Mauritius: The FSC issues an Information Booklet on Effective Customer Risk Assessment for Management Companies

The Financial Services Commission (the ‘FSC’) is pleased to announce the release of an Information Booklet on Effective Customer Risk Assessment (‘Information Booklet’) intended for Management Companies (‘MCs’). The Information Booklet serves as guidance for MCs to operate within a risk-based environment. It is intended to assist MCs in the development of their internal controls systems.

As highlighted previously by the Chief Executive of the FSC, “the international FATF principles and the Code on the prevention of Money Laundering & Terrorist Financing are valuable instruments to fight against global crimes which are a threat to sustainable economic growth. While the Anti-Money Laundering policies and procedures must be based on local regulations and global best practices, the challenge is always the same - to ensure that those actions designed to combat and prevent crimes, in addition to being well designed, are also effective”.

Therefore, to sustain its competitive edge acquired over the years in the financial services sector, Mauritius has to maintain its good repute as a financial services centre. Service providers in the global business sector, including MCs, must ensure that there is an effective system of monitoring of the control framework. Risk profiling and risk grading of clients remain the crucial components of this framework.

The FSC hence encourages all MCs to use the Information Booklet as a tool to establish their effective internal control system as well as an opportunity to review their existing structure.

Financial Services Commission

30 December 2013

France - Lutte contre la fraude : mise à jour de la liste des Etats et territoire non coopératifs

Le Ministère de l’Economie, des Finances et de l’Industrie a publié un communiqué de presse dans lequel il annonce avoir mis à jour la liste des Etats et territoire non coopératifs.

Dans le cadre de la politique de lutte contre la fraude, les ministres Pierre Moscovici et Bernard Cazeneuve ont adressé un courrier aux présidents et rapporteurs généraux des Commissions des finances de l’Assemblée nationale et du Sénat leur annonçant que les progrès effectués par les Bermudes et Jersey en matière d’échanges de renseignements leur permettent de sortir de la liste des Etats et territoires non coopératifs sur laquelle ils avaient été inscrits par arrêté du 21 août 2013.

Les Bermudes et Jersey ont satisfait à ce jour à la totalité des demandes de renseignements de la France, ce qui leur permettra d’échapper aux mesures de rétorsion prévues par la loi.

La liste sera mise à jour en 2014 en fonction des renseignements nécessaires à l’application de la législation fiscale française qui auront été obtenus par l’administration fiscale au titre des conventions d’assistance administrative.

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IMF Working Paper No. 13/263: Financial Soundness Indicators and Banking Crises

The paper tests the effectiveness of financial soundness indicators (FSIs) as harbingers of banking crises, using multivariate logit models to see whether FSIs, broad macroeconomic indicators, and institutional indicators can indeed predict crisis occurrences. The analysis draws upon a data set of homogeneous indicators comparable across countries over the period 2005 to 2012, leveraging the IMF’s FSI database. Results indicate significant correlation between some FSIs and the occurrence of systemic banking crises, and suggest that some indicators are precursors to the occurrence of banking crises.

Mauritius: FSC Circular Letter and FAQs on Financial Services (Administrative Penalties) Rules 2013

The Financial Services Commission (FSC) is issuing this Circular Letter and FAQ to inform its licensees and registered/authorized/approved persons about the Financial Services (Administrative Penalties) Rules 2013 and its application.

Circular Letter

FAQ

Form - Submission of Returns, Information and Reports

HSBC Mauritius: Global Business Tariff of Charges (effective 1st January 2014)

A monthly account maintenance fee of USD1,000 (or equivalent) will be applicable on all new Global Business accounts opened as from 1st January 2014. Please click here to consult the new Tariff of Charges for Global Business which will be effective as from 1st January 2014.   

Existing Global Business clients will benefit from a waiver of the monthly account maintenance fee for the first three months and a reduced preferential fee of USD100 until 31st December 2014.   

Customers are kindly advised to ensure that their accounts are properly funded as per the minimum balance requirement of USD50,000.

OECD - Aid at a glance charts: Mauritius

FSB: Global adherence to regulatory and supervisory standards on international cooperation and information exchange

The Financial Stability Board (FSB) commenced in March 2010 an initiative to encourage the adherence by all countries and jurisdictions to regulatory and supervisory standards on international cooperation and information exchange. The initiative responded to a call by the G20 Leaders at their April 2009 Summit in London for the FSB to develop a toolbox of measures to promote adherence to prudential standards and cooperation with jurisdictions.

To recognise the progress that most jurisdictions evaluated by the FSB under the current initiative have made towards implementing international cooperation and information exchange standards, and to incentivise improvements by those jurisdictions not cooperating fully, in November 2011 the FSB first published the names of all jurisdictions evaluated. This annual status update provides current information on the countries being evaluated under the initiative. The list includes those identified as non-cooperative jurisdictions.

Objective of the initiative

The focus of the FSB's current initiative is on adherence to internationally agreed information exchange and cooperation standards in the areas of banking supervision, insurance supervision and securities regulation. Cooperation and information exchange amongst financial supervisors and regulators are essential for effective oversight in an integrated financial system. Financial markets are global in scope and, therefore, weaknesses in international cooperation and information exchange can undermine the efforts of regulatory and supervisory authorities to ensure that laws and regulations are followed and that the global operations of the financial institutions, for which they have responsibility, are adequately supervised.

The current initiative is part of a framework that the FSB has put in place for encouraging stronger adherence to international standards more broadly. In this framework, FSB member jurisdictions have committed to lead by example. They have committed to implement international financial standards, participate in international assessments, and disclose their degree of adherence. In addition, FSB members undergo periodic peer reviews focused on the implementation and effectiveness of international financial standards and of policies agreed within the FSB.

Jurisdictions evaluated

While the ultimate objective of the FSB's initiative is to promote implementation by all jurisdictions, the initial focus is on the adherence of FSB members and other jurisdictions that rank highly in financial importance. Under the initiative, the FSB prioritised a pool of about 60 jurisdictions for evaluation, including all 24 FSB member jurisdictions together with non-FSB jurisdictions that rank highly based on a combination of economic and financial indicators. (The ranking process is described in more detail in Annex B of the November 2011 statement).

The FSB has to date evaluated the jurisdictions listed in Tables 1 to 3 to determine whether they demonstrate sufficiently strong adherence to regulatory and supervisory standards on international cooperation and information exchange. Adherence was evaluated by the FSB based on the latest available detailed assessment report underlying the IMF-World Bank Report on the Observance of Standards and Codes (ROSC), as well as on the signatory status to the IOSCO Multilateral Memorandum of Understanding Concerning Consultation and Cooperation and the Exchange of Information (MMoU)

Full text

US Foreign Account Tax Compliance Act

The Foreign Account Tax Compliance Act (FATCA), which is part of the US Hiring Incentives to Restore Employment Act of 2010, aims to combat tax evasion by US tax residents using foreign accounts. It includes certain provisions on withholding taxes and requires foreign financial institutions (FFIs) outside the US to pass information about their US customers to the US tax authorities, the Internal Revenue Services (IRS). Failure to meet these new reporting obligations would result in a 30% withholding tax on the financial institutions for payments of U.S. source income, gross proceeds of sales of property that could produce U.S. income, and passthru payments.

The FATCA provisions impose new and substantial burdens on FFIs in identifying US taxpayers, and registering and reporting information to the IRS. 

