31 October 2013

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

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.

U.S.: Treasury Takes Next Step in Effort to Curtail Offshore Tax Evasion

The U.S. Department of the Treasury and the Internal Revenue Service today issued a notice for foreign financial institutions (FFIs) to comply with the information reporting and withholding tax provisions of the Foreign Account Tax Compliance Act (FATCA).  FATCA is rapidly becoming the global standard in the effort to curb offshore tax evasion.  To date, Treasury has signed nine IGAs, has reached 16 agreements in substance, and is engaged in related conversations with many more jurisdictions.

The notice, which is the next step in implementation, previews proposed guidance and provides a draft agreement for participating FFIs directly engaging in agreements with the IRS and those reporting through a Model 2 intergovernmental agreement (IGA).  It provides FFIs with advance notice prior to the beginning of FATCA withholding and account due diligence requirements on July 1, 2014.  The FFI agreement will be finalized by year end. 

The Agreement and forthcoming guidance have been designed to minimize administrative burdens and related costs for foreign financial institutions and withholding agents,” said Deputy Assistant Secretary for International Tax Affairs Robert B. Stack.  “Today’s preview demonstrates the Administration’s commitment to ensuring full global cooperation and a smooth implementation.” 

Congress enacted FATCA in 2010 as a way to identify U.S. citizens using foreign accounts to evade their U.S. tax responsibilities.  FATCA requires U.S. financial institutions to withhold a portion of payments made to FFIs that do not agree to identify and report information on U.S. account holders.

Treasury has taken a global approach to the exchange of tax information in its implementation of FATCA.  To address situations where foreign law would prevent an FFI from complying with the terms of an FFI agreement, Treasury developed two alternative model IGAs.  Under Model 1, FFIs report to their respective governments who then relay that information to the IRS.  Under Model 2, FFIs report directly to the IRS to the extent that the account holder consents or such reporting is otherwise legally permitted, and such direct reporting is supplemented by information exchange between governments with respect to non-consenting accounts. 

Today’s notice provides guidance to FFIs entering into agreements directly with the IRS, and to those reporting through a Model 2 IGA.  The notice incorporates updates to certain due diligence, withholding, and other reporting requirements, and includes a draft FFI agreement.  The draft FFI agreement will be finalized by December 31, 2013.  Treasury and the IRS will continue to provide more detailed guidance on FATCA implementation as necessary.

The regulations were intentionally designed to appropriately balance the scope of entities and accounts subject to FATCA with due diligence requirements, while also phasing in the related obligations over several years.  For example, the final regulations exempt all preexisting accounts held by individuals with $50,000 or less from review.  For similar accounts with less than $1,000,000, an FFI is only required to search the account information that is electronically available.  In many cases, FFIs are permitted to rely on information that they already must collect for local anti-money laundering and know-your-customer rules.  

Many of these cost-saving simplifications were the result of comments received from affected financial institutions and foreign governments, which helped us to tailor the rules to achieve the policy objectives of the statute without imposing undue burdens or costs.  

While withholding requirements begin next July and the first report of FATCA information is due in 2015, the IRS FATCA registration website is already open so that FFIs can begin testing the registration process and entering information.

28 October 2013

Jersey Financial Services Commission: Chairman of the Commission

The Jersey Financial Services Commission announces that Clive Jones, the current Chairman of the Commission, has taken the decision not to seek re-appointment on the recent expiry of his present term on 22 October 2013. Clive Jones was first appointed a Commissioner on 23 October 2007 and was subsequently appointed Chairman on 18 September 2009.

John Averty, Deputy Chairman of the Commission, stated that Clive was appointed Chairman at a time of change for the Commission and he had proved to be a dedicated and effective leader, well respected by his Board colleagues and the staff of the Commission who regret that he has decided not to continue in the role.

Senator Ian Gorst, Chief Minister, added "I am most appreciative of the contribution Clive made to the work of the Commission through a time of global financial crisis that has presented regulators with many issues. I look forward to working closely with his successor and I have every confidence that working together, in concert with the finance industry, the Commission and Government will be successful in responding to the many new and significant challenges to be faced."

Notes

The process to select a new Chairman for the Commission is underway and, following the selection of search consultants, advertisements will be placed in both the local and the UK press. The recruitment process will follow procedures agreed with, and overseen by, the Jersey Appointments Commission.

