Friday, October 28, 2016

28/10/16: Rising Risk Profile for Italy

Euromoney Country Risk on Italian referendum and rising risks relating to Euro area's third largest economy:

Monday, October 24, 2016

24/10/16: Hacktivism on the rise? Welcome to the well-predicted future

Given a rising prevalence and impact of the cyber attacks in recent weeks, here are some slides from my February 2016 course notes on ERM with warnings about the same back at the end 2015 - start of 2016:

Sunday, October 23, 2016

23/10/16: Too-Big-To-Fail Banks: The Financial World 'Undead'

This is an un-edited version of my latest column for the Village magazine

Since the start of the Global Financial Crisis back in 2008, European and U.S. policymakers and regulators have consistently pointed their fingers at the international banking system as a key source of systemic risks and abuses. Equally consistently, international and domestic regulatory and supervisory authorities have embarked on designing and implementing system-wide responses to the causes of the crisis. What emerged from these efforts can be described as a boom-town explosion of regulatory authorities. Regulatory,  supervisory and compliance jobs mushroomed, turning legal and compliance departments into a new Klondike, mining the rich veins of various regulations, frameworks and institutions. All of this activity, the promise held, was being built to address the causes of the recent crisis and create systems that can robustly prevent future financial meltdowns.

At the forefront of these global reforms are the EU and the U.S. These jurisdictions took two distinctly different approaches to beefing up their respective responses to the systemic crises. Yet, the outrun of the reforms is the same, no matter what strategy was selected to structure them.

The U.S. has adopted a reforms path focused on re-structuring of the banks – with 2010 Dodd-Frank Act being the cornerstone of these changes. The capital adequacy rules closely followed the Basel Committee which sets these for the global banking sector. The U.S. regulators have been pushing Basel to create a common "floor" or level of capital a bank cannot go below. Under the U.S. proposals, the “floor” will apply irrespective of its internal risk calculations, reducing banks’ and national regulators’ ability to game the system, while still claiming the banks remain well-capitalised. Beyond that, the U.S. regulatory reforms primarily aimed to strengthen the enforcement arm of the banking supervision regime. Enforcement actions have been coming quick and dense ever since the ‘recovery’ set in in 2010.

Meanwhile, the EU has gone about the business of rebuilding its financial markets in a traditional, European, way. Any reform momentum became an excuse to create more bureaucratese and to engineer ever more elaborate, Byzantine, technocratic schemes in hope that somehow, the uncertainties created by the skewed business models of banks get entangled in a web of paperwork, making the crises if not impossible, at least impenetrable to the ordinary punters. Over the last 8 years, Europe created a truly shocking patchwork of various ‘unions’, directives, authorities and boards – all designed to make the already heavily centralised system of banking regulations even more complex.

The ‘alphabet soup’ of European reforms includes:

  • the EBU and the CMU (the European Banking and Capital Markets Unions, respectively);
  • the SSM (the Single Supervisory Mechanism) and the SRM (the Single Resolution Mechanism), under a broader BRRD (Bank Recovery and Resolution Directive) with the DGS (Deposit Guarantee Schemes Directive);
  • the CRD IV (Remuneration & prudential requirements) and the CRR (Single Rule Book);
  • the MIFID/R and the MAD/R (enhanced frameworks for securities markets and to prevent market abuse);
  • the ESRB (the European Systemic Risk Board);
  • the SEPA (the Single Euro Payments Area);
  • the ESA (the European Supervisory Authorities) that includes the EBA (the European Banking Authority);
  • the MCD (the Mortgage Credit Directive) within a Single European Mortgage Market; the former is also known officially as CARRP and includes introduction of something known as the ESIS;
  • the Regulation of Financial Benchmarks (such as LIBOR & EURIBOR) under the umbrella of the ESMA (the European Securities and Markets Authority), and more.

The sheer absurdity of the European regulatory epicycles is daunting.

Eight years of solemn promises by bureaucrats and governments on both sides of the Atlantic to end the egregious abuses of risk management, business practices and customer trust in the American and European banking should have produced at least some results when it comes to cutting the flow of banking scandals and mini-crises. Alas, as the recent events illustrate, nothing can be further from the truth than such a hypothesis.

America’s Rotten Apples

In the Land of the Free [from individual responsibility], American bankers are wrecking havoc on customers and investors. The latest instalment in the saga is the largest retail bank in the North America, Wells Fargo.