FATCA focuses on reporting:

• By U.S. taxpayers about certain foreign financial accounts and offshore assets
• By FFIs about financial accounts held by U.S. taxpayers or foreign entities in which U.S. taxpayers hold a substantial ownership interest

The objective of FATCA is the reporting of foreign financial assets; withholding is the cost of not reporting.

An Intergovernmental Agreement (IGA) makes it easier for partner countries to comply with provisions of FATCA. The IGA Model I provides for a partnership agreement between the U.S. and partner jurisdiction whereby FFIs in partner jurisdictions will be able to report information on U.S. account holders directly to their national tax authorities, who in turn will report to the IRS.

Offshore Pilot Quarterly (December 2013, Volume 16 Number 4)

Foaming at the Mouth

In a world of limitless possibilities we need to set boundaries for ourselves or our fate will be to face mounting despair.  I read words to that effect several years ago, put them on my mental shelf, and carried on.  They have had to be taken down from that shelf now, however, because I have just read an article describing shapeless trusts; these trusts, apparently, can be fashioned into various forms, just like Plasticine, and have found favour in Israel.  As a trust specialist, the concept for me strikes at the very roots of the relationship. 

I have in recent years watched the grim progress of the changes, however slight or cosmetic, made to the edifice of that bulwark of succession planning, the English trust, and which has been exported around the world; although, it must be said, not always with universal success; in the case of some countries, like a cheap wine, it has not travelled well.  But still the fundamental trust framework, enshrined in the legal maxim that requires three certainties (intention to create one as well as a clear identification of both its assets and the beneficiaries) has been sustained.  No matter how elaborate or fanciful the language, this is the kernel of a trust, and for which a trustee, as steward of the assets, is needed; well, that’s certainly how it once was.

Would you believe that the new interpretation stems from the very convention that was supposed to clarify the status of trusts internationally which was concluded back in 1985 and entered into force in 1992?  Because the Hague Convention entitled “The Law Applicable to Trusts and on their Recognition” does not stipulate that assets have to vest in the trustee, unlike the English law does, it is argued that the creator of the trust may retain title in the assets.  I should add that the trust regime in China speaks of entrusting property rights to the trustee, but this does not mean that the settlor is required to vest them in the name of the trustee.  Although there are moves afoot in Israel, as opposed to China, to change the law which has been in place since 1979, giving the trustee his rightful place, it is expected to take several years of parliamentary debate before the current position is reversed. 

The argument put forward is that such innovations extend the number of options available, like an extensive restaurant menu does, and that different trust models can suit different circumstances.  One defence is that for those cultures uncomfortable vesting assets in favour of a third party, diluting the trustee’s role is very comforting.  But if, like cell phones, we are going to see trust apps on offer, I predict that you will also see mishaps.  One can only imagine the opportunities for litigation which could be encouraged by disgruntled beneficiaries and any avaricious lawyers skilled in the art of word manipulation.   The solution?  Use a foundation, already very popular with Latin Americans who are also sensitive about control issues, but which is far from shapeless and holds title for succession planning in its own name rather than a trustee’s; importantly, it can grant generous powers to the founder that will have the Israelis and Chinese sleeping peacefully at night.

It is not just certain trust practitioners who are looking for the next big idea, but fortunately, in this fast-changing world, the durable still remains so, and can live alongside the innovative – provided you can recognise the value of both and not try to invent a better mouse trap. 

One word that is important in the Hague convention is “relationship” which is used to define the link between a trust’s creator and a trustee; it is not bound by a contract (which many believe it is) but its essence is the understanding between the giver and the receiver:  remember, the nature of the English trust has its origins in ecclesiastical law which preceded the court of equity, before clerics walked across from the church to the King’s chancery to confront the birth of trusts and let their consciences be their guide. 

The so-called shapeless trust has been described as substance without form but to my mind you are in danger of being unable to achieve substance over foam – just froth and nothing more, which would have had the clergy foaming at the mouth.

I am uncomfortable with the argument that the trustee does not need to have the assets vested in him to have control of them, as suggested in Beijing or Beersheba.  The reverse of this, of course, can, importantly, have equal application in the classic sham trust situation, where although the assets have been vested in a trustee, the settlor, effectively, continues to control them.  But whether this new species of trust, this Haifa hybrid if you will, ever gains traction elsewhere, it is yet one further example of the fine line that can sometimes be drawn between the authentic and the derisory.

Trust Hits the Dust

An aftershock following the Western world’s economic collapse calls on a different type of trust:  trust in governments and those providing professional services, such as accountants, bankers and lawyers, along with those professions allied with them.  Derision is a very apt word in this instance.  Not dissimilar to the English trust model, the bankers, for example, decided to re-invent banking, while the accountants split their time between being auditors and business advisers.  What about the lawyers?  Well, they required no new string to their bow because their trade is the essential prop, trying to ensure that all forms of business operate within the boundaries of the law.  Their principal tool is words; the right ones to get the job done.  And although as a professional class their reputation is not glowing, their function cannot be circumvented, any more than a doctor’s can; they are an essential part of the financial food chain, serving up on a tray their interpretation of the meaning, for instance, of “vesting”; “entrusting”; and “control”. 

In the mêlée, resulting from the hunt for tax evaders, to seek the definition of beneficial ownership for the purposes of not only transparency, but tax liability too, I have to ask myself:  are we on the way towards shapeless beneficial ownership?  If so, will the discretionary trust beneficiary be interpreted in some countries as having a vested interest for purposes of tax? 

The British chancellor of the exchequer, George Osborne, is the beneficiary of a discretionary family trust purported to be worth several millions of pounds.  Will the United Kingdom’s aggressive approach on how beneficiaries of trusts are to be treated have unintended consequences for him?  I ask the question because regardless of any input from lawyers, the level of understanding displayed so far in the interpretation and mechanics of trusts by many members of the Organisation for Economic Co-operation and Development has been abysmal. 

It is right and just that regulation demands protection from the fraudulent within the professional community, but one gets the idea that there are some functionaries in those bastions of officialdom scattered across the globe who might only associate “vest”, for example, with a garment worn under a shirt.

In France the trust is as popular with the government as the Duke of Wellington was with Napoleon Bonaparte and if George Osborne decided to retire there, his discretionary trust interest, regardless of whether he derives any future benefit from it, would nonetheless be required to be reported to the French tax authorities. 

Pulling Teeth

Words first uttered, as we know, can be important, just as first appearances are.  The Prince, Niccoló Machiavelli’s masterful treatise, which celebrated its quincentennial in 2013, labours the point and has had an influence ever since on political thought and culture, the elemental principle being that in the pursuit of power the use of immoral means can be justified.  Machiavelli told Raffaello Girolami, a diplomat and ambassador to the Holy Roman emperor, that “Occasionally words must serve to veil the facts.  But let this happen in such a way that no one becomes aware of it; or, if it should be noticed, excuses must be at hand to be produced immediately”. 

It is important to understand that whilst you can be master of your thoughts, once uttered, you become a slave of your words.  So of equal importance is lucid thought, before the tongue is engaged, in order to achieve Mark Twain’s imperative:  “I like the exact word, and clarity of statement, and here and there a touch of good grammar for picturesqueness”. 

Machiavelli had fallen from favour in 1512 when the Medici family returned to power in Florence and where he had held a post in the city’s chancery due to his close association with Piero Soderini, a prime Medici rival.  He was immediately removed and, linked with a conspiracy to overthrow the Medicis, was later imprisoned, tortured and subsequently placed under house arrest.  He died 14 years later in abject poverty, having written The Prince in the hope that he would gain favour and employment with the Medicis; they probably didn’t even read his book.

