the focus on world economies, business schools and universities recognize the need to create a global learning community for their students. Taking advantage of the University

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of Denver’s 100+ global university partnerships, the Daniels College of Business in Denver, Colorado, provides global study opportunities to 75% of its undergraduate student population.

Additionally, partnerships with companies like Deustche Bank, Molson Coors, Newmont Mining, and Opera Software allow Daniels’ graduate students to conduct live consulting projects all around the globe.

As part of this global focus, business schools are establishing campuses and partnerships outside of their home city and country. The Kellogg School of Management at Northwestern University in Evanston, Illinois, created a global learning community for its Executive MBA programs through partnerships with the following universities: Recanati Graduate School of Management at Tel Aviv University in Israel; WHU-Otto Beisheim Graduate School of Management in Vallendar, Germany; the School of Business and Management at the Hong Kong University of Science and Technology in China; and the Schulich School of Management at York University in Toronto. Additionally, Kellogg has its original home campus in Evanston, Illinois, and a campus in Miami, Florida. While schools are expanding their physical presence, they are also leveraging technology to create virtual worldwide communities.

To reflect the changing demography, business schools are diversifying their faculty and student populations to be representative of the world demographics. Within the Daniels College of Business, over 68% of our faculty engage in teaching or research outside of the United States and we are striving for more. The Daniels College is introducing a new program where faculty who have expertise in a particular foreign country or region, will be assigned as country managers to lead the college’s activities in that part of the world.

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3. Attention to interdisciplinary collaborations and partnerships. Collaborations and partnerships to deliver programs, conduct research, and to solve major issues will become the norm for business schools. For example, Duke University in Durham, North Carolina, received a $10 million grant from the U.S. Agency for International Development to develop a collaborative program among the Fuqua School of Business, Duke Medicine, and Duke Global Health Institute. The goal for the new program is to become a virtual hub for faculty and students on global health and social entrepreneurship initiatives. Within-university partnerships and crossuniversity partnerships allow business schools to expand their areas of expertise and impact. This partnership trend will continue to gain momentum in the upcoming decade.

Additionally, business leaders need to use their skills to make a difference in the world. The Executive MBA students in the Daniels College collaborated with Project Cure to create plans to carry medical supplies to remote areas of the world. Business schools, like the Daniels College, are increasingly emphasizing the idea that business can bring public good and change throughout the world.

4. Integration of technology. The greatest opportunities for business schools lie in their ability to leverage technology and social media to deliver powerful learning experiences, to disseminate their faculty’s research, to market and brand their own programs and services, and to develop important skills with their students.

Consider the data involving technology. A recent survey from Nielsen found that time spent on smartphones has doubled in the last two years alone with apps and mobile web being the two greatest areas of usage increase.

owners exhibit similar behaviors, with 86% using their phones for texting, 82% for the mobile web, 75% for email, and 63% for social networking.

South Korean smartphone owners are generally the most active in web browsing and online banking and Brazilians are the heaviest users of social media on their smartphones.

In many areas of the developing world, individuals are more likely to access the web through smartphones than with PCs. According to a study by IDC, smartphones and tablets already dwarf PC shipments, with over 5 billion smartphone users predicted by 2016.

Nils Broström, Vice President of Communications with Opera Software, ASA, the world’s leading provider of mobile web browser, notes that the “Mobile Only” generation skips the PC and jumps straight to the web from their phones.

Broström goes on to suggest that “this has great implications for businesses, schools and anyone else making use of the Internet as a medium, trying to reach this enormous group of people.

Information, advertising and content does not immediately translate well to the mobile screens - especially not to the lower end phones. What looks nice on your iPhone 5, does not necessarily look nice on an old Nokia, being used by millions to access the web. Reaching, and including, the “mobile only” generation means that you have to understand their needs and interests - but also understanding the technological platforms being used. “Mobile” is not only the big touchscreen 4G monsters we are carrying around using our unlimited data-plans, it’s also those older “feature phones” used in areas where 3G

For example, the Nielson study found that 68% of United Kingdom smartphone owners used their device to check email. Only text messaging was more popular (92%), while using the mobile web (66%) and social networking (63%) was on par with email. United States smartphone

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is unheard of, and where every megabyte of data costs a good part of a fortune compared to the average household income.”

Given these trends, and the headlines being made by Massive Online Open Courses (MOOCs), educators may soon be offering courses by mobile app or through the mobile web. Business teams already interact virtually around the world through mobile or tablet devices. Business leaders need to learn how to be a part of a highperforming team by mastering technology and gaining experience working across time zones to accomplish projects on deadline.

Business schools also need to consider how prospective students learn about their programs.

According to a study in eMarketer, mobile advertising spending will increase by four times from 2013 to 2016. The Nielson study found that, in general, smartphone owners in developed markets are the least likely to engage with mobile ads, while smartphone owners in high growth economies are more likely to engage.

Students today consume social media and content tailored to their interests and devices.

They will increasingly come to expect anytimeanywhere education tailored specifically to their needs. This expectation will add significantly to the challenge business schools face.

Business schools must develop programs, marketing plans, and, along with their students, the skill sets to operate in virtual global environments. The time is now, not in five years.

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5. Emphasis on creating value and impact.

Given the recent economic crisis, there is great price and return sensitivity for all higher education programs. Students are looking at how a business school can create value for them in the short and long run. As a result, business schools must ensure the quality and market relevance of their programs, provide hands-onlearning opportunities for students to develop skills, have strong networks with corporations and the community, provide employment security, and offer lifelong learning and skill

retooling opportunities. Business schools must also consider the affordability and accessibility of their programs and services. In the United States, President Obama introduced the higher education scorecard, which will help students compare the cost/benefit profiles for different higher education programs. Business schools should develop their own scorecards to evaluate their value for stakeholders.

Given the major trends associated with globalization, technology, world economic forces,

and shifting consumer demand and behavior, business schools must begin to reimagine business education to enhance their ability to create value for students and develop leaders who are equipped to face these rigorous new requirements. i

Thank you to my Daniels College of Business colleagues, Doug Allen, Tom Dowd, Carol Johnson, Barbara Kreisman, Julie Lucas, Charles Patti and Richard Scudder, who offered their insights in the development of this article.

About the Author As dean of the Daniels College of Business at the University of Denver, Dr. Christine Riordan leads a business operation of over $86 million and a global network of over 33,000 faculty, staff, students, and alumni.

Since Dean Riordan assumed the leadership role, Daniels has been ranked among the top business schools in the world by BusinessWeek, U.S. News & World Report, The Aspen Institute’s Beyond Grey Pinstripes, and the Financial Times. Among its many rankings, the Daniels College is proud of the #5 ranking in ethics by Bloomberg BusinessWeek; and the #15 ranking worldwide in ethics/ sustainability by the Aspen Institute. The College is among the approximately 630 business schools accredited by the Association to Advance Collegiate Schools of Business (AACSB) - International.

The University of Denver (DU) is ranked #83 among national universities and is #13 on the up-and-coming list by US News and World Report. The Daniels College was founded in 1908 and is the eighth oldest business school in the United States.

In collaboration with the University, Dr. Riordan and her team raise over $14 million a year in private and corporate funds. They have increased the college’s endowment over 50% from $70 million (2008) to over $106 million (2013).

They are also completing a $100 million campaign for the college in 2014.

Under Dean Riordan, the Daniels College of Business has created key initiatives and programs in response to the educational needs of the corporate and community landscape. A few of these initiatives include: the Institute for Enterprise Ethics; a highly selective one-year MBA program; a new professional MBA program which was recently ranked #25 in the U.S. by BusinessWeek; and an Inclusive Excellence Business Case Competition, which connects diverse Daniels student teams and select companies committed to inclusive excellence — one of the country’s few business case competitions surrounding diversity.

Dean Riordan also began the Daniels Corporate Partners program to encourage corporations to contribute to Daniels through financial support, recruitment, executive development programs, research partnerships, and event sponsorship. More than 75 companies are now part of this program including Visa, Inc., Toyota Motor Sales, Miller-Coors, Vail Resorts, Xcel Energy, Ernst and Young, and JPMorgan Chase. Dean Riordan also hosts a CEO speaker series with audiences typically over 1000 featuring CEOs from Starbucks, Enterprise, Visa, US Bank, REI, Molson Coors, Crocs, DaVita, and Western Union, Whole Foods, CH2MHill, Southwest Airlines, among others.

Dean Riordan serves on the board of trustees for the Mile High United Way, and is the treasurer and chair of the finance committee and a member of the executive committee. She is also on the board of directors for Junior Achievement-Rocky Mountain, the Colorado Society of CPAs, and the international business honor society, Beta Gamma Sigma. On behalf of the Governor of Colorado, Dean Riordan chaired a major committee of the Colorado Olympic Exploratory Committee. Dean Riordan was recently elected to the board of AACSB, the international accrediting association for business schools. She serves on the Corporate Relations and Maintenance of Accreditation Committees. For DU, she serves on the Inclusive Excellence Task Force, Strategic Renewal Task Force, Dean’s Council, Capital Campaign Committee, and co-chairs the Women’s Leadership Council.

Dean Riordan has a national reputation as a leadership development and workplace diversity expert. Her research focuses on labor-force diversity issues, leadership development and effectiveness, and career success. Dr. Riordan consults regularly with corporations on strategic planning, leadershipdevelopment activities, diversity management and team performance. She also serves as a leadership coach for senior-level executives. She writes leadership articles for media such as Huffington Post, CNBC, Wall Street Journal MarketWatch, CareerBuilder, Forbes, Politico, and Harvard Business Review. She has also published 29 academic articles with over 2200 citations of her research.

For more information, visit Dean Riordan’s website at www.christineriordan.com

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> Special Feature on Salman Khan:

Education and that Global Ah-ha Moment

By John Marinus

I

am looking at a portrait of James Garfield who was the 20th president of the United States. This is a fact Salman Khan politely assumes I am already aware of. I have just started watching a Khan Academy YouTube video. In the right-hand corner some kind of ticker starts counting but no reference to it is made and so I ignore it. Salman goes on to tell me that, while sitting as a member of the House of Representatives, James Garfield dabbled in mathematics, and in his spare time found a proof for the Pythagorean Theorem. If you had told me yesterday that a US Congressman had discovered a mathematical proof as a hobby, I probably would have thought you were messing with me. But Salman’s enthusiastic yet calm tone reassures me that I am being correctly informed.

Following a short introduction, Khan 68

goes on to demonstrate Garfield’s trapezoid proof. He is out of view as this is not a teacherin-front-of-the-blackboard format. Instead a cursor starts drawing a right angle triangle on a virtual blackboard. Then another triangle is drawn to connect with the first. Each line segment is colour-coded and labeled and each step is explained clearly and concisely by Khan.

Thankfully, none of the mathematics goes over my head. A final line segment connects two corners of the triangles to form a trapezoid. Some simple geometry and algebra follow to explain the proof and the nine minute clip draws to an end.

Confident that I’ve just learned something I could replicate myself- and genuinely charmed - I move my cursor to close the page. As I do so, a pop up appears and the CFI.co | Capital Finance International

nature of the ticker in the corner is revealed. I am informed that by watching the video I have earned 750 points and if I wish to claim them I can sign up for a Khan Academy account. I don’t know what kind of points these are, but 750 sounds like a lot and so I sign up. I am now hooked on Khan Academy, and using the video resources and revision software to make my way through mathematics and art history.

My latest addiction comes courtesy of Salman Khan, a graduate of both MIT and Harvard Business School, and former hedge fund analyst. According to Bill Gates, “We’ve moved about 160 IQ points from the hedge fund category to the teaching-many-people-ina-leveraged-way category. It was a good day his wife let him quit his job.” I would go along with that.

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individual students. The traditional model of testing is also flawed in that after each test a pupil moves along - with the entire class - to the next subject regardless of whether or not they have mastered their material. Using the Khan Academy, a teacher can structure lectures and homework tasks and then devote precious class room time for one-on-one instruction. Using the Khan Academy, a pupil will only move on to new work once they are shown to have mastered the material studied immediately before. In Salman’s native United States, which has seen its global ranking in education steadily dropping over the years (particularly in mathematics and the sciences) - and given the widening gap between academic achievement of the richest students and the poorest - such innovations may prove vital for the country’s continued good standing.

Beyond the practical benefits I have observed something deeper and almost spiritual at the Khan Academy. Humans cannot help but learn; nothing is more demanding of mental discipline than willful ignorance. Sure, there can be a certain amount of frustration and tedium during long periods of revision and exercises, but that Ah-ha moment is universally experienced as golden. Few things are more beautiful than that ah-ha moment but one of them is an ah-ha moment shared. Learning lends itself effortlessly as a communal activity: that sense of connectivity amplifying the euphoria of knowing you have just become slightly wiser. In an average classroom that sensation is shared with maybe thirty people. Online the number can run into the millions - with people all around the world becoming slightly wiser together. i

“Salman may not have set out to change the way we educate, but having found himself at the head of a fast growing global classroom he has quickly formed a remarkably perceptive vision of the state of education and has set an elegant list of goals.”

If Salman is not a born educator, he certainly settled into the role remarkably well. That said, having researched his story somewhat and watched a few talks and interviews, he strikes me as an incredibly driven and perspicacious individual. An individual that would not only excel, but very quickly become an innovating force in pretty much any area he might venture. As it happens, that area ventured into is education. Salman Khan is the founder and executive director of Khan Academy, a nonprofit educational organisation.

Salman may not have set out to change the way we educate, but having found himself at the head of a fast growing global classroom he has quickly formed a remarkably perceptive vision of the state of education and has set an elegant list of goals. Beyond the obvious benefits to poorer students in developing and third world countries who lack access to regular education, Salman makes the case that the Khan academy can be a boon to any classroom anywhere in the world.

In the traditional classroom, the majority of time is spent on lectures and testing with the exercises as homework. This leaves very little face-to-face teaching time for CFI.co | Capital Finance International

About the Author John Marinus is a freelance writer who has contributed to our Editor’s Heroes feature in this issue. See his work on Hrabowski, Koofi, Chinoy and find out more about Salman Khan.

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Announcing

AWARDS 2013 SPRING HIGHLIGHTS Once again CFI.co brings you reports of individuals and organisations that our readers and the judging panel consider worthy of special recognition. We hope you find our short profiles interesting and informative.

All the winners announced below were nominated by CFI.co audiences and then shortlisted for further consideration by the

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panel. Our research team gathered additional information to help reach a final decision.

In many cases, senior members of nominee management teams provided the judges with a personal view of what sets their companies and institutions apart from the competition.

As world economies converge we are coming across many inspirational individuals and

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organisations from developing as well as developed markets - and everyone can learn something from them. If you have been particularly impressed by an individual or organisation’s performance please visit our award pages at www.cfi.co and nominate.

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> DEL VALLE TORRES: BEST TAX TEAM. MEXICO, 2013 The tendency for tax affairs to become ever more complicated has resulted in the need for an increasing level of qualified attention both personal and corporate on the international stage. It has never been more important – whether you are a high net worth individual or multinational corporation – that effective tax advice is taken into account. Of course, many full service law firms have excellent tax teams – and the big four accounting firms are everywhere – but the panel felt that the quality and track record of the tax team built up by Luis Del Valle warranted special attention. The team has clearly displayed the advantages of engaging a specialist firm who are totally dedicated to your tax affairs. The judging panel was particularly impressed with the structure created for an international financial group, the Terrafina IPO of approximately $700m investing in real estate in Mexico. In addition the judging panel noted the strength and quality of the nominations received. It is therefore with great pleasure that we announce that the award for ‘Best Tax Team, Mexico 2013’ goes to Del Valle Torres S.C.

> LEGAL AWARDS, 2013: MJM IS A WINNER IN BERMUDA CFI.co is pleased to announce MJM Barristers & Attorneys as ‘Best Corporate and Commercial Team, Bermuda 2013’. The judging panel pointed to the high level of personal attention the team at MJM provide according to comments and ringing endorsements received from clients and fellow lawyers in several jurisdictions. Of course the firm is particularly well positioned to help with legal matters relating to Bermuda having been closely involved in the modernisation of its company law and the team is large enough to cover all aspects of client requirements while remaining nimble.

“MJM Limited is one of Bermuda’s leading law firms. We have a broad ranging practice with an emphasis on civil and commercial litigation, banking and finance, general corporate, insolvency and restructuring, trusts and private client work. MJM is regularly retained by leading international law firms. We offer practical advice based on an in-depth knowledge of the legal, regulatory and commercial environment in Bermuda. We also offer a high degree of partner involvement in the work that we do and each practice area is led by a partner who is recognised as a leading practitioner in Bermuda.”

> EMPLOYMENT LAW WINNERS IN THE UK: BINDMANS LLP According to the CFI.co judging panel, Bindmans are the rising stars of employment law in the United Kingdom and the winners of the award for 2013. The firm, founded by Sir Geoffrey Bindman QC, is high profile with focused and intelligent employment lawyers who are making a difference and bringing in good settlements. Bindmans recently won a substantial award for an Asperger syndrome sufferer in dispute with his former law firm employer and is acting for a lap dancer who used to work at the London club Stringfellows.

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> CFI.CO CORPORATE GOVERNANCE WINNER, GERMANY, 2013 BASF wins Best Corporate Governance, Germany, 2013. The overall standard of corporate governance in Germany is outstanding and the judges commented that almost all of the short listed candidates would have been winners had they been located in other countries. However, the way in which BASF has implemented its corporate governance programme stood out. The panel felt that BASF had benefited from a particularly strong and active supervisory board, excellent risk management with its transparency and strong analysis giving all stakeholders the highest levels of confidence in the company.

> THE IP AWARD FOR THE UNITED STATES GOES TO LOEB & LOEB Loeb & Loeb takes the 2013 award for Best Intellectual Property Team in the United States. This firm has a welldeserved reputation for litigation and the negotiation of licencing agreements in the entertainment industry. The judging panel congratulates John Frankenheimer, chair of the Music Industry Practice Group, who was named on Billboard’s 100 Power List of music business notables.

> GIDE LOYRETTE NOUEL: BEST BANKING & FINANCE TEAM, FRANCE

The judging panel has drawn attention to the outstanding negotiation skills of this firm’s banking and finance group, and Gide Loyrette Nouel is our 2013 winner in France. Founded in 1920, the firm now has 600 lawyers operating throughout the world. Last year GLN advised HSBC France on the first mortgage bond to be listed on Euronext, Paris.

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> ARNTZEN DE BESCHE’S ENERGY TEAM WINS 2013 LEGAL AWARD

This outstanding Norwegian law firm offers a wide range of services across corporate law and is well known for its first class energy work. Last year, Arntzen de Besche represented Tullow Oil in the acquisition of Spring Energy Norway AS. The firm provided mediation services in Sudan for two years with an agreement that came in place in September 2012.

> MENA CITY LAWYERS, LEBANON: HELPING TO DRIVE GROWTH

The CFI.co award panel are pleased to announce Mena City Lawyers as the Best Corporate and Commercial Team, Lebanon, 2013. MCL, under the chairmanship of Fady Jamaleddine, has built up a strong and internationally experienced team of legal experts. The firm is well placed to provide advice to both local and international clients particularly those who focus on the MENA region. With the ability to bring to bear a multi-disciplined team to help with the most complex matters and a history of seeing client business through from formation to exit, MCL has an enviable track record. The judges were also particularly impressed by the firm’s pro bono work and clear focus on its internal code of ethics. We believe that this ethical approach and the firm’s high level of expertise help explain why MCL has been recognised by the World Bank for its contributions to SME development. As SMEs form the cornerstone of economically sustainable development, MCL is without doubt a leading law firm contributing to growth in the region.

> COLOMBIAN LAW FIRM BRIGARD & URRuTIA TAKES 2013 AWARD The long and well established Dispute Resolution Team at Brigard & Urrutia is favourably placed to provide advice on a wide range of cases in Colombia. According to the CFI judging panel the firm has completed substantial and impressive work on disputes over public sector concessions, has very strong litigation skills and is very active throughout the sectors.

The panel had no hesitation in naming Brigard & Urrutia as ‘Best Dispute Resolution Team, Colombia’.

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> SNR DENTON NAMED BEST CORPORATE & COMMERCIAL TEAM, OMAN

SNR Denton in Muscat brings its clients the benefits of thirty years of experience in the Oman market. Last year the firm advised HSBC on a merger of its Oman branch and clients include Bechtel, USG and Oman Refineries & Petroleum industries. It was the depth of knowledge of lawyers at SNR Denton that persuaded the judging panel that the Corporate & Commercial award for 2013 should go to this outstanding firm.

> BEST OF BOTH WORLDS AT BAKER & MCKENZIE, BAHRAIN Baker & McKenzie Limited is the CFI.co Islamic Finance team winner in Bahrain this year.

The judging panel agreed that this team stands out from the competition to a significant degree and is moving further ahead. Baker & McKenzie has been active in the region for thirty years and has practised in Bahrain since 1998. The CFI panel pointed to the firm’s ‘best of both worlds’ advantage in having deep understanding of the region through its strategic location alongside the massive resources of Baker & McKenzie offices throughout the world.

> CHARLES RUSSELL: BEST CORPORATE & COMMERCIAL TEAM, BAHRAIN, 2013 Charles Russell LLP has done good work for Edamah (Bahrain Real Estate Investment Company), was instructed by the Central Bank of Bahrain in 2009 and has a reputation for building good long term relationships with clients.

Charles Russell’s head office is in London, a further international office is located in Geneva and the Middle East office is housed at the Bahrain World Trade Centre. The judging panel commented on the Bahrain winner’s core strengths in communications, energy and property matters.

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> LEGAL AWARDS, 2013: PRIETOCARRIZOSA IS AT THE HEAD OF COMPETITION IN COLOMBIA Prietocarrizosa is congratulated by the CFI.co judging panel for its successful representation of Nestle and good work for others including Visa International, Mexichem Colombia, Corn Products International and Johnson Controls. The competition and antitrust department is long established, highly effective and the judges believe that the firm’s activities in this category are very likely to expand.

There was no hesitation in naming Prietocarrizosa as ‘Best Competition Team’, Colombia, 2013.

> ASHURST IN AUSTRALIA WINS 2013 LEGAL AWARD

The strong Intellectual Property team at Ashurst is acting for Samsung in its dispute with Apple. The lawyers here are very experienced and led by a highly effective litigator. The IP group in Australia provides a full range of services and the firm rightly prides itself on its global presence and impressive industry sector coverage. Ashurst LLP is our award for ‘Best IP Team’, Australia, 2013.

> IP AWARD FOR DREW & NAPIER, SINGAPORE Drew & Napier continues to lead the Intellectual Property field in Singapore and is the well-deserved 2013 CFI award winner in this category. The IP department at D&P accounts for a quarter of all patents filed in the country and the firm represents high profile clients across a broad range of industries. The firm and its talented lawyers are regularly recommended as leaders in their field. The judging panel pointed to the firm’s skills in biomedical science.

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> SWISS RE WINS AWARD FOR BEST CORPORATE GOVERNANCE, SWITZERLAND, 2013 There are few industries where stakeholders have more to lose than in reinsurance and accordingly the strength of corporate governance is critical.

The panel were impressed in particular by the continual assessment and development of Swiss RE’s corporate governance standards. Under Walter B Kielholz’s leadership, the Chairman’s and Governance committee has helped ensure that Swiss RE continues as a stable and innovative player in the critically important reinsurance market - and this was borne out in the Company’s 2012 results.

> MANAL ZRAIQ AND CORPORATE LEADERSHIP IN THE MIDDLE EAST: MANY HATS Manal Zraiq claims to wear many hats. This is most certainly the case and CFI’s award panel wishes to recognise the leadership role she has played in Palestine. Ms Zraiq has been instrumental in managing projects involving the World Bank, the EU and USAID and plays a major role at Massar International where she is director general of Massar Associates. With a broad range of business experience, Ms Zraiq brought the Rawabi project to reality. But it is her work to empower entrepreneurial women that the panel felt should be recognised here. Ms Zraiq’s leadership role in ensuring that women fully participate in the Palestinian economy is vital to economic convergence to the region and stability in her country.

> CFI AWARD: HKEX HAS BEST CORPORATE GOVERNANCE IN HONG KONG

Hong Kong Exchanges and Clearing Limited (HKEx) is recognised by CFI’s award panel for ‘Best Corporate Governance, Hong Kong, 2013’. With the aim of being the global exchange of choice for Chinese clients and internationals seeking exposure to China, it is critical that HKEx corporate governance is of the highest possible standard and the management of HKEx have taken this prerequisite to heart. Given the transparent approach to corporate governance, the judging panel were not surprised by the number of nominations HKEx received. The panel felt that HKEx were going well beyond the statutory requirements with all stakeholder interests being fairly taken into account.

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> CORPORATE GOVERNANCE, 2013: VESTAS WINS IN DENMARK Vestas Wind Systems A/S wins CFI’s award for ‘Best Corporate Governance, 2013’. The panel decided that the approach taken by all the Danish companies considered for the corporate governance award was outstanding and that this reflected extremely well on Denmark’s approach to business. However the judges took the view that Vestas’s approach to the on-going adaptation of corporate governance alongside their efforts to ensure highly transparent communications in all aspects business and marketing strategy set them apart from their competitors.

> ARREGUI NAMED CORPORATE LEADER, NORTH AMERICA, 2013

Alvaro Rodriguez Arregui is selected as one of our Corporate Leaders for North America.

Mr Arregui is the managing partner of Ignia Partners - a venture capital firm based in Monterrey, Mexico. He is a pioneer in impact investing and micro finance and his work is directly impacts opportunities for low income entrepreneurs. Having attracted funding from - amongst others - the IFC, Omidyar Network and J.P. Morgan, Ingnia now have an innovative business model that services the base of the pyramid. Innovators and leaders such as Mr Arregui, who have the charisma and determination to drive their vision, are key to helping ensure sustainable economic convergence.

> EXCELLENT CORPORATE GOVERNANCE: FTP IN VIETNAM As Vietnam continues its rapid development, companies need to adapt and change their corporate governance.

FPT, a leading Vietnamese ICT company has been doing just that. With FPT approaching its 25th anniversary it is clear to the CFI panel that the Company has come a very long way and is now set to become a truly global player. As the company grew its corporate governance improved dramatically and there is now good separation between the governance of the board of management and the execution of the board of directors. The judging panel panel welcomed the strong nominations for FPT and comments that the proactive way FPT uses its corporate governance practices to ensure sustainable growth for all stakeholders is to be commended.

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> THE DISPUTE RESOLUTION TEAM AWARD FOR MALTA GOES TO CAMILLERI PREZIOSI Camilleri Preziosi Advocates win the ‘Best Dispute Resolution team Malta’ award for 2013.

As should be expected we do not receive many nominations in some of the smaller juristictions but the CFI panel could not ignore the strength of nominations received for Camilleri Preziosi. The panel commented that what sets Camilleri Preziosi apart from the competition is the team’s holistic approach to dispute resolution matters. The firm has an excellent track record for looking beyond the dispute to the overall needs of clients minimising the impact of disputes by keeping cases out of court whenever possible. Of course, their court room performance over the years has enabled the firm to achieve this. The panel felt that the quality outcomes and the multi-disciplinary nature of the firm deserved recognition this year.

> CFI AWARDS 2013: A LAW FIRM IN THE YEMEN

The Law Offices of Sheikh Tariq Abdullah advise a number of international law firms promptly and efficiently in what is a rather difficult jurisdiction. This firm is frequently consulted by the World Bank and has a good reputation for the quality of its services and the care and attention it lavishes on enquiries that may not be particularly profitable. The judges commented on an attitude at the firm that not all rewards for services are financial. Pro bono work at this office includes advice to the UK Seafarers Association.

> CFI LEGAL AWARDS, 2013: MORALES & BESA FOR THEIR PRO BONO WORK IN CHILE Pro bono work has been important at Morales & Besa since the firm was founded twenty years ago. They have been trailblazers ever since and take their responsibilities very seriously. Pro bono is voluntary for the firm’s lawyers but the take up is high.

The firm has created a pro bono manual and a committee to decide on eligibility.

When lawyer performance is evaluated equal weight is given to pro bono work and hours charged to clients. The judges commended Morales & Besa on the firm’s constant encouragement to pro bono activities in Chile.

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> DISPUTE RESOLUTION AWARD, UAE, 2013, GOES TO GALDARI IN DUBAI

Galadari and Associates in Dubai work in dispute resolution very effectively and across most industry sectors. The firm has excellent litigation skills which now result in some 75 per cent of turnover. The CFI judging panel decided to make the award to Galadari because of its excellent track record of court success. Construction is a very real strength of the firm and the expertise of the firm’s local advocates is paying very real dividends. This firm is moving from strength to strength.

> CORPORATE & COMMERCIAL TEAM AWARD IN INDIA Desai & Diwanji has been named ‘Best Corporate & Commercial Team, India, 2013’ in the CFI Legal Awards programme. This substantial firm has three offices and a team of 185 lawyers with around half of personnel working in the corporate group. The volume of corporate deals places the firm at the very top of the table of Indian law firms. Growth has been more than satisfactory and the firm is well placed to take advantage of any upturn in client business optimism. Desai & Diwanji act as non-exclusive attorneys to some 150 of the biggest Indian companies.