Following that recruitment process, the States of Jersey has the power to appoint Commissioners and a Commissioner to be Chairman from persons nominated by the Chief Minister.

Commissioner John Averty, current Deputy Chairman, will preside at meetings of the Commission pending the selection of a new Chairman (as stipulated by paragraph 3(b) of Schedule 1 to the Financial Services Commission (Jersey) Law 1998)

26 October 2013

Bank of England: Developments in the Bank’s approach to liquidity insurance

Alongside a speech by the Governor, the Bank of England has today announced changes to its approach to providing liquidity insurance to the banking system.

The principles and tools the Bank uses in providing liquidity insurance are set out in the Sterling Monetary Framework (SMF), which has been substantially reformed in recent years.  In 2012, the Court of the Bank asked Bill Winters to review how these reforms were working in practice and to consider whether further changes were warranted.  In light of the recommendations from that review, together with the Bank’s own assessment of the changing regulatory and financial market landscape, the Bank is announcing a number of further significant changes to the SMF’s liquidity insurance toolkit.  Taken together, these changes are designed to increase the availability and flexibility of liquidity insurance, by providing liquidity at longer maturities, against a wider range of collateral, at a lower cost and with greater predictability of access.

Further details on the approach are provided in ‘Liquidity insurance at the Bank of England:  Developments in the Sterling Monetary Framework’ (available at www.bankofengland.co.uk/markets/Documents/money/publications/liquidityinsurance.pdf) and an updated edition of the Bank’s ‘Red Book’, which provides a comprehensive description of the SMF (available at www.bankofengland.co.uk/markets/Documents/money/publications/redbook.pdf).

The UK at the heart of a renewed globalisation

Mark Carney, the Governor of the Bank of England, announced a sweeping overhaul of the way the central bank deals with lenders in financial difficulties in a Speech as part of the Financial Times 125th anniversary celebrations, London.

1. Introduction

When the Financial Times opened for business in 1888 London was the world’s preeminent financial centre.

It had the most international banks, the largest capital markets, and the deepest money and gold markets. It backed projects all over the world, and most of world trade was financed by bills drawn on London. Supporting the critical mass of banks, insurers and investors was an army of solicitors, accountants and clerks.

What London had lacked, at least until the FT’s great rival Financial News was founded in 1884, was a ready provider of financial news. The FT famously set out to report “Without Fear and Without Favour”, and declared itself to be the friend of the honest financier, the respectable broker and the legitimate speculator; and the enemy of the closed stock exchange, the unprincipled promoter and the gambling operator. Perhaps as a consequence, its initial circulation was modest.

The preoccupations of 1888 were not very different than today. Editions of the FT 125 years ago contained stories on economic development in China, the health of Spanish government finances, and the state of Irish banks.

What is clear in those early editions is the decidedly international flavour of a London investor’s interests – from tramways in Buenos Aires to copper mines in Portugal. Since then, London has been a truly international financial centre. In 1913, at the twilight of the last great wave of globalisation, 71 foreign banks had London offices. A century later, there are nearly four times as many. Today, almost twice as much international banking activity is booked here as anywhere else.

London is the home of global markets as well as global banks. Almost half of all turnover in over-the-counter (OTC) derivatives takes place here. London’s share of global foreign exchange turnover is almost as high and it remains a major hub for trading in gold. UK insurance companies have around 10% of the global market. Extending the net further, the UK is home to the third largest ‘shadow banking system’ with assets of $9 trillion.

The emergence of London as a financial centre in the nineteenth century owed a lot to the UK’s position as the world’s greatest trading nation. Britain accounted for as much as a quarter of world trade and produced around a tenth of global GDP. Over the following 125 years the UK’s shares of world trade and output have fallen to around 3%. Despite some ups and downs, London has remained a centre of global finance.

Partly as a consequence, the size of the UK’s financial sector relative to its economy has increased dramatically. When the FT was in its infancy, the assets of UK banks amounted to around 40% of GDP. By the end of last year, that ratio had risen tenfold.

As we have recently been painfully reminded, a specialisation in financial services carries risks as well as rewards. And those risks will grow, unless we put global banks and markets on a sounder footing. Suppose, for example, that UK-owned banks’ share of global banking activity remains the same and that financial deepening in foreign economies increases in line with historical norms. By 2050, UK banks’ assets could exceed nine times GDP, and that is to say nothing of the potentially rapid growth of foreign banking and shadow banking based in London.