Without doubt, Francisco Franco, the late dictator of Spain, would have been a wise prince in Machiavelli’s eyes and needed no guidance from his book.  Here was a man who ruled his country for almost 40 years (1939-1975), and who contrived to create a myth about himself, appearing little in public and using rhetoric and reclusiveness to great effect.  He was impenetrable, sphinx-like, about whom his chaplain of 40 years once remarked that if he was cold, as many said, he didn’t show it and “In fact, he never showed anything”.  Anger and sorrow were rarely expressed, and he signed sheaves of death sentences over dinner with absolute indifference.  Adolph Hitler, after spending 9 hours with him, later told Benito Mussolini that he would rather have three or four teeth taken out. 

It was luck (which Machiavelli also wrote much about), boundless optimism and low cunning that served Franco well during his lifetime; he was 83 years of age when he died whereas Machiavelli had only been 58 years old.  Ironically, Machiavelli’s fellow Italian, Mussolini, like himself, also played his cards very badly, eventually being brought to heel, literally, to which a rope was tied to both of them as he hung suspended and was spat at by his countrymen in 1945.

Seiko and you Shall Find 

It is a good new year’s resolution to try and read a selection of well-chosen books, if you do not already do so.  I subscribe to the former French President Francois Mitterand’s conviction that “A man loses contact with reality if he is not surrounded by his books”; he never did, in political terms, and equalled Franco’s guile.  China’s former premier, Wen Jiabao, for instance, was a frequent reader of history, saying that it was like a mirror; and once again, as Mark Twain so aptly put it:  “The man who doesn’t read good books has no advantage over the man who can’t read them”.

Speaking of good books, it is also true that the contents, and not the cover, is always what counts, reminding us to be wary, in fact, of first appearances.  This caution has equal application when, for example, you are seeking professional help on where to either bank or invest your money.  It is true, for example, that many luxury watches are very attractive and expensive, but isn’t their prime purpose just to tell the time? And accurately.  44 Christmases ago, Seiko introduced its Quartz Astron 35SQ that was accurate to within one minute a year.  Tokyo may not have the same cachet as Geneva does, but it is also true that today an average, reliable Chinese watch costs US$2. 

Like the lure of what I describe as commercial cosmetics, a lot of people buy up-market Swiss watches not to tell the time, but to tell other people something about themselves; status and branding reign and the purveyors of perception are well aware of the seductive attraction of both.

One of my indulgences, and a testimony to the durability of quality, is to not only buy good books (a new year’s resolution that never changes) but to occasionally purchase some which are very old and are encased in lovingly-produced, hand-sewn covers.  But, again, two points should be made (and also considered in the context of finance):  it is the text wherein the true value lies, with the adornment only adding visual pleasure and nothing material.

I have bought most of my treasured volumes (some published at the beginning of the last century) from a bookstore in Oxford in the UK.  Originally established in 1879 on Broad Street, the tiny bookshop (12 square feet) now holds some 250,000 books with a very large, used books section where some real gems are to be found.  By excavating under neighbouring Trinity College Gardens an additional 10,000 square feet was made available.  I wonder if that advocate of quality, Mark Twain, visited the book shop when he was in Oxford? 

Trust, however, synonymous with integrity, has been the thread throughout this year’s final newsletter and Niccoló Machiavelli spoke and wrote a lot about it – as have so many contemporary bankers.  He found himself pursued by the Medicis, and the bankers today by regulators and depositors.  I read where a town crier, mounted on a horse and using a silver trumpet to attract the attention of crowds, was employed by the city of Florence earlier in the year to celebrate the 500th anniversary of The Prince.  This got me thinking.  It could be a good idea to employ the horseman’s services in New York and London to draw the bankers out of their bunkers with the sound of his trumpet and then publicly denounce them, just as Machiavelli experienced – although imprisonment and torture would not, of course, be entertained.

Offshore Pilot Quarterly has been published since 1997 by Trust Services, S. A. and is written by Derek Sambrook

Jersey signs FATCA agreement with USA

An intergovernmental agreement between Jersey and the USA was signed at the US Embassy in London today (13 December). The agreement to improve international tax compliance and to implement FATCA (the US Foreign Account Tax Compliance Act) was signed by the Chief Minister, Senator Ian Gorst, on behalf of the Government of Jersey. The US Ambassador to the UK, HE Matthew Barzun, signed on behalf of the Government of the USA.

Senator Gorst said: “The signing of this agreement is further evidence of Jersey’s full commitment to the fight against tax evasion, and of our support of current international initiatives enhancing transparency and exchange of information for tax purposes. The OECD, at the request of the G20, is developing a single global standard for automatic exchange of information based on the US FATCA model and Jersey is also actively engaged in this process.”

Treasury and Resources Minister, Senator Philip Ozouf, said: “This agreement with the USA is of great importance for the many financial institutions in the Island with US interests. It will further strengthen the existing business relationships and will ensure that both existing and new business can be fostered free of the threat of the US 30% withholding tax, which would have otherwise been applied.”

After the signing of the agreement with the USA, which follows the signing of a similar agreement with the UK, the next step will be to issue guidance notes covering both agreements, on which the finance industry will be consulted. The States of Jersey will also be asked to ratify the agreements and make the necessary Regulations to bring them into effect.

Guernsey signs FATCA agreement with the US

Guernsey has today [Friday 13 December] signed a Model I intergovernmental agreement with the US Government in relation to the Foreign Account Tax Compliance Act (FATCA).

It was signed by Guernsey's Chief Minister, Peter Harwood, at the US Embassy in London with the US Ambassador to the UK, His Excellency Michael Barzun.

Guernsey's Chief Minister said: "Guernsey has been committed to exchanging tax information since it signed its first Tax Information Exchange Agreement (TIEA) with the US authorities in 2002. Today we have enhanced those arrangements, and in doing so we have further enhanced our reputation and our leadership position on tax transparency.

"This is a further step in the direction we have been travelling for a decade or more. FATCA is shaping the new global standards in information exchange and once again Guernsey has shown its commitment to meeting those new global standards decisively and at the earliest possible juncture.

"This is an important agreement for our finance sector. It gives them the long-term sustainability and stability that they have asked for clearly and consistently."

Jersey and the Isle of Man also signed similar agreements with the US Government at the same time as Guernsey.

Fiona Le Poidevin, Chief Executive of Guernsey Finance - the promotional agency for the Island's finance industry, said: "I am very pleased that Guernsey has signed this FATCA agreement with the US. It builds on the TIEA we have had with the US since 2002, our adoption of automatic exchange of information under measures equivalent to the EU Savings Tax Directive in 2011 and the package of tax measures we signed with the UK Government in October.

"The OECD has continually reaffirmed that Guernsey adopts international standards of tax transparency and exchange of information and this FATCA agreement with the US further demonstrates our continued fight against tax evasion."

The FATCA agreement was concluded 48 hours after Guernsey's parliament gave its unanimous approval and committed Guernsey to continuing to meet the highest standards of tax transparency. At the same time, the Island's parliament also agreed to request the extension to Guernsey of the OECD Multilateral Convention on Mutual Administrative Assistance in Tax Matters.

Mauritius receives African Peer Review Mechanism Report

The Mauritius African Peer Review Mechanism Report following the conclusion of the country’s first review exercise was presented to the Minister of Foreign Affairs, Regional Integration and International Trade, Dr Arvin Boolell, yesterday afternoon in Port Louis.