Last month, the U.S. Consumer Financial Protection Bureau (CFPB) announced a $185 million settlement with the bank. It turns out, the customer-focused Wells Fargo created over two million fake accounts without customers’ knowledge or permission, generating millions in fraudulent fees.

But Wells Fargo is just the tip of an iceberg.

In July 2015, Citibank settled with CFPB over charges it deceptively mis-sold credit products to 2.2 million of its own customers. The settlement was magnitudes greater than that of the Wells Fargo, at $700 million. And in May 2015, Citicorp, the parent company that controls Citibank, pleaded guilty to a felony manipulation of foreign currency markets – a charge brought against it by the Justice Department. Citicorp was accompanied in the plea by another U.S. banking behemoth, JPMorgan Chase. You heard it right: two of the largest U.S. banks are felons.

And there is a third one about to join them. This month, news broke that Morgan Stanley was charged with "dishonest and unethical conduct" in Massachusetts' securities “for urging brokers to sell loans to their clients”.

Based on just a snapshot of the larger cases involving Citi, the bank and its parent company have faced fines and settlements costs in excess of $19 billion between the start of 2002 and the end of 2015. Today, the CFPB has over 29,000 consumer complaints against Citi, and 37,000 complaints against JP Morgan Chase outstanding.

To remind you, Citi was the largest recipient of the U.S. Fed bailout package in the wake of the 2008 Global Financial Crisis, with heavily subsidised loans to the bank totalling $2.7 trillion or roughly 16 percent of the entire bailout programme in the U.S.

But there have been no prosecutions of the Citi, JP Morgan Chase or Wells Fargo executives in the works.

Europe’s Ailing Dinosaurs

The lavishness of the state protection extended to some of the most egregiously abusive banking institutions is matched by another serial abuser of rules of the markets: the Deutsche Bank. Like Citi, the German giant received heaps of cash from the U.S. authorities.

Based on U.S. Government Accountability Office (GAO) data, during the 2008-2010 crisis, Deutsche was provided with $354 billion worth of emergency financial assistance from the U.S. authorities. In contrast, Lehman Brothers got only $183 billion.

Last month, Deutsche entered into the talks with the U.S. Department of Justice over the settlement for mis-selling mortgage backed securities. The original fine was set at $14 billion – a levy that would effectively wipe out capital reserves cushion in Europe’s largest bank. The latest financial markets rumours are putting the final settlement closer to $5.4-6 billion, still close to one third of the bank’s equity value. To put these figures into perspective, Europe’s Single Resolution Board fund, designed to be the last line of defence against taxpayers bailouts, currently holds only $11 billion in reserves.

The Department of Justice demand blew wide open Deutsche troubled operations. In highly simplified terms, the entire business model of the bank resembles a house of cards. Deutsche problems can be divided into 3 categories: legal, capital, and leverage risks.

On legal fronts, the bank has already paid out some $9 billion worth of fines and settlements between 2008 and 2015. At the start of this year, the bank was yet to achieve resolution of the probe into currency markets manipulation with the Department of Justice. Deutsche is also defending itself (along with 16 other financial institutions) in a massive law suit by pension funds and other investors. There are on-going probes in the U.S. and the UK concerning its role in channelling some USD10 billion of potentially illegal Russian money into the West. Department of Justice is also after the bank in relation to the alleged malfeasance in trading in the U.S. Treasury market.

And in April 2016, the German TBTF (Too-Big-To-Fail) goliath settled a series of U.S. lawsuits over allegations it manipulated gold and silver prices. The settlement amount was not disclosed, but manipulations involved tens of billions of dollars.

Courtesy of the numerous global scandals, two years ago, Deutsche was placed on the “enhanced supervision” list by the UK regulators – a list, reserved for banks that have either gone through a systemic failure or are at a risk of such. This list includes no other large banking institution, save for Deutsche. As reported by Reuters, citing the Financial Times, in May this year, UK’s financial regulatory authority stated, as recently as this year, that “Deutsche Bank has "serious" and "systemic" failings in its controls against money laundering, terrorist financing and sanctions”.