> ROJS, PELJHAN, PRELESNIK & PARTNERJI: M&A TEAM WINNER IN SLOVENIA

This Slovenian firm has a strong track record in banking and construction and has does sterling M&A work. RPPP have been involved in major privatisation programmes and pride themselves on their work in such sectors as pharmaceuticals, construction, media and the steel industry. The judging panel recognise RPPP as one of Slovenia’s most important law firms and a worthy recipient of the award: ‘Best Mergers and Acquisitions Team, Slovenia, 2013’.

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> ERNST & YOUNG: BEST TAX TEAM, GEORGIA, 2013

Ernst & Young LLC is the longest established tax practice in Georgia and top player in the country by most indicators. Competition for business is intense but the CFI judging panel feel that the firm is well placed to take advantage of opportunities as they unfold. The client base of the firm is solid and its reputation is good. According to CFI Ernst & Young in Georgia would most certainly be a suitable partner for foreign investors. There is a strong understanding of the Georgian culture as well as appreciation of the needs of newcomers to the market.

> BEST LAW FIRM GEORGIA AWARD FOR 2013 GOES TO DLA PIPER DLA Piper has been named ‘Best Law Firm, Georgia, 2013’ by CFI. Founded as a local firm, it is now uniquely well positioned to provide international expertise as well as demonstrate indepth understanding of the jurisdiction. The majority of the firm’s work is for international clients and sophisticated Georgian businesses. Training of lawyers is a continuous process at the heart of the success of this outstanding Georgian legal firm.

> CalPERS Wins USA Corporate Governance Award 2013

CalPERS stands out as an example of the highest level of corporate governance and wins the 2013 award in the United States. CalPERS provides retirement and health benefits to some 1.6 million public sector employees and retirees in California and the Company is responsible for nearly $250 billion in funds. Not only are CalPERS’s internal standards exemplary, they also provide a driving force domestically and internationally in improving levels of corporate governance. Sharing their expertise in effective governance with companies in which it invests, the CalPERS hands on approach to investment is helping to ensure that shareholder and all other stakeholder benefits are maximised.

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> Dispute Resolution Award for Germany goes to Freshfields Bruckhaus Deringer

Freshfields in Germany is very strong in dispute resolution and, according to the judging panel, executes assignments very efficiently across sectors and jurisdictions. CFI.co named the firm as ‘Best Dispute Resolution Team, Germany’, 2013. Freshfields is headquartered in London and is a member of the magic circle.

> Obsessing about Client Satisfaction: Kresta Laurel, Our Winner in Nigeria

Kresta Laurel Limited, the winner of CFI’s Customer Satisfaction Award, Nigeria, 2013 started operations in 1990 and offers total engineering services in vertical and horizontal transportation systems (elevators, cranes hoists etc.), power systems and similar electro-mechanical equipment. The judging panel was impressed by the outstanding sales and after sales service offered at a company where customer expectations are exceeded routinely and word of mouth recommendations significantly boost business. KLL set out to deliver world class technical solutions in a market that had been dominated by foreign firms and multinationals and has done so very successfully. The panel commented that, ‘Management is obsessively concerned with the realisation of the very highest levels of customer satisfaction and have a plan in place that delivers to international standards. Kresta Laurel has a roster of international affiliations – well-known brands that they work with very happily and on an exclusive basis in Nigeria’.

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> Edward Bibko, Baker & McKenzie:

Impact of a New UK Regulatory Framework on Capital Markets The UK Financial Services Act 2012, which came in to force on 1 April 2013, significantly restructures the regulatory framework in the United Kingdom for monitoring the financial markets and for supervising the banking and financial services industries. The Act implements comprehensive revisions to the regulation of financial services and markets in order to uphold the integrity of the UK financial system. This article focuses on two key reforms which affect the London capital markets: changes to the regulation of sponsors and the adoption of new market manipulation criminal offences.

General overview of regulations The Act replaces the Financial Services Authority with a new tripartite regime comprised of: • the Financial Conduct Authority, a focused conduct of business regulator regulating the financial markets and retail and wholesale financial services firms; • the Prudential Regulation Authority, a focused micro-prudential regulator regulating financial firms, including banks, investment banks, building societies and insurance companies; and • the Financial Policy Committee of the Bank of England, an expert macro-prudential regulator advising the PRA on macro-economic policymaking and risk assessment and monitoring and responding to systematic risks in the financial sector.

The FCA inherited the FSA’s authority to regulate the issuance and trading of securities, supervise multi-lateral trading platforms, establish market codes of conduct, and impose civil and criminal penalties for market abuse and insider dealing.

As the FSA’s successor as market regulator, the FCA regulates securities transactions in accordance with the United Kingdom Listing Authority’s Listing Rules, Prospectus Rules, and Disclosure and Transparency Rules. Although the Act in general does not materially change the UKLA rules in effect prior to the Act, one significant change to the UKLA Listing Rules

is to broaden the FCA’s authority to authorise, monitor, and discipline sponsors. These changes are designed to make the sponsor system more flexible and responsive to the market, and are summarised further below.

The FCA also inherited the FSA’s authority to prosecute criminal offences under the market abuse regime of the UK Financial Services and Markets Act 2000. The Act extensively amends a number of the provisions of FSMA, including repealing the misleading statements criminal offence and adopting new criminal offences for misleading statements, misleading impressions, and misleading statements and impressions relating to benchmarking activities. The changes, which are discussed further below, are intended to govern benchmarking activities in line with, and in response to, the final report of the Wheatley Review of LIBOR. Changes to the sponsorship regime The Act amends the UKLA Listing Rules to provide that restrictions or limitations can be placed on the services which a sponsor may provide to make the sponsor system more flexible and responsive to the market. As a result of these changes: • it is now possible to apply to become a sponsor for a limited number of services, rather than having to become a sponsor for all purposes;

• the FCA can alter the level of approval and limit the scope of activities a firm can be a sponsor for after they have been given approval; • the FCA has the power to suspend a sponsor’s approval, rather than cancelling it, allowing sponsors to more easily return to the market once they have regained the FCA’s approval; and • the FCA has a wider range of disciplinary sanctions to use in its regulation of sponsors, including the ability to impose financial penalties.

These changes could provide new opportunities for firms wishing to become sponsors. In its consultation on the changes, the FSA (as the predecessor to the FCA) explicitly acknowledged that one purpose for the new powers is to make it easier for new sponsors to enter the market and therefore to increase competition. The changes mean that sponsors can now apply to be approved to carry out only certain sponsor services, requiring them to meet the eligibility criteria for those services only. This is a significant change from the previous regime, which required all sponsors to satisfy all eligibility criteria and therefore made it potentially difficult for firms to enter the market.

The recent changes will clearly be of interest to existing sponsors. They will also be of interest to firms who are considering becoming new sponsors, in particular those who have in the

“The FCA inherited the FSA’s authority to regulate the issuance and trading of securities, supervise multi-lateral trading platforms, establish market codes of conduct, and impose civil and criminal penalties for market abuse and insider dealing.”

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past been put off by the need to satisfy all of the eligibility criteria. For example, there may be firms who are keen to become sponsors in order to service their global clients on certain transactions in the UK, but only have experience and expertise in certain types of transactions.

Under the previous regime, such firms would not have been able to become sponsors without first acquiring additional skills in order to satisfy all of the criteria required by a sponsor. However, under the new regime, such firms would be able to be approved as sponsors for specific types of transactions, allowing them to make an initial entry into the UK market, and then possibly expand their operations at a later date.

To become a sponsor it is necessary to meet several criteria which are set out in the Listing Rules. These criteria must not only be met upon application but continuously whilst a firm remains a sponsor. An applicant must show, to the satisfaction of the FCA, that it: • is either an authorised person or member of a designated professional body; • is competent to perform sponsor services; and • has appropriate systems and controls in place to ensure that it can carry out its role as a sponsor.

There is a multi-step application process for becoming a sponsor in the UK. The process does not have a set timeline as the period taken will depend on the specific firm applying and the quality of its application. It is therefore best to begin the process as soon as possible and to contact the regulator at an early stage. The steps are: • first, write to the Sponsor Supervision team of the UKLA, providing details of the firm.

The Sponsor Supervision department will then provide guidance on how the Listing Rules will apply to the firm; • second, submit an application form, together with the non-refundable application fee of £15,000; • and third, the UKLA Sponsor Supervision team will then conduct an onsite assessment of the firm, examining its systems and controls.

A prospective sponsor will need to demonstrate that its systems and controls are sufficient. If a firm is considered competent it will be given approval to become a sponsor. The sponsor will be liable to pay the annual sponsor fee of £20,000.

Expanding market manipulation offences The Act replaces the provisions of FSMA for misleading statements and misleading impressions, adopting some new standards and introducing a new offence for misleading statements and impressions relation to benchmarking activities. These changes are primarily in response to the final report of the Wheatley Review of LIBOR, which was issued

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“The FCA’s powers to regulate capital markets activities have been significantly expanded as compared to its predecessor to meet these strategic objectives.” in 2012 amidst increasing concerns about the accuracy and reliability of benchmarks, such as LIBOR. As a result of these changes, benchmarking activities are regulated activities under FSMA and intended to fall within the market abuse regime of FSMA. The FCA inherited the FSA’s responsibilities for the market abuse regime under FSMA, and retains the power to prosecute the following criminal offences: • “misleading statements”, or making a statement which is knowingly or recklessly materially false or misleading, or dishonestly concealing a material fact, to induce investment activity; • “misleading impressions”, or any intentional or reckless act to create a false or misleading impression of the market in or price or value of an investment to induce investment activity and/ or the making of an economic gain or the causing of an economic loss; and • “misleading statements and impressions relating to benchmarks”, or making a statement or impression which is knowingly or recklessly false or misleading in connection with setting a benchmark.

The offence of “misleading statements” substantively restates the offence in effect prior to the Act, and the offence of “misleading impressions” broadens the offence in effect prior to the Act by including reckless as well as intentional acts. For example, a statement or impression which is likely to induce a shareholder to sell its shares could constitute a criminal offence if the person making the statement was reckless as to whether the statement was misleading, false or deceptive.

The “misleading statements and impressions relating to benchmarks” offence is a new criminal offence which did not exist prior to the Act. All three criminal offences may be punishable by imprisonment of up to seven years or fines up to the statutory maximum.

The Act’s Misleading Statements Order clarifies which investments, activities and benchmarks fall under the new criminal offences, and the FMSA’s Regulated Activities Amendment Order

CFI.co | Capital Finance International

affirms that providing information in relation to a specified benchmark and administering a specified benchmark constitute regulated activities. In addition, the FCA issued the new handbook General Guidance on Benchmark Submission and Administration, which includes new rules for entities carrying on benchmark related regulated activities. Although the orders specify that currently the only regulated benchmark is LIBOR, the FCA has the authority to regulate other benchmarks as well. For example, the FCA could adopt similar provisions for benchmarks for the energy or commodity markets.

Conclusion The new financial regulatory framework is intended to increase the reliability and stability of the UK financial markets, and the Act balances the need to protect a broadening definition of financial consumers, to increase effective competition, and to enhance the integrity of the financial markets. The FCA’s powers to regulate capital markets activities have been significantly expanded as compared to its predecessor to meet these strategic objectives, and the new regulatory authorities will need to continue to work with market participants to ensure that the new regime is practical and effective. i

ABOUT THE AUTHOR Edward Bibko is a partner in Baker & McKenzie’s International Capital Markets Group based in London. He joined Baker & McKenzie’s London office in February 2001.

Prior to joining Baker & McKenzie, Edward practiced in New York and Chicago law firms and worked as a financial analyst for IBM. Edward is ranked as a leading capital markets practitioner in Chambers Global 2009 and currently serves as a member of the Firm’s International Capital Markets Group. Mr Bibko specialises in international equity and debt capital markets transactions. He received a doctorate from Syracuse University.

ABOUT BAKER & McKENZIE Baker & McKenzie is the world’s leading law firm, with 3,750 lawyers who “speak” 75 languages in 71 offices worldwide. The company had $2.27 billion in revenue in 2011.

W H E R E C H I N E S E O U T B O U N D I N V E S TO R S M E E T G LO B A L M I N I N G O P P O RT U N I T I E S

Spring 2013 Issue

1 7- 2 0 J U N E 2 0 1 3 – C H I N A W O R L D, B E I J I N G

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Li Zhilin President of International Affairs Zijin Mining Group

Amy Cheng MD & Vice Chairman of Investment Banking Bank of China International

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Li Xinchuang Deputy Secretary General China Iron and Steel Association

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85

> Grant Thornton, Turkey:

Economic Environment in Turkey

By Aykut Halit

I

n last decade, Turkey positioned itself as a regional and economical leader in its neighbourhood. Despite current account deficit and the reduction in the volume of exports to its main export trade market which is Europe, a shift to alternative markets mainly in The Middle East and Africa has more than made up the reduction for Europe. Turkey has some key advantages. First one is the stable banking system. Compared to Western European and American counterparts, banking system has been stable and strong. Another strength is the growing population of 76 million, with a work force which is young, well educated, well trained, motivated and productive. 74 million of total population create a huge mass of demand in the market. Another advantage of Turkey is the incentives granted for new investments in the form of industrial site allocation, reduction of taxes and even subsidies. Besides low corporate tax rates, Turkey has incentives also for strategic investments and R&D. Summary of Grant Thornton International’s ‘Emerging Markets’ Report According to our research dated December 2012, Turkey has maintained its position of sixth in the Emerging markets opportunity index (among 28 emerging economies). It occupies a strategic geographic location, situated between Europe and the Middle East, North Africa and Central Asia. Turkey scores particularly highly in terms of of GDP per capita of US$17,500 (on PPP basis), the fifth highest in the same index behind Hungary, Poland, Russia and Argentina.

FDI inflows into the Turkish economy increased rapidly over the past decade, growing by an annual average rate of 45% in the period 200008, and peaking at US$22bn in 2007. After

“Another strength is the growing population of 76 million, with a work force which is young, well educated, well trained, motivated and productive.” a sharp contraction in 2009 due to the global financial crisis, inflows recovered to US$16bn in 2011. Early estimates for 2012 look promising: inflows increased by 21% in H1-2012 compared with H1-2011.

The economy has cooled slightly in the face of strong headwinds particularly from Europe and year end 2012, growth was 2.2%. However, growth is expected to accelerate to 4.8% per year in the period 2013-17. The main risks to this outlook include continued weakness in Europe, Turkey’s main export market, and the large current account deficit which currently is around 7% of GDP. Turkey’s main export markets are Germany (%10.3), Iraq (%6.2), UK (%6), Italy (%5.8) and France (%5.0) whereas the main imports sources are Russia (9.9%), Germany (9.5%), China (9.0%), USA (6.7%) and Italy (5.6%) Some investment tips Turkey is a fresh and attractive market for many investors. Therefore, competition is strong and markets need to be fully investigated before making any investment. Local customs and culture might be different to other countries, so investors need to learn and adapt to their methods. Additionally, investors should be aware

Top 10 list of Grant Thornton International’s ‘Emerging Markets’ Report.

Source: Grant Thornton International Business Reports

86

CFI.co | Capital Finance International

that although there are many incentives for investment, there are also some bureaucratic constraints. A well qualified advisory firm will be helpful at all stages.

What about sectors in Turkey?

Financial services, food and drink, real estate development, energy and health sectors are promising sectors of Turkey.

Financial Services Turkey’s strong financial services sector is ready for further expansion, driven by solid economic growth. According to the Turkish Banking Regulation and Supervision Agency (BRSA), the Turkish financial sector increased by approximately 20 percent of CAGR between 2002 and 2010. As regards asset sizes, 77 percent of the assets belong to the banks, meaning that the sector is dominated by the banks. The Turkish insurance sector is also developing rapidly with 25 percent of CAGR during 2002-2010, and has gained new momentum after the social security reform that has introduced universal health insurance.

Food and Drink Food and drink sector is another promising sector of Turkey. Turkey’s food industry has registered a steady growth in recent years, with the Turkish consumers becoming increasingly demanding, driven by the multitude of choices offered by mass grocery retail outlets. Rising disposable income and changing consumption patterns, along with the increase in the number of females in full-time employment, have all led to an increase in interest as regards agricultural production, packaged and processed food, such as ready-to-eat meals and frozen food. The food and beverage industry contributes to Turkey’s

Spring 2013 Issue

exports as well, achieving USD 6.7 billion accounting for around 6 percent of the total exports in 2010.

Real Estate Turkish real estate sector, offering ever-greater opportunities for investors every year, has come to prominence especially in the last decade.

Although with the recent economic crisis and the global economic recession the European and US real estate markets have been negatively affected, the real estate market in Turkey is still promising. While the reduction in demand and a downward trend in house prices have been observed all over Europe, according to TurkStat statistics the number of apartment units sold in Turkey in the second quarter of 2011 increased by 18 percent compared with the same period of 2010, which shows that the country has huge growth potential in the real estate sector.

Energy Turkey has become one of the fastest growing energy markets in the world in parallel to its economic growth registered in the last eight years and is rapidly gaining a competitive structure. The Turkish Electricity Transmission Company estimates that Turkey’s demand for electricity will increase at an annual rate of six percent between 2009 and 2023. The growing energy demand in Turkey is one of the significant factors along with market liberalization and the country’s potential role as an energy terminal in its region. These three factors play an important role in shaping the investment opportunities in Turkey. Turkey’s ambitious vision of 2023, the centennial foundation of the Republic, envisages grandiose targets for the energy sector in Turkey.

These targets include to reach 125,000 MW of installed power (up from 54,423 MW in 2010) and to increase the share of renewables to 30 percent.

Healthcare The healthcare system in Turkey has entered a long period of development during 2003-2013 via Health Transformation Program. The purpose of the program is to increase the quality and efficiency of the healthcare system and enhance access to healthcare facilities. According to the Pharmaceutical Manufacturers Association of Turkey (IEIS), the Turkish pharmaceutical market was around USD 9.2 billion in 2010, up from USD 4 billion in 2003, growing by 12.6 percent of CAGR. There are 49 manufacturers in the industry, and 13 of them are foreign investors.

The industry employs approximately 25,000 people. Turkey is an attractive health tourism destination for the ageing population of Europe and for Thermal facility seekers.

Private Equity activities in Turkey In Turkey, PE deals are increasingly receiving approval by local businessmen. Until about three years ago, based on Grant Thornton research, only about 10 percent of Turkish businessmen saw PE funds as a way of raising funds. In 2012,

Aykut Halit: Managing Partner, Grant Thornton, Turkey. aykut.halit@gtturkey.com

this perception has increased to more than 30 percent. During 2011, about 200 deals were settled by private equity firms in Turkey at a total amount of around US$20bn. In the first six months of 2012, about 125 deals were settled at about US$10bn. PE firms in Turkey have so far been mainly interested in hospitals, food, logistics, retail (including consumer products and clothing) and energy (including hydro electric and wind farm power plants). We expect that while these sectors will still attract attention, e-commerce, education, entertaintment and media will also be popular for PE firms. The predictions for the PE asset class in Turkey will increase steadily. PE interest mainly comes from London at the moment, however we have recently started to see interest from the US, China, Brazil and India. We also believe that Gulf funds will be more active and that wealthy businessmen from the Arab world will be particularly interested in Turkish SMEs. In addition, with the New

CFI.co | Capital Finance International

Commercial Law, the Turkish State now accepts international commercial arbitration and EU Directives – this has considerably increased the confidence of foreign investors. i

About Grant Thornton Grant Thornton is one of the world’s leading organisations of independent assurance, tax and advisory firms. These firms help dynamic organisations unlock their potential for growth by providing meaningful, actionable advice.

Proactive teams, led by approachable partners in these firms, use insights, experience and instinct to understand complex issues for privately owned, publicly listed and public sector clients and help them to find solutions. Over 35,000 Grant Thornton people, across 100 countries, are focused on making a difference to clients, colleagues and the communities in which we live and work. For more information visit www.gti.org

87

> Grant Thornton, Armenia:

Armenia’s Economy and Development Trends

By Gagik Gyulbudaghyan

In 1991 Armenia became an independent state leaving the centrally planned economy and gradually evolving as an emerging small and mid-size entrepreneurship based market. During the 22 years of Independence, the Armenian economy has undergone major transformation.

Today it is a market full of opportunities for foreign investments, encouraged also by the liberal investment legislation.

The Economy in Figures The present day Armenian economy and financial system date back to November, 1993, when the national currency – Armenian dram (ISO: AMD) was put in circulation by the newly shaped national bank – the Central Bank of the Republic of Armenia. Since then, exchange rate has been volatile settling occasionally by means of the Central Bank’s currency interventions. In January

88

2006 Armenia moved to fully fledged inflation targeting strategy from the monetary targeting regime. Price stability is the primary objective of the Central Bank generally defined through a low and stable level of inflation, which now is 4 %, within the band of +1.5 pp, for the Armenian economy. This is the target inflation indicator in the medium-run as well.

Inflation rate for 2012 stood at 2.6%. The GDP in 2012 was 3,981.5 billion AMD (USD 9.91 billion per the average exchange rate of the Central Bank of Armenia for the year 2012), equivalent to 1,313.6 thousand AMD (USD 3,270) per capita. GDP production structure based on 2012 data in %-age terms is as following: industry (16.5%); agriculture (19%); services and other activities (39%); construction (11.7%) and retail and wholesale trade (13.8%).

The snapshot of the nominal, real GDP growth and inflation rate is provided in the graph below.

As in the rest of the world, Armenian economy was challenged by the economic and financial Economic snapshot

turbulences resulting in over 13% drop in 2009, though economic stability gradually recovered with up to 4.7% GDP growth in 2011 and 7.2% GDP growth in 2012.

The underground deposits of black and precious metal ores make mining and quarrying industry the third largest branch of industrial output in the country, carving up 17% share in total industrial production. Manufacturing industry is the leader with 61% share, where food and beverages production make up 36% and 14% respectively.

Unique place in beverages production is granted to legendary Armenian cognac, which has constantly sustained the economy of the country.

In export makeup, brandy comes in second only after copper concentrate. Armenia is also rich in energy resources. Hydropower, electricity and gas production constitute the second largest component of industrial output, making up 19% in total.

Specific place in the Armenian economy is devoted to high-tech sector. In recent years, the sector has witnessed major inflow of foreign investors who have entered the market to capitalize on the young and highly qualified workforce and highly competitive wage rates.

Around 55% of the industry’s output is exported to over 20 countries, mainly USA, Europe, and CIS. The major specializations include embedded software and semiconductor design, custom software development and outsourcing, financial applications, multimedia design, web development, MIS and system integration.

Economic Snapshot

4,500,000

20.0%

4,000,000

15.0%

3,500,000

10.0%

3,000,000 2,500,000

5.0%

2,000,000

0%

1,500,000

(5.0)%

1,000,000

(10.0)%

500,000 0

%

Armenia rates significantly higher than world and regional averages in terms of Investment Freedom according to 2013 Index of Economic Freedom (the 38th freest). Commercial regulations are flexible and rather simple. Armenia is World Trade Organization (WTO) member since 2003, has free trade regime with CIS countries, double tax treaties with more than 30 countries. Moderately low tax rates and government spending contribute to an impressive degree of fiscal freedom. Major types of taxes in the country are profit, income, turnover, property, value added, excise and land tax. The freedom to start, operate, and close a business is well protected under Armenia’s regulatory environment. The banking system is wholly private and well regulated by the Central Bank of Armenia. One of the most important policy aspects of the financial sector development adopted by the Central Bank of Armenia is formation of financial sector legislation fully compliant with the EU regulations.

“Armenia rates significantly higher than world and regional averages in terms of Investment Freedom according to 2013 Index of Economic Freedom.”

Mln AMD

Foreword Armenia is located in the Southern Caucasus neighbouring with Georgia in the north, Azerbaijan in the east, Turkey in the west and Iran in the south. Armenia’s more than 2795-yearold capital, Yerevan is currently hometown of over 1 million of population (around 33% of total population), followed by two largest cities of Gyumri and Vanadzor. More than 95% of the country’s population are Armenians. Armenians are Christians, the overwhelming majority of which belong to Armenian Apostolic Church.

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

(15.0)%

Gross Domestic Product at market prices, mln. drams (left axis) CPI (same period last year %) (right axis) Gross Domestic Product % change at basic prices (right axis)

The underground deposits of black and precious metal ores make mining and quar CFI.co | Capital Finance International the third largest branch of industrial output in the country, carving up 17% share industrial production. Manufacturing industry is the leader with 61% share, where

Referring to the recent statistics, the assets of the Armenian banking system increased by about 19.9% (2,478 billion AMD as of 31 December 2012) and capitalization by about 12.7% (401 billion AMD as of 31 December 2012) during 2012. The net profit of Armenian banks reached 42.4 billion AMD. The volume of loans by the Armenian banking system, extended up to 1,527 billion AMD by the end of December 2012.

Spring 2013 Issue

Commercial bank loan portfolio and deposit figures are presented in the two graphs below. Loan portfolio figures are exclusive of due and arrear loans.

Commercial credit portfolio Commercial Banks’banks Credit Portfolio

Commercial Banks’ Deposits Commercial banks deposits

1,400,000

900,000 800,000

1,000,000

Mln AMD

Mln AMD

1,200,000

800,000 600,000 400,000

949,754

1,000,000

1,171,994

700,000 600,000 500,000 400,000

355,892

300,000

262,391

200,000

200,000

100,000

0 Short-term

Dec-12

0 Long-term

Dec-12

Non-resident deposits

Resident deposits

“Overall, one of the most important characteristics of the banking system in Armenia is the rigid and strict monitoring and prudential regulation by the Central Bank.

Although criticized heavily by some commentators, this policy has been given tribute since it has ensured low risk taking profile of the banks in the country buffering the global financial turmoil shocks on the domestic economy. ”

Contributing to the technology sector as well, payment instruments and payment documents Referring to the recent statistics, the assets of one of the distinctive of the consumer Armenian loans clearing processing companies, investment Wholesale and retailfeatures trade loans, andand mortgage constituted largest share inthe Armenian banking system increased by about economy is also the of large from companies, etc.

19.9% (2,478 billion AMD as of 31 December credit investments the currency economyflow in 2012. abroad, more specifically - the Armenian 2012) and capitalization by about 12.7% (401 Diaspora. These remittances partake significantly Banks are classified according to CAMELS billion AMD as of 31 December 2012) during in the development of trade and construction, as international standards (Capital, Assets, 2012. The net profit of Armenian banks reached well as stimulate export and private consumption Management, Earnings, Liquidity and Sensitivity 42.4 billion AMD. The volume of loans by the of the country. In export markets, Armenia’s to the market changes). The minimum charter Armenian banking system, extended up to 1,527 major counterparts are EU27, Russia, Iran, USA, capital required for operation of an existing bank billion AMD by the end of December 2012.

Georgia, China, Canada, Switzerland, Ukraine, is 50 million AMD and the minimum total capital Commercial bank loan portfolio and deposit and Turkmenistan. Import partner countries are is 5 billion AMD, which mitigates the risk of figures are presented in the two graphs below.

EU27, Russia, China, Ukraine, Turkey, Iran, bankruptcy. In summer of 2005, a bank deposit Loan portfolio figures are exclusive of due and Credit investments by sectors USA, Japan, South Korea and Switzerland. guarantee fund was created to guarantee the arrear loans.

Agriculture loans 6.35%

Manufacturing industry loans 10.39%

Other 23.58%

Electricity, gas, stream power loans 6.86%

Consumer loans 18.49% Trade loans 20.09% Mortgage loans 7.97% Credit Investments by Sectors

The Financial system

Construction loans 6.26%

Wholesale and retail trade loans, consumer loans and mortgage constituted largest share in credit investments of the economy in 2012.

Armenian banks provide for all types of banking transactions (opening a bank account, banking transfers, currency exchange, foreign exchange futures,3 options, guarantees and letters of credit, savings, mortgage, consumer and other loans, factoring, financial and operational lease, credit card services, check books, traveller’s checks, financial dealing, managing securities and investments, managing precious bullions, etc), though some of them are demanded than others.

The Capital Markets In January 2008 Swedish stock exchange operator OMX became the owner of the stock exchange and the Central Depository of Armenia.

In February, the same year, consequential on the merger of NASDAQ and OMX world’s largest stock exchange was created. Armenian stock exchange and the Depository were restructured and merged, using best international practice and forming the NASDAQ OMX Armenia. New trading platforms were created for new instruments, government bond, repo/reverse repo transactions, as well as other tailored services. Shortly after new milestones in the area were development of stock exchange listing requirements and the corporate governance code, new platforms and settlement schemes (T+3), first Armenian IPO in 2009.

Still the most important accomplishments are ahead with the introduction of the new pensions system in Armenia. The process started in 2009

The biggest player of the Armenian financial deposits held in banks. Commercial banks Armenian banks provide for all types ofthebanking transactions (opening a bank account, bank market is banking sector that accounts for about are in line with recent international trends moving transfers, currency exchange, foreign exchange 90% of assets of the financial system.