Dr Mustapha Mekideche, member of the APR Panel of Eminent Persons and Lead Panel Member for the Mauritius Review Process, and Mr Dalmar Jama, Coordinator for Mauritius, APR Secretariat, handed over the Report to the Minister.  Dr Mekideche and Mr Jama also met APRM Mauritian stakeholders.

In his address during the ceremony, Minister Boolell said that implementing the Mauritius APRM Report is not only the business of Government but also that of all stakeholders hence it is necessary to ensure to get on board everyone from trade unions, civil society, to the private sector.  He emphasised that the essential feature remains governance which also incorporates political, economic and corporate governance.

According to the Minister a responsible approach is required for implementation as well as diligent actions coupled with ensuring that the shortcomings are addressed very forcefully and meaningfully.  The Report will be implemented on the basis of a well-established roadmap and a committee will be set up to oversee its implementation.

For his part, Dr Mustapha Mekideche observed that Mauritius has to be congratulated for its best practices in terms of governance.  We wish other countries, who are already members of the panel, to adopt such best practices and make the most of these.  He cited the important role of corporate governance which has enabled the country to progress and that of social governance including the health and education systems.  Dr Mekideche was hopeful that within a year the Prime Minister will present to his peers a report of implementation of the Mauritius APRM Report.

The APRM

The APRM, launched in 2003 as part of the New Partnership for Africa’s Development (NEPAD), is a self-monitoring tool voluntarily acceded to by Member States of the African Union (AU).

Its objective is to foster the adoption of policies, standards and practices leading to political stability, high economic growth, sustainable development and accelerated regional and economic integration through sharing of experiences and reinforcement of successful and best practice, including identifying deficiencies, and assessing the needs for capacity building.

As per the requirements of the Country Review Exercise in line with the Memorandum of Understanding signed by Mauritius and APRM, the Mission needs to have wide consultations with government officials, political parties, parliamentarians, representatives of civil society (including the mass media, academia, trade unions, business and professional bodies).

The Panel of Eminent Persons (APR Panel) oversees the conduct of the APRM process to ensure its integrity, considers review reports and makes recommendations to the APR Forum.

Mauritius was among the first States, along with Ghana, Kenya and Rwanda which volunteered to be the first four pilot countries to be peer reviewed.  The country acceded to the APRM through the signature of the Memorandum of Understanding on the APRM on 9 July 2003 during the meeting of the NEPAD Heads of State and Government Implementation Committee held in the margins of AU Summit in Maputo.

It is recalled that the Mauritius’ APRM Country Report was presented to the APRM Forum by the Prime Minister, Dr Navinchandra Ramgoolam, and peer reviewed on 24 July 2010 in Kampala, Uganda.

Captive Review : Malta Report 2014

Compared with some of the more established European jurisdictions such as Guernsey, Luxembourg and Ireland, Malta is a relatively new captive domicile. Yet the island has proven to be a huge success in the captive world, boasting its position as the only EU domicile with fully fledged ICC and PCC legislation; an appealing tool for many managers looking to set up onshore.

Click here to read the Captive Review Malta Report 2014

Nautilus expands into Mauritius

As part of its global growth strategy, Jersey based Nautilus Group, has opened an office in Mauritius. 

The addition of Nautilus Fiduciary Mauritius Limited to the Nautilus Group will see the company strengthen its team by 12, bringing the number of Group employees to 77. 

‘The creation of Nautilus Fiduciary Mauritius Limited will give our clients access to a greater pool of experts,’ said Jason Cowleard, managing director of Nautilus Trust Company Limited. ‘We are focused on delivering clients an exceptional service through a robust and dynamic regulatory framework, with access to multiple jurisdictions, and this move will help us to continue doing this. Our clients are increasingly globally mobile and by offering the same Nautilus service in multiple jurisdictions, we are best placed to meet their needs.’ 

Nautilus was incorporated in 1999 and has grown from a team of two to 65 through organic growth and a series of acquisitions, including the acquisition of New World Trustees (Jersey) Limited earlier this year. Nautilus is an independent trust company based in Jersey and boasts a client-focused team offering flexible solutions to clients around the world. The company specialises in the establishment and management of trusts and companies, and also offers an exhaustive list of comprehensive financial solutions to assist with wealth management. 

‘While we continue to explore our growth strategy and are looking at other international jurisdictions, it is equally important that we maintain our client focused working ethos. Our controlled approach to Nautilus’ expansion strategy over the last 14 years demonstrates the level of importance we place in maintaining our high levels of client service - our clients’ best interests are very much at the centre of our business strategy,’ added Mr Cowleard. 

Tim Bennett, director of Nautilus Fiduciary Mauritius Limited, added: ‘It is excellent news for Nautilus’ client base that the Group has expanded into Mauritius, the gateway into Africa. It is also great for Jersey, to have a brand with such a strong reputation as Nautilus, flying the flag for Jersey in this jurisdiction.’

Mauritius: FSC Releases Statistical Bulletin 2013

The Financial Services Commission (FSC) is pleased to announce the release of its sixth Annual Statistical Bulletin. Pursuant to section 6(j) of the Financial Services Act 2007, one of the functions of the FSC is to “collect, compile, publish and disseminate statistics in respect of the financial services and global business sectors.”

The Bulletin provides up-to-date figures on the sectors regulated by the FSC and presents a synopsis of current trends in the financial services sector (other than banking) in 2012 and 2011.

The total assets for the financial services sector (excluding companies holding a Category 1 Global Business Licence) rose from MUR 21 billion in 2011 to MUR 24 billion in 2012, representing an increase of 16%. 

The total income generated by the entities in 2012 amounted to MUR 4 billion which represented an increase of 8% over the previous year. The aggregate Profit after Tax for the financial services sector (excluding Companies holding a Category 1 Global Business Licence) reached MUR 674 million in 2012 compared to MUR 706 million in 2011.

Total assets of Corporate and Trust Service Providers amounted to USD 175 million in 2012 representing an increase of 11% over the previous year. Total income of Management Companies witnessed an increase of 5% from USD 397 million in 2011 to USD 417 million in 2012. Profits reported by Management Companies in 2012 stood at USD 48 million as compared to USD 40 million in 2011.

Gross premium received for Long Term insurance business stood at MUR 13.9 billion in 2012 with an increase of 7% compared to MUR 13.0 billion in 2011. For General insurance business, gross premium stood at MUR 6.18 billion compared to MUR 6.25 billion in 2011.

Total assets of companies in the long term insurance business stood at MUR 92.6 billion in 2012 compared to MUR 84.2 billion in 2011. For companies in the general insurance business, total assets stood at MUR 12.4 billion compared to MUR 11.7 billion in 2011.

Total (direct) employment in the financial services sector in 2012 was 5,819 as compared to 2011 which was 5,868.

Down the Annual Statistical Bulletin 2013

Jersey announces intention to launch aircraft registry in 2014

Jersey’s Economic Development Department has announced plans to establish a Jersey Aircraft Registry.

Following extensive analysis and consultation, the Minister for Economic Development Senator Alan Maclean has now given approval for the Registry, which is due to be launched in summer 2014 and is expected to open up a range of new business opportunities for the Island.

The Registry is anticipated to be particularly attractive to internationally mobile business jet owners, who can benefit from registering their aircraft in a highly regarded, stable and well regulated jurisdiction, whilst making use of Jersey’s mature, robust and sophisticated financial, legal and fiduciary services infrastructure. Local aircraft owners will also be welcome to register their aircraft on the Registry.