Some would react to this prospect with horror. They would prefer that the UK financial services industry be slimmed down if not shut down. In the aftermath of the crisis, such sentiments have gone largely unchallenged.

But, if organised properly, a vibrant financial sector brings substantial benefits. Today financial services account for a tenth of UK GDP and are the source of over 1 million jobs. Two thirds of those are outside London, including jobs in asset management in Edinburgh, transaction processing in Bournemouth and insurance in Norwich. Being at the heart of the global financial system also broadens the investment opportunities for the institutions that look after British savings, and reinforces the ability of UK manufacturing and creative industries to compete globally. Not to mention that financial services represent one of the UK’s largest exports.

More broadly, London’s markets serve a vital global role. London acts as Europe’s window to global capital; is a centre of emerging market finance; and can play an important role in the financial opening of China.

The UK’s financial sector can be both a global good and a national asset – if it is resilient.

It is not for the Bank of England to decide how big the financial sector should be. Our job is to ensure that it is safe. The UK can host a large and expanding financial sector safely, if we implement a reform agenda that extends well beyond domestic banking.

That is not to suggest that the focus on reforming domestic banks has been misplaced. Following the crisis, it was imperative to fix first the fault lines at the core of our system, with initiatives ranging from rebuilding the capital of major UK banks and building societies, to changing the structure of compensation and the responsibilities of senior officers. In tandem, some major banks are working to change their cultures.

But reforms of domestic banking are far from sufficient for a global hub like London. Now is the time for a greater focus on what’s needed for resilient international banking and robust global markets. This will require sustained international engagement. Unlike in the early days of the FT, the UK can no longer dictate standards. Rather than ruling the waves, we must spur collective action through a demonstrated commitment to openness and the promotion of better ideas in Europe and at the G20 via the Financial Stability Board (FSB).

More fundamentally, such engagement would be timely because globalisation itself is under siege. Cross-border capital flows have fallen sharply since the crisis. Multilateral trade liberalisation has stalled, to the detriment of global prosperity.

If we are to stem this tide towards financial fragmentation we must make global finance more resilient. That serves both national and global interests.

Accordingly, I will concentrate today on three core elements of the Bank of England’s new Financial Stability strategy: creating resilient global banks, building robust markets and conducting central banking for global markets. These initiatives support a fourth leg of our strategy: improving the supply of finance in the UK. You will hear more about supply-side initiatives, aimed for example at rebuilding securitisation and supporting SME lending, in coming months.

2. Strengthening the Resilience of International Banking

Making international banks safer is fundamental to a renewed globalisation.

To this end, new global standards for capital and liquidity have been agreed. The major global banks have raised $500 billion of new equity over the past few years and are on course as a group to meet the Basel III standards more than four years in advance of the deadline. In the UK, all major banks and building societies now have in place credible plans to achieve the Bank of England’s thresholds for capital and leverage.

To finish the job, international regulators need to agree over the next year new rules for capital to be held in banks’ trading books, a simple leverage ratio and a guideline which governs the stability of banks’ funding.

Alongside these efforts to increase resilience, our focus is on solving the problem of banks that are too big to fail. Systemic resilience depends on being able to resolve failing banks in a way that does not threaten the entire system. Fairness demands the end of a system that privatises gains but socialises losses. And simple economics dictates that the UK state cannot stand behind a banking system that is already many times the size of the economy.

Moreover, without a credible means to resolve failing banks, regulatory Balkanisation will continue as national regulators seek to protect their own interests, threatening the efficient operation of the international financial system and accordingly London’s competitiveness.

To avoid these risks, we need to make the resolution of global banks a real option.

Successful cross-border resolution requires coordination and cooperation between authorities across multiple jurisdictions. This will only work if all authorities are confident that global resolutions will deliver domestic financial stability and protect local services. Cross-border cooperative agreements will help, but fine words must also be backed up by harsh economic incentives. Operating structures of banks must be made consistent with resolvability and, above all, banks must have substantial loss-absorbing capacity that cascades through their group structures.

At the St Petersburg summit in September, G20 leaders mandated the FSB to develop these proposals. The Bank of England is now working intensively with other authorities and the financial industry. Our aim is to complete the job by the next G20 Summit in Brisbane.