The other towards the Basel III standards futures, in addition to options, guarantees and letters of cre players of the Armenian financial market include already well-established framework of Basel financial and operational lease, cred savings, mortgage, consumer and other loans, factoring, credit organizations, insurance companies II. Liquidity and capital adequacy measures card services, check books, traveller’s checks, financial and insurance brokerage firms, pawnshops, are quite high, and the percentage of officially dealing, managing securities and exchange offices, money transfer companies, overdue loans on the books is insignificant. investments, managing precious bullions, etc), though some of them are demanded than oth

The Capital Markets CFI.co | Capital Finance International 89 In January 2008 Swedish stock exchange operator OMX became the owner of the stock exch

1,200,000 1,000,000 800,000 600,000 400,000 2

2

37

40

253

9

2008

2009

2010

2011

2012

2013 (3 months)

Stock market activity

Value (right axis)

Number of deals

200,000 0

Volume (left axis)

'000 AMD

500,000 450,000 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0

'000 AMD

Volume

Stock Market Activity Stock market activity

About the Author Gagik Gyulbudaghyan is the Managing Partner of Grant Thornton Armenia, member of Grant Government Bond Market Activity Thornton International and the leading audit Government bond market activity and advisory firm on the market. He has 20 6,000,000 7,000,000,000 years of experience in corporate finance, 6,000,000,000 5,000,000 5,000,000,000 transaction support, lead advisory, recovery and 4,000,000 4,000,000,000 bond market activity Government reorganization, management consulting and 3,000,000 3,000,000,000 7,000,000,000 6,000,000 company management. Mr. Gyulbudaghyan 2,000,000 2,000,000,000 6,000,000,000 5,000,000 is specialised in assessment of enterprise 1,000,000 1,000,000,000 191 460 249 115 22 5,000,000,000 81 4,000,000 business performance and identification of 0 0 4,000,000,000 2008 2009 2010 2011 2012 2013 (3 viable options for restructuring and privatisation.

3,000,000 months) 3,000,000,000 Value (right axis) Number of deals Volume (left axis) 2,000,000 He has managed numerous advisory projects in 2,000,000,000 such industries, as information technologies, 1,000,000 1,000,000,000 Foreign currency market 81 191 460 249 115 22 Foreign currency market electronics, telecommunications, chemical Foreign currency share in the stock exchange 0 trade transactions constitute by far the largest 0 transactions.

Primary foreign trades is US dollar, the second is EUR. beverages & food processing, 2008 currency 2009 2010 2011 exchange 2012 2013 (3 Foreign currency tradeof transactions constitute production, energy, months) by far theValuelargest in the exchange hospitality, health, education, agriculture, (right axis) shareNumber of deals stock Volume (left axis) Foreign exchange market activity transactions.

Primary currency 400,000,000 of foreign manufacturing, construction, mining, metal 1,200,000,000 Foreign currency market exchange trades is US dollar, the second processing, machinery building, wholesale and 350,000,000is EUR. 1,000,000,000 Foreign currency trade transactions constitute by far the largest share in the stock exchange 300,000,000 retail trade, as well as financial services. transactions.

Primary currency of foreign exchange trades is US dollar, the second is EUR. 800,000,000 '000 AMD

Below chart shows exchange trading statistics from 2008-2013:

Not surprisingly, opposing to the picture of the corporate bond trades transactions with government bonds have increased after 2009.

The trading volumes, trade values and number of deals made in the stock exchange are shown in the graph below:

Volume

Equity markets Total number of deals in 2012 was 253 with total value traded of AMD 410,796,210 and total of 176,940 securities of 8 listed companies. Over April 2013, total value traded and total number of securities traded increased dramatically by over 250%, while the number of trades decreased by over 28 times.

The four public debt instruments in Armenia are Government T-Bills (short-term), Government coupon T-Notes (mid-term), Government serial repayment coupon T- Notes (mid-term), Government T-Bonds (long -term), Government Savings Coupon Bonds (long-term). Government T-Bills are discount securities with a maturity varying from one to 52 weeks and average yield of 9.32-10.64%, offered in weekly auctions. The issuer of government securities is the Ministry of Finance and the Central Bank acts as the underwriter, principal depository and the clearing and settlement system for the securities.

Volume

and the implementation is said to be in force from January 1, 2014. The new pension reforms envisage transition from the previous PAYG (“payas-you-go�) system to privately managed asset funds formed from mandatory and voluntary contributions. Infrastructure projects to support the new system include the Central Depository of Armenia AMPIS -Armenian Mandatory pension information system and State revenue committee Personified record keeping system. Forecasts are that gradual flow of pension money will help to develop capital markets and improve competitive position of capital markets compared to the already well-established banking system.

Volume

'000 AMD

500,000 1,200,000 450,000 250,000,000 1,000,000 400,000 600,000,000 200,000,000 Foreign Exchange Market Activity Bond 350,000markets Foreign exchange market activity 800,000 150,000,000 300,000 markets function in two tiers: the corporate and the government Bond bonds. Corporate bonds 400,000,000 1,200,000,000 400,000,000 250,000 600,000 100,000,000 are represented in three categories - Abond, Bbond and free Cbond markets. Free Cbond market 200,000,000 200,000 350,000,000 50,000,000 400,000 only requires the bond issue to be no less than AMD 100 million.1,000,000,000 Money market instruments 8993 6235 6464 5680 5232 1150 150,000 0 0 300,000,000 including bonds and other short-term debt instruments can only be admitted to the free Cbond 100,000 200,000 800,000,000 2008 2009 2010 2011 2012 2013 (3 253 37 40 2 2 9 50,000 250,000,000 market. months) 0 0 Value (right axis) Number of deals Volume (left axis) 200,000,000 600,000,000 2008 2009 2010 2011 2012 2013 (3 The financial turmoil especially hit themonths) corporate bond market.

150,000,000

Volume

'000 AMD

'000 AMD

Volume

'000 AMD

Volume

Volume

'000 AMD

About Grant Thornton Bond markets Grant Thornton Armenia is a member of Grant Bond markets function in two tiers: the corporate Thornton International, one of the world’s leading and the government bonds. Corporate bonds are organisations of independent assurance, tax and represented in three categories - Abond, Bbond advisory firms. The firm is a multi-professional and free Cbond markets. Free Cbond market group of over 130 experienced international and 400,000,000 only requires the bond issue to be no less than Closing thoughts Value (right axis) Number of deals Volume (left axis) local public accountants and auditors, specialist 100,000,000 AMD 100 million. Money market instruments With robust 200,000,000 banking system, gradually evolving capital markets and ongoing reforms in the 50,000,000 Corporate bond market activity advisers in finance, business and management, 6235 6464 5680 5232 1150 economy overall,8993 Armenia has established itself as an attractive spot for foreign investors. Given including bonds and other short-term debt 0 0 1,400,000 9,000,000 Bond markets well as tax andand legal advisers working at the its strategic geographic location, big human capital potential, liberalas business environment 2008 2009 2010 2011 2012 2013 (3 instruments canin only be the admitted free vastbonds.

Bond markets two tiers: corporate to andthe the 8,000,000 government bonds 1,200,000 function varietyCorporate of business venture options, evolving technologies the way of months) innovations and new two offices inonYerevan.

7,000,000 areCbond represented in three categories Abond, Bbond and free Cbond markets.

Free Cbond market becoming part of the worldwide e-society Armenia has strived its way through centuries towards market.

Value (right axis) Number of deals Volume (left axis) 1,000,000 6,000,000 Grant Thornton firms help dynamic organisations only requires the bond issue to be no less than AMD 100 million.

Money instruments bettermarket and brighter future.

800,000 5,000,000 including bonds and other short-term debt instruments can only be admitted to the free Cbond unlock their potential for growth by providing 4,000,000 600,000 Closing thoughts The financial turmoil especially hit the corporate market.

By Gagik Gyulbudaghyan 3,000,000 meaningful, actionable advice through a With robust banking system, gradually evolving capital markets and ongoing reforms in the 400,000 Managing bond market.

ClosingPartner thoughts 2,000,000 economy overall, Armenia has established itself as an attractivebroad spot forrange foreignof investors.

Given The financial especially hit the 86corporate bond market. services.

Proactive teams, led 200,000turmoil 1,000,000 32 329 673 83 27 With robust banking system, gradually evolving its strategic geographic location, big human capital potential, liberal business environment and 0 Market Activity 0 by approachable partners in these firms, use Corporate Bond vast varietymarkets of business venture options,reforms evolving innovations 2008 2009 2011 2012 2013 (3 capital and ongoing in the and new technologies on the way of Corporate bond market activity2010 months) insights, experience instinct to solve complex becoming part of the worldwide e-society Armenia has strived its way through centuriesand towards economy overall, Armenia has established itself 1,400,000 9,000,000 better and brighter future.

Value (right axis) Number of deals Volume (left axis) issues for privately owned, publicly listed and 8,000,000 1,200,000 as an attractive spot for foreign investors. Given 7,000,000 public sector clients. For more information, 1,000,000 6,000,000 By Gagik Gyulbudaghyan its strategic geographic location, big human The800,000 four public debt instruments in Armenia are Government T-Bills (short-term), Government please visit www.grantthornton.am.

5,000,000 Managing Partner capital potential, liberal business environment coupon T- Notes (mid-term), Government serial4,000,000 repayment coupon T- Notes (mid-term), 600,000 Government T-Bonds (long -term), Government3,000,000 Savings Coupon Bonds (long-term).

Government and vast variety of business venture options, 6 400,000 2,000,000 from one to 52 weeks and average yield of T-Bills are discount securities with a maturity varying 200,000 evolving innovations and new 32 329 offered 673 83 weekly 86 27The1,000,000 9.32-10.64%, in auctions. issuer of government securities is the Ministry of technologies on the 0 0 way of becoming of the Finance and the Central Bank2011 acts 2012 as the underwriter, principal depository and thepart clearing and worldwide e-society 2008 2009 2010 2013 (3 months) settlement system for the securities.

Armenia has strived its way through centuries Value (right axis) Number of deals Volume (left axis) towards better and brighter future. i Not surprisingly, opposing to the picture of the corporate bond trades transactions with

government have increased after 2009.

The trading volumes, trade values and number of The four public bonds debt instruments in Armenia are Government T-Bills (short-term), Government dealsTmade the stock exchange areserial shown in the graph below: coupon Notesin(mid-term), Government repayment coupon T- Notes (mid-term), Government T-Bonds (long -term), Government Savings Coupon Bonds (long-term). Government T-Bills are discount securities with a maturity varying from one to 52 weeks and average yield of 9.32-10.64%, offered in weekly auctions. The issuer of government securities is the Ministry of Finance the clearing and Finance 5International 90 and the Central Bank acts as the underwriter, principal depository andCFI.co | Capital settlement system for the securities.

Not surprisingly, opposing to the picture of the corporate bond trades transactions with

6

Spring 2013 Issue

> CFI.co Meets Enrique Gómez Junco:

A Q&A Session with the Founder of Optima Energia, Mexico What would you say most motivates you?

I like to be able to create something from scratch - something different, something better. I want us always to be the leader in what we do. I especially enjoy BIG challenges.

What excites you?

I am excited by entrepreneurship, new ventures and helping others to achieve their dreams. I want to take Optima Energía all the way to be the leading provider of energy efficiency solutions in Latin America. I want to keep Optima growing in fast mode, to build an organization that can do anything with the best talent in our market.

Do you think entrepreneurs are made or born?

It can be either. I know for a fact that we all need both. Having someone that can inspire you, someone that can teach you, someone that can share knowledge is crucial to the decision to initiate a project.. School programs, incubators, accelerators, mentors, are part of the environment that will help entrepreneurship develop.

Where did you grow up?

I grew up in Monterrey, Mexico, part of a very united family. My father was a great example of hard work and honesty and had a huge commitment to our community. He was always a high level professional with the courage to create personal businesses even towards the end of His career.

Did you have any key mentors or people who deeply influenced you?

• Mike Ahearn, ENDEAVOR Global Board Member and funder of First Solar, the biggest solar energy company in the world.

• Fernando Fabre, President of Endeavor Global • Pedro Aspe, former funder of ENDEAVOR México, and co president of EVERCORE. • Salvador Alva, former president of Pepsico Mexico, and President of Instituto Tecnologico de Monterrey.

Are there any highlights from your youth you would like to mention?

I was fortunate to participate in the pilot entrepreneur program at my university; the first company to be born was Tecnologico of Monterrey and they now have one of the biggest entrepreneur university programs in the world. In my years with Optima Energía (up to now 24) I have been fortunate to have had world class mentors, opportunities to assist to the World Economic Forum (WEF) as Global leader for Tomorrow (GLT), be selected as an ENDEAVOR entrepreneur organization that transformed me

and Optima Energía. And that inspired me to create ENDEAVOR E + E, an organization that supports early entrepreneurs through mentoring, with more than 250 professionals helping entrepreneurs in nine different cities in Mexico.

Do you have any hobbies?

I enjoy helping entrepreneurs and water skiing.

Did you have any life-changing experiences that put you on the path to what you’re doing today?

At university the entrepreneur pilot program, and then ENDEAVOR: an accelerator program for high potential growth companies. It has been wonderful to have world class mentors helping my career.

What are the key attributes you look for in your staff?

I look for a positive attitude, accountability; they should place no limits on what is possible. companies are successful because they have good staff.

CFI.co | Capital Finance International

What are the most frustrating factors that have held back expansion?

Expansion is always painful, you need to make decisions regarding evolving standards and people that help you start and create your venture. Not having the right talent in place while you are expanding is painful.

If you could set up Optima anew, would you do anything differently? Why, and what would you do?

I would get help faster, have an independent board of directors earlier, make decisions faster with less heart and more brain, Identify opportunities that can be standardised, reproduced and go into mass production.

What’s next for Optima? What are you looking forward to achieving?

We will grow during the coming years by more than 50% a year. We will maintain our leadership in energy efficiency and be the company that will transform Latin-America into a continent of low carbon emission cities. i

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> Del Valle Torres, SC:

Award Winning Tax Specialists in Mexico CFI’s Best Tax Team, Mexico, 2013

D

el Valle Torres, S.C. has one of the most preeminent tax practices in Mexico, specializing in cross border transactions, fund structuring, administrative and tax litigation of fund private clients. Our fund practice is very extensive and the funds on which we have worked include funds with both Mexico and non-Mexico investment focus and which seek to attract capital globally through public and private placements. The Firm advises some of the preeminent fund sponsors in the world, including Clarion Partners, Prudential Real Estate Investors and Walton Street Capital. The Firm also represents some of the most well-known fund investors in their review of prospective investments in funds, which gives the Firm a broader insight into emerging trends and developments in the fund environment.

Del Valle Torres S.C., also provides tax advice to high net-worth and ultra highnet-worth individuals, international banks and insurance companies on the design of products for purposes of estate and wealth planning.

The Firm also has a strong tax and administrative litigation practice specializing in federal and local tax litigation, including tax assessments, refunds and levies. The Firm has broad expertise in administrative reviews before the tax authorities, as well as litigation on nullity Petitions and Amparo procedures before the Mexican Federal Court of Tax and Administrative Justice, District and Circuit Courts and the Supreme Court of Justice.

Del Valle Torres specializes in tax advice and tax litigation with strong focus on trust investment fund and cross-border transactions. Tax planning is also an area of strength, according to sources. The firm is currently advising a real estate investment fund sponsored by Walton Street Capital on the structuring and placement of a publicly traded fund focused on industrial properties worth USD200 million. Representative clients include Prudential Real Estate Investors, HSBC Switzerland and Société Générale. Sources say: “The firm excels in terms of client service and commercial awareness. It can solve problems in a very pro-business way, achieving results and meeting objectives, even in highly complicated cases.” i

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In Pictures: Plaza Carso, Mexico City, Mexico

CFI.co | Capital Finance International

Spring 2013 Issue

RECENT WORK HIGHLIGHTS

WORK HIGHLIGHTS IN THE LAST 12 MONTHS

The Firm advised a major international financial group in structuring the public placement of two real estate investment funds with a portfolio of more than 140 properties located throughout Mexico. The closing of this transaction was February 2012.

Value: US$1 billion.

Lead partner: Luis Gerardo del Valle Other team members: Eduardo Medina, Mario Karim Other firms advising of the matter and their roles(s): - Creel, Garcia-Cuellar, Aiza y Enriquez, S.C. Financial attorneys The transaction involved Mexican and US entities.

The Firm advised a real estate investment Fund, in planning a corporate re-structure to merge two real estate companies holding a (joint) portfolio of industrial properties situated in strategic locations throughout Mexico with a value of approximately US$100 million.

Lead partner: Luis Gerardo del Valle Other team members: Eduardo Medina Other firms advising on the matter and their role(s): - Ritch Müller, S.C.: transactional attorneys - Greenberg Traurig LLP: real estate and transactional attorneys Date of completion: February 2012.

The transaction involved Mexican and US entities.

The Firm is currently advising the US Government in the restructure and disposition of real property and other assets of a large group of companies domiciled in Cancun and Panama.

During 2012, the Firm advised in structuring a complex sale of a high end residential project located in the Puerto Cancun development of Cancun, and one hotel located in the most prestigious area of Cancun. These two transactions alone involved real property with a fair market value of more than US$200 million.

Value: Transactions closed during 2012 involved properties with a fair market value of more than US$200 million.

Lead partner: Luis Gerardo del Valle Other team members: Eduardo Medina Cross-border deal: The transaction involves Mexican, Panamanian and US entities.

Other firms advising on the matter and their role(s): - Jauregui y Navarrete, S.C.: corporate and transactional attorneys - Mayer Brown LLP: real state, bankruptcy and financial attorneys

Client: Walton Street Capital. Walton-FINSA CKD. The firm advised a real estate investment Fund sponsored by Walton Street Capital in the structuring and placement of a publicly traded fund mainly focused on industrial properties located in Mexico.

Value: US$215 million.

Lead partner: Luis Gerardo del Valle Other team members: Eduardo Medina, Santiago Llano Other firms advising on the matter and their role(s): - Creel, Garcia-Cuellar, Aiza y Enriquez, S.C.: Financial attorneys.

Public placement closed in September 2012.

Client: Walton Street Capital. Walton-Planigrupo CKD. The firm is advised a real estate investment Fund sponsored by Walton Street Capital in the structuring and placement of a publicly traded fund mainly focused on retail properties located in Mexico.

Matter Value: US$200 million.

Lead partner: Luis Gerardo del Valle Other team members: Eduardo Medina Other firms advising on the matter and their role(s): - Creel, Garcia-Cuellar, Aiza y Enriquez, S.C.: Financial attorneys.

Public placement closed in May 2012.

The Firm recently obtained a favourable decision for a large group of companies based in Cancun, Mexico in a very relevant administrative appeal involving constitutional grounds to render tax investigations null and void.

Value: US$37 million.

Lead partner: Eduardo Medina Other team members: Luis Gerardo del Valle, Josemaria Férez Date of completion: August 2012.

Other firms advising on the matter and their role(s): - Mayer Brown LLP: real state, bankruptcy and financial attorneys

The Firm is currently advising a real estate focused Mexican company holding a real estate portfolio worth more than US$100 million in a very relevant value added tax refund claim process. During this process the Firm achieved the amendment of certain criteria issued by the Tax Administration Service disallowing to claim value added tax credits on the contribution of real property to Mexican companies.

Value: US$12 million.

Lead partner: Luis Gerardo del Valle Other team members: Eduardo Medina, Mario Karim

The Firm recently advised a publicly traded real estate fund worth more than US$200 million mainly focused on industrial properties in a very complex value added tax refund process. The value added tax refund during this process was the first of its kind in Mexico.

Value: US$2 million Lead partner: Eduardo Medina Other team members: Luis Gerardo del Valle, Mario Karim, Josemaría Ferez Date of completion: September 2012 Other firms advising on the matter and their role(s): - Mayer Brown LLP: real state, bankruptcy and financial attorneys

The Firm recently advised in structuring and implementing a complex restructuring of the largest Mexican chocolate manufacture group in order to optimize the admission of new investors.

Value: US$200 million Lead partner: Luis Gerardo del Valle Other team members: Mario Karim Date of completion: October 2012

The Firm recently advised an international financial group based in Canada in structuring a credit facility granted to a Mexican automotive company for an amount of US$107 million.

Value: US$107 million Lead partner: Luis Gerardo del Valle Other team members: Santiago Llano Date of completion: November 2012

CFI.co | Capital Finance International

93

> Ernst & Young, Argentina:

The Controversial Deduction of Interest in a Leveraged Buyout of Companies in Argentina – A New Court Ruling in Favour

By Leonardo Favaretto & Sergio Caveggia

T

ax planning in the acquisition of businesses is important to maximize company’s profits. Accordingly, an increasing focus on tax efficiency to reduce the cost of, or improve the return from, deals continues to be an important driver for tax in transactions.

The discussion regarding the most efficient structure in the acquisition of equity interests is centered mainly on whether it is carried out as a capital contribution, financing through loans or with a combination of both alternatives, among others that can be explored.

Where a stock purchase in a company is financed using financial loans, the income tax deduction of the related interest has been the subject matter of many rulings in Argentine courts, generating opinions that are both for and against this.

Recently, the Federal Administrative Tax Court entered a judgment [Federal Administrative Tax Court, Room A, 09/21/2012, “Sociedad Anónima Organización Coordinadora Argentina on appeal (Tribunal Fiscal de la Nación., Sala A, 21/09/2012, “Sociedad Anónima Organización Coordinadora Argentina s/recurso de apelación)] that takes on great significance with regard to whether the interest paid on loans intended to finance the purchase of stockholdings in a company should be income tax deductible. This financing procedure is normally referred to as a ‘leveraged buyout’.

“The new economic scenario has made this old discussion resurface for new transactions.” acquired all of Opco’s shares, a transaction that was financed with the irrevocable contributions of Holdco’s shareholders and a payment plan granted by the sellers themselves.

Subsequently, and through a tax-free reorganization process – a merger within the same group of companies- (Income Tax Law, section 77(c)), Holdco was absorbed with and into Opco. It is important to note that federal tax authorities did not challenge the legitimacy of the business reorganization or of the leveraged buyout under Argentine Corporate law.

Opco, as the surviving company of the merger, made the following income tax deductions: (i) the interest resulting from the debts assumed

by Holdco before the reorganization date to purchase Opco’s shares; and (ii) the interest resulting from the loan granted to Opco by a group of banks, once the merger had been completed, the purpose of which was to arrange working capital and refinance Opco’s obligations, settling the debt incurred originally to acquire the shares.

The diagram shows the structure described above:

This article will not address the Income Tax Law limitations contemplated in regard to thin capitalization rules.

Facts An Argentine stock corporation (hereinafter, “Opco”) considered that the interest resulting from financial payables originally incurred by its former shareholder, an Argentine holding company (hereinafter, “Holdco”), intended for the acquisition of Opco’s shares, was income tax deductible.

Holdco – a company organized in Argentinawhose main shareholder was a stock corporation domiciled abroad (hereinafter, “Foreign Holdco”)

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Foreign Holdco Interest

Loan Agreements

HoldCo Argentina

Interest deduction

Merger OpCo Argentina

CFI.co | Capital Finance International

Local Bank

Tax authorities’ position Federal tax authorities argue that the interest Opco paid the former shareholders (the shareholders who sold Opco’s shares to Holdco) as well as the interest paid for the bank loans taken out after the tax-free reorganization process cannot be deducted from taxable income as they do not involve a Company payable incurred to finance its core business, but rather to finance and refinance, respectively, part of the cost of acquisition of Opco’s shares.

The arguments on which the Federal Administrative Tax Court’s position is grounded – the principle of universality of liabilities In its analysis, the Federal Administrative Tax Court refers, first of all, to the Income Tax Law provisions, stating the relationship between income for the year and inherent deductible expenses, i.e., the expenses necessary to obtain such income or maintain and preserve the source, as the case may be.

Then, the Federal Administrative Tax Court, in its ruling, introduces the analysis of section 81, Income Tax Law, which sets forth that debt interest constitutes a deductible expense.

This section establishes the principle of equity allocation, which only applies to natural persons and undivided successions. According to that principle, debt interest and related expenses are income tax deductible when it can be evidenced that they result from debts incurred to acquire goods or services used to obtain, maintain or preserve taxable income.

It is worth noting that there are two broad lines of opinion: the universality of liabilities criterion, according to which the loans do not finance any Company activity in particular, but are merely used for all kinds of tasks it carries out, on the one hand, and the equity allocation criterion, according to which whenever there is a direct relationship between the funds received and the activity for which they are used, they should be directly allocated to that activity.

The Federal Administrative Tax Court concludes in favor of the application of the principle of universality of liabilities, considering that Opco’s

Spring 2013 Issue

liability is related to the Company’s total assets.

The discussion in this sense is central, as tax authorities, by adopting the equity allocation criterion, contend that the deducted interest is related to income not computable under income tax (dividends from Argentine companies) and, therefore, they would not be deductible.

The Federal Administrative Tax Court, on the other hand, in its ruling, considers that the shares represent a potential source of income that can be received by collecting dividends or the opportunity to sell those shares. We consider that Foreign in its suggesting that the dividends received are Holdco a source of income, the Federal Administrative Tax Court would be referringLoan to the fact that Interest they have already constituted taxable income at Agreements the operating company level (Opco, prior to the merger).

About the Authors Leonardo Favaretto is a Senior Manager of the Transaction Tax Area in Argentina. He joined the Transaction Tax area of Ernst & Young in 2008.

Leonardo has developed strong expertise over 16 years in tax advisory services, tax planning and due diligence for local and international companies. He specializes in international and local business acquisitions and M&A consulting with a strong focus on mergers and reorganizations.

Leonardo Favaretto

He has given lectures in national universities and is a frequent speaker in tax seminars and has also written several articles dealing with Argentine tax issues.

HoldCo We found that structures such as the one we Argentina have described here have started to be analyzed over the past years. The effect of the current Interest Argentine foreign exchange scenario, Merger with deduction restrictions in place that limit the transfer of OpCo foreign currency abroad, have forced parties to Argentina seek alternatives that will allow them to carry out the transaction. That is how, once again, we see the intention of acquiring shares through an Argentine holding company, which incurs local bank debt in Argentine pesos, mostly financed by local financial entities.

Leonardo is a Certified Public Accountant, graduated from University of Buenos Aires in Argentina. He is also a member of the Professional Council of Economic Sciences of Buenos Aires. He is fluent in English and Italian.

Local Bank Institution Sergio Caveggia

Loan Agreements

Interest

Interest deduction

HoldCo Argentina

OpCo Argentina In other words, we find that the “old” local discussion on whether or not interest resulting from the leveraged buyout of a company is income tax deductible is coming to light again, and now, with a ruling validating that deduction.

Closing words The Administrative Tax Court with its ruling commented in this article has added another precedent in the list of case law related to the deduction of interest in stock acquisition

processes. Regardless of the technical arguments to validate the deduction from income tax, case law is controversial on the matter and ultimately the Argentine Supreme Court of Justice should settle this issue.

The amounts at stake in these kinds of transactions and the divided opinion of case law has, over the past decade, discouraged the use of these structures (the so-called BCRA mandatory deposit (encaje) of foreign currency established in Presidential Decree No. 616/2005 has also proved to be a deterrent for incurring this kind of debt). However, the current foreign exchange scenario and the practical difficulty to distribute funds and profits abroad has, once again, caused market players to negotiate the convenience of taking on local debt in Argentine pesos to acquire companies through an ad hoc vehicle.

The new economic scenario has made this old discussion resurface for new transactions, no longer as an option of the parties in a transaction with the tax aspects described in this article, but also as an alternative under current market conditions to secure successful deals that would otherwise be highly unfeasible. i

CFI.co | Capital Finance International

Sergio Caveggia is a Tax Partner currently in charge of the Transaction Tax Area in Argentina.

He joined the tax division of Ernst & Young in 1994, and has developed strong expertise, over 18 years, in International taxation and mergers and acquisition matters. He is highly experienced in acquisition structures for inbound and outbound investments, buy side, sell side and corporate restructuring services within the Transaction Tax area.

Sergio has served numerous clients in a variety of industries, moreover has also been involved in practically all Buy-side and Sell-Side due diligence processes performed by our firm in the last 10 years.

He has given lectures in national universities and is a frequent speaker in tax seminars. Sergio has also written several articles dealing with Argentine tax issues.

Sergio is a Certified Public Accountant, graduated from University of Belgrano. He also obtained his Tax Specialist’s Degree at the University of Belgrano and has a postgraduate certificate in Business and Management. from Universidad Católica Argentina (UCA). He is also member of the Professional Council of Economic Sciences of Buenos Aires and the Argentine Fiscal Association. He is fluent in English.

95

> CFI.co Meets Luis Gerardo Del Valle Torres:

Chairman of Del Valle Torres SC, Mexico City Expertise Luis has extensive experience in Tax consultancy in both domestic and international tax fields, including corporate and commercial, mergers and acquisitions, banking and finance insurance law, strategic alliances, joint ventures, investments and fund structures, tax litigation and private clients.