Policy relating to the structure of the Registry has been developed through a private sector working group, chaired by Assistant Minister for Economic Development Deputy James Baker and composed of leading aviation experts. Having now received instruction to proceed, the Law Draftsman’s Office will begin drafting the legislation that will underpin the Registry.

In addition, Economic Development have invited Brian Johnson, Director of Operations for Appleby Aviation Ltd and former Director of Civil Aviation for the Isle of Man, to advise on the establishment of the Aircraft Registry.

Commenting on the new plans for the Jersey Aircraft Registry, Senator Maclean said:

“This is an exciting opportunity for Jersey which will form an incredibly strong additional element to our inward investment strategy. Thanks to its business friendly environment, simple and attractive tax framework and world class professional and financial services infrastructure, Jersey already offers a compelling proposition to individuals and companies looking to relocate or expand their businesses. The launch of the Jersey Aircraft Registry will undoubtedly add to Jersey’s overall offering and provide local businesses with significant opportunities, particularly in the fiduciary, legal and financial services arenas.

“It is also fantastic news that Brian with his many years of experience in the aviation industry, and especially in the establishment of another very successful registry, Jersey will have an individual with unparalleled expertise to advise on this exciting project.”

India: Clause to avoid Mauritius treaty abuse

Indian and Mauritius authorities engaged in renegotiating the tax treaty between the two countries have agreed to include a "limitation of benefit" (LOB) clause to prevent any misuse of the beneficial provisions of the tax treaty. The insertion of the LOB clause—an anti-abuse provision which limits the ability of third country residents to obtain benefits under a tax treaty between two other countries— had been a long-standing demand from India.

The Times Of India

Offshore Investment ( December 2013 / January 2014): Why should Chinese HNWIs wishing to establish offshore trusts act now?

China produces more millionaires and billionaires than any other country. Chinese high-net-worth-individuals (HNWIs) generally have great interest in using offshore trusts for wealth planning as a result of the unique benefits offshore trusts can offer coupled with the fact that Chinese domestic trusts are not suitable for wealth planning. One of the common questions I hear from my clients is “when is the best time to establish an offshore trust?” My standard response in the past was “it depends”. However, given certain recent developments in China relating to the next wave of tax reform, perhaps it is advisable to act immediately in order to avoid the adverse consequences caused by such tax reform. So what are these new developments?

Offshore Investment ( December 2013 / January 2014): 2014 - What in the world is going to happen?

If 2013 was a year of resilience in Western economies, 2014 could be a year of proper recovery. Christian Schulz reflects on what will happen in 2014 and observes that as the developed world finally emerges from the aftermath of the greatest recession since World War II, it may finally be time to say "Good bye Lehman".

IFC Review - Blood, Sweat & TIEAs: Tax Information Exchange Litigation in Bermuda

Alex Potts and Amy Murray discuss Bermuda’s global tax information exchange network, which brings into question the decision of the French Government to add the jurisdiction to its tax ‘blacklist’.

IFC Review - Niche Products Help Differentiate The Bahamas

Aliya Allen discusses how The Bahamas remains one of the most agile financial centres, responding to client needs with ground breaking products such as the Bahamas Executive Entity (BEE).

IFC Review - Islamic Finance Securitisation in Luxembourg

Vassiliyan Zanev examines the success of Luxembourg as an Islamic finance hub, with its flexible, tax efficient regime and significant number of Shari’a vehicles incorporated in the jurisdiction.

IFC Review: Due Diligence - Social Media

Burke Files discusses due diligence in the digital realm of social media, its increasing use as a tool to check up on job and college applicants and asks what could people share online to make them more or less desirable.

IFC Review: The Rule in Hastings-Bass Under Jersey Law

Mason Birbeck examines the rule in Hastings-Bass, as applied under Jersey law, which has its origins in the English courts and has been a hot topic among those working in the Jersey fiduciary sphere.

IFC Review: Dispelling the Offshore Myth

Ingrid Pierce and Grant Stein discuss transparency, the industry buzzword of the past year, and why IFCs can be less defensive about their role in the global economy going forward and more vocal about their attributes 

Transport & Environment: Particle emissions from petrol cars

Vehicle tests show that without the use of gasoline particulate filters (GPF) the number of particles emitted from gasoline direct injection (GDI) engines is likely to exceed future European emissions limits, known as Euro 6 standards. Nowadays, particle emissions from these new petrol engines are higher than equivalent diesel vehicles. The cost of a filter to eliminate particle emissions is low (around €40), with no fuel economy penalty. Despite this, carmakers are delaying fitting filters on GDI cars and instead rely on manipulating tests. Their reluctance is worsening urban air pollution and reducing the health benefits of the new limits.

Air pollution in the EU is estimated to contribute to 406,000 deaths annually and cause over 100 million lost days of work, costing the EU economy €330-940 billion per year. Small particles in the air pose the greatest risk to health, penetrating deep into the lungs and being absorbed into the blood, causing a range of illnesses and even death. T&E calls upon carmakers to ensure GDI cars minimize their particle emissions by fitting filters.

GDI Briefing

TUV Technical Report

Fitch Publishes Special Report on Protected Cell Insurance Captives

Fitch Ratings believes the legal separation of the protected cells, the credit profile of the protected cell sponsor and the credit profile of the protected cell company are important considerations when analyzing a captive insurer organized as a protected cell. Accessibility, if any, to the assets in the general account is a potential credit positive. A protected cell company is an insurer that consists of a general account, or core, and one or more protected cells. A protected cell company and its protected cells are a single legal entity, though the individual protected cells are designed to be segregated from each other in the event of a protected cell's insolvency.

Cell company legislation has been enacted in several jurisdictions throughout the world, including 10 U.S. states. Clearly the legislative intent is that the assets of each cell are segregated and not available to satisfy the creditors of another cell in the event of that second cell's insolvency. However, in most jurisdictions the cells are not organized as separate legal entities. Further, there is not a substantial history of these structures being successfully defended, or even challenged, in court. This introduces uncertainty into the rating process for protected cells.

"It may be helpful to borrow insight from structured finance," said Don Thorpe, senior director of the Insurance group at Fitch, "In structured finance, it is common to obtain legal opinions regarding the enforceability of contracts and the nonconsolidation of the transaction parties in the event of one transaction party's insolvency. This is often referred to as bankruptcy remoteness."

Fitch also believes the financial strength of both the captive sponsor and the entity that sponsors the protected cell company could affect the credit profile of the individual protected cell. This will depend on the degree of linkage between the entities and structural mitigants, if any. Once again, Fitch believes there are analogies that can be drawn between protected cell companies and structured finance.

Some protected cell credit profiles may benefit from access to the assets of the protected cell company's general account. However, this will require a thorough analysis of the applicable regulations, and agreements between the protected cells and the protected cell companies, if any. Thus, this determination would rely heavily on the individual circumstances.

Deloitte advised big business on how to avoid tax in some of the poorest countries in Africa, ActionAid report reveals

One of the world’s Big Four accountancy firms, Deloitte, offered advice to large companies on how to avoid potentially hundreds of millions of dollars of tax in some of the poorest countries in the world, according to an ActionAid investigation released today.

ActionAid has uncovered a Deloitte document called ‘Investing in Africa through Mauritius' (pdf) which details how tax can be avoided in African countries by structuring business through Mauritius.

The strategy, which is entirely legal, could potentially be used to deprive African countries of vitally needed tax revenue.

As part of the presentation, the document gives the specific example of how tax can be avoided in Mozambique. It shows how withholding tax can potentially be reduced by 60 per cent and capital gains tax by 100 per cent.