By increasing the resilience of banks and tackling too big to fail we can help make London a safe global banking centre. But that is far from sufficient; we must also dramatically improve the resilience of global markets.

3. Creating Robust Markets

To do so, we need first to consider how measures to increase the resilience of banks affect the functioning of markets. For example, the combination of higher capital held against trading books, the new leverage ratio, and the proposed Volcker restrictions on proprietary trading have already combined to reduce dealer inventories across a range of securities. With dealers less willing to deploy capital against large market moves, volatility has increased and liquidity fallen in the face of shocks such as the potential shift in US monetary policy earlier this year.

On the other hand, with limited proprietary positions, banks generally emerged from a summer of stress unscathed. Certainly, no one wants to return to the days when major dealers’ trading books were crushed under the weight of worthless leveraged super senior debt.

To strike a balance between making banks safer and maintaining adequate market liquidity, we need to draw lessons from the financial crisis, when contagion from stressed banks spread rapidly through the global financial system via counterparty credit concerns, liquidity hoarding and mass deleveraging. In this environment, core funding and OTC derivative markets seized up and conditions were set for the panic that ensued.

By contrast, markets with greater transparency and more robust trading and settlement infrastructure, such as equity markets and exchange-traded futures and options, performed rather better. Prices were not always to participants’ liking, but these markets remained open.

London should lead the way in ensuring that fixed income and derivative markets meet such standards. At the FSB, the Bank of England is helping to devise reforms that increase transparency, build more robust infrastructure and encourage better collateral management.

Since collateral management is a cornerstone of resilient markets and goes to the heart of central banking, let me take a few minutes to expand on it. Collateral reduces credit risk between market participants and supports market-based sources of credit to the real economy. It is central to the functioning of OTC derivatives markets and the funding of the shadow banking system. Since market-based finance needs good collateral to grow sustainably, its availability directly influences the supply of finance to British households and businesses.

The use of collateral is not without risks. When collateral values rise, fixed haircuts allow banks and non-banks to borrow more, pushing up asset values further. The reverse is also true. This inherent pro-cyclicality exposes the system to sharp corrections in collateral values. In extremis, a sell-off in financial markets leads to higher haircuts, a run on repo and ultimately a market freeze.

To reduce these risks, the FSB has proposed minimum regulatory standards for collateral valuation and management as well as a schedule of numerical haircut floors to repo transactions. The FSB also now requires central clearing of ‘standardised’ derivative transactions to limit exposures between counterparties, promote efficient netting of positions and moderate collateral cycles. New minimum capital and margining requirements for bilateral OTC derivative trades will similarly protect banks from defaults of their counterparties while reducing procyclicality in the system.

The combination of such reforms and the experience of the crisis will mean that institutions both need more collateral and need to manage it better. Fortunately financial markets know how to innovate. Investor expectations for liquidity are changing and models for risk intermediation should evolve in ways that reduce balance sheet usage.

4. Central Banking in Global Markets

Central banks need to keep up. In particular, we can catalyse more efficient and effective private collateral management by backstopping private markets.

140 years ago in Lombard Street, Walter Bagehot expounded the duty of the Bank of England to lend freely to stem a panic and to make loans on “everything which in common times is good ‘banking security’.” Bagehot was particularly scathing on the Bank’s failure at that time to state a “clear and sound policy” on this general topic writing “...until we have on this point a clear understanding with the Bank of England, both our liability to crises and our terror at crises will always be greater than they would otherwise be.”

140 years on, the Bank has a clear and sound policy. It is set out in a revised Sterling Monetary Framework (SMF), published today.

The new framework builds on the lessons learned throughout the financial crisis and draws on the recommendations made by Bill Winters in his review of our system.

Five simple words describe our approach: we are open for business.

Our facilities are not ornamental. They are there to be used by banks to access money and high-quality collateral. We are offering money and collateral for longer terms. The range of assets we will accept in exchange will be wider, extending to raw loans and, in fact, any asset of which we are capable of assessing the risks. And using our facilities will be cheaper. In some cases the fees are being more than halved.

Banks can be confident that, when they want to use our facilities, they will be allowed to access them. Because we are both the supervisor and the central bank, the strong presumption is now that, if a bank meets the supervisory threshold conditions to operate and has signed up to our framework, it will be able to use our facilities.