Professional Highlights: • Cambridge Overseas Society • Barra Mexicana Colegio de Abogados • Colegio de Profesores e Investigadores de Derecho Fiscal y Finanzas Públicas • Asociación Nacional de Abogados de Empresa.

• Luis Del Valle received from the Universidad Nacional Autónoma de México authorities the Eduardo García Maynez and Gabino Barreda medals for obtaining the highest academic achievement in his class; He has also been awarded with the first place in the National Contest of Administrative Justice organized by the Federal Court of Tax and Administrative Justice and has participated in numerous seminars and panels.

Affilliations International Fiscal Association Languages French, English and Spanish Academic Background Universidad Nacional Autónoma de México, Attorney at Law, magna cum laude, 1999; University of Cambridge, England, BritishChevening Scholarship, Master’s in Commercial Law, 2001; University of New York, NYU, Master’s in International Tax Law, 2002.

Publications: Sistema Fiscal Federal Mexicano.Su Revisión ante los Principios Jurídicos y Económicos” edited by the “Tribunal Federal de Justicia Fiscal y Administrativa,” 2001 OVERVIEW OF THE FIRM Del Valle Torres, S.C. has its offices in Mexico City and is one of the leading law firms in Mexico specializing in tax. In general the firm’s attorneys have law degrees from Mexican universities and LLMs or post-graduate studies in leading Universities in the United States of America and Europe. Del Valle Torres, S.C. is committed to excellence and has worked on major transactions having one of the most important practices in the country in tax on cross-border –transactions, real estate, private clients and litigation.

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MAIN AREAS OF PRACTICE: Del Valle Torres, S.C. renders tax consultancy services in general, including domestic and cross-border transactions.

This Mexican law firm has ample expertise in the structuring of investment funds for the most important real estate funds and pension plans both domestic and international.

The firm provides tax advice to high networth and ultra high-net-worth individuals,

CFI.co | Capital Finance International

international banks and insurance companies on the design of products for purposes of estate and wealth planning.

Del Valle Torres S.C. has broad expertise in administrative reviews before the tax authorities, as well as litigation on nullity Petitions and Amparo procedures before the Mexican Federal Court of Tax and Administrative Justice, District and Circuit Courts and the Supreme Court of Justice. i

> Ernst & Young, Panama:

Panama Treaty Network: A Key Factor for Enhancing Investment

By Luis Eduardo Ocando & Isabel Chiri

The Republic of Panama is the only country in Central America with an extensive tax treaty network. It is the only country in Latin American that negotiated more than eighteen double tax treaties in a short time, most of these treaties are signed with European countries.

S

ince 2009, Panama has made great progress in the negotiation of Double Tax Treaties (hereinafter DTT), and up to this moment, eleven DTT are already in force.

Those are the DTT with Mexico, Spain, Barbados, the Netherlands, Luxembourg, Singapore, Qatar, France, South Korea, the Portuguese Republic, and Ireland (comes into effect 01/01/2014).

Besides, as of today, Panama has already negotiated seven additional DTT which are in the process of final approval and ratification by the corresponding states. Those are the DTT signed with Czech Republic, the Italian Republic, the Kingdom of Bahrain, the Kingdom of Belgium, the State of Israel, the United Arab Emirates, and the United Kingdom.

As a result of the expending treaty network, new legislation has been enacted, related to residence status, permanent establishment, and the procedure to apply treaty benefits, among others topics.

This extensive treaty network creates a new scenario for foreign investors in Panama, not only for the elimination of double taxation, but also for the use of this network as a tool to improve fiscal efficiency for companies involved in cross-border transactions. Moreover, the different ways of the return of an investment, such as dividend and interest, may be subject to treaty benefits.

General WHT Tax Reduced Under % Participation Requirement % of Participation for WHT Rate Exempt in the Source State Under LOB Provision Branch tax

México 7.50% 5% 25% N/A 5%

if some conditions are met. Considering that Panamanian Law includes a branch tax of 10%, it should be taken into account that most of the DTTs include a special provision in their dividend article. According to this provision, the branch tax is reduced.

“This extensive treaty network creates a new scenario for foreign investors in Panama, not only for the elimination of double taxation, but also for the use of this network as a tool to improve fiscal efficiency for companies involved in cross-border transactions.”

The Key Features of this matter are shown in Table 1.

Regarding to the taxation of interest, in principle, every DTT follows the provision that the Source State may tax the interest; however the withholding tax rate could be reduced. In most cases the withholding tax rate could be reduced up to 5%. Furthermore, every DTT provides an exemption in the Source State in some scenarios (e.g. interest paid between the States, their Central Banks or a political subdivision, and certain public banks).

The following paragraphs provide a brief overview of the benefits under the Panamanian treaty network, as well as the legislation framework, with regard to the key topics for foreign investors.

All the DTT signed by Panama are in accordance with the OECD Model in most of the topics and some from the United Nations Model (UN).

The main differences with the OECD Model are mainly in royalties, capital gains on shares, and the treatment of services as well as the permanent establishment definition.

Table 2 summarizes the treatment of each DTT. As it was mentioned before, the main differences with the OECD Model is the treatment of royalties, services and capital gains.

Generally, under Panamanian Tax Law, dividends are subject to a 10% withholding tax. However, under DTT, dividend can be reduced to 5% if a minimum percentage of ownership is met.

Furthermore, treaties with Spain and the Netherlands allow for a 0% withholding tax rate Spain 10% 5% 40% Yes 0% / 5%

Barbados 75%* 5% 25% N/A 5%

Luxembourg 15% 5% 10% N/A 5%

Regarding royalties, every DTT follows the UN Model instead of the OECD Model. This means that Panama may subject royalties to tax, but the general withholding tax of 12.5% will be reduced.

The Netherlands 15% N/A N/A Yes N/A

Qatar 6% N/A N/A N/A 6%

Singapore 5% 4% 10% N/A 4%

France 15% 5% 10% N/A N/A

Portugal 15% 10% 10% N/A 10%

South Korea 15% 5% 25% Yes 2%

France N/A 5% Yes

Portugal N/A 10% Yes

South Korea N/A 5% Yes

Portugal 25% (no

South Korea 25%

* of the statutory nominal rate

Table 1

Tax Reduced if Beneficial Owner is a Bank General WHT Exempted in the Source State In Some Cases

México 5% 10% Yes

Spain N/A 5% Yes

Barbados 5% 7,5% Yes

Luxembourg N/A 5% Yes

The Netherlands N/A 5% Yes

Qatar N/A 6% Yes

Singapore N/A 5% Yes

Table 2

General WHT

México Spain Barbados Luxembourg The Netherlands Qatar Singapore France Portugal South Korea 10% 5% 7,5% 5% 5% 6% 5% 5% 10% 3% or 10%

98 % of Participation + Holding Period

CFI.co | Capital Finance International México 18%

Spain 10%

Barbados 25%

Luxembourg N/A

The Netherlands 10%

Qatar 10%

Singapore 50%

France 25%

Tax Reduced if Beneficial Owner is a Bank General WHT Exempted in the Source State In Some Cases

General WHT

México 5% 10% Yes

Spain N/A 5% Yes

Barbados 5% 7,5% Yes

Luxembourg N/A 5% Yes

The Netherlands N/A 5% Yes

Qatar N/A 6% Yes

Singapore N/A 5% Yes

France N/A 5% Yes

Portugal N/A 10% Yes

South Korea N/A Spring 2013 Issue 5% Yes

France 25% (no holding period)

Portugal 25% (no holding period)

South Korea 25% + 12 months

México Spain Barbados Luxembourg The Netherlands Qatar Singapore France Portugal South Korea 10% 5% 7,5% 5% 5% 6% 5% 5% 10% 3% or 10%

Table 3

México

Spain

Barbados Luxembourg The Netherlands Qatar Singapore 25% N/A hand, DTT 10% signed with 10% South50% On the other + Korea, 12 + 12 months (for and + 12Ireland+ 12 The Netherlands, France, months months months individuals), 24 months months are following the OECD Model. months (for The rest of the benefits may result DTT signed by Panamaentities) (i.e. Mexico, Qatar, and

18% % of Participation + Holding Period The limited withholding rate of each 10% DTT is + 12 + 12 summarized in Table 3.

The application of tax treaty especially advantageous for capital gains on shares, considering that under Panamanian legislation both direct and indirect sale of shares are subject to a 10% capital gain taxes.

Nevertheless, the buyer must withhold 5% from the purchase price and consider it to be the final income tax payment All DTT in force do not limit the source country to tax the capital gain on shares if the greatest part of their value derives, directly or indirectly, from immovable property situated in the source country. Under the OECD Model that is the only case in which the capital gains on shares may be taxed in the source country.

However, most DTT signed by Panama, did not follow the OECD Model, and included other cases according to which the source country may tax the gain from the sale of shares provided that a minimum percentage and a holding period requirement are met. Otherwise, the capital gain may be taxed only in the residence country.

It should be emphasized that the DTT with Luxembourg does not include this provision.

Table 4 compares the treatment and requirements in each DTT. Services are a sensitive issue in the Panamanian economy. Under domestic law, the withholding effective tax rate for services paid to non-resident companies is 12.5%, even if the services are provided abroad. However, if the local company does not take a deduction for the expense, no withholding tax applies.

Some treaties signed by Panama (i.e. Spain, Barbados, Luxembourg, Portugal), included a special article regarding services. Both the OECD Model and the UN Model do not include a similar article.

México To summarize this special article provides5% that Tax Reduced if Beneficial Owner is a Bank the taxation 10% General WHT of some services (e.g. consulting, Exempted in industrial, the Source State In Some Cases technical, management servicesYes etc.)

Singapore) are following the UN Model.

The new scenario required amendments in the legislation of Panama. As a consequence, new legislation was approved in 2010, and modifications were made in 2012. New legislation was created in relation to permanent establishment rules, transfer pricing, residence definition, and the procedure to apply treaty benefits.

In summary, the definition of Panamanian resident for tax treaties purposes includes individuals who remain in Panama for over 183 consecutive or interrupted days in one fiscal year or in the year immediately prior, or individual who have established their permanent residence in Panama; and Corporations incorporated per the Laws of Panama and having material means of direction and management in Panama, or Corporations incorporated overseas with material means of direction and management in Panama, registered in the Public Registry of Panama.

According to permanent establishment rules, they are considered taxpayer of the income tax, and they must pay such tax over the income attributable of Panamanian source, via an annual tax affidavit.

Finally, in order to apply treaty benefits in Panama, the Tax Administration should be informed no more than 30 days prior to the transaction or operation for which the respective DTT will be applied, with the corresponding support documentation; and the residence certificate of the beneficiary.

To conclude, we can say that the extended treaty network and the new legislation have made Panama an even better country for foreign investors. Furthermore, we can expect Panama to conclude more DTT in the near future. i

Spain Barbados Luxembourg N/A 5% N/A Luis Eduardo is an 5% 7,5% Ocando 5% Yes Partner ofYesErnst & Yes Young,

The Netherlands Qatar N/A N/A International Tax 6% 5% Yes Central Yes Panama,

Singapore N/A 5% Yes

France N/A 5% Yes

Portugal N/A 10% Yes

South Korea N/A 5% Yes

France 25% (no holding period)

Portugal 25% (no holding period)

South Korea 25% + 12 months

is not limited to the source country, provided America, and Dominican Republic. Isabel Chiri is that the services are performed in that country. an International Tax Manager of Ernst & Young México Spain Barbados Luxembourg The Netherlands Qatar Singapore France Portugal South Korea Notwithstanding, the withholding tax rate is Panama, Central America, and Dominican General WHT 10% 5% 7,5% 5% 5% 6% 5% 5% 10% 3% or 10% limited.

Republic, based in Panama.

% of Participation + Holding Period

México 18% + 12 months

Spain 10% + 12 months

Barbados 25% + 12 months

Luxembourg N/A

The Netherlands 10% + 12 months (for individuals), 24 months (for entities)

Qatar 10% + 12 months

Singapore 50% + 12 months

Table 4

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99

Paul BARBOUR Senior Risk Management OfficeR

Paul Barbour is a Economics and P Guarantee Agenc World Bank Group

> MIGA (World Bank):

Investing in the Middle East and North Africa: Risky Business?

Paul worked pr Corporation (the World Bank Grou to this he was Department for I number of projec served as an econ

By Paul Barbour

M

ore than two years have passed since the beginning of the so-called Arab Spring and results are certainly mixed.

Violence in Syria has escalated, with spillover effects to Iraq, Lebanon, and Jordan.

In many of the post-revolutionary countries in the Middle East and North Africa (MENA), the drafting of new constitutions remains a key, pending issue. In the tumult of transition, levels of public expectation are high and maintaining the stability needed to allow the transitions to succeed will depend in large part on the ability of new governments to deliver significant improvements in the lives of their citizens.

Creating the right environment for growth is critical as it drives job creation for the large numbers of unemployed, especially young people. An estimated 40 million jobs are needed in the coming decade in the region, and this will require significant investment in productive assets. Yet so far the private sector falls well short of transforming MENA countries into diversified, highly performing economies. In fact, it can be argued that there is a mutual mistrust between the government and the private sector in many countries in the region. According to a World Bank report, From Privilege to Competition: Unlocking Private-led Growth in the Middle East and North Africa, a majority of public officials interviewed across the region thought the private sector in their countries was rent-seeking and corrupt. On the private sector’s side, businesspeople tend to believe that the governments of the region do not act to improve the investment climate for all businesses, but rather for the benefits of politicians and a narrow group of their allies.

Against this backdrop, the growth perspective of the region has become even more cloudy since the end of 2010 onward, as political turbulence has impacted MENA’s economies.

In those countries directly affected, there have been significant disruptions in economic activity, including plummeting tourism and FDI flows.

While the economic impact has been uneven across the region, for the developing countries in MENA the growth rate has fallen from an average of 4.2% between 1998-2007 to an estimated 2.4% in 2012. Even prior to the Arab Spring, the global financial crisis was already affecting FDI flows into MENA—so the region has been doubly hit. In fact, as MENA has historically lagged with respect to other regions in FDI indicators, we

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“Now more than ever, the investment environment in MENA is not for the faint of heart.” could also argue that the challenges are threefold.

From the perspective of investors, MENA has been considered one of the riskier regions for some time. If we use political risk insurance issuance as a measure of risk perception, we see that from 2005-2011, developing countries within MENA accounted for 4.9% of all foreign direct investment (FDI) into the developing world, yet 10.6% of all political risk insurance issued into the developing world covered investments in MENA. Evidence that the Arab Spring has directly led to a reduction in FDI inflows further is found in a foreign investor survey jointly undertaken in 2012 by the World Bank’s Multilateral Investment Guarantee Agency (MIGA) and the Economist Intelligence Unit (EIU). Results of the survey confirmed that the crisis in the region is having a negative effect on FDI, as nearly

20 percent of investors had plans pbarbour@worldbank.org to withdraw t. 202.473.7349 existing investments in Arab Spring countries.

The survey found political violence—especially civil disturbance and to a lesser extent war and terrorism—ranked particularly high as the risk of most concern, as did governments’ abilities to honor their sovereign financial obligations.

Despite heterogeneity among the different countries in MENA, on balance, the turmoil has stressed existing investments and dampened plans for expansions and new investments.

Some investors in the countries directly affected by the civil disturbances, especially investors in the energy and service sectors, 1818 H Street, NWhave Washington,reported DC 20433 www.miga.org suspending operations. All of this has been amplified by the worsening state of domestic economies, as current account deficits and budget deficits have widened, private capital flows have weakened, inflation has risen, and production and investment have declined.

The glass appears to be half-empty. What now?

On the bright side, the MIGA-EIU survey results mentioned earlier also show that the majority of investors targeting MENA do not plan to change their current (low) level of investment in the region writ large. This means that any “perception contagion” within the region has been limited, and this is important news.

Figure 1: How developments in the Arab World over the past year have affected current and future plans for investments in the Middle East and North Africa. Percent of respondents.

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Paul has a Mast University, and an Paul is also a Char

Spring 2013 Issue

long-term deals in risky markets—especially in energy and natural resource investments.

Also, guided by their development mandate, during difficult times public-sector insurers (such as MIGA) often are open for business even when privatesector insurers are offcover.

Moreover, public insurers’ development mandates ensure that they put a lot of muscle into resolving disputes before they reach a claims situation. MIGA, for example, has been involved in more than one hundred disputes between investors and governments in its 25-year history. In all but two cases the disputes were resolved before they reached a claims situation. While it is clear why this is important from the Figure 2: How Developments in the Arab World over the Past Year Affected your Current and Future insurer’s perspective, Plans for Investments in the Middle East and North Africa? Percent of respondents. the benefit that accrues Nevertheless, investors considering new projects to the insured is also important: few would or those who already have projects active in disagree that what most investors want is to keep the region face a very fragile and uncertain their projects on track. From the host countries’ environment. How can this risk be mitigated? perspective as well, it is best to keep productive investments moving forward inasmuch as they MIGA conducted a different survey in 2010 create jobs, provide infrastructure, and stimulate together with the Dubai International Financial economic dynamism.

Centre. It showed that traditionally the preferred risk mitigation instruments in MENA have been Political risk insurance is becoming an informal: investors in the region preferred to rely increasingly important tool for investors and on their knowledge and personal connections lenders. Interestingly, MIGA’s World Investment to manage risk. Yet, this situation has changed and Political Risk 2012 report notes that as old connections have left power and the demand for political risk insurance has landscape that investors once knew has shifted. continued to increase at even faster rates than FDI growth. The proportion of FDI covered by Another way investors can mitigate the political political risk insurance is at a historic high: risks they face is through political risk insurance. 11.9%. This corroborates MIGA’s experience A tool for businesses to mitigate risks arising over the past two years: our business volume in from the adverse actions—or inaction—of general is also at a historic high, as is the portion governments, political risk insurance typically of our volume that corresponds to insurance for covers expropriation; currency inconvertibility investments in MENA. These trends indicate and transfer restriction; war, terrorism, and more interest in emerging markets amidst lowcivil disturbance; breach of contract; and non- return environments elsewhere coupled with honoring of sovereign guarantees. greater perceived risk—largely as a result of the Arab Spring.

Once a decision is made to obtain political risk insurance, an investor or lender needs to Sustainable and sustained FDI is a critical part choose between the private and public insurers. of developing countries’ success stories and The industry consensus is that while private countries in MENA are no exception. Political insurers are generally more price-competitive on risk insurance is an important arrow in the quiver transactions such as export credit insurance, the of investors and risk managers operating abroad public insurers are generally better placed for to secure this investment.

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The hope is that, going forward, the MENA economies will become more open and begin to resemble some of the more successful middleincome economies. Consider: Egypt exports in one year what South Korea exports in two and a half days. This means that there is tremendous unrealized potential for Egypt to improve the performance of its economy, create jobs, and improve the standard of living of its citizens. And Egypt is just one example.

Now more than ever, the investment environment in MENA is not for the faint of heart. But opportunity—both for investment and for the stark development needs of the region’s citizens—is unprecedented. Nimble risk mitigation instruments like political risk insurance can help investors navigate this water where many charts have been redrawn. i

About the Author Paul Barbour is a Senior Risk Management Officer, in the Economics and Policy Group of the Multilateral Investment Guarantee Agency, the political risk insurance arm of the World Bank Group.

Paul worked previously for the International Finance Corporation (the private sector investment arm of the World Bank Group), as an economist and strategist. Prior to this he was a senior economic advisor in the UK’s Department for International Development, advising on a number of projects across Africa. In his early career, Paul served as an economic adviser for the Government of Fiji.

Paul has a Master’s Degree in Economics from Oxford University, and an MBA from the Yale School of Management. Paul is also a Chartered Financial Analyst.

About MIGA MIGA was created in 1988 as a member of the World Bank Group to promote foreign direct investment into emerging economies to support economic growth, reduce poverty, and improve people’s lives. MIGA fulfills this mandate by offering political risk insurance (guarantees) to investors and lenders, covering risks including expropriation, breach of contract, currency transfer restriction, war and civil disturbance, and non-honoring of sovereign financial obligations.

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> Christopher Baines, Gulf Capital:

SME and Mid Cap Bank Lending in MENA

I

t is widely acknowledged that on a global scale commercial bank lending to SMEs is not sufficient despite rhetoric and various Governmental incentives seen in a number of countries to grow this area.

“MENA region is the place in the world where SMEs are the least likely to have access to credit lines.”

There are two primary reasons for this: many banks are seeking to rebuild their capital bases to prepare for tighter regulations (e.g. Basle III) and also protecting themselves against additional potential write-downs or other un-quantifiable adverse effects to their business in the near future. This rationale is common in many countries and is likely to prevail for the short term at least, given the broader unresolved issues in global finance and the finely poised global macro economic situation.

Within the wealthiest part of MENA - the Gulf Cooperation Council (GCC), which includes countries such as Saudi Arabia, the UAE, Qatar and Kuwait with some of the highest GDP per Capita rates in the world – bank lending to SMEs is almost negligible. In the GCC, only 2 % of bank lending is devoted to SMEs.

Both of these factors foster a cautious approach for commercial bank lending to SMEs. In geographies with more developed capital markets we have consequently seen the development of SME dedicated funds making direct lending investments and filling the gap in the market left by banks.

These numbers are extremely low but are even more surprising when compared to the importance SMEs have in the overall GCC economy, whether that is expressed through a share of employment or of GDP. Even in oil exporting countries such as the United Arab Emirates, SMEs account for 60 % of GDP and 86 % of employment.

With that in mind, what chance do the smaller mid-market borrowers have of raising loans to fund their expansion especially in a region such as the Middle-East and North Africa region (MENA)?

According to a World Bank study, the MENA region is ranked as the place in the world where SMEs are the least likely to have access to credit lines from financial institutions. Only 20% of SMEs in MENA have this access, which makes them less likely to have available bank lines than their peers in Africa and half as likely to have bank facilities than their Latin American & Caribbean equivalent.

SMEs therefore represent a very important part of both the regional economy and social fabric due to their ability to rapidly create (or destroy) jobs significantly impacting sentiment. This is why Governments in the region are increasingly keen to foster the development of bank lending to SMEs. Given this situation, a number of the larger banks in the region have established dedicated SME finance teams however, while this certainly helps, it does not necessarily make an immediate difference improving access to finance in all cases.

% of Firms with a Loan/Line of Credit from Financial Institution, MENA and Other Region 80% 70% 60% 50%

Africa East Asia and Pacific East Europe & Central Asia Latin America & South Asia MEN

The typical form of security required by banks is a mortgage over assets as well as personal guarantees from the owners/main shareholders.

As such, asset-light SMEs with strong cash generation that require growth capital, can often find it difficult to raise flexible debt financing.

40% 30% 20% 10% 0%

SMEs

Sources: World Bank (January 2011)

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At Gulf Capital, we believe that this new emphasis on SME bank lending will be an evolutionary rather than revolutionary process as SMEs move from being primarily financed on the basis of the assets they can pledge to lenders (on a LTV or Loan to Value approach) rather than the amount of cash flow they generate.

Large

Banks in the region are also typically very cautious when it comes to cross border transactions (even to a bordering country in the

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region) with domestic clients being the main focus. Acquisition finance is something that in our experience SMEs struggle to raise and this would be especially challenging in the case of cross-border acquisition financing.

The LTV financing approach also limits Private Equity’s ability to mix debt with equity when completing an acquisition of an SME. In Western Europe, the US and certain parts of the Far East, private equity (PE) investors typically secure debt financing either via banks (senior bank loans, and/or mezzanine/subordinated loans) or via the capital markets, (high yield bonds). In some cases, both instruments are combined. In the MENA region, where there are no established sub-investment grade capital markets and only a few examples of institutional credit investors, PE investments are typically fully equitised (i.e., not supported by a combination of debt and equity). We believe that this is holding back the development of PE in MENA. Why is this the case and why does it matter?

There are some peripheral reasons for this situation like the lack of need for the tax shield that debt provides in countries with higher levels of taxation, which can make debt less attractive in the MENA region.

However, in our view the main constraint on SME corporate and PE-related financing is not due to the lack of demand but rather the limited supply of structured lending. When asset-light borrowers seek growth capital in the form of an acquisition or a capex loan, lenders are often required to take a view on future cash flows rather than relying mostly on the present situation of the borrower.

We believe this structured lending approach is not yet widespread enough in the region.

The core of structured lending, we believe, is to analyse and quantify the future financial benefits of a proposed growth plan and carry out detailed due diligence on the borrower’s financial and commercial prospects. In short, for asset-light businesses, ascertain whether the growth plan generates sufficient additional free cash flow to repay the loan or bond under a realistic scenario (cash flow approach) rather than determine whether a mortgage on assets will give the lender sufficient asset coverage (asset approach).

Why does this matter? Put simply, structured cash flow lending is required to maximise regional entrepreneurs’ growth and PE investments’ profitability. For example, a strong corporate with

Spring 2013 Issue

Source: GCC Economic Review (October 2011), IFC (September 2012), A.T. Kearney, * Hussein Elasrag, “The developmental role of SMEs in the Arab countries”, Oman Ministry of Commerce and Industry, UAE

few tangible assets available to mortgage but with high margins and limited debt can struggle to receive bank financing despite potentially being a good investment. Similarly, a corporate seeking to invest in earnings-enhancing capex that does not involve making assets available to pledge to banks can find limited appetite from regional lenders. A cash flow investor can look favourably at and analyse the future value of these investments. For PE, an investment mixing debt with equity has the potential to generate a significantly higher IRR than one using only equity. This should matter to their LPs. Gulf Capital’s solution Gulf Capital Credit Partners has established a UAE-based USD 300million regional credit fund focusing on bringing much needed liquidity to faster growing companies in the MENA and Turkey regions. Investments from this innovative fund will be carried out using the

more sophisticated cash flow investing approach described above. Investments will therefore be tailored to the specific needs of borrowers.

strengthen its market position and expand its operating footprint in existing and new strategic markets.

This bespoke approach to direct lending to SMEs provides them with the flexibility they require.

The final maturity and amortisation profile of a loan can be structured to take into account a company’s cash flow generation, especially in the first few years of its business plan when preserving cash to grow the business is vital.

Orion Group, a company providing outsourced facility services in Turkey including cleaning, catering and laundry services, also received a US$20 million investment from Gulf Credit Partners. Proceeds of the investment were used to fund a set of acquisitions, which expand Orion’s presence in their core services in Turkey.

Examples of the fund’s investments include a US$25 million investment in a UAE based company, SES FZCO (SES). SES is a leading provider of temporary and medium term energy solutions that caters to the growing need for power across the Middle East, Africa, and South East Asia region. The financing facility from Gulf Credit Partners provides meaningful growth capital to SES, which will be used to help it

We are very pleased with the success we have encountered during fund raising having secured anchor investments from blue chip regional institutions as well as the IFC. Equally importantly, we look forward to adding more investments to our current portfolio of three companies where we have provided growth financing to businesses across a range of sectors. i

about the author Christopher Baines is the Managing Director and Co-Head of Gulf Credit Partners, an innovative USD 300 million credit business initiative for the MENA and Turkey region. This initiative by Gulf Capital invests in debt products across the whole capital structure, from senior debt to mezzanine and quasi equity instruments. Mr Baines has over 25 years’ experience in international banking, structured lending and investment management acquired in various houses in Europe and the region.

fund based in Bahrain which he established in late 2008. Before moving to the region over three years ago, Mr Baines spent over two decades in banking in London and Paris, mostly at Societe Generale where he held a number of senior roles in structured lending (origination and capital markets) covering the entire spread of credit products with a special focus on sub-investment grade transactions such as LBO finance, mezzanine and high yield.

Prior to joining Gulf Capital early in 2011, Mr Baines was the Managing Director and Head of Investcorp’s USD 300 million MENA mezzanine

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Mr Baines holds an economics degree from the London School of Economics. He has also attended executive courses at the Kellogg School of Management at Northwestern University and at the London Business School.

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> DESERTEC:

From Vision to Reality

By Hani El Nokraschy

DESERTEC Power established in Kingdom of Saudi Arabia – a first step to provide clean energy and potable water for 10 Billion people expected on the planet in 2050.

T

he DESERTEC concept was developed to: • Encourage emerging economies to consider renewable energies in their portfolio when extending their electricity production park, which is growing at a yearly rate of typically 6-8%.

• Develop renewable energies to maturity and thus achieve cost parity with fossil fuels.

• Support industrialised countries in their efforts to reduce their own CO2 emissions by cooperating with emerging economies.

• Produce potable water – also for irrigation – by means of seawater desalination powered by renewable energies.

The above mentioned topics, fostered by capacity building through education, are capable of securing food production and raising the GDP of emerging economies.

DESERTEC Power A wide step towards these goals was achieved in February 2013 by founding “DESERTEC Power”, a private company in the Kingdome of Saudi Arabia which is devoted to electricity production and seawater desalination by means of renewable energies.