Mozambique is one of the poorest countries on the planet, where one third of the population is chronically food insecure and average life expectancy is only 49.

The document was part of a presentation given by Deloitte in China in June this year at a conference attended by more than 80 major western and Chinese companies with interests in Africa.

The document also reveals how Mauritius is being promoted as a favoured tax haven for use by big businesses operating in Africa.

Amade Suca, Country Director of ActionAid Mozambique said:

"When big companies avoid tax in Mozambique they are taking money out of the hands of the poor.

"Mozambique desperately needs increased tax revenues to lift people out of poverty, build schools for our children and hospitals for the sick, and reduce the need for foreign aid.

"But as long as wealthy companies continue to avoid tax in our country – none of this will happen.

"The people and government of Mozambique have a right to expect big companies making big profits in our country to pay their fair share of tax.

"We must also close the tax loopholes that allow big companies to behave in this way.”

Last year Deloitte generated more than $32 billion in revenue – more than any other Big Four company.

The document was presented at the conference two weeks before the G8 summit when David Cameron condemned tax avoidance both in the UK and in developing countries.

ActionAid Tax Policy Adviser Toby Quantrill said:

“This document helps lift the lid on the tax avoidance techniques that are being used to deprive poor countries of hundreds of millions of dollars in tax.

“These techniques may be legal, but that does not mean they are moral. Tax revenues are desperately needed to meet peoples most basic needs and to move countries away from aid dependency.

“Big businesses have an important role to play in economic development in poor countries. But they also have to act in a socially responsible way. Deloitte is failing Africa for as long as it continues to advise on tax avoidance strategies in the way they have been doing.”

According to the Organisation of Economic Co-operation and Development, developing countries lose more than three times more money to tax havens than they receive in aid.

A Deloitte spokesperson said:

"It is wrong to describe applying double tax treaties, such as the treaty between Mauritius and Mozambique, as tax avoidance. Such treaties are freely negotiated between the Governments of the countries involved.

"Double tax treaties exist to enable the countries concerned to strike a balance between the need to encourage investment, including cross-border investment, to raise tax revenue, and to work together with other countries who have the same legitimate concerns to raise revenue and promote business.

"The absence of such treaties could result in a reduction of investment, and less profit subject to normal business taxes in the countries concerned.

"Any discussion of tax treaties by tax professionals would typically be around the technical and administrative aspects of the treaties and not an expression of favour of any particular country at the expense of any other country."

Read ActionAid's report Deloitte in Africa

ActionAid: Deloitte’s tax avoidance advice could cost poor African countries hundreds of millions of dollars

From Starbucks to SAB Miller, and from Associated British Foods to Google, there’s been a constant stream of tax avoidance controversies over the last couple of years.

But who dreams up the tax plans that make this kind of avoidance possible?

The answer is that some of the chief architects include accountancy firms.

These firms not only audit the books of other companies, but also sell them advice on how to minimise their tax bills.

Until now it has been quite difficult to see how this might work in practice – but today we hope to partly answer this by revealing evidence of how Deloitte is advising big business on how to avoid tax in some of the world’s poorest countries by using the Indian Ocean tax haven of Mauritius.

Deloitte earned made more than $32 billion in revenue last year alone – the most money out of any of the Big Four firms.

The kind of avoidance it is advising, which is entirely legal, could be costing African countries hundreds of millions of dollars a year.

It could mean teachers or doctors don’t get hired or roads and sewers don’t get built, keeping whole countries dependent on international aid.

The document we found is called Investing in Africa through Mauritius (pdf) and was part of a presentation which Deloitte made at conference in June this year attended by many large companies.

Using the country of Mozambique as an example, Deloitte showed how withholding tax and capital gains tax could be avoided by structuring a business through Mauritius.

Mozambique is one of the poorest countries in the world, where the average age at death is 49 and 40% of people are malnourished.

However the document is also important for another reason – because it lifts the lid on how big businesses with operations in Africa use the tax haven of Mauritius to avoid tax.

According to one estimate, three times as much money is being lost to tax avoidance globally as developing countries receive in aid each year.

Want to know more about Deloitte and tax?

Download our report Deloitte in Africa here

Offshore Investment (November 2013): The OECD / G20 tax agenda

The recent St Petersburg G20 declaration endorsed (obviously without much thought by jetlagged and overburdened heads of government with too little time to think about things), a Tax Annex prepared by the Organisation for Economic Co-operation and Development (OECD) in conjunction with various tax agencies and foreign ministries across the world.  Perhaps because the G20 government leaders could not agree about things like Syria (and their involvement in promoting and financing the civil war that is costing thousands of lives and has made 2 million or more people homeless), they were more willing to agree on motherhood statements about tax, thinking that they were subscribing to nothing more than the nostrum that “we ought to do something about tax dodgers”.

It can’t work, it won’t work and it shouldn’t work

Offshore Investment (November 2013): Special Purpose Vehicles - Clarity in Type

The world of private wealth planning has become more complicated and this has been in response to both client demand and legislative change. There has been a gradual shift away from classic trust and company structures to more exciting and innovative structures which more closely match the requirements of the clients. This has to be a good thing but it has also meant that advisers have had to up their game and start understanding how these new exotic vehicles actually work.

The rise of alternative vehicles in private wealth planning

IFC Review: Caribbean Financial Centres – Where Does the Future Lie?

Timothy Ridley comments on the future for the offshore financial industry, amid exaggerated reports of its demise in the aftermath of the 2008 financial crisis.

IFC Review: Due Diligence - Chinese Corruption

Burke Files assesses the various levels of corruption in China and considers where this problem might lead in the future.

IFC Review - The Bahamas: The Right Choice for Latin America

Ryan Pinder examines how The Bahamas has sought to align its financial services strategies with the needs of the emerging economies within Latin America, continually evaluating new products for Latin American clients.

IFC Review - Money Does Not Buy Happiness: Can Bermuda Help?

Randall Krebs discusses the issues facing wealthy private clients in Bermuda - one of the oldest private client jurisdictions in the world.

IFC Review: Q&A with… Julien Martel and Brian Balleine, Butterfield Trust

IFC Caribbean speaks to the MDs of Butterfield Trust in The Bahamas and Cayman to assess how the international finance industry is developing in the region.

IFC Review: BVI - Regulation ‘Right’

Marianne Rajic discusses the BVI's success in both implementing AIFMD and preparing for FATCA, further evidence of why the jurisdiction is considered one of the most flexible and user friendly in the region.

Chinese Mauritians: Paradise Island’s Next Dodo?

While the fat island fowl (RIP) is infamous for its stupidity, flightlessness, and large rump, the Chinese Mauritians, and Chinese across the world, are known for their work ethic, adaptability, and mobility. Like any competent bird, they will migrate elsewhere. They won’t go extinct; they will simply change form. They will become Chinese-Mauritian-Canadians and Chinese-Mauritian-Australians.

Novare Investments Africa Fund Manager Survey 2013

This survey focuses on Africa (including North Africa) and the funds that give investors access to listed instruments on the continent. Although the focal point of the survey is to review at what is available excluding South Africa, the latter remains the continent’s most developed and regulated financial market, providing unbridled access for investors as a gateway into the rest of Africa.

Mauritius: FSC Public Notice - Suspension of COPEX Management Services Limited

Notice is hereby given that in accordance with Section 27(7) of the Financial Services Act 2007 (the “FSA”), the Management Licence of COPEX Management Services Limited has been suspended with immediate effect.