Our Discount Window will be open every day for those firms requiring a bespoke facility with lagged disclosure. Its price will be lower. We will hold monthly repo auctions to provide predictable and regular access to high-quality collateral in exchange for a very broad range of collateral. And in times of actual or prospective stressed conditions we stand ready to provide cheap, plentiful money through more frequent auctions.

None of this means financial institutions are excused from the need to manage their balance sheets prudently. But as Bill Winters observed, more exacting liquidity requirements mean the conditions for using central bank facilities can be less stringent (and more effective). This is one example of the synergies that arise from the return of banking supervision to the central bank.

With our announcements today, we are building a liquidity framework for the markets of tomorrow. In the markets of today, initial usage of these facilities is likely to be limited. The MPC’s stock of asset purchases and the Funding for Lending Scheme currently provide all the liquidity and collateral that the sterling system needs. But as these operations are wound down over time, we expect to see banks making increasing use of our new permanent facilities.

While today’s announcement is significant, it does not mark the end of history for the Bank of England’s market operations. We will continue to evolve our approach as the financial sector changes. In particular, we need to respond to two big questions.

First, should the Bank of England allow non-banks to have access to our regular facilities? After all, our responsibilities for financial stability run much wider than the banking sector. Institutions that play a central role in markets, like broker-dealers, are obvious first candidates. We will also consider the case for opening them to other participants including financial market infrastructures. If the scope of access to central bank facilities increases, the scope of regulation can be expected to expand in a proportionate manner. Backstopping the collateral management of a range of institutions should reduce the need for the Bank to act as a Market Maker of Last Resort.

Second, given that we host an international banking system and global markets, to what extent should the Bank of England provide liquidity in currencies other than sterling? As markets evolve, banks and markets here may need backstops in other currencies in our time zone before business opens for the Federal Reserve and after it has closed for the Bank of Japan.

Although the Bank of England can supply limitless quantities of sterling, we rely on other central banks for access to their currencies. In response to the crisis, a network of swap agreements between advanced economy central banks was established giving us the ability to provide a range of currencies to UK-based institutions.

This network of swap lines should not necessarily be limited to the G7 economies. In June, the Bank of England signed such an agreement with the People’s Bank of China, reflecting the growing international role of the Renminbi. That dovetails with the possibility of establishing a Renminbi clearing bank in London and our decision to include branches of Chinese banks in our broader policy of openness to hosting foreign wholesale banking activities.

Helping the internationalisation of the Renminbi is a global good, consistent with London’s historic role. But rest assured that the Bank will act in a manner consistent with our domestic responsibilities. As my colleague Andrew Bailey said last week, our risk appetite for foreign branches will largely be determined by whether their activities in the UK are covered by credible recovery and resolution plans. As always, renewing globalisation and building resilience go hand in hand.

5. Conclusion

After perhaps the worst financial crisis in the FT’s long lifetime, it is reasonable to expect financial services will again grow in importance.

The process of financial deepening in emerging markets is only beginning. In Europe, there is a strong case for greater reliance on robust financial markets relative to weakened banks.

The UK stands to benefit because of London’s place at the heart of the global financial system. Properly structured, this creates investment opportunities for British savers, reinforces trading ties for UK firms and improves access to credit for the real economy across this country. London’s international markets in turn provide a valuable service to the global economy. These benefits, on both sides, will be greatest as part of an open, integrated global financial system.

The Bank of England’s task is to ensure that the UK can host a large and expanding financial sector in a way that promotes financial stability. Only then can it be both a global good and a national asset.

To those ends, we are working to complete the jobs of making banks more resilient and tackling too big to fail. We are making markets more robust in order to turn the shadow banking system from a source of risk to a pillar of resilience. And we are changing how we backstop private firms’ liquidity management. These efforts will help set the stage to improve further the supply of credit within the UK.

Let me put my point more succinctly, in the style of the FT 125 years ago. The Bank of England today is the friend of resilient banks, continuous markets, and good collateral; and we are the enemy of taxpayer bailouts, fragile markets and financial instability.

Our circle of friends – like the FT’s readership in its infancy – is expanding. As it does, the UK is helping to renew globalisation to the benefit of all.

OIL celebrates 25 years of doing business in the BVI

OIL commemorated its 25 years of doing business in the BVI with an anniversary cocktail reception in Hong Kong and Singapore on 11 and 18 September 2013.