“DESERTEC Power” will be supported by the DESERTEC Foundation and the DESERTEC Network to enable deploying sustainable and viable solutions using technologies that are “ready to install” beside improving the same to higher efficiencies and better cost effectiveness, as well as adapting to the site conditions in the Kingdome of Saudi Arabia by means of accompanying research work.

was predicted to 120 000 MW, which is nearly tripling and reflects the enormous growth of this country.

As electricity in KSA is mainly produced by burning oil, it contributes significantly to the increase in domestic oil demand of 27% in the last 4 years, the largest increase compared to other countries, which have partly succeeded to decrease their demand.

Figure 1: The test rig for the Point Focus Fresnel Collector (PFFC) shows provision for positioning the mirror elements to maximize sunrays’ collection and minimize shadowing.

Driving force towards renewables The news that the Kingdome of Saudi Arabia is considering renewable energies in its future energy portfolio was met with astonishment in many scientific communities.

The question was raised: why does the world’s largest oil exporter look for alternatives?

The answer is given by the Saudi “Electricity and Cogeneration Regulatory Authority” in a paper available at the KA-CARE predicting future electricity demand, reflecting required installed capacity including emergency standby capacity.

Taking the electricity peak demand in the summer of 2010 as starting point, it was 43 000 MW, the required capacity in summer 2030

The increase in domestic oil demand is really dramatic when considering the words of Mr. Khalid Al-Faleh, CEO of Saudi Aramco ; business as usual would increase the domestic demand from about 4 in 2012 to 8.2 Million barrels of oil equivalent per day in 2030.

Considering the average daily oil production of KSA figured to approximately 9.0 Million barrels per day; it is obvious that the government is interested to find adequate solutions for the future.

Therefore beside renewable energies also atomic energy is considered for the future electricity mix. However the DESERTEC foundation is confident that the newly founded company “DESERTEC Power” will be able to demonstrate that building capacities in renewable energy will be much faster than building atomic power stations, especially because mainly fostered by an increasing share of local production.

Research is another important pillar in the envisaged structure. That is the reason for the strong cooperation with Saudi Universities and education institutions especially the “King Abdullah City for Atomic and Renewable Energy” (KA-CARE) and the King Saud University.

Especially the King Saud University is developing a solar collector that may get a leadership in the country, because it considers the special conditions on spot.

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Figure 2: Domestic oil demand in selected countries/regions. Source: International Energy Agency IEA and KA-CARE.

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Spring 2013 Issue

Demand fulfilment Seawater desalination is one of the main issues for the Kingdome of Saudi Arabia. Most of the oil burning power stations in KSA are built near the sea shore and produce desalted water beside electricity in cogeneration by using the waste heat at the condenser of a steam turbine, an established concept for decades that has proven its validity and cost effectiveness.

This proven concept can be continued with Concentrating Solar Power (CSP) power stations that are capable to produce electricity day and night thanks to their thermal storage capabilities.

Using mainly a steam turbine for power generation, they fit optimally in the existing scheme and can even take over for thermal power stations that are out-phased.

According to the published plans of the government, 25 000 MW of CSP and 16 000 MW of photovoltaic power (PV) are planned to be installed till 2032.

In Pictures: Hani El Nokraschy

This mix beside existing fossil power stations is justified when having a closer look at the typical pattern of electricity demand, which differs according to the seasons.

Figures 4 and 5 show the main characteristics of warm countries, typically having a higher demand on electricity in summer than in winter.

In KSA it is even an exceptionally large difference as the winter peak demand is about 60% of the summer peak demand.

This correlates well – globally seen - with the sun energy received by the desert areas, thus it is obvious that this kind of renewable energy will have an exceptional advantage in KSA. Figure 3: Professor Hany Al-Ansary, Chairman of the Mechanical Engineering Department in the College of Engineering at King Saud

As known, PV delivers its peak electricity at noon.

This correlates quite well with the expected demand in summer 2030. It is typical for KSA that the electricity demand peak is around noon in summer because of the intensive application of air conditioning.

In contrast to KSA, the summer peak in Mediterranean countries is in the early evening (whereas demand in summer is about 20% higher than in winter).

A more detailed insight to the curves reveals that in winter the peak is during the evening, while in summer it is around noon. Accordingly using PV will develop enough electricity especially in summer around noon and CSP power stations can take over for the evening and base load all the year.

Peak Swap over the borders The fact that neighbouring countries have different peak day time gives the chance of electricity swapping between them to compensate the peaks and thus avoiding a part of investments in peaking power stations for both countries.

Figure 4: Summer electricity demand pattern.

Figure 5: Winter electricity demand pattern.

University and Dr. Thiemo Gropp, Director of the DESERTEC Foundation visiting the testing facility.

Explanation: Typical electricity demand pattern expected 2030. Source: KA-CARE, Khalid Al-Sulaiman.

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Figure 6: Typical PV electricity production during the day.

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The Mediterranean Ring – an International Success Story As renewable energy resources are often in sites far away from the centers of industry and inhabitants, where the energy is consumed, it is essential to have an appropriate means to transport this energy.

Electric energy is easily transported by cables and lines, however, such networks – called grid - were limited to an area of about 2000 x 2000 km, e. g. European grid.

Figure 7: Typical electricity demand pattern in Egypt during summer, peak about one hour after sunset.

Source: Ministry of Electricity and Energy, Egypt.

Figure 8: The Mediterranean ring, proposed 1987 by the Egyptian minister of electricity Maher Abaza and agreed upon with the prime minister of Turkey Algot Oezal, was decided in a conference held in Ankara for that purpose in 1988. The connection Egypt-Saudi Arabia was added in 2010. Source: Ministry of Electricity and Energy, Egypt and Author.

This is the case for KSA and Egypt. For that reason a connection between both countries is planned to swap 3000 MW in 2016 each day during the summer months.

To overcome the distance of about 1400 km connecting the grids of KSA and Egypt, the High Voltage Direct Current (HVDC) technology is the best choice. This gives a supplemental advantage, the grids have different AC frequencies, in KSA it is 60 Hz and in Egypt it is 50 Hz. Thus a backto-back joint is not required as its purpose is fulfilled by the HVDC line.

Principles and Criteria Just shifting the energy production to renewables may be insufficient if the implementation is not sustainable. For that reason the DESERTEC Foundation is creating - and continuously updating - a catalogue of sustainability criteria, starting with CSP projects, based on several principles upon which power production may be evaluated.

A selection of principles and their criteria are summarized as follows: Principle - provision of security and distribution of electricity. Criteria:

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• Limited share of fossil fuel in yearly electricity production • Dispatchability • Minimized down-time • Local and national benefit • Interconnectivity and • Grid stability Principle - social responsibility and economic sustainability. Criteria: • Participation • Maximized involvement of local/regional economy • Profound consideration of socio-economic impacts Principle - environmental responsibility. Criteria: • Profound consideration of environmental impacts • Conservation of rare, threatened or endangered species and habitats • Minimized waste production.

• Maximized use of renewable energy • Minimized use of water/optimum: neutral water balance • The power plant shall be responsibly decommissioned and materials shall be recycled after the operational period.

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This is the story how the European grid was extended to cover double as much area and embracing the Mediterranean with a ring to enable renewable energy from the vast resources of sun and wind in North Africa to be transported to Europe where they are needed.

1987 - Mr. Maher Abaza, minister of Electricity and Energy in Egypt, contacted Mr. Algot Özal, prime minister of Turkey. He suggested to expand the national grids in both countries and to connect them together and to the European grid. Mr. Özal found it a challenging idea and took action immediately.

1988 - Upon invitation of Turkey, 42 Islamic Countries, represented by the ministers of Energy, held a conference in Ankara; the project was accepted and recommended by all the members of this conference.

1989 - The Arab Fund for Investment declared that it will finance the project.

1992 - Start of the project with Arab fund financing.

European Investment Bank participated in funding the Turkish part.

1994 - The portion from Italy to Turkey via Greece was chosen to go through the Adriatic Sea to avoid passing through the Balkan, as at that time political instability was expected. The European Union financed the Turkish part.

1998 - In October, a meeting was held in Rome between the North African ministers of Energy and the Spanish, Portuguese, French, Italian, Greek ministers of Energy and signed an agreement. This agreement envisaged the Mediterranean Ring with 400 kV cables.

2002 - The Mediterranean Ring is under construction, Africa is connected via Asia up to Syria and Morocco is connected to Spain with a marine cable of 400 kV. Interconnections between Syria-Turkey and TurkeyGreece as well as between Libya-Tunis are still under construction. Also the planned marine connection Tunis-Sicily-Italy has not yet started.

2003 - 1st and 2nd December, again in Rome, the ministers responsible for electricity and energy of the Mediterranean countries signed the final agreement to complete the ring and to add two more marine connections, AlgeriaSpain and Libya-Crete-Greece.

Thus this Ring is a 400 kV interconnected system planned to be expanded to 600 kV direct current lines for low loss transportation of electricity.

Spring 2013 Issue

The DESERTEC concept for 10 billion people Responsibility when managing the remaining resources: • Education for wise Resource Management.

All peoples of the earth shall have a realistic chance for development: • Energy for Development.

Collect energy from the deserts, as it is abundant and not used: • The Sun gives in 6 hours the Energy used in one year Transport the collected energy from the deserts over long distances to the users: • Via HVDC, an available technology.

Produce potable water by desalination to satisfy food demand: • Clean Electricity and use of Waste Heat for Desalination. i

About the Author Hani El Nokraschy Vice-Chairman of the Supervisory Board Coordinator for Egypt DESERTEC Foundation After graduating as mechanical engineer (BSc) from the Cairo University, Faculty of Engineering, he continued his studies in Germany at the Technical University of Darmstadt, where he achieved his Dr.-Ing. In 1968, he worked as head of the research department for vibrating machines at SCHENCK in Darmstadt/Germany, then as head of design and R&D at MOGENSEN in Wedel/Germany.

In 2003 he founded his own consultancy services, NOKRASCHY ENGINEERING, where he discovered the attractiveness of renewable energies, especially for his birth country Egypt which is blessed by excellent sun and wind conditions.

He participated as a team member at the studies

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of the German AeroSpace Center DLR, which are the scientific pillar for the idea of the DESERTEC foundation.

In 2008/2009 he was one of the founders of the DESERTEC foundation and since then vice chairman of the supervisory board and coordinator for Egypt.

In 2009 the Egyptian government asked him to edit a study about the future of electricity production in Egypt. He suggested therein a gradual but definitive shift to renewable energies within this century.

References • DLR Studies mED-CSP, TRANS-CSP, AQUACSP: www.menarec.org • Presentation of H.E. Dr. Khalid Al-Sulaiman, KA-CARE vice president for renewable energies at the Third Saudi Solar Energy Forum, 3rd April, 2011 in Riyadh: http://ssef3.apricum-group.com/downloads/

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> CFI.co Meets Chairman & Founding Partner of MENA City Lawyers:

Fady Jamaleddine

F

ady Jamaleddine (FJE) is the Founding Partner of MENA City Lawyers – MCL Lebanon, whereby he brings to the team over 25 years of experience. Prior to creating MENA City lawyers, FJE headed a prominent Lebanese law firm.

FJE leads a large team of local and international lawyers, and is the driving force behind the growth of MCL, and the desire to establish and strengthen the most prominent Global Pan-Arab law firm.

FJE has extensive experience in Banking, Commercial and Corporate law, Real Estate and Construction and is responsible for handling and assisting MCL’s most high-profile international and local clients. He also works extensively in the field of Intellectual Property, and has created a service unmatched within the MENA region providing not only the monitoring, mitigation and management of Intellectual property, but a service whereby an undertaking is made to ensure that all compliance, language translations and any proscriptions offered meet with the requirements and local laws of the region.

FJE’s wealth of experience stems from his years of acting as Counsel for some of the world’s largest multi-national corporations conducting business in the Middle East region, coupled with his provision of legal services and advice to numerous Governmental entities throughout his long and successful career.

MCL Lebanon was built on an idea that FJE personally intended to create a truly Pan-Arab law firm, founded on a strategic regional knowledge base and network and thereby creating a practice able to compete with the most successful Global firms. His management oversight has ensured that MCL Lebanon has fast become one of the largest, premier and most successful law firms in the region.

Multi-lingual, FJE provides advice and assistance in Arabic, English and French on a daily basis, offering clients the utmost professional service, and relying on his large team of lawyers and partners to assist him on the most complex of cases.

FJE has also been instrumental in creating the first Code of Ethics for Lawyers in commercial

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“FJE’s wealth of experience stems from his years of acting as Counsel for some of the world’s largest multi-national corporations conducting business in the Middle East.” practice within the region, and constantly strives to ensure MCL Lebanon is renowned for it’s corporate responsibility in all aspects of it’s practice.

FJE has authored numerous articles, and has also created an Islamic Finance lexicon offering insight and guidance to his International clients, unfamiliar to the terms and practices intrinsically linked with the Islamic Finance sector.

FJE is an extremely accomplished individual, who has traveled extensively, and possesses a great understanding of numerous global cultures, affording him skills and attributes which permit him to provide unmatched services to any of his clients.

FJE has actively sought to promote the issue of Human Rights throughout the years of his corporate practice in the Middle East Region.

He was instrumental in launching the MCL Annual pro bono initiative. FJE also successfully inaugurated the first Lebanese Association for Human Rights. He drafted and implemented a Code of Ethics within his MCL network, and remains committed to the development of the legal sector in Lebanon. FJE truly does encompass the skills and qualities of one of the most forward thinking practitioners in the MENA region.

On a personal level, FJE runs a large, successful Bio-experimental farm in the Bekaa valley of Lebanon. This farm has seen the implementation of a solar panels initiative and continues to strive for novel, organic planting. FJE is a true champion of development within his home country.

FJE’s ambitious plans for MCL Lebanon have assured that his firm will continue to grow and retain the title as the most prominent and most successful Pan-Arab law firm for many years to come. i

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“Fady Jamaleddine has also been instrumental in creating the first Code of Ethics for Lawyers in commercial practice within the region, and constantly strives to ensure MCL Lebanon is renowned for it’s corporate responsibility in all aspects of it’s practice.”

www.cityscapeqatar.com/fqv

Creating a picture of Qatar’s National 2030 Vision

> Joschka Fischer:

The Middle East’s Lost Decade

T

he United States has waged three wars since Al Qaeda’s terrorist attacks on September 11, 2001: against Al Qaeda, in Afghanistan, and in Iraq. The first two were forced upon the US, but the third was the result of a willful, deliberate decision by former President George W. Bush, taken on ideological grounds and, most likely, for personal reasons as well.

Had Bush, former Vice President Dick Cheney, former Secretary of Defense Donald Rumsfeld, and their neocon allies been forthright about their intentions – to bring down Saddam Hussein by means of war, thereby creating a new, proWestern Middle East – they never would have received the support of Congress and the American public. Their vision was both naive and reckless.

So a threat – Iraqi weapons of mass destruction – had to be created. As we now know, the

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threat was based on lies (aluminum tubes for a nuclear-weapons program, for example, meetings between the 9/11 plot leader, Mohamed Atta, and Iraqi officials in Prague, and even glaring forgeries like supposed Iraqi orders for yellowcake uranium from Niger).

Such were the justifications for a war that was to claim the lives of almost 5,000 US soldiers and more than 100,000 Iraqis. Add to that the millions more who were injured and displaced from their homes, as well as the destruction of one of the world’s oldest Christian communities.

For this, the US alone spent up to $3 trillion.

Bush’s war against Saddam did radically change the Middle East, though not as he envisaged.

For starters, if the US had set out to destabilize Iraq, its efforts could hardly have been more successful: ten years later, the country’s viability as a single state has never been in greater doubt.

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With Saddam gone, Iraq’s Shia majority assumed power after a horrendous civil war, leaving Iraq’s defeated Sunnis longing for revenge and waiting for an opportunity to regain their ascendancy.

The Kurds in the north cleverly and adeptly used the window of opportunity that opened before them to seize de facto independence, though the key question of control over the northern city of Kirkuk remains a ticking time bomb. And all are fighting for as large a share of Iraq’s enormous oil and gas reserves as they can get.

Taking stock of “Operation Iraqi Freedom” a decade later, the Financial Times concluded that the US won the war, Iran won the peace, and Turkey won the contracts. I can only agree.

In political terms, Iran is the big winner of Bush’s war. Its number-one enemy, Saddam, was dispatched by its number-two enemy, the United States, which presented Iran with a golden

Spring 2013 Issue

Leaving aside the lies, fictions, and questions of morality and personal responsibility, the critical mistake of America’s war against Iraq was the absence of either a viable plan or the necessary strength to enforce a Pax Americana in the Middle East. America was powerful enough to destabilize the existing regional order, but not powerful enough to establish a new one. The US neocons, with their wishful thinking, grossly underestimated the scale of the task at hand – unlike the revolutionaries in Iran, who quickly moved in to reap what the US had sowed.

The Iraq war also marked the beginning of America’s subsequent relative decline. Bush squandered a large part of America’s military strength in Mesopotamia for an ideological fiction – strength that is sorely missed in the region ten years later. And there is no alternative to be seen without America.

While there is no causal link between the Iraq war and the Arab revolutions that began in December 2010 their implications have combined in a malign manner. Since the war, the bitter enmities between Al Qaeda and other Salafist and Sunni Arab nationalist groups have given way to cooperation or even mergers. This, too, is a result brought about by the American neocon masterminds.

opportunity to extend its influence beyond its western border for the first time since 1746.

“Bush’s war, with its poor strategic vision and worse planning, increased Iran’s regional standing in a way that the country was unlikely ever to have achieved on its own.”

Bush’s war, with its poor strategic vision and worse planning, increased Iran’s regional standing in a way that the country was unlikely ever to have achieved on its own. The war enabled Iran to assert itself as the dominant power in the Gulf and the wider region, and its nuclear program serves precisely these ambitions.

The losers in the region are also clear: Saudi Arabia and the other Gulf states, which feel existentially threatened, and have come to regard their own Shia minorities as an Iranian fifth column. They have a point: with the Shia in power in Iraq, Iran will seek suitable opportunities to use local Shia populations as proxies to assert its hegemonic claims. This is what is fueling Bahrain’s domestic turmoil, beyond the Shia majority’s local grievances.

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And the regional destabilization triggered by the Arab revolutions is increasingly converging on Iraq, mainly via Syria and Iran. Indeed, the gravest current danger to the region is a process of national disintegration emanating from the Syrian civil war, which is threatening to spread not only to Iraq, but also to Lebanon and Jordan.

What makes Syria’s civil war so dangerous is that the players on the ground are no longer its driving forces. Rather, the war has become a struggle for regional dominance between Iran on one side and Saudi Arabia, Qatar, and Turkey on the other. As a result, the Middle East is at risk of becoming the Balkans of the twenty-first century – a decline into regional chaos that began with, and was largely the result of, the US-led invasion ten years ago. i

About the author Joschka Fischer was German Foreign Minister and Vice Chancellor from 1998-2005, a term marked by Germany’s strong support for NATO’s intervention in Kosovo in 1999, followed by its opposition to the war in Iraq. Fischer entered electoral politics after participating in the anti-establishment protests of the 1960’s and 1970’s, and played a key role in founding Germany’s Green Party, which he led for almost two decades.

Source: www.project-syndicate.org

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Spring 2013 Issue

> MENA City Lawyers - MCL:

Winners in Lebanon

M

CL is an innovative, Pan-Arab Law Firm crossing jurisdictional boundaries and challenging Middle Eastern norms by developing the first professional network of law firms in the Middle East and North Africa (MENA) region.

Each client of MCL receives incomparable local knowledge and strategic counselling based on international models. Our goal is to be the best in our field by continuously updating our international knowledge, while staying true to our roots and maintaining our distinctive local character MCL has unparalleled and world-renowned global presence and exposure, having received numerous international awards and holding affiliation with a selection of key international organizations.

MCL’s distinguished reputation for exceptional legal service has received consistent, esteemed recognition from numerous International award bodies, and our commitment to becoming the most prominent Pan-Arab International law firm has solidified our reputation for excellence across the world.

MCL engages the most promising and successful lawyers to join our ever-expanding practice. Our young, talented lawyers work alongside some of the most accomplished Senior Partners in the region; Partners who have decades of experience in their respective field. Employing both local and internationally educated and qualified lawyers, MCL has an incredibly diverse team. Our lawyers, having graduated from leading universities, both here in Lebanon and internationally, offer specialized knowledge, skills and world-class experience.

“MCL has unparalleled and world-renowned global presence and exposure, having received numerous international awards and holding affiliation with a selection of key international organizations.”

MCL runs an innovative International Associate program, the first of its kind in our region, whereby we invite candidature from British and Irish lawyers to work alongside our local lawyers in an intensive program in our Beirut office. Only the most accomplished individuals from toptiered law schools are selected ensuring uniform excellence across our firm’s recruitment.

MCL lawyers understand the commercial realities of the region and are capable of handling our clients’ needs in their entirety in an expedient, reliable and professional manner. Moreover, we build long lasting relationships with our clients and are committed to supporting them at all times as they adjust to changes in their respective markets, as well as to changes in the regulatory landscape.

MCL Lebanon is a full-service, multi-practice firm offering our clients legal expertise in a wide range of corporate and commercial legal issues.

We work with a range of clients stemming from Governmental entities, to large multi-national Corporations, to more locally based businesses and individual clients. Our lawyers always ensure to provide the most distinguished legal services, no matter the scale or size of the transaction. Our ability to provide a truly Pan-Arab service keeps MCL Lebanon ahead of our competitors, and ensuring our position as the premier Middle East and North African regional law firm.

MCL Lebanon places huge emphasis and importance on our corporate responsibility, and upholds a commitment to provide a considerable amount of pro bono work each and every year for various projects being implemented across our region.

Our adoption of our own Code of Ethics, Internal Rules and Regulations for lawyers and stringent By-laws have assured that MCL Lebanon stands high above our competitor law firms in such regards, providing a commitment to such issues which remains completely uncommon across our region.

MCL continues to seek new business development opportunities across our network, and is constantly working to secure further partnerships across the MENA region, and the rest of the world, in order to firmly found our practice with an ability to provide a truly global service with local values and expertise. i

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> Burgan Bank:

Defeating All Odds Burgan Bank’s solid performance has helped position it as one of the most diversified financial group’s across the Middle East & North African region

2

012 was an eventful year for Burgan Bank Group. It marked a new chapter of solid growth and performance, in which the group was successfully able to improve its profitability levels, overall asset quality, capitalization, liquidity and market positioning.

The group demonstrated prudence in delivering sound results across its business and financial metrics.

Burgan Bank Group’s exceptional performance was carefully guided by the excellent execution of the corporate strategy and the objectives achieved through delivering tangible results and creating a niche for its operations amongst existing competition. Leading indicators for the group are pointing to the right direction; Burgan Bank group is well positioned to continue building on its strategic initiatives to achieve new heights of its organic and inorganic growth plans aiming at maximizing returns to shareholders, customers and staff.

2012 Solid Growth & Performance Burgan Bank Group reported a consolidated net profit of KD 55.6 million for the year ending 31st December, 2012, reflecting a 10% increase from the same period of 2011 which was reported at KD 50.6 million. Earnings per share (EPS) grew 12% to reach 37.8 fils in comparison with 33.7 fils in 2011. The group’s operating income surged by 16% to reach KD 190 million, while operating profit before provisions soared by 17% to ultimately reach KD 119 million. Returns of Equity reported at 12.4% while Return on tangible equity reported at 20.2% - the highest among domestic peers.

Revenue composition in 2012 has been stable, and core earnings continue to grow stronger.

The group is continuously increasing its market share with profitability. The group’s loans and advances grew by 50% to reach KD 3.4 billion, whereas customers’ deposits totaled to KD 3.9 billion reflecting an increase of 39%. The group’s operating profit margins stood at 62.6%. The group’s loans to deposit ratio currently stands at 86%.

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CEO: Eduardo Eguren

During 2012, Asset quality improved as NonPerforming Loans (NPLs) continued their downward trend. The NPL ratio (net of collateral) to gross loans stood at 1.9% while loan loss coverage ratio improved to 46%.

The balance sheet remains healthy with optimal capitalization levels and liquidity; and the capital

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adequacy ratio stands at 18.5%. In 2012, Burgan Bank Group successfully completed an issuance of KD 100 million Lower Tier II Subordinated debt, the first bond issuance of its kind in Kuwait in terms of currency, tenor and size. The initiative was in line with our strategy of raising funds from debt capital markets to strengthen our capital base post acquisition,

Spring 2013 Issue

diversify its investor base and to help in the creation of a yield curve in Kuwait. Burgan Bank Group maintained a robust Liquidity level that is higher than all domestic peers with a liquidity ratio of 23.4%.

Regional Operations Burgan Bank Group’s regional expansion approach is aimed at building and acquiring scale, capabilities and footprint. Diversifying revenues streams has positioned Burgan bank as the most diversified bank in Kuwait.

The group’s subsidiaries are all profitable and growing despite being in what has been seen as risky environments due to the Arab Spring.

As part of the regionalization strategy and to complement the consistent growth plans, Burgan Bank completed its acquisition process in Turkey to acquire a 99.26% stake of Eurobank Tekfen. Eurobank Tekfen and its subsidiaries (EFG Istanbul Equities & EFG Leasing) became majority owned subsidiaries of Burgan Bank group as of December 21, 2012.

“Burgan Bank Group’s exceptional performance was carefully guided by the excellent execution of the corporate strategy.”

Following the acquisition, Eurobank Tekfen, as of January 2013, is operating under the name of Burgan Bank – Turkey, where its subsidiaries EFG Istanbul Equities and EFG Leasing will be branded as Burgan Securities and Burgan Leasing respectively. Expanding the group’s brand into Turkey marks a key milestone in its continued efforts to building a strong regional banking franchise and, to ultimately be able to provide customers with sound financial solutions across its network of subsidiaries in the Middle East, North Africa, and now, Turkey. Burgan Bank-Turkey is backed by a clear cut strategy

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that focuses on the upside geo-economic growth potential Turkey provides, along with the benefits of the bank’s wider group synergies across Jordan, Iraq, Tunisia, Algeria and Lebanon.

Acquiring Eurobank Tekfen marked a unique opportunity to enter a key market with a fully operational and diversified banking platform at an attractive pricing level. It further represents a strategic fit with Burgan Bank Group’s overall expansion approach. The deal was presented at an attractive price; below book values, and accordingly there was no creation of goodwill. The bank also has been benefiting from Turkey’s ever increasing growth potential.

Generally, the Turkish economy and banking sector have continued to demonstrate solid performance and offer opportunities for continued long term expansion. Burgan Bank will benefit from the attractive Turkish banking market through an established franchise led by seasoned management team and offering broad banking services to Corporate, SME, private and Retail clients. i

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> Shahid Javed Burki:

Demilitarising Muslim Politics

C

an Muslim governments free themselves from their countries’ powerful militaries and establish civilian control comparable to that found in liberal democracies?

This question is now paramount in countries as disparate as Egypt, Pakistan, and Turkey.

helps to understand the region’s past. Since Islam’s founding in the seventh century, it has maintained a tradition of deep military engagement in politics and governance. Indeed, Islam’s increasing military prowess helped it to spread rapidly around the world.

To predict how this struggle will play out, it

The

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military

was

responsible

for

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Islam’s

implantation throughout the Middle East, as well as in Persia, Southern Europe, and the Indian sub-continent. And once a Muslim state was established in newly conquered lands, the military became integral to its governance.

The military’s incorporation into the state was most prominent in the Ottoman Empire, whose

Spring 2013 Issue

rulers created a new type of military force that drew its manpower mostly from Islamic-ruled parts of Europe. These Janissaries (Christian boys conscripted to serve in Ottoman infantry units) were either recruited from Europe or abducted from countries under Ottoman control.

Janissaries were not allowed to marry or to own property, which prevented them from developing loyalties outside of the imperial court. But, after these restrictions were removed in the sixteenth century, and up until their extermination in the nineteenth century, the Janissaries became extremely powerful in Istanbul (and even established their own dynasty in Egypt).

Military domination in Muslim countries survived right up to the fall of the Ottoman Empire in the early twentieth century. The colonial powers that filled the vacuum left by the declining empire had their own militaries, and therefore did not need local forces to govern. But when Europeans withdrew from the Muslim world in the twentieth century, these forces rushed back in to wrest control of politics.

The military rose to power in Egypt, Pakistan, and other Arab countries in the early and mid-twentieth century. In Turkey, the military proclaimed itself the guardian of the secular Republic of Turkey, founded in 1923 by Mustafa Kemal Atatürk, himself a military man.

Today, the revolutions rocking much of the Muslim world are bedeviled by Islam’s military past. In the first phase of these popular uprisings, those who had been politically and economically excluded began to demand inclusion and participation.

Now a second phase is underway, marked by a serious effort to divest the old military establishment of its power. This struggle is manifesting itself in different ways in Egypt, Turkey, and Pakistan.

In Egypt, the military’s takeover of the political transition after the ouster of former President Hosni Mubarak is unacceptable to Muslim and secular forces alike. Most Egyptians want the soldiers to leave politics and return to their barracks.

“Turkey’s generals have intervened in politics several times to defend Kemalism – Atatürk’s secular ideology of modernization that pushed Islamic Turkey towards European-style liberalism.”