In accordance with Section 27(5) of the FSA, COPEX Management Services Limited shall cease to carry out the activity authorised under its licence but shall remain subject to the obligations of a licensee and to the directions of the Commission until the suspension of the licence is cancelled.

Financial Services Commission

FSC House

54 Cybercity

Ebene

Mauritius

30 October 2013

Mauritius: FSC Public Notice - Suspension of COPEX Trustees Limited

Notice is hereby given that in accordance with Section 27 (7) of the Financial Services Act 2007 (the “FSA”), the Management Licence of COPEX Trustees Limited has been suspended with immediate effect.

In accordance with Section 27(5) of the FSA, COPEX Trustees Limited shall cease to carry out the activity authorized under its licence but shall remain subject to the obligations of a licensee and to the directions of the Commission until the suspension of the licence is cancelled.

Financial Services Commission

FSC House

54 Cybercity

Ebene

Mauritius

30 October 2013

Investment Planning – Where to begin!

Interview with John Cronin, CFA, by Francis Katamba

Francis Katamba – John, why do you put such a strong focus on investment planning before the investment process?

John Cronin – Well Francis, before people rush to buy an off-the-shelf investment product, or decide to make direct investments in the financial markets; they really need to consider their current financial circumstances and where they would like to get to – their goals.  By doing this they can reduce their risk of buying an investment plan or building an investment portfolio, which is not consistent with their current situation and/or their financial goals.

Francis Katamba – So how would you recommend going about the investment planning process?

John Cronin – You have to be methodical; you must go through a process of self-analysis, even if you are using the services of a financial adviser.  Self-analysis is important as it helps you develop an understanding of your own situation.  Further, in addressing the issues raised in your self-assessment you can assist your financial adviser in designing an investment plan that best suits your personal circumstances, goals and preferences.

Francis Katamba – Interesting, so this methodical process of self-analysis can help you make better decisions.   Can you outline the self-analysis process?

John Cronin - The methodical process has seven elements, the first two concern setting up your risk and return objectives, the remaining five are your: 

• liquidity needs, 
• time horizon, 
• tax circumstances, 
• legal and regulatory issues, and lastly
• unique circumstances.

The last five are potential constraints on your investment strategy, affecting the type of investments that you may choose.  Today, I am mainly going to talk about the process of setting up your risk and return objectives, which can actually be quite a fun and thought provoking process.

Francis Katamba – What are the key points in setting risk and return objectives?

John Cronin - There are two elements here.  First you have an individual’s willingness to take risk, which is based on personal experience.  Second you have the individual’s ability to take risk, which is based on cold analysis.  The tricky issue is reconciling the individual’s willingness to take on risk with their ability to take such risks, where the two differ.

   

As I said an individual’s willingness to take risk is built on experience, which brings us into the realm of behavioural finance.  In shorthand, behavioural finance is the study of why people don’t invest rationally.  There are many types of irrational investment behaviour; the two best known are loss aversion and biased expectations.

  

Loss aversion is the tendency for people to feel the regret of their losses more deeply than the pleasure of their gains. 

Francis Katamba – Why does this matter?

John Cronin - There has been a lot of research in this area and what emerges is that people’s financial decisions are often swayed by emotion rather than rational analysis and this means that they do not always act in their own best interests!  So for example, behavioural economists have observed that the tendency of people to react more strongly to losses than to gains, which is known as an “asymmetric tendency” can lead to people holding their losing investments longer than they should, and selling their winners too early. 

This behaviour has been identified as one of the most common reasons why many investors suffer poor investment returns.  The solution is to take a completely dispassionate approach and assess every investment on its expectations and whether those expectations have changed – fundamentally – on the arrival of new news.

  

Francis Katamba – What other kinds of behaviour commonly lead people to make poor financial decisions?

John Cronin - As I mentioned, there are many different types of irrational investment behaviour.  Loss aversion is one of the most common, but another is having “biased expectations”, which results in misplaced self-confidence. Some people are overconfident in their approach to investing, whereas others can suffer a serious lack of confidence.

  

The over confident feel they have better judgement and insight than they really have, which can lead to poor investment decisions.

Francis Katamba – Can you provide some practical examples of how this might manifest itself?

John Cronin - Sometimes people convince themselves that they have influence over uncontrollable events, such as predicting the outcome of a toss of a coin.  This character trait can lead to overoptimistic expectations of investment returns, where judgement is biased on overoptimistic feelings rather than assessment of the facts.  Look at how many people became self-declared property tycoons because they bought and sold houses during the property boom, only to become unstuck when house prices faltered and fell in the subsequent house price crunch.  They developed unrealistic expectations that strong house price inflation was the new norm.  They overlooked several controlling factors that influence house prices, such as affordability, economic prosperity and the level of employment.

An indication of just how widespread overconfidence is in the population is the famous survey of US drivers, which found that 88% of those interviewed believed they were safer road users than the average American driver.

Francis Katamba – You have explained how overconfidence can be a problem and you have also touched on how people tend to react emotionally to losses.  Before moving on from this point, could you just expand on how lack of confidence can also negatively impact on people’s financial decision making abilities?

John Cronin - Yes, there are people with little self-confidence; who may appear to be at less risk, because they cannot begin the investment appraisal process and therefore would not normally make any risky investments. However the outcome can be very similar to that of the overconfident.  Sadly these people often end up investing into booming markets just as they are reaching their peak, this is known as the bandwagon effect.  They then panic sell, deeply feeling their losses, vowing never to do it again, which is called the snakebite effect.  When they come to reconcile what has happened, they conclude that they invested against their better judgement, known as hindsight bias, and never learn from their mistakes.  Like the overconfident, the under confident also suffered from the busting of the property market, because they were some of the last buyers before house prices started to slide.

As you can see behavioural issues can knock an investor off making rational investment decisions.  Hence self-appraisal of your behaviour traits is a key part of the investment planning process, as it permits a clearer understanding of your ability to take risk.

  

Francis Katamba – Having assessed my attitude towards risk what sorts of factors should I consider in order to weigh up my ability to take risk?

John Cronin - The determining factors that dictate your ability to take risk weigh upon your age and how much you can contribute towards attaining your savings goals.  A person in their 30s who can contribute 25% of their monthly income towards a pension can take more investment risk than a person in their 60s who can only set aside 10% on a limited stock of accumulated wealth.  The former is more able to withstand adverse market movements, because they have a long contribution period ahead of them and a greater likelihood of earning the long term expected return on the financial markets in which they invest.

Francis Katamba – How would I then go about measuring the risk of a particular investment?

John Cronin – Well there are a number of ways to measure risk.  One common method is the absolute measure that uses standard deviation of return.  Standard deviation may have been something that you came across at school.  In this instance, you don’t need to know how to calculate it, but just be aware that the larger the standard deviation of return the larger the investment risk.

Francis Katamba – So assuming I have gone on the internet or, dug out my old school books in order to calculate the standard deviation how do I apply this to an investment strategy?

John Cronin – All investments have an expected risk and rate of return.  What this means is that you might expect an investment to go up by 10% in any one year, but because this is a forecast, you can expect a range of outcomes either high or lower than your expected return.  This range of outcomes is your investment risk.  Hence investment risk is not only getting a return that is less than you expected, but also getting a return that is more than you expected.  By using the standard deviation of return (the value that is produced from the calculation) you can establish the probability of the expected range of outcomes using some simple maths.