OIL celebrated this special milestone with more than 300 valued clients and business partners. We were honoured to have the presence of Lorna Smith - Director of BVI House Asia and members from the BVI International Finance Centre and the BVI Financial Services Commission, at our event in Hong Kong.

Speaking to the guests, Lorna Smith said: “Heartiest congratulations to OIL on its 25th Anniversary of a relationship with the BVI, on behalf of the Government and its people. Our relationship has been a very happy one: in fact we often say that OIL was instrumental in launching the BVI’s star in the East! The Government continues to be grateful for the huge contribution that OIL makes to its financial services sector and looks forward to celebrating OIL’s golden anniversary with the BVI.

Martin Crawford, CEO of OIL, remarked, “The BVI is a world-class jurisdiction. Since we launched the first BVI company promotion in 1988, OIL has grown alongside the BVI by catering to the diverse needs of Asian investors with a broader range of solutions. OIL has been the leading company formation specialist in BVI companies in Asia for more than two decades. We thank our clients for their valuable support and loyalty over the years.

Jersey is first with amendment to trust legislation

The latest amendment to Jersey’s trust legislation comes into force today (October 25). The Trusts (Amendment No. 6) (Jersey) Law 2013 further strengthens Jersey’s legislative framework and provides greater clarity for the courts, practitioners and those who work with or benefit through Jersey trusts.

The amendment incorporates into the Trusts (Jersey) Law 1984 the existing law on mistake and the so called ‘rule in Hastings-Bass’, the latter being a legal first within the international trust’s arena.

The effect of the amendment is to confirm the Royal Court’s ability to provide discretionary relief in a number of trust scenarios, e.g. where a settlor has made an error in settling assets into trust, or where a trustee has erred in exercising a power, perhaps failing to take into account matters which should have been considered, or acting on incorrect professional advice.

 Geoff Cook, CEO, Jersey Finance, commented,

 “Since its enactment in 1984, the Trusts (Jersey) Law has proved to be a highly effective and hugely influential piece of legislation.  This latest amendment, only the sixth in nearly 30 years, provides welcome clarity for the Royal Court and for the many settlors, trustees and beneficiaries, all over the world, who enjoy the benefits of having Jersey law as the governing law of their trusts.  The ability for the Royal Court to give discretionary relief when a beneficiary finds itself materially prejudiced by a trustee’s decision - made, perhaps, in good faith but unfortunately founded upon erroneous advice - provides a welcome alternative to the uncertainties and costs which surround ‘classic negligence litigation’. 

With an estimated £0.4 trillion of trust assets under administration in Jersey, this amendment can only serve to further bolster Jersey’s already highly regarded international private wealth offering.

25 October 2013

What a Difference a Ph.D. Makes: More than Three Little Letters

Several hundred individuals who hold a Ph.D. in economics, finance, or others fields work for institutional money management companies. The gross performance of domestic equity investment products managed by individuals with a Ph.D. (Ph.D. products) is superior to the performance of non-Ph.D. products matched by objective, size, and past performance for one-year returns, Sharpe Ratios, alphas, information ratios, and the manipulation-proof measure MPPM. Fees for Ph.D. products are lower than those for non-Ph.D. products. Investment flows to Ph.D. products substantially exceed the flows to the matched non-Ph.D. products. Ph.D.s’ publications in leading economics and finance journals further enhance the performance gap.

Chaudhuri, Ranadeb and Ivkovich, Zoran and Pollet, Joshua Matthew and Trzcinka, Charles, What a Difference a Ph.D. Makes: More than Three Little Letters (October 15, 2013). Available at SSRN: http://ssrn.com/abstract=2344938

22 October 2013

Ile Maurice: Category 2 Global Business Licence company (GBC 2)

La «Category 2 Global Business Licence company (GBC 2)» de l'île Maurice, anciennement dénommée «International Company» est une société non résidente, dont le statut est identique à celui de la compagnie de commerce international des îles Vierges britanniques. Ce type de société offshore, fiscalement non résidente, n'est pas autorisée à exercer des activités commerciales sur le territoire mauricien et et ne peut bénéficier du réseau conventionnel de l'île Maurice. Elle n'est pas autorisée à être en relation d'affaires avec des résidents de l'île Maurice ou à détenir des comptes bancaires en roupies mauriciennes. 