Essam el-Erian, whose Islamist Freedom and Justice Party recently won the most seats in Egypt’s parliamentary elections, recently said that the Muslim Brotherhood (to which the party is closely tied), does not expect the military rulers to relinquish power voluntarily. They will have to be persuaded to leave, and, if that does not

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work, forced out. The parliament’s first step in ultimately removing them would be to defend its authority to choose the members of a planned 100-person constitutional assembly.

Meanwhile, in Turkey, the Justice and Development Party, which has strong roots in the country’s Islamic tradition, is now seeking to limit the military’s role. The armed forces, however, claim a constitutional mandate to protect the Republic’s secular traditions. And Turkey’s generals have intervened in politics several times to defend Kemalism – Atatürk’s secular ideology of modernization that pushed Islamic Turkey towards Europeanstyle liberalism.

But, of the three countries, Turkey has most successfully demilitarized its politics. The charismatic prime minister, Recep Tayyip Erdogan, having won three consecutive elections, has been able to exert his authority over the military. Controversially, he has jailed the army’s top general, Ilker Basbug, whom Turkish prosecutors have accused – many say implausibly – of plotting to overthrow the government.

Finally, Pakistan’s military, which has governed the country for half of its 64-year history, is fighting hard to retain influence over policymaking. Humbled by its inability to control United States military operations, including the one that killed Osama bin Laden, the army is struggling to play a hand in the country’s evolving relations with India and the US. Nevertheless, wary of provoking widespread hostility, military leaders have indicated recently that they have no intention of intervening in politics.

Since the Arab Spring began, four longestablished regimes have been removed, while others are under increasing pressure, giving ordinary Arabs hope that their demands will no longer be ignored, and that those who govern will be mindful of citizens’ needs. But that – the real revolution – will happen only when true representatives of citizens, rather than the military, begin to set their countries’ political course. i

About the Author Shahid Javed Burki, former Finance Minister of Pakistan and Vice President of the World Bank, is currently Chairman of the Institute of Public Policy in Lahore.

Source: project-syndicate.com

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>

tHE eDITOR’S hEROES

O

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nce again, CFI.co has selected for your consideration ten individuals who help shape a better world. This is not a ranking but rather a mixed group of people who are outstanding in their own special ways. There was some agreement regarding the choices we

made in the last issue and we were happy to hear anecdotes from readers who have met, studied or admired those Heroes from a distance. However, there are bound to be controversial choices and so do let me know when you think we get things wrong. I would welcome all feedback at editor@cfi.co

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Spring 2013 Issue

> Freeman Hrabowski Educator, USA “There is something exciting about being in an environment in which it’s really cool to be smart.”

It’s Birmingham Alabama in 1962 and a twelve year boy with an unusual name is sitting at the back of his church doing maths homework while listening to the minister preaching. Even at that young age it was clear to Freeman Hrabowski III that he lived in a society which, because of his complexion, did not afford him the same rights and opportunities as others. But inspired by his preacher Martin Luther King Jr., he led a group of other children through the streets of Birmingham, against the fire hoses, against the police dogs and against the police chief Bull Connor. He led his group of underage activists all the way to the jail house where they would stay for five days.

As we all know, Hrabowski’s country would overcome the evils of racial segregation and the nation would start the healing process. Freeman Hrabowski knew in very real terms the value of an education and took full advantage of each one of his hard-fought opportunities. Hrabowski graduated at age 19 from Hampton Institute with high honours in mathematics. At the University

of Illinois at Urbana-Champaign, he received his M.A. in Mathematics and four years later his Ph.D. (Higher Education Administration/ Statistics) at age 24. Since 1992 he has served as president of the University of Maryland, Baltimore County.

Knowing from a tender age what it is to be on the winning side of history, Freeman Hrabowski uses his position as educator to make sure his country stays a winner. Over the last few decades the US has been losing ground in the field of education, particularly in maths and the sciences. The figures given by Hrabowski in his many lectures are disturbing. Less than a third of students who start off in maths or sciences will finish their studies, most will either change major or drop out altogether. The numbers are worse when considering only African American and Hispanic students and there are also huge discrepancies between the genders. Beyond the socio-economic factors, Hrabowski sees these trends as symptomatic of a failing educational

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culture. Students are not properly engaged; they are told early on what kind of student they are: that science just isn’t for them and as clichéd as it may sound, that mathematics isn’t for girls.

Even before taking on the role of president of UMBC, Hrabowski fought to correct demographical discrepancies in education. In 1988 he co-founded the Meyerhoff Scholars Program which is open to all high-achieving students committed to pursuing advanced degrees and research careers in science and engineering and seeks the advancement of under-represented minorities in these fields.

As President of UMBC Hrabowski does not settle for mediocrity, he demands excellence not only of his students, but also of his faculty and of himself. He has implemented major changes in the learning culture, particularly in the science departments. A major component of the studies of all students is learning through problem solving, real world problems supplied by private companies located on campus. This style of teaching is intended to engage students and to teach the principles of their discipline at the hand of practical implications. In 2008, he was named one of America’s Best Leaders

by U.S. News & World Report, which in 2009, 2010, and 2011 ranked UMBC the #1 “Up and Coming” university in the nation.

Having watched hours of talks given by Freeman Hrabowski, it is clear he has the best qualities of an excited inspiring professor, but it is equally clear that on stage and behind a lector stands a man committed to make a change. His style of rhetoric seems almost to be evangelizing; his passion, his punctuation, provoking audience response, even the occasional corny joke. The parables he tells are about the students he meets on campus, or the story of his grandmother passing the literacy test and being able to vote.

There are boundless clichés espousing the importance of learning, all of them true, but none comes close to articulating that importance quite like an educator with the infectious drive to make sure all his students succeed. One story that comes up quite a lot is that of orientation at UMBC. Students are told to look to the person to their left and to the person to their right, Hrabowski then states his mission – which is to make sure all three graduate.

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> Fawzia Koofi Politician and Women’s Rights Activist, Afghanistan

“I will not rest in my desire to lead my people out of the abyss of corruption and poverty.”

Some of us are burdened with lives of few hardships. Some of us are born to loving parents, have never experienced hunger, have access to quality healthcare and education, live in countries without war or unrest and have never had our rights denied by the hatefulness of others. We unfortunate few simply have had to learn to do without the luxury of obstacles. The best we can do is hope and fantasise - whenever we hear stories of true heroism - that we too, given the opportunity, could be so courageous. But then there are stories where no amount of self-delusion could grant such a fantasy.

It’s a very unsettling feeling when you hear stories of people and you know immediately that they are much braver than you could ever be. If after hearing the story of Fawzai Koofi you do not find yourself in this position, then congratulations - you are a better person than me and in all honesty, you frighten me slightly.

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Initially rejected by her mother on the day she was born, Fawzai Koofi was left out to die in the Afghan sun. Luckily, at the last minute her mother had a change of heart and rescued her.

When Fawzai grew up she persuaded her parents to send her to school, making her the only girl in the family to attend. She went on to graduate from Preston University in Pakistan with a master’s degree in business and management.

Koofi originally wanted to become a physician, but chose instead to study political science and become a member of UNICEF. She worked closely with vulnerable groups such as Internally Displaced People (IDP) and Marginalized Women and Children – serving as a child protection officer from 2002 to 2004.

Following the 2001 invasion of Afghanistan, Fawzia embarked on her political career and campaigned for the right to education for girls.

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In 2005, she was elected as a member of the Afghan parliament - following in the footsteps of her father whose 25 year political career came to an end when he was killed by the Mujahideen during the first Afghan war. Re-elected in the parliamentary elections of 2010, Fawzia is currently serving as a Member of Parliament in Kabul and is the Vice President of the National Assembly. Earlier this year, she announced the intention to run for the presidency of Afghanistan in the 2014 elections.

Since taking up office, Fawzia Koofi has championed the growing role of women in her country but has also fought to secure access to basic services and education - especially in rural areas and has seen her popularity grow in the Badakhshan district. Despite a growing number of supporters, there are those who do not approve of the changing face of Afghanistan as represented by her and there have been several attempts on her life. Fawzia believes that with the withdrawal of US troops starting next year, discussions with the Taliban will be needed to secure stability but holds that there are certain terms which are unconditional - namely the rights of women, respect for the constitution, and the denunciation of any ties to Al-Qaida.

Fawzia has two daughters. Her husband died in 2003 shortly after being released from Taliban custody. Considering her level of education, she could have easily have carved out a comfortable career and gained respect for doing so well despite many obstacles. But instead, love for her country and her people have compelled her to fight. She is fighting to ensure that her beautiful country becomes the stable and prosperous place she knows it can be. Fawzia Koofi fights so that her daughters can fulfill their potential in their own country, and -just like us -need never know how courageous they might have been.

Spring 2013 Issue

> Rashid al-Ghannushi Politician, Tunisia

“We used the police to keep order before. Today we’re not resorting to violence. People are free to do what they want, so they are learning how to exercise their freedom in a responsible way.”

Rashid Al-Ghannouchi, 71 years, was cofounder of the Ennahda Movement which is now Tunisia’s largest political party. A philosophy graduate of Damascus University, he moved to Syria following the expulsion of Tunisians from Egypt where he was studying in 1964. A writer of the first order, Al-Ghannouchi has had enormous influence in religious and political thought throughout the region.

In 1981, Al-Ghannouchi founded Islamic Tendency which was defined by non-violence and called for a more equitable society, political pluralism and democracy. Within months he was

arrested, tortured and imprisoned. He would become a political exile in Europe and vocal opponent of the regime at home.

A key figure in Tunisia’s post Arab Spring democratic transition, Al-Ghannouchi was instrumental in allaying fears that the void would be filled by radical Islam. He offered a vision of an inclusive political movement but one that was rooted in Islam. After election success he proposed a secular partner as president (Moncef Marzouki - one of our Autumn 2012 Heroes) and took no office for himself.

> Nujood Ali Human Rights Activist, Yemen

“A divorce party - that’s really better than a wedding party!”

Divorce can be a traumatic experience – but for a ten year old?

Nujood Ali, now a fifteen year old activist opposing forced marriage, obtained a divorce five years ago breaking with tribal tradition in the Yemen. The law allows marriage at any age but forbids sexual relations until an undefined age of suitability. Ali’s marriage broke this law because she was raped. Hers was the first such case to be heard in the Yemen.

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This young girl wrote her memoirs to encourage other potential child brides in the country. It seems that her campaign will come close to home as a dowry for her younger sister Haifa has been agreed and she is now engaged to a stranger.

A further concern is that their father may have used book royalties meant to finance Nujood’s education for quite different purposes.

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> Betsy Kawamura Human Rights Activist, Norway

“My anguish ended when my family left Okinawa after this man had paid me $5 during our last encounter for my ‘services’.”

Human rights activist Betsy Kawamura, founder and director of Womer4NonViolence, works relentlessly to provide a platform for survivors of gender-based violence and others who are unable to find a voice in the wilderness of despair. She draws on insights from the trauma of her early life to bring hope and opportunity to other victims.

Betsy was twelve years old and living in Okinawa when she was befriended by a middleaged Caucasian man whom she considered to be an ‘authority figure’. This man sexually abused her on several occasions and spoke openly and without remorse about his violence to young girls including his own daughter. These encounters came to an end only when her family moved home but the associated pain and suffering was to continue. This resulted in a major psychotic breakdown and the loss of her ability to read for a period in adult life despite having been one of the smartest in her class and earning an MBA at an American university. Betsy became homeless and lived on the streets. It was at this desperately

> Sheikh Hamad bin Khalifa Al-Thani Ruling Emir, State of Qatar “As you know, our Arab region stands on the verge of a quantum leap. The Arab Spring bloomed into a generation of young people who are determined to achieve their dreams and ambitions.”

Sheikh Hamad bin Khalifa Al-Thani became Emir of Qatar in 1995 and his reign has coincided with a period of rapid economic growth at home and increasing political and social influence throughout the region. Qatar has seen a modernisation programme for the military and can boast of a very successful reform programme. This is one of the smallest countries in the world (with just a quarter of a million nationals out of a total population of some 2 million) but Qatar is at the top of the GDP per capita league as the world’s top exporter of liquefied natural gas.

Billions have been spent on national

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infrastructure and his $400 million development package for Gaza saw Sheikh Hamad at regional centre stage. There has also been significant humanitarian funding of reconstruction efforts in Darfur. Qatar was first to support the Libyan rebels against Gaddafi and has been extremely active elsewhere indicating that Qatari influence is out of all proportion to its size.

Qatar funded the TV network Al-Jazira which is massively influential and has brought a breath of fresh air to regional reporting. The country’s international profile should rise as host of the 2022 World Cup.

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low point that she realised that trauma survivors need strong political and socio-economic support to prevail over past miseries.

Much later, when Betsy had resumed her professional career, she came to know in detail of the suffering of some women and children in North Korea and the difficulties they face as refugees. She has devoted much of the past dozen years of her life to helping these survivors and was instrumental in the making of a short film ‘Under a Different Sky’ which tells the story of a North Korean woman now living in the north of England who was a victim of human trafficking.

Betsy doesn’t rest for one moment and is now working on her ‘Voice of Free North Korea’ project which seeks to empower 500 refugees living in Britain by training them in modern communication skills. We have no doubt that Betsy will open important channels for these survivors – and our hope in that some of these voices will be as eloquent as her own.

Spring 2013 Issue

> Salman Khan Educator, USA

“If Isaac Newton had done YouTube videos on calculus, I wouldn’t have had to.”

Salman Khan during his TED Talk in Long Beach, California, March 2011 Looking for a practical means of tutoring family members, Salman created the Khan Academy YouTube account in late 2006. Initially nothing more than a means of helping friends and family members brush up on their algebra, the YouTube account was not planned as the first step in some major innovation in education. But, as tends to happen to good ideas on the internet (good ideas and Korean music videos that is) Khan’s video lessons went viral. His concise, practical, and relaxed teaching methods attracted viewers from all over the world. In 2009, prompted by the growing popularity of his videos and the testimonials of appreciative students, Salman quit his job as a hedge fund analyst to focus entirely on developing Khan Academy to the point it has reached today.

Backed significantly by - amongst others Google and the Bill & Melinda Gates Foundation, Khan Academy has grown tremendously and currently offers over 4,000 lecture videos in 23 languages free of charge to anyone with access to the internet. Both Khan Academy and Salman himself have been featured in numerous media outlets. The TED talk outlining his vision of the future of education – explaining how Khan academy fits into that picture - is a subject he also covers in his excellent book: The One World Schoolhouse: Education Reimagined.

CFI.co tests out the Khan Academy method in this issue. Go to our special feature on Education.

> Chen Lihua President of Fu Wah International Group, Hong Kong China’s Chen Lihua, now in her early 70s, has a net worth of well over one billion dollars. This wealth comes from the Fu Wah International Group which she established to undertake residential housing projects. By all accounts she is a humble and focused philanthropist with a desire to share her love of her country with people around the globe.

Coming from a poor family, Lihua finished her education at the high school level and travelled to Hong Kong in the 1980s to polish her business skills. She returned home to set up Fuw Wah and has never looked back.

Chen Lihua has invested 200 million RMB in her China Red Sandalwood Museum which is spread over 100,000 square metres in Beijing. It is a monumental achievement and she has gifted sandalwood artwork to museums throughout the world.

She doesn’t keep accounts but donates massive amounts for disaster and poverty relief and education of the needy.

“I should be responsible for everybody around me. It is only a natural thing to give money to those most in need.”

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> Sharmeen Obaid Chinoy Journalist and Documentary Filmmaker, Pakistan

“Daniel and I want to dedicate this award to all the heroes working on the ground in Pakistan, including Dr. Mohammad Jawad, who’s here with us today. He is the plastic surgeon working on rehabilitating all these women.

And to Rukhsana and Zakia, who are the main subjects of the film, whose resilience and bravery in the face of such adversity is admirable. And to all the women in Pakistan who are working for change, don’t give up on your dreams. This is for you.”

Sharmeen Obaid-Chinoy’s Oscar acceptance speech was short, concise and without fluff -very much like her documentary work. She exemplifies what it means to be an investigative journalist. In an age when cable news networks are rapidly losing attention span and there is a growing reliance on online reporting, it is certainly worth taking every opportunity to celebrate long form investigative journalism.

Sharmeen won the 2012 Academy Award, Best Short Documentary, for her latest film Saving Face. This tells the story of victims of acid throwing attacks in Pakistan and includes interviews with both victims and perpetrators

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(who are usually family members). The film focuses on two women: Rukhsana and Zakia, documenting their rehabilitation through facial reconstructive surgery and struggle for justice through the courts and political system. Although the film is upsetting, particularly when the details of each case are discussed, ultimately it has a message of hope.

Having worked on investigative pieces since the age of fourteen, Sharmeen produced her first documentary in 2002. Terror’s Children follows the lives of eight Afghan refugee children living in Sharmeen’s native Karachi. Eleven years on and the subject matter of her documentaries

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hasn’t got much lighter.

Sharmeen is a very angry person and when something angers her she channels that anger into her film making. Audiences very quickly get the message that she will fight injustice despite the dangers she faces and will not put up with frivolity. Her documentaries cover major issues, but these issues are brought to our attention via the stories of the individuals affected. This leads to an offering which is very personal and often appropriately uncomfortable to watch. Powerful in their simplicity, always bringing to light stories in desperate need of being told, her films will leave you sharing her anger.

Spring 2013 Issue

> Pope Benedict XVI Pope Emeritus of the Catholic Church

“My strengths, due to an advanced age, are no longer suited to an adequate exercise of the Petrine ministry.”

Pope Emeritus Benedict, elected by the cardinals in 2005, resigned his office effective February 28th 2013. And as you will have been informed many times before, dear reader, he was the first pope to tender his resignation in the past six hundred years.

There has been speculation that Benedict had other honourable reasons for wishing to stand down. This may be true, but CFI.co is prepared to take him at his word. Is it so surprising that a man of 86 years of age should take his leave after eight long years doing his duty in such a high profile role? Whatever his motivation may be we believe that Benedict took this action having considered the best interests of the presently troubled Catholic Church. It should, perhaps, not need to be the case, but his resignation was a heroic step.

Although we must be careful not to take the analogy too far, a pope could be considered the CEO of the Catholic Church. This pope was a decisive chief executive who understood the need for change. No individual - however capable - is more important than the organisation they lead. Knowing when to step down and pass the mantle is in some ways the most important decision a leader can take. Pope Benedict had no way of knowing who would succeed him but trusted that the very system that had elected him would decide upon a worthy successor.

Change came in the form of Pope Francis - who is dazzling us daily with his humility and lack of concern for the trappings of high office.

There are, of course, those who say that Francis should be accepting the trappings with humility and even that there is some ‘arrogance in his humility’. Whatever the case, we are optimistic: the new pope is a welcome breath of fresh air and we credit Benedict with having paved the way for a new leader.

There have been precious few papal intellects equal to that of Benedict and we believe him to be a true and faithful servant of God. However, he is our Hero not because of these considerations or for any of his past works. Benedict is our Hero for taking a difficult but very important decision.

We believe that this year he was right to give the Catholic Church an opportunity for change.

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> PwC, South Africa:

Africa Rising

By Denny Da Silva

Introduction Africa is rising. These days, one cannot pick up a newspaper or magazine without coming across an article or some piece of insightful and fascinating enunciation about the opportunities in Africa. Africa is ripe for the picking and there is certainly no lack of interest worldwide from potential investors. Be that as it may, potential investors must always ensure that a sound investment plan is put in place when embarking on any investment. This includes both an entry and exit strategy. The focus of this article is on the former and it is premised on the basis that the potential investor will utilize interest bearing funding in order to acquire the equity shares in the target company.

Options available for potential investment in South Africa When faced with a potential investment, investors will either acquire the shares in the target entity

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or they will choose to acquire the business as a going concern from the target. It may well even be, however, that the potential investors have no choice but to acquire the shares in the target entity. The shareholders of the target entity are acutely aware that by disposing of the shares in the target entity, they effectively get rid of any potential gremlins that may exist in the target entity. The same result would not be achieved if the business were sold out of the target entity.

Furthermore, the tax costs would also differ under the two scenarios. If the shares are sold in the target entity, the shareholders would, assuming that the shares are held on capital account, be subject to South African capital gains tax on the difference between their original cost in the shares and the proceeds received for the disposed of shares. Under the South African Income Tax Act No. 58 of 1962 (“the ITA�), a portion of this gain would be included in the taxable income of the shareholders and

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taxed accordingly. The resultant gain would be taxed at an effective rate of 13.3%, 18.6% or 26.6% depending on whether the shareholder is a South African resident individual, company or trust respectively. On the other hand, should the target entity dispose of its business as a going concern, the disposal may give rise to income tax and/or capital gains tax. Thereafter, the proceeds from the disposal would have to be distributed to the shareholders and this may add another layer of tax costs. In terms of the South African ITA, distributions made by a company to its shareholders are subject to a 15% dividend withholding tax, subject to certain exemptions.

For example, dividends distributed to a South African resident company are exempt from the 15% dividend withholding tax.

Funding the acquisition of shares in a South African entity Not all potential investors have a reservoir of

Spring 2013 Issue

cash resources which they can access in order to acquire the shares in a target entity. In most instances, interest bearing funding will be required in order to acquire the relevant shares. The funding can either be sourced from within the group (from a finance entity or the holding company) or from a foreign or local bank. However, before the transaction is implemented, potential investors generally set up a new South African entity (where they do not have an existing presence in South Africa) or they use an existing South African subsidiary in order to undertake the transaction. The South African entity would then be funded, either through equity funding or a combination of equity and debt funding. This funding would then be used to acquire all the shares in the target entity.

Interest incurred on the loan utilized to acquire the shares It is a global principle that the treatment of interest incurred on qualifying debt is often more favourable than the treatment of a dividend paid by a company. Whilst a dividend distribution is a simple means of extracting profits from a company it is not without consequences as, from a South African tax perspective, the dividend will be subject to a 15% dividend withholding tax (see discussion above) and the company declaring the dividend cannot deduct the dividend declared from its taxable income. Interest, on the other hand, receives more favourable treatment but it too is not without its own complications.

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“It is a global principle that the treatment of interest incurred on qualifying debt is often more favourable than the treatment of a dividend paid by a company.”

Firstly, the general principle in South Africa is that interest incurred on a loan utilized to acquire shares is not deductible due to the treatment of dividends as exempt income in the hands of the shareholder. In order to overcome this, creative methods have been employed in order to secure an interest deduction.

One such method is the debt push down mechanism which is a global phenomenon and not “proudly South African”. The rationale behind employing such a structure is that interest incurred on a loan utilized to acquire a business is deductible. From a South African tax perspective this structure is implemented together with the so called roll-over provisions in the South African ITA in order to indirectly secure an interest deduction in South Africa.

Sound commercial rationale for implementing the debt push down structure is required and it cannot simply be a window dressing exercise.

Potential investors must also take cognizance of the South African exchange control provisions and, where a group company provides the requisite funding, the South African thin capitalization and transfer pricing provisions.

Furthermore, despite South Africa currently exempting from tax any South African sourced interest earned by a non-resident (provided that the non-resident has not carried on a business through a permanent establishment situated in South Africa), it should be noted that South

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Africa will be implementing a withholding tax of 15% (before the application of any relevant double tax agreement) on any interest that accrues to a non-resident from a South African source on or after 1 July 2014.

Reprieve may be found in the form of provisions effective from 1 January 2013. These provisions represent a shift from the common law position regarding the deduction of interest incurred on a loan used to acquire shares in an entity. In terms of these new provisions, potential investors may obtain a deduction for any interest incurred on a loan used to acquire more than 70% of the shares in a South African entity. But as expected, not all is sunshine and roses and taxpayer’s are required to approach the South African Revenue Service for a directive permitting the deduction of any interest incurred on the loan utilized to acquire the shares in the target entity. In considering the application for the directive, the South African Revenue Service will consider the tax leakage to the fiscus. Experience has shown that a tax leakage of 15% appears to be acceptable to the revenue authorities and anything beyond this will become a matter of debate as to how much the revenue authorities are willing to part with.

Factors that would play a role here would be the aggressiveness of the transaction, the parties involved in the transaction and their reputation in the market and with the revenue authorities.

Potential investors are forewarned however that where foreign interest debt funding is used to fund the acquisition of shares, a directive from the South African revenue authorities would most likely be subject to much scrutiny and debate. Coupled with the soon-to-be-introduced withholding tax on interest as noted above, foreign interest bearing debt funding may not be the order of the day for these particular types of transactions. There may be light at the end of the tunnel though. With careful planning it may be possible for potential investors to increase their chances of a deduction under these new provisions or indirectly via a debt push down structure. Potential investors are therefore advised to seek advice before embarking on an investment in South Africa because if you fail to plan, you plan to fail! i

This publication is provided by PricewaterhouseCoopers Inc. for information only, and does not constitute the provision of professional advice of any kind. The information provided herein should not be used as a substitute for consultation with professional advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all the pertinent facts relevant to your particular situation. No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication can be accepted by the author, copyright owner or publisher.

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> Nataly Marchbank, IBM:

South Africa’s Tax System South Africa has a well-developed and regulated taxation regime. While the laws are constantly being revised and amended to keep them up to date and in line with international best practice, here are a few tax basics for foreigners interested in investing and or working in South Africa.

I

n South Africa the tax regime is set by the National Treasury and managed by the South African Revenue Service (SARS).

This is a summary of the key points of how the South African Tax regime functions: 1. Individuals who are South African residents are taxed on their worldwide income.

2. Non-South African residents are only taxed on income from a source in South Africa.

3. There is no group taxation in South Africa – so each company is taxed as a separate taxpayer.

4. Partnerships are not recognized as separate entities for income tax purposes and are fiscally transparent. Instead, the individual partners are taxed separately on their share of the partnership profits.

5. A company is regarded as a South African resident if it is incorporated in South Africa or if it has its place of effective management in South Africa.

6. Businesses may select their own financial year-end. For individuals, the tax year runs from 1 March to 28 February and thus cannot elect their year of assessment.

7. Businesses must file annual income tax returns with SARS. It is also a legal requirement for all companies and close corporations to file annual returns with Companies and Intellectual Property Commission known as CPIC on annual basis.

8. Special dispensations are provided for companies who derive their income from mining, gold mining, oil and gas, and farming.

How does income tax work in South Africa?

1. The principal source of direct taxation revenue in South Africa is income tax. Individuals are taxed on a progressive basis up to a maximum rate of 40% on taxable income exceeding ZAR 671 000 a year (tax year end February 2013).

2. Tax on the income of non-South African residents is source-based, meaning that any income from a source within (or deemed to be within) South Africa is taxed, irrespective of the residence of the recipient of the income.

3. Domestic companies are taxed at a flat rate of 28%.

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“The headquarter company regime is another push for South Africa to enhance its role as the gateway to the continent.”

4. A 15% withholding tax is imposed on dividends paid to resident or non-resident shareholders.

5. Trusts (other than special trusts) are taxed at a flat rate of 40% on income and 66.6% of capital gains that do not vest in a beneficiary of the trust during the tax year in question.

6. Special trusts, such as those created solely for the benefit of a person who is mentally ill or disabled are taxed on the same progressive basis as individuals as individuals are taxed.

Indirect taxes: Value Added Tax (VAT) 1. The principal source of indirect taxation revenue in South Africa is Value Added Tax (VAT).

If a subsidiary or branch of a foreign-owned company sells goods or provides services, it must register as a vendor with SARS and charge and pay over VAT. 2. The standard rate of VAT is 14%, therefore exports on certain foodstuffs and other supplies are zero-rated, and certain supplies are exempt (mainly certain financial services, residential accommodation and public transport) to mention a few.

Does South Africa have Capital gains tax?

Yes capital gains tax (CGT) is levied and the portion of 66.6% of your gain is in included into your taxable income for companies and trusts. Whereas 33.3% is the inclusion rate for individuals. CGT is levied on non-residents to the extent that they dispose of immovable property situated in South Africa, or have a permanent establishment in South Africa and dispose of an asset of that permanent establishment.

Does South Africa have double taxation agreements?

In South the principle is that the tax liability of

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a foreign company depends on the nature of the income derived by it, as well as the existence of a double taxation agreement.

Therefore South Africa has double tax agreements with most of its trading partners to prevent double taxation of income accruing to South Africa taxpayers from foreign sources, or of income accruing to foreign taxpayers from South African sources.

In terms of these arrangements a foreign resident will be taxed in South Africa only if it conducts business through a permanent establishment in South Africa. It should be noted that any person who is deemed to be a resident of another state through the application of a double tax agreement will not be treated as a South African resident.

What happens to foreign tax credits?

The Income Tax Act grants rebates in respect of foreign taxes on income. A South African resident is entitled to a rebate equal to the sum of any taxes on income payable to the government of another country, in respect of, inter alia, income received by such individual from a source outside South Africa which has been included in that individual’s taxable income in South Africa. The foreign tax credit is limited to the attributable South African income tax on the foreign income.

Does South Africa have a Headquarter company regime?