  

To expand a little, financial models predict that 68% of all expected outcomes lie in a range that is one standard deviation either side of your expected return.  95% of all expected outcomes lie in a range two standard deviations either side of the expected return.  Using this knowledge we can work out that if an investment is expected to appreciate by 10% in one year and has a 5% standard deviation of return, there is a 68% probability that your return at the end of the year will lie in a range between 5% (10% - 5%) and 15% (10% + 5%).  However if the standard deviation of return is 10%, then, applying the same principles, you could expect a range of returns between 0% (10% - 10%) and 20% (10% + 10%).  In other words, the higher the standard deviation of return the more risky the investment return.  Knowing the standard deviation of return is therefore a very useful tool for getting an idea of how risky a particular investment is.

Francis Katamba – OK, so the principle seems to be that your risk objective sets your return objective? 

John Cronin – Yes you are almost right, as there is a strong link between risk and return, your risk objective largely determines return objective.  However there are other factors to consider.  Firstly how much return do you need?  Is that expected return realistic?  Naturally, you can’t hope for high returns that are risk free!  

Francis Katamba – Let’s say I wanted to buy a house but, I needed to save and invest in order to have enough money, how would I apply the principles we have discussed?

John Cronin – Well, suppose you want to buy a house in two years’ time and, your savings are 15% below what you expect to pay in two years’ time, then the target annual rate of return needed to fill the gap between your savings and the purchase price is in the region of 7.5%.  Fortunately due the effect of compounding, the fact that after the first and subsequent years your savings are larger by the return earned in the previous year, the compound annualised rate of return needed over two years is slightly less at 7.24%.

Therefore to fill the gap between your savings and the purchase price, you need an investment capable of earning at least 7.24% per year for the next two years that carries an acceptable level of risk.  The challenge here is to identify investments (assets) that can reconcile the return objective with an acceptable level of risk.

  

By way of example, let’s look at the historical returns and standard deviations of return for two classes of asset:  UK government bonds and the UK equity market.  The UK government issues many types of government bonds (known as Gilts) with different interest rates and different maturities.  The UK’s Debt Management Office provides at full list on its website.  The long term historical rate of return and standard deviation of return for UK gilts, with a 10 year maturity, is 5.5% and 13.8%.  Therefore in any one year you can expect with a 68% probability of earning a return between minus 8.5% (5.5% - 13.8%) and plus 19.3% (5.5% + 13.8%).  Equities have a higher expected return and a higher standard deviation of return, 9.4% and 19.9% respectively.  Using the same formulae again an investor has a 68% probability of experiencing a range of returns between minus 10.5% (9.4% - 19.9%) and plus 29.3% (9.4% + 19.9%).  As you can appreciate these results demonstrate the different risk and return characteristics of UK Gilts and UK equities.   However I must caveat this statement by stating that past performance is no guarantee of future returns.

Both the historical returns on ten year UK Gilts and UK equities illustrate that they capable of delivering the required return.  However the current yield on 10 year Gilts is 2.73%, which is well below the 7.24% required return.  It is unlikely that 10 year Gilts will achieve the required return because interest rates are close to their historical lows.  Further, if interest rates return towards historical averages, then investors face a capital loss.  Because when interest rates rise, the price and capital value of bonds fall.  Given the associated expected range of returns that we discussed above, then both 10 year Gilts and UK equities are too risky (too volatile) to be used as investment vehicles to help buy your house, because of the risk of losing a substantial amount of the capital sum invested.  An alternative strategy, which provides a high degree of capital protection because it matches the time or investment horizon to the pending house purchase, is the purchase of a UK Gilt with a two year maturity.  Unfortunately the yield on two year gilts is 0.44%, a long way below your required rate of return.

  

Going through this exercise demonstrates that it would be wiser to buy a smaller house or put more money aside in savings, because the investments that meet your return requirement exceed what would be an acceptable level of risk, given these specific circumstances; the chief investment constraint being the short time horizon.  You can go through a similar exercise with retirement planning, where you might find your investment horizon is much longer and hence your ability to use more risky assets to take advantage of potentially higher expected returns increases.

Francis Katamba – Are there other issues you should consider?

John Cronin – Yes indeed, once you have established your risk and return objective, you need to consider the five investment constraints: liquidity, time horizon, tax concerns, legal and regulatory issues and your own personal choices.  The first two, liquidity and time horizon directly influence your ability to take risk.

  

Liquidity is your need for readily accessible funds, money set aside for anticipated near term expenditure or for precautionary reasons, such as unemployment, sickness or domestic emergencies – like the need to buy a new boiler for your hot water system.  These readily accessible funds could take the form of money in your deposit account, or some investment which is safe and accessible at short notice.  Naturally the low risk nature of liquidity reserves means they do not earn a high return.  As a rule of thumb, households should aim to have the equivalent of three months of salary or wages set aside as precautionary liquidity.  If the amount of money set aside for precautionary liquidity represents a large portion of your portfolio, then your overall ability to take investment risk is constrained, compared to if your liquidity reserves represent only a small portion of your overall wealth.

  

Your time horizon, also affects your ability to take risk.  The house purchase example I mentioned earlier illustrates a relatively short time horizon, in that example the desire was to buy a house in two years’ time, hence the time horizon, the period between now and realising your investment goal is two years.  As I mentioned earlier, a short time horizon limits your ability to take risk.  Whereas if you are investing for a retirement that is 30 years in the future your time horizon is long; hence you more able to bear short term adverse movements in stock and bond markets, and likely to earn the long term expected return.

Francis Katamba – You mentioned three other investment constraints: tax concerns, legal and regulatory and lastly personal choices.  Can you expand on these issues?

John Cronin – tax concerns are simply the taxes that you may be liable for on your investments.  The point to recognise is that taxation on investments reduces your net return.  Some investments are taxed on income, some on capital gains and sometimes both.  Consequently this is a consideration for the type of investments you make.  However care must be taken not to distort your portfolio by investing in assets which lead you to exceed your overall risk objective.  In Jersey, where the tax rate is 20%, 80% of something is worth considerably more than 100% of nothing.

Legal and regulatory constraints are often put in place to protect your interests.  For example certain investments which would be regarded as high risk are only available to investors who can prove that they have wealth that exceeds a certain threshold.  UCITS funds are required to manage risk by being diversified and being virtually prohibited from using loans to magnify their returns – both up and down – known as leverage.

Personal choices are restrictions that the investor places on their portfolio.  For example some investors invest with an ethical style, refusing to invest in companies that produce alcohol, tobacco, defence equipment, or provide gambling services, damage the environment or use child labour.  Another personal choice could be a requirement to hold investments that generate an income, for example to fund retirement.  Either way, personal choices affect the type of investments that can be held in your portfolio.

Francis Katamba – Briefly summarise how investors should set about the investment planning process?

John Cronin – Investors need to be methodical in their self-analysis.  An investor needs to recognise the behavioural weaknesses that could cause them to embark on a less than optimal investment strategy.  An investor must balance their appetite for risk with their ability to take risk; this depends on their age and relative wealth.  They should plan with an investment horizon in mind, to help calibrate the level of investment risk they can bear in their investment portfolio.  They should make evidence and facts the source of their investment decisions, not feelings.  Lastly, they should always have a precautionary reserve of readily available funds for rainy days.

Biographies

John Cronin is a Chartered Financial Analyst (CFA) with over 20 years of experience as a financial markets professional.  During this time he has worked as a stockbroker, stock analyst and portfolio manager.

Francis Katamba is qualified lawyer, with over 10 years of professional experience in corporate finance and commercial law.

Both John and Francis are senior managers in the policy section of the Jersey Financial Services Commission.