Une GBC 2 constitue la forme juridique la plus répandue car elle peut être créée en deux jours  ouvrés et est exonérée d'imposition mauricienne sur le total des revenus générés à l'échelle mondiale. Jusqu'au 12 juillet 2011, ces sociétés n'avaient pas l'obligation de soumettre annuellement leurs comptes et pièces comptables. Cependant, le droit des sociétés régi par le «Companies Act de 2001» a été modifié en 2011 afin d'imposer la tenue d'une comptabilité aux GBC 2 ainsi que la conservation des documents comptables.

21 October 2013

Mauritius : FSC issues Consultative paper on Competency Standards for Insurance Intermediaries

The FSC is working on the development of competency standards for the financial services sector. The standards development process will be done in a phased approach. The development of the competency standards is being initiated with the insurance sector. The exercise will be extended to licensees in the capital markets, fund management, global business and pension sectors at a later stage.

The FSC is inviting comments on the consultative paper with respect to the development of the competency standards for insurance salesperson, insurance agent and insurance broker.

Please use the comment template and send your comments by email to competency@fscmauritius.org on or before 6th December 2013.

18 October 2013

FSC Communiqué following allegations against Kross Border Corporate Services Ltd

The Financial Services Commission (the “FSC”) was made aware of allegations against Kross Border Corporate Services Ltd (“KBCS”), holder of a Management Licence, in relation to the following companies: Velankani Holdings Mauritius Ltd, Velankani Mauritius Ltd and Velankani Renewable Energy Mauritius Ltd (the “Companies”). The allegations are mainly improper issue of shares, wrongful appointment of directors and irregularities in companies’ documentations.

A complaint by Mr Reddy, shareholder of the Companies, was made to the FSC on 11 September 2012. The complaint emanated basically from a shareholders’ dispute, the inability of Mr. Reddy to have access to records and facing difficulties in transferring files to another Management Company. The FSC intervened with respect to access to records and informed both parties that the transfer of the Companies should be conducted in accordance with the requirements of the laws and as per the constitutive documents of the Companies.

Since the matter was not sorted out between the parties as advised, the FSC enquired into the matter. In the meantime, the complainant made a statement against KBCS for forgery of documents with the Police (the competent authority). Simultaneously, the complainant filed cases before the Supreme Court of Mauritius with respect to all allegations made in the complaint. The FSC was made a party as a Co-respondent in these cases.

The matter relating to shareholders’ dispute is under the consideration of the Supreme Court and the FSC cannot provide further information for matters already sub –judice.

The allegations with respect to the forgery are being investigated by the Police authorities.

According to KBCS, the police seized the companies’ files and other statutory records and it is thus unable to respond to FSC’s queries. However, the FSC is proceeding with the inquiry by liaising with the Police and the other parties within the remit of its regulatory framework and may take appropriate remedial and penal actions as deemed necessary in due course.

The FSC is bound by its duty of confidentiality and cannot reveal any further information during its inquiry.

Financial Services Commission 
18 October 2013

16 October 2013

Salamanca Group Acquires Investec Trust from Investec Bank Plc

Salamanca Group ("Salamanca"), the Merchant Banking and Operational Risk Management business, has together with existing management, acquired the Investec Trust group of companies ("Investec Trust" or "the business"), from Investec Bank plc ("Investec") for an undisclosed consideration. Investec Trust Services currently has over £4.5 billion in assets under administration. The transaction is subject to regulatory approval.

Fenchurch Advisory Partners acted for Investec Bank Plc and Salamanca Advisory acted for Salamanca Group and management.

The business will be run as a stand-alone division, and will be re-branded Salamanca Group Trust Services. It currently has offices in Jersey, Switzerland, South Africa and Mauritius and employs around 100 people, administering some 600 trust structures on behalf of clients. Clients include high net worth individuals and entrepreneurs; financial and professional intermediaries; family offices and corporate entities. Additionally the business regularly partners with specialist legal and tax advisers to achieve bespoke solutions for clients.

Commenting on the acquisition, Martin Bellamy, Chief Executive of Salamanca Group said: "The addition of Trust services has been a strategic objective for Salamanca Group for some time and having undertaken an extensive analysis of the market place, the Group concluded that the acquisition of Investec's Trust business represented the ideal opportunity. We have bought a business with a first class management team and the highest levels of corporate governance."