Yes, the headquarter company regime is another push for South Africa to enhance its role as the gateway to the continent. This aims to reduce the tax cost of operating a headquarter company in South Africa. For example, it exempts companies from withholding dividends tax and tax on interest and royalties on income flowing through them from foreign subsidiaries.

Any other taxes other taxes affecting subsidiaries or branches of foreign-owned companies?

1. If a firm employs personnel, it must register as an employer with SARS and deduct tax (PAYE) from its employees’ salaries.

Spring 2013 Issue

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2. A skills development levy at the rate of 1% of remuneration is payable.

3. Transfer duty is payable on land and buildings (8% of the value of the property in the case of a corporate purchaser).

4. Stamp duty at 0.25% is payable on transfer and issue of shares. Stamp duty is also payable on certain other agreements, such as leases and mortgage bonds.

5. Securities transfer tax is due on the change in beneficial ownership of securities, such as shares in a company or members’ interests in a close corporation.

6. Customs and excise taxes.

7. Compulsory workmen’s compensation, assurance and unemployment insurance fund premiums are payable, although these are relatively insignificant. There are no other social security payments.

8. Estate duty (20%) is paid on all assets of a deceased person’s estate if they are South African residents. For non-residents, only the assets within South Africa form part of the total value of the estate.

9. Donations tax (20%), paid by the donor, is levied on the value of property donated by South African individuals and companies. Certain donations are exempt and non-residents are not liable for donations tax.

Have there been any new changes to the tax legislation to South Africa?

Annually, after the budget speech, there are usually some new announcements and or tax legislation that is updated and revised. The most recent developments in the past 18 months have been the following items.

1. In October 2012, the new Tax Administration Act (TAA) was enacted. This is a piece of legislation that provides SARS with the necessary enforcement for non compliant taxpayers, it is aimed to simply and consolidate, into one Act, a more logical and systematic way of dealing with the tax administration law. It eliminates duplication, removes redundant requirements and aligns different requirements that currently exist in different tax Acts. The Act reflects the constant endeavour to simplify law, reduce redtape and streamline the administration process to provide a better service to taxpayers, whilst strengthening enforcement and compliance.

2. Transfer pricing (‘’TP”) in South Africa has seen a significant change over the last 12 months. This change came into affect 1 April 2012, although at the time there was no guidance issued by SARS, but in recent weeks a draft interpretation note was issued by SARS that has set out some guidelines for the new TP legislation. The prior legislation was primarily on a safe harbour principle, whereas now the focus is on an arm’s length principle.

Revised wording in the Income Tax Act has moved the focus on TP and the classification of cross border, ‘arms-length’ transactions, a

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“The onus to make any transfer pricing adjustment therefore shifts from SARS to the taxpayer, placing a considerably greater onus on taxpayers, whilst not diminishing the powers of SARS. This obliges tax payers, at year-end, to make any TP adjustments that may be necessary.” change that that has major implications for taxpayers. There are two key changes in South Africa’s TP regulations will impact on taxpayers.

Firstly, the application of the arm’s-length principle has changed. In the past, the legislation focused on the pricing of crossborder transactions between related parties and stipulated that, if arm’s-length pricing is not used, SARS may substitute what it considers to be an arm’s-length price. Under the revised wording the focus will no longer be only on the pricing of transactions, but rather on all aspects of the relationship between contracting parties.

have existed under an arm’s-length relationship and which results in a tax benefit being derived by a South African contracting party.

The new TP rules indicate that, to the extent that there is a difference between the arm’s- length price and the price actually charged, the amount of that difference will constitute a deemed loan for the purposes of section 31 of the Income Tax Act. An arm’s-length interest must be applied to the amount of the deemed loan. The deemed interest will accrue to the taxpayer for each year of assessment until the deemed loan is repaid.

The practical implications of this change are quite daunting and there have been informal indications from SARS that the deemed loan may be abolished, but this remains to be seen.

A possible, practical alternative would be a deemed dividend – with a consequent liability for dividends tax for the South African entity. Such a mechanism would be similar in practice to the previous rule which imposed STC on transfer pricing adjustments.

The above two main changes in South African Tax Law are going to be challenging new pieces of legislation for taxpayers to manage going forward but in order to do business in South Africa taxpayers will have to ensure that they are compliant in terms of the TAA and will have to ensure that they adhere to the new TP legislation that has been introduced. i

Although the arm’s-length principle will continue to apply, SARS has indicated that it intends to look more widely at all aspects of the intra-group relationship to identify, and address if necessary, any aspects which are not arm’s-length.

The second key change relates to the triggering of transfer pricing adjustments and the consequences for a South African taxpayer entity of such an adjustment. The new rules significantly affect both the timing and the determination of the quantum of any such adjustment. In terms of the new rules any TP adjustments will have to be made by the taxpayer that is party to the affected transaction in the tax return.

This differs from the previous rules, which did not allow for a TP adjustment to be made by the taxpayer itself, but rather provided SARS with the discretion to make such an adjustment, if SARS was of the opinion that the transaction had not been priced on an arm’s-length basis.

The onus to make any transfer pricing adjustment therefore shifts from SARS to the taxpayer, placing a considerably greater onus on taxpayers, whilst not diminishing the powers of SARS. This obliges tax payers, at year-end, to make any TP adjustments that may be necessary. In addition, the obligation to make a TP adjustment is automatically triggered if the intra-group crossborder transaction contains one or more terms or conditions that are different to that which would

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About the Author Nataly Marchbank is a qualified professional accountant (CPA (SA)) and master tax practitioner (MTP (SA)), with a specialism in Tax. She has a Higher Diploma in Tax and a Masters degree in South African and International Tax. She is currently employed as the Country Tax Manager for IBM South Africa.

Spring 2013 Issue

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> LEX Africa:

Energy Crisis Giving Rise to a New Order

By Greg Knott

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have had a number of interactions with businesspeople in the last week where the phrase “The old order is gone” was used and it made me think of the exciting new business landscape developing within the African energy sector.

This notion of a ‘new order’ and a different way of doing business was confirmed when I listened to a presentation by the South African National Energy Association chairman, Brian Statham. He was providing feedback at a business meeting on the recent Africa Energy Indaba, which brought together the Continent’s leading minds and international players, like the World Energy Council, to discuss Africa’s energy future.

“The time for opportunistic gouging is past,” Statham said. “We claim to be a leading country on the African continent, but are we focused on issues important to Africans or are we posturing for the benefit of OECD patronage?”

Statham “No one can asked.

passionate about what this means for Africa’s people, can shape this sector.

No one can deny that the world of business has changed; South Africa is no longer the mining powerhouse it used to be. Despite mining houses trying to do things differently, restructuring and changing leadership styles, the application of old methods to this new business landscape isn’t working. In a climate of increasingly frequent and violent service delivery protests, joblessness and inequality, new thinking is required.

When businesses think only about profit in the traditional colonial sense, it seems that there is too much risk, too much red tape, too much corruption, making Africa too challenging a place to do business. But as Statham asks, are we genuinely thinking about the people – because if we are, we will find a way through to successful energy projects.

South Africa has lost some of its shine, but it still has a critical role to play in Africa, especially in steering its energy future. In the midst of this crisis, a new order has already begun to emerge – thanks to the role the South African government and business are playing together with investors in the emerging renewable energy landscape. This growing sector is a good example of where sound government policies and vision that have social equity at the core, has provided the certainty and confidence for business and investors in order to commit.

deny that the world of business has changed; South Africa is no longer the mining powerhouse it used to be.”

The World Economic Council defines success in the energy sector today as the balance between three competing elements in the “Energy Trilemma”: electricity security, environmental impact mitigation and social equity. It’s no longer acceptable to do business with only profit in mind – we have to consider the environment and people if we want businesses and projects that will promote both peace and prosperity.

This new order – that recognises the important relationship between people, profit and the environmental sustainability of projects - needs to come together with the primary focus of declaring war on poverty. That’s because war on poverty in Africa will only be won when the war on energy poverty is won. Energy access is fundamental if Africa is to reach its enormous economic growth potential, which the World Bank forecasts at between 4-6% - much higher than the developed world’s growth rates.

As we provide our people with access to electricity so it will open doors for growth and innovation in education, medicine and health, governance and business sectors on the Continent. So, the drive for new energy on the Continent is coupled with the drive to combat poverty. A new order,

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Despite the naysayers, I see a new era and a new order emerging in the South African renewable energy sector that is influencing the rest of the Continent. The Department of Energy’s Renewable Energy Independent Power Producers Programme has been lauded internationally and I’ve had the privilege of working on several energy deals with international investors who are investing on the Continent. It’s not business as usual – balancing the different elements of the “Energy Trilemma” have added new complexities to business – but they can and must be overcome if we are to avoid future resource wars and overcome the shadow of colonialism.

Just as the profit-at-the-expense-of people mind set has exacerbated Africa’s energy crisis, so the magnanimity of business can overcome it. i

CFI.co | Capital Finance International

About the Author Greg Nott, director at Werksmans Attorneys, is the Head of the Africa practice area at the firm. He specialises in corporate governance, cross border transactions, arbitration and public/private partnerships, as well as contractual, statutory and regulatory issues in the power, mining and telecommunication sectors.

In 2010 Greg was awarded Lawyer of the Year (Legal Business UK) and has been recognised in Chambers and Legal 500 Publications

About LEX Africa With its extensive network of leading legal firms spanning 27 African countries, Lex Africa affords the international business community access to an established pool of skilled and reputable lawyers, all of whom strive to facilitate trade and investment in the continent through best legal practice. Established in 1993 Lex Africa’s management office is situated at Werksmans Attorneys in Johannesburg. For more information on member firms and to view the 2012 Guiwde to Doing Business in Africa please, visit www.lexafrica.com.

Spring 2013 Issue

> CFI.co Meets Managing Director of Kresta Laurel Limited, Nigeria:

ENGR. DIDEOLU FALOBI, FNSE, MIoD

D

ideolu Falobi, a certified engineer, graduated from the University of Lagos in 1987. He started his career as a Design and Supervision Engineer (1987-89) and later Junior Partner (19921996) with Edison Group & Partners, a foremost Electrical power engineering consultancy firm.

In these capacities, he was involved in several rural electrification design projects like Local Government Headquarters Electrification scheme (Nationwide, 1987/88), Electrification of 92 towns and villages in Ogun State, Nigeria under DFFRI in 1989, Electrification of 151 towns/villages in Oyo State under its Rural Electrification Scheme in 1992/1993.

A lot of major projects have been executed under his watch since 2005 with the client list including but not limited to Shell Petroleum, UBA Plc, Central Bank of Nigeria, The Silverbird Group, Julius Berger Plc, Bank of Industry and several State and Federal Ministries and Parastatals.

In 1996, he carried out a comprehensive Redesign of the Power Generation, Transmission and Distribution Systems in the Greater Banjul Area of The Gambia.

Two of his notable publications are: • “Design of Elevators and Escalators” which was presented to the National Conference of the Nigerian Society of Engineers held in Calabar, Nigeria in December 2011; as well as • A Publication titled “The Industrialisation of Ijesaland” which was presented to the World Conference of the Ijesas held in Houston, Texas in the USA in November 2011.

He was also the Assistant Marketing Manager of H.F.SCHROEDER (W.A.) Limited and pioneer Project Manager of Kresta Laurel Limited between 1989 and 1992. In these companies, he was directly responsible for the Lift and Crane Departments and superintended the execution of several Lift and Crane Installation Projects all over the country.

Dideolu joined Lordmart Nigeria Limited in 1996 as the Head of the first Generator Assembly Plant in Black Africa with a capacity for the assembly of 120 generators per month with the capacities being between 27KVA and 1500KVA. In Lordmart Nigeria Limited, he was also involved in the Sales, Assembly, Marketing and Repairs of Massey Ferguson Tractors. He was appointed the Head of the Abuja Branch of the company in 2001.

Engr. Dideolu Falobi assumed duties as the Managing Director of Kresta Laurel Limited in 2005 with the mandate to carry out a comprehensive restructuring of the company.

Engr. Falobi took on the challenge with gusto and went on to comprehensively re-organise the company such that today, the company is the leading wholly indigenous company in the fields of elevators, escalators, Overhead Travelling Cranes and Hoists, Industrial UPS and Industrial and Hangar doors.

In recent times, the efforts of Engr. Falobi and his team have been rewarded with major awards and recognition including the 2010 Corporate Merit Award by the Institution of Mechanical Engineering Division of the Nigerian Society of Engineers and the 2010 African Order of Merit in Elevators, Escalators and Cranes among others.

Engr. Dideolu Falobi, a certified ISO 9000 Auditor, is a fellow of the Nigerian Society of Engineers and a member of the Institute of Directors (IOD), the Lagos Country Club and the Ijesa Sports Club among others. i A BRIEF PROFILE OF KRESTA LAUREL LIMITED Kresta Laurel Limited, incorporated in 1984, has become one of the most respected indigenous Engineering Companies in the field of Electro Mechanical Engineering. KLL is the authorized representative (sole) of some of the most respected brands in Europe such as KONE Elevators of Finland, DEMAG Cranes and Components of Germany, Power Source Generators of UK, AEC INTERNATIONAL SRL of Italy and FRONIUS of Austria.

The Company employs over 200 Nigerians and Expatriates. The head office is in Lagos, the commercial capital of Nigeria, with Branches in Abuja, Port Harcourt, Kaduna and Ibadan.

Kresta Laurel have as our clients almost all the major construction companies in Nigeria, banks, oil producing companies and various other corporate giants in the private and public sectors of the economy.

The company’s website is www.krestalaurel.com

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“Engr. Falobi took on the challenge with gusto and went on to comprehensively re-organise the company such that today, the company is the leading wholly indigenous company.”

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> Crowd Funding:

Small but Bountiful

By CFI

If you can get people to chip in online, crowd funding offers you a chance to turn that costly pet project into a reality.

I

n the past, if going to the bank was not an option, the best way to raise cash was to pass round a hat to friends and family. Technology has changed that.

Social networking sites have led to many individuals with a compelling idea or passion amassing sizeable funds from thousands of strangers each chipping in pocket change. This kind of ‘crowd funding’ received much publicity in 2011 when the controversial whistle-blowing site Wikileaks called for financial aid from its millions of supporters worldwide to set up a legal defence fund. When Paypal and Mastercard blocked payments to the fund, those supporters registered their outrage – and their determination to protect crowd funding – by launching a cyberattack on PayPal and MasterCard’s websites.

Most crowd funding is less fraught. The charity Cool Earth was formed after Frank Field, a British member of parliament, read about Johan Eliasch, the wealthy chief executive of Austrian sporting goods firm Head, buying up chunks of rainforest to protect them from loggers. ‘Most of us don’t have your resources but imagine what millions of us could achieve together’ Field wrote to Eliasch in 2008. So Far Cool Earth has saved 333 000 Acres of Rainforest.

By 2010 a huge number of crowd- funding startups had sprouted, each jostling for a piece of what had become a lively market. These include Kickstarter in the US, FundBreak in Australia, Startnext.de in Germany and My Major Company in France – though there are many, many more.

Projects funded include documentary films, software development, micro generation, schools in Africa, fashion and music.

In the past, for legal reasons, crowd funding has typically involved soliciting donations in return for some kind of membership or prepurchase of products. In effect, they have been subscriptions. What they have tended not to offer are financial rewards – because it is illegal to solicit investments from the general public unless the opportunity has been filed with an appropriate securities regulator.

Ecotricity, a green-energy firm based in Stroud, England, took care to comply with regulators when it sought funding through a type of crowd funding last year. Ecotricity wanted to build wind

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“The charity Cool Earth was formed after Frank Field, a British member of parliament, read about Johan Eliasch, the wealthy chief executive, buying up chunks of rainforest to protect them from loggers.” turbines for which it had planning permission; and the sole shareholder, Dale Vince, a former hippie, wished to avoid diluting his ownership but steer clear of banks. So he offered to sell £10m in low- denomination bonds to the public, with a higher rate of interest payable to his own customers. The bonds raised £14.3m – the largest ever private issue in the UK, the company claims.

Ecotricity’s bond issue was substantially oversubscribed because it offered a valuable investment: 7% interest, or 7.5% to Ecotricity customers, is a lot more than you get on most savings accounts. Ecotricity decided to prioritise customers, who received 100% of what they subscribed for – in other words, it paid out more in interest than it might have done, because it recognised the value of customers’ support. It’s for that reason that Ecotricity’s bond issue should be regarded as crowd funding, rather than a conventional sale of high-value bonds to a small handful of financial institutions.

That particular bond issue was regulated, but smaller fundraisings, along very similar lines, often take place without such oversight. A well-known example involves a New England restaurant owner named Frank Tortoriello who was looking to move to a nearby location but couldn’t get a bank loan. He sold food vouchers worth $10 to customers for $8 – in effect, discount vouchers worth 20% off– and in 30 days he raised thousands in hard cash.

Tortoriello’s example has been followed by countless advocates and promoters of local or complementary currencies.

Inevitably such inventiveness has soared online.

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The 2009 climate-change film The Age Of Stupid, for example, was funded by pre-selling a percentage of [hoped-for] profits to 258 individuals and syndicates while 400 others donated to the £450,000 production budget.

“When we first came up with the idea and put it on our website,” says the film’s director, Franny Armstrong, “our lawyer said: ‘It’s the most innovative film-financing scheme I’ve seen in 25 years. But it’s totally illegal.’” Armstrong made the changes her lawyer suggested and got the plan approved by the Financial Services Authority to give investors confidence.

Today, bagging funds for cherished projects no longer depends on serendipitous visits to someone’s Facebook page. The best-known of the new online ventures encouraging crowd funding is Kickstarter, which is based in Manhattan’s hip Lower East Side and whose model is similar to that used by the in-vogue group-purchasing sites.

To raise funds, creators of each project must set a cash goal and a time limit, though there’s no limit on the amount that can be raised. If enough ‘buyers’ pledge funds, the project keeps them. If they don’t, they are returned. Kickstarter takes a 5% fee on all successfully funded projects.

Typically, individuals or organisations seeking funds offer a range of rewards. A band might give away a T-shirt to small donors and dinner with its lead singer to people with the deepest pockets.

Kickstarter works with the project sponsors to establish specific price points at which rewards are offered.

Some donors argue that making a very small payment is effectively a gift, because usually the rewards are not hugely desirable. At a higher level, backers are in effect buying the reward – they really want dinner with the rock star.

Publisher and writer Craig Mod, who used the crowd-funding model to republish a book, says: “People don’t mind paying $50 or more for a project they love.”

Kickstarter’s chief community officer, Yancey Strickler, says that in general the firm accepts around half the projects it receives, weeding out begging letters and straight business expenses.

Roughly half of those realise their funding ambitions: around 39,000 projects have been funded to date.

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“Some donors argue that making a very small payment is effectively a gift, because usually the rewards are not hugely desirable.”

Buzzbnk, a British version of Kickstarter formally launched in January after a successful prelaunch by the serial social entrepreneur Michael Norton, has already helped 61 projects raise over £540,000 for social enterprise projects, enabling donors to participate in the upside of a new company’s growth. Rather than making a one-off donation, investors have the option to take dividends or recoup once the social enterprise moves into profit. Investors can browse through the Buzzbnk ventures and pledge money and/or time while carrying the message through to their own social networks and communities.

Buzzbnk has also won an Innovation in Giving

Award, a fund created by the UK Cabinet Office and NESTA, which backs innovative ideas for increasing participation in social and environmental change.

People opt to list on PeerBackers and similar sites that take a cut, she says, simply because it removes the need to ask people they know for money in person.

This new market is nourishing an ecosystem of intermediaries, each with a slightly different model. ChipIn, for example, started in 2005 as an online fundraising service but has become a “web payment simplification app” that’s free to use for other companies. GoFundMe charges 5% on each transaction, on top of PayPal fees.

However not all social networks are online and not all entrepreneurs are so shy. Armstrong promoted the idea of The Age of Stupid at an event held by The Funding Network – a club that runs ‘auctions’ where individuals bid to back a wide range of projects.

RocketHub takes money upfront rather than just a pledge: if the donor’s preferred project fails, the money is not returned but must be allocated to another project instead. Give.fm enables donors to make recurring payments, providing financial stability to causes they support. “And with a monthly pledge that can be cancelled any time, you’re holding the cause accountable,” says a spokesman.

PeerBackers co-founder Sally Outlaw says most businesses already know their backers. “Probably 80%-90% are from their own network who learn about them through networking and the media.”

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Promoters looking for cash make short pitches and there is a Q&A afterwards. It is not unusual for projects to receive as much as £10,000 in a night, sometimes much more. The founder, Fred Mulder, set up the network after bad experiences as a donor. He says: “I realised that I’d be in a much better position if I had a group I could check with. With our events you hear a presentation and talk to other donors. You compare and contrast.”

One person at the Funding Network event who contributed to Armstrong’s film was Michael Norton, who went on to set up Buzzbnk. “We felt proud to have helped create an award-winning film – but the surprise was when payments from the profits appeared in my bank account.” i

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> USAID:

Diasporans – Forging Economic Ties With Home Countries

By Romi Bhatia

• Worldwide, 215 million first-generation migrants are living in countries other than their country of origin.

• An estimated $534 billion U.S. dollars in recorded remittances were sent worldwide in 2012.

• According to the World Bank, in the United States alone, diaspora communities had cumulative savings of over $400 billion in 2010.

T

hese numbers show that the diaspora – often defined as a community of people who live outside their shared country of origin or ancestry, but maintain active connections with it and includes both emigrants and their descendants - are becoming important stakeholders in the global economy.

For the money transfer industry, this is not a new realization as the diaspora comprise their core customer base. Companies like Western Union, MoneyGram, Xoom and ViaAmericas offer a variety of money transfer services, enabling senders a critical financial link in supporting the consumption needs of family, friends and others back home. Increasingly, these money transfers are going into savings accounts and toward home purchases and new business start-ups.

Policymakers, development practitioners and private sector companies alike are recognizing not only the economic prowess of this community but also their role as important stakeholders and potentially powerful actors in international affairs and foreign assistance.

“These start-ups have led to high-tech jobs that have a ‘multiplier’ effect.” awareness. It donates a pair of sandals to people in need in a developing country for every pair sold.

It also provides basic healthcare and education to communities on plantations where raw material for the sandals is cultivated and uses recycled materials to make its sandals. Flores, with his multi-cultural background and international mindset, is an example of the potential human and financial capital that diasporans possess to become change makers both in their country of residence and origin.

In the case of the United States, the foreignborn are only an eighth of America’s population, yet a quarter of high-tech start-ups have an immigrant founder, according to an April 13th

Diaspora communities are not only using their influence and financial resources to contribute to socio-economic development back home, but they are also making their impact felt in the voting booth, whether it is the Dominican Republic, Haiti or Mexico.

For diasporans who may self-identify as hyphenated Americans, their affinity to a place of origin or ancestry can lead to action that has a positive socio-economic impact. Take for example, entrepreneur Jose Alejandro “Bati” Flores, the son of U.S. and Guatemalan parents who founded the VOS Flips brand in 2008.

VOS Flips is a sandals company that promotes social development and increased environmental

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Economist article titled The jobs machine: Startups founded by immigrants are creating jobs all over America.

These start-ups have led to high-tech jobs that have a “multiplier” effect, leading to additional job creation in the manufacturing and service industries. Having established themselves in the United States, these individuals are also taking their capital, intellectual expertise, and business acumen to start enterprises in their countries of origin. In turn, these businesses are impacting the marketplace by introducing new technology, products and business processes that are fostering innovation and enhancing competitiveness in the local economy.

Companies such as Sproxil Inc, a technology company ranked number seven on Fast Company’s Most Innovative Businesses in 2013, is a good example of a diaspora-driven company that is having a positive impact in Nigeria, Kenya and India. The company was founded in

Spring 2013 Issue

and development outcomes in their countries of origin or heritage. The three main goals of IdEA are to expand entrepreneurship and investment, to advance science and technology collaborations, and to give back through philanthropy and volunteerism. IdEA has become a unique platform for diaspora communities to seek collaborations with each other, share their perspective on issues related to foreign affairs and assistance, and explore ways to collaborate with public and private partners.

Romi Bhatia

“Having established themselves in the United States, these individuals are also taking their capital, intellectual expertise, and business acumen to start enterprises in their countries of origin.”

2009 by Dr. Ashifi Gogo, a Ghanaian-American educated in the United States who returned to Nigeria to launch a business to address the high incidence of counterfeit drugs in Nigeria. Sproxil utilizes a coding system and SMS technology to enable consumers to verify the authenticity of prescriptions at the point of sale with their mobile phones. Sproxil’s technology has enabled drug manufacturers to view and analyze realtime consumer data to detect and prevent drug counterfeiting pharmaceuticals in developing countries. Sproxil was one of 14 winners in the African Diaspora Marketplace; a flagship business plan competition launched in 2009 as a public-private partnership by the United States Agency for International Development (USAID)

and Western Union Corporation. ADM served as a catalyst for USAID and the Department of `State to establish another online marketplace and business plan competition called the Latin America Idea Partnership (LA Idea) that connects entrepreneurs from the Latin American diaspora with those back home to business opportunities and resources that will help them grow innovative businesses and startups throughout the Americas.

At the U.S. Department of State and USAID, we seek to harness the entrepreneurial drive of diasporans through a series of business plan competitions that combine seed capital with technical assistance to catalyze small and medium enterprises in developing countries.

Skeptics might question the role of a donor agency in providing support to start-ups something that typically happens in Silicon Valley and not in Washington. But a paradigm shift has been occurring in the development field.

In May 2011, former Secretary of State Hillary Clinton and USAID Administrator Dr. Rajiv Shah co-convened the inaugural Global Diaspora Forum and launched the International diaspora Engagement Alliance (IdEA). IdEA is a joint collaboration between the State Department, USAID and a multitude of private actors, that seeks to harness the global connections of diaspora communities to strengthen diplomacy

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In response to the growing calls for diaspora dialogue and engagement worldwide, the third-annual Global Diaspora Forum (GDF) in May 2013 will embark on an unprecedented endeavor by expanding from a Washington DCbased event to a multi-city engagement across continents with events occurring in Los Angeles, Silicon Valley, Dublin and Washington DC. Under the theme of “Where Ideas Meet Action,” GDF 2013 will convene leaders in business, technology, investment and trade, government, and other prominent members of global diaspora communities as they uncover new ways of collaborating around innovation, technology and youth-focused engagements.

At USAID, public-private partnerships are a critical way we are doing business differently. We are seeking to leverage resources, expertise, and technology to maximize our impact and deliver results that are sustainable long after public funding ends. Diaspora groups are one of the new partners that USAID is engaging as they often possess the social connections, cultural and linguistic competence, and the willingness and resiliency to invest in markets that traditional investors view as risky. We encourage diaspora groups to join the IdEA platform and explore ways to partner with us. i

To learn more about how to become a member of the International diaspora Engagement Alliance and the upcoming third-annual Global Diaspora Forum, please visit: www.diasporaalliance.org.

Questions and inquiries about how to partner with USAID can be directed to: robhatia@usaid.gov About the Author Romi Bhatia is a Senior Advisor for Diaspora Partnerships in the Global Partnerships Division at the US Agency for International Development.

He is part of the core team that is helping to drive the Agency’s engagement with diaspora communities in the U.S. in order to achieve development objectives of the Agency.

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> Otaviano Canuto,World Bank Group’s PREM:

Fiscal Policy Redux

A

s part of their response to negative shocks coming from advanced economies after the Lehman Brothers’ collapse in 2008, most developing countries resorted to countercyclical fiscal policy. Such a policy choice was available to many developing economies that entered the global economic crisis in good macroeconomic and financial shape, with smaller fiscal and current-account deficits, lower inflation, higher international reserves, lower public and external debt, and less financial vulnerability than in the past.

Today there is a swing toward pursuing more ambitious goals through fiscal policy than countering economic downturns. In that context, it is worth revisiting those requisites that must be in place for fiscal policy to truly succeed.

Counter-Cyclical Fiscal Policies in Developing Countries Prior to the financial crisis, an improvement in the fiscal position of many developing countries was reflected in a substantial decline in their public debt during the 2000s (see Chart 1).

The median ratio of general government debt to GDP among middle income countries (MICs) almost halved from near 60 percent in 2002 to just over 30 percent in 2008. Median debt in a sample of low income countries (LICs) fell even more precipitously over this period, aided by substantial debt relief.

Some of that fiscal space built prior to the crisis proved to be a buffer against the crisis, with the strength of post-crisis recovery in many developing countries partially reflecting increased public

“Today there is a swing toward pursuing more ambitious goals through fiscal policy than countering economic downturns.” spending. Median debt ratios rose close to 10 percentage points in the last few years (see Chart 1) and, although not all developing economies are now in a relatively benign position, in most cases the use of short term fiscal stimulus could take place without raising general concerns with fiscal sustainability. Debt build-up has remained modest, given interest rates at low levels and less than GDP growth rates in most developing countries.