Avron Epstein of Investec Bank plc said: "As a professional services business we feel the trust company would benefit under independent ownership. We believe Salamanca, together with management, is best placed to take this business forward and to provide certainty and clarity to our clients and people. The professionalism and excellent service our staff have demonstrated throughout is testament to the strength and quality of the business. We wish them all the best and look forward to continuing our mutually beneficial relationship with the trust company."

Salamanca Group Trust Services will offer an innovative and flexible approach to structuring, efficient estate planning, robust asset protection and complete confidentiality; providing solutions that extend across generations, across a choice of financial jurisdictions. Services include:

  • Complex and vanilla trusts, foundations and company structures
  • Multi-family office services
  • Wide experience of holding financial and non-financial assets
  • Experts in working with entrepreneurs
  • Philanthropy

Martin Bellamy added: "Salamanca Group's primary focus is establishing long-term, trusted relationships with our clients. This acquisition provides the Group with another significant medium through which to achieve this, expanding our offering to include a comprehensive range of high-end, tax compliant wealth preservation and succession planning services. There are also clear synergies with our existing business particularly our Advisory and Private Client divisions. There will be no changes for existing clients nor will the other relationships with Investec be affected. We will work with management to build on the business' solid foundations to create the pre-eminent Trust provider, distinguished by our core principles of integrity and agility."

Xavier Isaac, CEO of Investec Trust Division said: "The acquisition by Salamanca Group and our existing management of the Investec Trust Group is a fantastic opportunity to deliver on our vision. High and ultra-high net worth individuals are no longer looking for traditional trust and fiduciary services in an increasingly complex environment. They expect independent thinking and high touch administration services complemented by multi-family office capabilities. By joining forces with a dynamic company like Salamanca Group, we will retain the entrepreneurial spirit that characterised us when we were operating under the Investec banner."

14 October 2013

Investec offshore unit sale to Salamanca nears

Investec, the Anglo-South African investment bank, is in late-stage talks to sell its £4bn offshore investment trust administration business to boutique merchant bank Salamanca.

It is understood that the pair are this weekend close to signing a deal for the transfer of the business, which has offices in locations including Guernsey, Mauritius, and Geneva.

12 October 2013

South Africa: Statement on Auto Exchange Tax Info

Today, South Africa and the United Kingdom have agreed to work closer together to tackle offshore tax evasion, including through pressing for stronger international action. This builds on the strengthening resolve of the G20 to ensure everyone pays the tax that is due.

South Africa will join the pilot scheme for the automatic exchange of tax information launched by the United Kingdom, along with France, Germany, Italy and Spain. This initiative has received growing support worldwide, demonstrating the growing number of jurisdictions committed to quickly implementing the new standard in the automatic exchange of tax information being developed by the OECD.

Greater automatic information exchange will provide a step change in our ability to expose hidden assets and ensure the correct payment of tax. Both South Africa and the United Kingdom strongly encourage other countries to join in this effort.

Greater tax transparency and exchange of information will benefit both developed and developing countries. The G20 has committed to provide technical assistance to developing countries to ensure they can benefit from greater tax transparency, given the importance taxation plays in governance and state-building. As part of this, the United Kingdom and South Africa have committed to a long-term partnership to support the tax capacity building of revenue authorities in the region.

South African Finance Minister Pravin Gordhan said: "The automatic exchange of tax information will contribute to the establishment of a more effective, efficient and fair international tax system. As more countries join this movement, it will ultimately benefit poor countries who are often the victims of organised efforts to undermine their tax bases. In this regard, there needs to be increased cooperation between advanced and developing countries in order to enhance the protection of the tax base of developing countries and to build the capacity of their tax administrations. South Africa has been working with more than 28 fellow African nations through the African Tax Administration Forum (ATAF) to improve the efficacy of their tax legislation and administrations."

UK Chancellor of the Exchequer, George Osborne said: "I strongly welcome this significant step taken by South Africa, which shows the increasing momentum behind stepping up our efforts to crack down on offshore tax evasion. The message to those who attempt to conceal their assets offshore is clear: our resolve is stronger than ever, the net is closing in and the world is becoming a smaller place for those looking to evade their responsibilities by seeking not to pay the taxes that are due."