As the global economic environment seems to have changed from consecutive negative shocks to a more chronic disease of low growth in advanced economies, fiscal policy in most developing countries has also shifted from pro-activeness to a more low-profile resort to automatic stabilizers. Nevertheless, one can notice an increasing appetite for using fiscal policy as an instrument to foster growth, reduce poverty, boost social inclusion and equity, and to protect against risk and vulnerability to shocks.

A Three-Pronged Rationale for Fiscal Policy A threefold rationale for public action through fiscal policy can be pointed out.

First, there is macroeconomic stabilization.

Given that often relying on monetary policy is not enough to get the job done, governments should also maneuver taxation and/or spending levels in a countercyclical manner. Before the crisis, many economists had discarded the effectiveness of proactive fiscal policy as a stabilization tool, but its widespread use in the early stages of the global economic crisis has since rescued it from the limbo to which it had been relegated.

Chart 1. Source: World Development Indicators, World Bank

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Second, there is a resource allocation rationale, i.e., improving economic performance via expenditure and tax policies that raise efficiency and tackle relevant market failures. The existence of public goods, externalities and increasing scale returns, as well as information failures and missing markets, are recognized as

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factors frequently undermining the operation of pure markets. Therefore, taxes and government expenditures addressing those factors could be considered as policy options as a way to fuel economic growth.

Third, there is the distribution rationale underpinning policies that are designed to mitigate inequalities of income, opportunities, assets, or risks that result from private-market activities. We should not forget to include a dimension of intergenerational distribution, since fairness toward future generations may demand taxes and expenditures that guarantee some carry-over of the value of natural assets, for example. After all, one may ethically consider it unfair that current generations consume the whole gift received from Mother Nature, so to share prosperity over time and for future generations may require taxes and government expenditures.

Recipes for Fiscal Policy to Succeed There are preconditions that must be followed if fiscal policies are going to deliver. First of all, the quest for stabilization has to be symmetrical on both upturn and downturn stages of the economic cycle. The fiscal space of maneuver used to offset negative shocks has to be replenished during boom times, to make sure that public finance remains sustainable, rather than becoming another source of macroeconomic instability. Fortunately, good news is the proportion of developing countries implementing countercyclical fiscal rules went up from less than 10 percent in 1960-99 to above one-third in the new millennium. This is an encouraging trend.

The pursuit of economic growth, in its turn, will justify the resource allocation rationale only if costs of government failures do not exceed the costs of the same market failures that fiscal policy is supposed to address. That will require efficiency in revenue collection by governments, cost-effective public service delivery, and protection of public resources against waste and corruption. Quality of public investment management is crucial. In that context, besides capacity-building in governments, transparency and feedback from stakeholders - civil society organizations, citizens, users of public infrastructure, and contractors - have been shown to help improve performance. The good news is that information and communication technology

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United States Capitol

has made it easier to progress on transparency and social monitoring.

Finally, shared prosperity can only be obtained through fiscal policy if tax structures and government expenditures adopted for the other two rationales do not conflict with that objective. The good news is, on the expenditure side, a lot has been learned in the last decades about what works and under what conditions regarding cost-effectiveness of different social and environmental policies. On the taxation side, the challenge remains how to reconcile adequate levels of revenue with progressivity on income and wealth among citizens and generations.

The Special Case of Natural Resource Rich Countries Fiscal policy in natural resource-rich countries demands a separate discussion, as they share many uniquely distinctive features. Taxation and royalties from the natural resource sector too often become a predominant source of government revenues. Given the high volatility of international resource prices, they also face a tendency of high volatility in government revenues and economic activity. In the case of so-called “point-source” natural resources - such as minerals and oil – they become a tempting target for corruption and rent-seeking. The struggle to control such assets is sometimes a source of civil strife and war. Extractive natural resources themselves are depleting assets so a key question arises as to how much to consume today and how much to save for future generations.

The problems of natural resource-led development get exacerbated in Low-Income Countries (LICs), where governance conditions are often weak, present consumption demands

by the large numbers of poor are hard to resist and where it is hard for governments to commit and stick to rational plans for natural resource depletion.

Fiscal policy in resource-rich countries plays a central role with respect to capital accumulation and long run growth. The key to increasing future living standards lies in increasing national wealth, including not only traditional measures of capital such as produced and human capital, but also natural capital. Standard economic measures of GDP and savings are inadequate to tell us whether national wealth is indeed rising: we need instead measures of adjusted net national income and savings which, among other things, take into account the depletion of natural assets as a form of depreciation, complemented by comprehensive measures of the stock of wealth.

This is a matter of much practical importance: conventionally measured GDP growth has been strong in many Sub-Saharan African countries in recent years, for example, but may be unsustainable because adjusted savings rates are estimated to be negative, indicating that their overall wealth may be declining.

To ensure that their long run growth is sustainable resource-rich countries must ensure that they capture an efficient and fair share of natural resource rents, and then invest that share effectively, so as to increase the country’s wealth.

This is where sound fiscal policy and good public sector governance become crucial.

growth, poverty reduction and equity has followed. Instead of denying it, we believe the most fruitful path is to work on those conditions necessary for it to succeed. i

ABOUT THE AUTHOR Otaviano Canuto is Vice President and Head of the Poverty Reduction and Economic Management (PREM) Network, a division of more than 700 economists and public sector specialists working on economic policy advice, technical assistance, and lending for reducing poverty in the World Bank’s client countries.

He took up his position in May 2009, after serving as the Vice President for Countries at the Inter-American Development Bank since June 2007.

Dr. Canuto provides strategic leadership and direction on economic policy formulation in the area of growth and poverty, debt, trade, gender, and public sector management and governance.

He is involved in managing the Bank’s overall interactions with key partner institutions including the IMF and others.

He has lectured and written widely on economic growth, financial crisis management, and regional development, with recent work on financial crisis and economic growth in Latin America.

He speaks Portuguese, English, French and Spanish.

Bottom Line: A Fiscal Policy Renaissance?

The global economic crisis has given back to fiscal policy its high profile as an instrument of macroeconomic stabilization. A revived interest in the potential of fiscal policy to boost economic

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> Yves Leterme, Deputy Secretary General, OECD:

How to Motivate Savings in a Climate of Distrust in the Financial Sector?

By Harry Smorenberg & Eric Eggink, Chairmen of the WorldPensionSummit

WorldPensionSummit, Amsterdam, 13-14 November 2013 Yves Leterme is key-note speaker at the WorldPensionSummit in Amsterdam on 13 and 14 November. This Summit is the only worldwide platform for pension professionals. In this interview Mr Leterme addresses a number of current key pension dilemmas. An outlook on future pension developments.

We have been experiencing an economic crisis in Europe for many years now. What do you think will be the (short and long term) effects on pension developments and pension provisions within the Euro zone?

Leterme: “Pension reforms have been underway since the early 1990s in many Eurozone countries. The crisis has accelerated some of these reforms, in particular in countries such as Greece, Spain and Italy, where retirement ages were increased and benefit promises were often reduced. These are reforms which will show their effect in the longer term. In order to achieve shorter-term savings many countries are adopting or considering freezes of benefit levels, in particular of higher pensions. Pension savings took a hit in the initial phase of the crisis but now asset levels have recovered in most countries.

The biggest challenge for private pension provision is now how to motivate savings in a climate of distrust in the financial sector and in a very low interest-rate environment, considering that in many countries fees and charges of pension management companies are still rather high, resulting in low returns for savers.”

Based upon the annual research by OECD, huge differences occur in the pension schemes and structures in the various countries. What are the key dilemmas for all nations out of the studies of recent years?

Leterme: ”Despite the fact that, across the OECD, countries have very different pension schemes the challenges they are facing are remarkably similar. All countries are struggling with the same tension between financial sustainability and social adequacy of pension provision. In large pay-as-you-go systems, for example in Continental European countries, financial sustainability is the primary concern: how can the huge success of past decades in the reduction of old-age poverty be maintained while making sure that the costs of pension 140

“Despite the fact that, across the OECD, countries have very different pension schemes the challenges they are facing are remarkably similar.”

providers? And how can we maintain solidarity in a context of rising inequalities? Answering these questions will require comprehensive discussions and the design of holistic plans; so far we have seen little of this happening.”

provision do not become too high for the next generations in the context of population ageing?

Other countries with smaller public pension systems, such as the Anglophone countries or the Netherlands, are more concerned with ensuring adequate pensions in the interplay between public and private pension schemes. Depending on the systems in each country, the answers for a long-term reform approach will vary, but all countries are currently working on 3 tracks: encouraging people to work longer, protecting the most vulnerable when reducing benefits of public pension systems, and promoting personal retirement provision.”

Leterme: “Public pensions will remain the backbone of retirement income provision in the future. The crisis has shown how important the role of government in pension provision is, not only in the provision of the core of pension provision and in the prevention of old-age poverty, but also in the regulation and supervision of private pensions. Given the pace of population ageing and the pressure this is putting on younger generations, however, it is unlikely that private pensions will be rolled back significantly. While many people are now concerned about the risks of private pension provision, it also increasingly clear to most that public pension systems will not be able to provide all of the necessary retirement income on their own. Countries with smaller public systems are now also recognizing that private pension saving on a purely voluntary basis is unlikely to result in high coverage rates and sufficient contributions; they are therefore considering either soft compulsion, such as autoenrolment, or even mandatory private pensions.”

Ageing will be a dominant issue. Do you perceive this is dealt with sufficiently.

Leterme: “Addressing population ageing will require a much broader view than most governments are currently taking. It is fair to say that the urgency of pension reform is recognized and countries have been acting on this, even though some of them have not gone far enough yet in reforming their retirement income systems. But ageing will entail much more policy action than just pension reform, and much more strategic thinking: what will our societies of the future look like? How will we deal with the old age care challenge? What will be the fiscal impact of ageing and what will this mean for social protection systems and the sharing of responsibilities between the individual and the state, between public and private service CFI.co | Capital Finance International

What will be the impact on pensions in general and to what extend should governments be / or stay in control to secure sufficient pension provision?

Concern of the average pension age , the workability index for most countries is around 75 year of age. On average people stop working at 63 - 65. How can we bridge this 10 year gap? What should change, who should be catalysts (government / employers / third parties)?

Leterme: “The first priority has to be to get the effective retirement age up, i.e. the age at which people withdraw permanently from the labour

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market, and move it closer to 65 years which is now the normal pension age in most OECD countries. While many countries are moving this normal age up rapidly towards 67 years more still needs to be done to actually enable most people to work longer. This will require action on many fronts: governments need to phase out remaining incentives to retire early and offer more flexible solutions for combining work and pensions, employers need to provide better work environments, more training and adapted work schedules so that older workers can effectively remain in work in ways that are in line with their skills, experience and health status, and workers need embrace the fact that working longer is not only inevitable but also something that needs to be prepared for over the life cycle.

What is your perception on harmonizing pensions in the EU. The difference are huge.

Portability of pensions in schemes (employers) are scarce... there where we endorse free movement of labor.

Leterme: “Harmonizing pensions in Europe is a long way off. There are major social and cultural differences that will be difficult to reconcile.

However, Europe needs to keep working at improving the efficiency of pension provision, particularly in the private pensions sector, by for instance lifting barriers to the cross-border provision of pension plans. We should be seeing more cross-border occupational pension plans in Europe and citizens should have access to Europe-wide personal pension arrangements, like the passport system that exists for UCITS. Scale and good governance also go hand in hand, and the truth is that in many European countries pension funds are just too small to be able to be managed at low cost. The consolidation of the pension fund industry should be in the policy agenda.”

There is a strong tendency toward the individual responsibility. Risks are moved to

the individuals. Is that the trend to be? A DC structure on a personal basis? No solidarity, and collectivity? Or do you see other trends and developments?

Leterme: “The move towards DC is widespread, not just in Europe but in many OECD countries and beyond. But we should not forget that the DB plans that they have replaced were not riskless.

Moreover, there are both good and bad kinds of DC plans. Good types have high contributions and long contribution periods, low costs, mitigate investment risks close to retirement and offer efficient opportunities to transform the accumulated balance into annuities. We have summarized these criteria in our Roadmap for the Good Design of DC pension Plans which we published in June last year. Solidarity is best addressed through the public pension system.

Risk sharing is also an option for private pension arrangements, but it seems to work best where you have industry-wide plans with a good record of employer-employee relations. Another option is to provide a performance guarantee, but these are costly and can lead to suboptimal investment strategies.”

How should the FSI anticipate. So far there is quite a lot of people ( also in the West) who are illiterate and lack understanding in planning their financial continuity.

Leterme: “Financial literacy is a major challenge for DC pension systems. Governments have a responsibility to prepare the population for some of the major pension reforms that are taking place. But financial literacy is not enough. We know quite a lot from the behavioural economics literature about the limits of human rationality, the impact of cognitive biases and emotional factors on decision-making, and the common mistakes that even people well versed in financial matters can make. The more we rely on DC plans, the greater will be the need to help steer individuals towards appropriate choices.

Key-note speaker: Yves Leterme

Governments face a tremendous responsibility in choosing appropriate defaults, such as default contribution rates, investment strategies and annuitisation policies.” i

About the WorldPensionSummit: The Summit is a perfect opportunity to exchange knowledge and innovative ideas for a sustainable pension provision. Offering key analysis, insights and ample room for discussion amongst peers. In plenary sessions and 35 dedicated specialist working groups, top experts in the field of retirement management, pension fund strategy, social security, employee benefits, discuss latest insights. Learn from key questions and actual best practices in pensions. More than 350 pension professionals from over 45 countries meet at the Summit every year!

For REGISTRATION & INFORMATION go to www.worldpensionsummit.com. Use the special conference code for 20% discount: MEDIA2013WPS20 CFI.co | Capital Finance International

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> Grant Thornton, Hong Kong:

Coping with Emerging Technology Risks

By Eugene Ha

O

ne of internal audit’s primary responsibilities is to evaluate and improve the effectiveness of risk management processes. And in the universe of risks, those posed by emerging technologies are rapidly multiplying as these technologies become more sophisticated.

The Hong Kong government has thrown HK$9 million at a new Cyber Security Centre in a bid to tackle the growing threat to critical IT systems and infrastructure. The centre is the step for the technology crime division to work more closely with public and private sector organisations.

Financial losses due to ‘technology crime cases’ in Hong Kong have jumped from HK$45 million in 2009 to HK$148.5 million last year, with online fraud, Distributed Denial-ofService Attacks (DDoS) – related blackmail and hacktivism among the most common threats.

Not surprisingly, internal audit departments are struggling to get a handle on these risks. That’s not to criticise. Even the most forward-thinking IT departments can find it challenging to wrap their minds, hands and policies around the risks presented by the explosion in the use of cloud computing, smart phones, tablet computers, social media, and mobile applications.

The hurdles are even more significant for internal auditors. Not only are they often unfamiliar with new technologies, but their traditional approaches to risk assessment do not necessarily transfer well to evaluating the vast array of risks inherent in emerging technologies. Moreover, internal auditors are already up to their necks managing known and potential financial risks.

The view from the CAE’s office In the US, Grant Thornton LLP’s most recent survey of approximately 300 chief audit executives (CAEs) shows that, and not surprisingly, emerging risks are on the minds of CAEs. (See www.GrantThornton.com/CAESurvey) Just over one-third of respondents (34%) say that cloud computing represents a significant organisational change and that they understand the implications. On the other hand, 20 percent believe that neither internal audit nor IT fully comprehends the implications of transitioning to the cloud. The chart below shows how respondents ranked four areas of emerging risk.

Furthermore, 42 percent of respondents said they see the greatest cybersecurity threat to their organisation coming from external hackers or other outside parties.

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“The Hong Kong government has thrown HK$9 million at a new Cyber Security Centre in a bid to tackle the growing threat to critical IT systems and infrastructure.”

Despite the prevalence of concerns about new technologies, internal audit plans to evaluate the associated cybersecurity risks are often lagging or nonexistent. Many times, CFOs and other executives don’t see the risk when they align each new technology with revenue streams, contracts or expenditures. But if a company doesn’t have many contracts or expenditures that involve emerging technologies, managing the related risks may get short shrift. Therefore, the need for internal audit to adapt its audit plan to accommodate emerging technology risks becomes all the more urgent. We offer a primer for getting started.

Leverage existing internal audit strengths and approaches Internal auditors are experts at traditional risk assessment. They have a mindset for risk management and are adept at creating audit objectives and plans. But their focus has typically been on examining areas that are known causes for concern (e.g. inventory management problems or lax financial controls). Although there are the usual risks associated with technology, such as network failures or security breaches, many of the risks inherent in new technologies are truly emerging ones that require internal auditors to adopt a more forward-looking, what-if approach.

The blank sheet of paper approach is a good starting place. As its name suggests, this approach involves an internal audit professional sitting down with the IT department with a blank sheet of paper to discuss the universe of emerging technology risks and the current controls that are in place. From this starting point, internal audit can apply its risk management mindset to evaluate the design and strength of existing controls and implement a monitoring programme that addresses the new risks. Specific areas of focus would likely include the following: Understand IT governance processes and how risks are assessed prior to deploying new technologies Internal audit needs to ensure that IT does not put the cart before the horse when it comes to introducing new technologies. Before rolling out tablet computers to employees, for example, the organisation should implement procedures to safeguard sensitive data located on each device, such as wiping the hard drive remotely if the device gets lost or stolen. The organisation should also establish controls to protect against malicious software that could be embedded in apps downloaded by employees for personal use.

Review existing policies Not only are policies needed to govern the various technologies, but internal auditors have to ensure that those policies are adequate and enforceable.

When it comes to social media, for instance, how far-reaching are the policies? Do they cover whether employees can make comments about the company while using personal accounts?

As an example, a company considering an acquisition would not want one of its employees broadcasting from the office of the acquisition target about what a great cafeteria it has. Also,

*Score is a weighted calculation.

Items ranked first are valued higher than the following ranks; the score is the sum of all weighted rank counts.

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does someone monitor Facebook or Twitter for corporate mentions, especially those that could signal an emerging customer service or public relations issue?

Examine third-party data security measures Most organisations have internal controls in place to protect sensitive and confidential data stored at their location. However, when information is moved into the cloud, there is no guarantee that the organisation’s internal controls over data security will be applied. Internal auditors need to examine how company data is protected in the cloud. What does the cloud provider offer in terms of intrusion detection, firewalls, physical security, timely application of security patches, and data leakage protection, among other safety measures?

Collaborate in assessing risk Recognising that evaluating the risks posed by emerging technologies is not necessarily their greatest strength, many internal audit departments turn to outsourcing or co-sourcing arrangements to access subject-matter expertise.

Another way to tap into this expertise is to involve your IT group in risk assessment and audit planning. This process can start with the blank sheet of paper approach discussed earlier, but IT’s involvement can go well beyond that initial consultation.

Rather than operating in a silo, consider engaging the IT group to help with risk assessment, audit planning, and implementing and monitoring controls. Internal audit may even want to consider inviting a senior IT professional to be a guest auditor. IT personnel could work on just the technology portion of the audit or participate in a broader way to gain a deeper understanding of internal audit’s mission. Either way, collaborating with an internal subject-matter expert is sure to result in a better audit.

Similarly, internal audit may want to tap into the organisation’s customer relationships or marketing groups to get a better grasp of how they’re using emerging technologies such as Facebook, Twitter, LinkedIn and blogs. And internal audit should examine the controls that guard against reputational and cybersecurity risks.

Special considerations: Reputational risk and crisis management Internal auditors will want to give special attention to the reputational risks associated with emerging technologies. Considering how quickly negative information can spread in today’s hyperconnected marketplace, even minor missteps can quickly sweep through social media and deliver a corporate black eye, sometimes even a knockout punch. Although it’s impossible to anticipate or control every event that could give rise to reputational risk, internal auditors can help ensure that their organisations have plans in place for what to do should an unforeseen event

Rose Zhou: Partner, Advisory, Grant Thornton Hong Kong Limited

develop into a full-blown public relations crisis.

Realise, too, that your company may not have the luxury of waiting to assemble top executives and outside advisers to discuss a crisis in depth before deciding on a course of action.

With this in mind, organisations should make contingency plans for rapidly responding to and minimising the effects of crises that may range from high-profile cyberattacks to public relations debacles. A solid crisis management plan should include designated responders and streamlined procedures to address situations before they spiral out of control.

Conclusion: Act first Internal audit faces many challenges in auditing emerging technology risks. Not only is it a nontraditional, complex and fast-evolving area, but there are many portals through which risks can enter. Internal auditors can’t afford to wait for these risks to emerge on their own and announce themselves. Rather, practitioners must begin to think more broadly about the expanding universe of risks and develop strategies and controls to mitigate them. i

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About Grant Thornton Hong Kong Limited Grant Thornton Hong Kong Limited is a member firm of Grant Thornton International Ltd (Grant Thornton International). The firm is fully integrated with Grant Thornton China and be part of a network of 17 offices providing seamless access to 120 partners and over 2,700 professionals across mainland China and Hong Kong. For more information visit www.grantthornton.cn Grant Thornton is one of the world’s leading organisations of independent assurance, tax and advisory firms. These firms help dynamic organisations unlock their potential for growth by providing meaningful, actionable advice.

Proactive teams, led by approachable partners in these firms, use insights, experience and instinct to understand complex issues for privately owned, publicly listed and public sector clients and help them to find solutions. Over 35,000 Grant Thornton people, across 100 countries, are focused on making a difference to clients, colleagues and the communities in which we live and work. For more information visit www.gti.org

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> Grant Thornton, China:

Insights on Transfer Pricing Issues with ‘Unique Chinese Characteristics’

By Rose Zhou & Richard Bao

Background In mid 2012, the State Administration of Taxation of China (“the SAT”) delivered a presentation on the current transfer pricing (“TP”) environment of China during the Tax Justice Network Transfer Pricing Conference in Helsinki. In this presentation, the SAT explored the TP issues with “unique Chinese characteristics”.

Furthermore, with the announcement of the “China Country Practices” (“the Paper”) which is a part of “Practical Manual on Transfer Pricing for Developing Countries” (draft version) by the United Nations (“UN Transfer Pricing Manual”), the SAT sets forth a series of issues and challenges in China TP practice and the opinion as well as the practical experience in dealing with such issues and challenges.

Key topics In the current global economy, TP has proved its significance in both developed countries and developing countries. As a member of developing countries, China has faced some unique issues in its TP administration.

Lack of Reliable Comparables Due to the limited number of Chinese-listed companies, there would be a lack of reliable public information on local comparables.

In addition, the lack of information sharing mechanisms among different administration authorities also makes it even more difficult for the SAT and taxpayers alike to obtain the information of local comparables. As a result, most comparables selected are located in developed countries, such as Japan and Australia. The SAT holds that comparability adjustments may be necessary when there are significant geographical differences (i.e., when companies in developed countries to be used as comparables for Chinese companies, but with significant differences). However, in practice, it is quite difficult to conduct reasonable adjustments among the companies.

Location Savings Location savings refer to the net cost savings derived by a multinational enterprise (“MNE”) when it sets up its operations in low cost jurisdiction such as China. Net cost savings are commonly realised through lower expenditures on items such as raw materials, labour, rent, transportation, and more. The SAT clearly

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“The announcement of the Paper as part of the UN Transfer Pricing Manual indicates a great leap in the transfer pricing administration of the SAT.” indicates that the advantages of low cost gained from China enable the MNEs to generate higher profits globally, therefore a major share of such profits should be retained by the Chinese entity.

The Paper identifies certain circumstances under which China may have location specific advantages (“LSAs”) and illustrates the advantages with an example of automotive industry. The LSAs of the automotive industry may include: • the “market-for-technology” industry policy, which attracts foreign automotive manufacturers to enter into the China market by forming joint ventures in China • Chinese consumers’ general preference to foreign brands and imported automobiles enables foreign automotive companies to charge higher sales prices and earn additional profits on automotive products sold in China • huge and inelastic demand for automotive vehicles in China due to the large population and growing wealth of the population • policy constraints on the supply of domestically assembled automotive vehicles • duty saving from the lower duty rates on automotive parts (i.e., 10%) compared to imported vehicles (i.e., 25%) – when foreign automotive companies manufacture products in China as opposed to importing the products from outside of China, they are able to generate overall savings • a large supply of high quality, low costs parts manufactured by suppliers in China.

In addition, the SAT also discusses the use of a “Four Step Approach” on the issue of location savings.

Market Premium Market premium relates to the additional profit derived by a MNE by operating in a

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jurisdiction with unique qualities impacting on the sale and demand of a service or product.

As an emerging market, China definitely has its unique dedication to the foreign companies in making excess profits in China due to the strong purchasing power of China in the sectors such as automotive and luxury goods.

The SAT argues that a share of the profit derived from market premium should be recognised by the Chinese entity. In the Paper, the SAT sets forth its various considerations regarding the local marketing intangibles, and extends the definition of the intangibles to the workforce, goodwill, and more. Therefore, the issue of market premium is becoming more complicated.

Method Selection The SAT takes the view that when evaluating the profitability of the Chinese entity, the focus should be on the profitability of the Chinese entity in the context of the MNE’s whole supply chain rather than looking at the Chinese entity on a standalone basis. In order to reasonably determine the return that the group companies should earn, the SAT will have a preference towards profit split method or other hybrid method.

In the Paper, the SAT also mentions that the application of traditional transactional net margin method (“TNMM”) will be restricted due to the lack of comparables. Under such circumstances, profit split method would be more appropriate, such as for electric manufacturing services industry.

Other Issues The Paper also explores other issues encountered in the daily TP administration of the SAT, including: • Royalty: The SAT has stated its view in regard to the royalty repatriated from a Chinese entity to the overseas entity. For example, if a Chinese entity was charged a 3% royalty for the use of a manufacturing process for over a ten year period, the SAT would not consider it reasonable for the Chinese entity to continue paying the same royalty without revisiting whether the intangible has continued to provide the same value over time. Moreover, the SAT may question whether the Chinese entity should be entitled to a return on the intangibles that it developed during the 10-year manufacturing process.

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Hong Kong

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China: Hong Kong

• A holistic view of functions and risks: A MNE has set up multiple companies in China with each company performing only a single function, such as manufacturing, distribution, R&D, and services, by claiming that each entity is a single function entity and is entitled to a limited return.

The SAT takes the view that all the affiliated companies in China may have to be taken into consideration as a whole in order to properly determine the return the group companies should earn in China.

• Contradiction between “contract R&D” and “high and new technology enterprise”: Some Chinese entities have obtained “high and new technology status” under China income tax law. However, they also claim to be the contract R&D service providers without valuable core intangibles. The SAT takes the view that the real business of the entity conflicts with what it claims. Furthermore, the SAT also views that it would be insufficient to use cost plus method in evaluating these entities. Instead, other method (such as profit split method) would be more appropriate.

• Adjustment for difference regarding selling expenses: When there are significant differences in selling expenses between the tested party and

the comparables, how to perform a reasonable adjustment in terms of functional profile (such as sales, marketing, distribution, and more) remains to be a key consideration.

Observations and recommendations In recent years, the SAT has obtained an important position on the global stage of international anti-tax avoidance. The announcement of the Paper as part of the UN Transfer Pricing Manual indicates a great leap in the TP administration of the SAT. Meanwhile, this initiative broadcasts the TP issues with Chinese characteristics to a wider audience.

While endorsing the arm’s length principle, the SAT will retain its unique approach such as comparability adjustment and the adoption of non-traditional TP methods. The SAT initially proposed new concepts and methods, i.e., holistic approach and contribution analysis. As such, it could be predicted that in the foreseeable future, the SAT and tax authorities at all levels will prefer to adopt such concepts and methods. However, these concepts and methods are concerned to be potentially controversial between tax authorities and enterprises.

The industries (such as automotive, retail and luxury goods), R&D enterprises, and high and new technology enterprises as mentioned above, are highly correlative to the concepts of “location savings”, “market premium”, “location advantages” and “local marketing intangibles”.

It is observed that the tax authorities are focusing on the TP practice of the above industries and enterprises, e.g., the tax authorities already have had interviews with the enterprises after obtaining their TP documentations to explore “location savings”, “market premium”, “location advantages”, “local marketing intangibles”, and more. It is necessary for the above enterprises to review the TP policies of the enterprises, especially consider the concepts underlined in this article, and ensure that the TP arrangements are in line with the development of China practices. In the context of stringent TP administration, enterprises in China should take into consideration the views of the SAT and its potential impacts on the TP arrangements of the enterprises, so as to adopt prompt and effective measures with the aim to mitigate the TP risks in China. i

Grant Thornton China We are the Chinese member firm of Grant Thornton International Ltd, one of the world’s leading organisations of independent assurance, tax and advisory firms. Leveraging on its extensive global network and vast resources spanning 120 countries, we can provide world class services that combine local knowledge with global perspectives.

Rose Zhou: Tax partner, Grant Thornton China

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Richard Bao: Tax partner, Grant Thornton China

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Established in 1981, Grant Thornton China was one of the country’s first accounting firms. Now, we have 17 offices with more than 120 partners and 2,700 staff throughout China. Our unique ‘one firm, one China’ approach enables us to offer a full range of assurance, tax, advisory, asset valuation and project cost management services to nearly 140 public companies and over 2,000 state owned enterprises, as well as private companies and foreign invested companies.

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