As if this was not enough, last month, a group of senior Deutsche ex-employees were charged in Milan “for colluding to falsify the accounts of Italy’s third-biggest bank, Banca Monte dei Paschi di Siena SpA” (BMPS) as reported by Bloomberg. Of course, BMPS is itself in the need of a government bailout, with bank haemorrhaging capital over recent years and nursing a mountain of bad loans. One of the world’s oldest banks, the Italian ‘systemically important’ lender has been teetering on the verge of insolvency since 2008-2009.

All in, at the end of August 2016, Deutsche Bank had some 7,000 law suits to deal with, according to the Financial Times.

Beyond legal problems, Deutsche is sitting on a capital structure that includes billions of notorious CoCos – Contingent Convertible Capital Instruments. These are a hybrid form of capital instruments designed and structured to absorb losses in times of stress by automatically converting into equity. In short, CoCos are bizarre hybrids favoured by European banks, including Irish ‘pillar’ banks, as a dressing for capital buffers. They appease European regulators and, in theory, provide a cushion of protection for depositors. In reality, CoCos hide complex risks and can act as destabilising elements of banks balancesheets.

And Deutsche’s balancesheet is loaded with trillions worth of opaque and hard-to-value derivatives. At of the end of 2015, the bank held estimated EUR1.4 trillion exposure to these instruments in official accounts. A full third of bank’s assets is composed of derivatives and ‘other’ exposures, with ‘other’ serving as a financial euphemism for anything other than blue chip safe investments.

The Financial Undead

Eight years after the blow up of the global financial system we have hundreds of tomes of reforms legislation and rule books thrown onto the crumbling façade of the global banking system. Tens of trillions of dollars in liquidity and lending supports have been pumped into the banks and financial markets. And there are never-ending calls from the Left and the Right of the political spectrum for more Government solutions to the banking problems.

Still, the American and European banking models show little real change brought about by the crisis. Both, the discipline of the banks boards and the strategy pursued by the banks toward rebuilding their profits remain unaltered by the lessons from the crisis. The fireworks of political demagoguery over the need to change the banking to fit the demands of the 21st century roll on. Election after election, candidates compete against each other in promising a regulatory nirvana of de-risked banking. And time after time, as smoke of elections clears away, we witness the same system producing gross neglect for risks, disregard for its customers under the implicit assumption that, if things get shaky again, taxpayers’ cash will come raining on the fires threatening the too-big-to-reform banking giants.

Note: edited version is available here:

22/10/16: U.S. Election: Can There Even Be a Winner?

Despite offering, to many people, especially those tending to think of themselves as either 'liberal left' or centre to centre-right, the upcoming U.S. Presidential vote offers one alternative: voting for Hillary Clinton. It is an undesirable alternative for many of them. And yet, given the state of her opposition, it is (allegedly) the only one.

Hence, it is rare in the current political sh*t storm (which does not qualify for a mature debate) to see reasoned, well-argued analysis of the potential outrun of Hillary Clinton. And, hence, it is very important to try to understand such an outrun.

One of the best articles on the topic I have run across (no, I do not fully agree with it in its entirety, which, of course, does not subtract from its merits) is here:

There are serious and measured facts provided in the piece on, for example, Hillary Clinton's innate inability to inspire even her core constituency. And there are serious claims being made about incremental change potential from the Clinton Presidency, or at least a claim to such change as a mandate. There is a very important point of learning here for the Republican party, even though that point is not original and was, in fact, made by the previous Republican nomination contestant, Ohio Governor John Kasich.

But the most important bit remains as noted above: the devision, the gap, the chasm that separates American voters by socio-demographic lines: "White non-college-educated voters are going two-to-one for Trump, 62 percent to 31 percent, according to the ABC News-Washington Post poll. College graduates favor Clinton by more than 20 points, 55 to 34 percent. For the first time in more than 50 years, whites with a college degree are voting Democratic, 51 to 38 percent."

That is right: American society is now divided to the point of mutual aversion across the education line. And this is something that the next President will have to live with and deal with. Given that Hillary Clinton is failing to energize her own core constituency, what chance does she have in energizing two disparate demographics into finding a reconciling common ground? Recall that Hillary Clinton readily and cheerfully labeled a large strata of the American majority "as a “basket of deplorables . . . racist, sexist, homophobic, xenophobic, Islamophobic – you name it.”" Not a hell of a lot of confidence in her ability to heal the nation can be glimpsed from this statement.

And, as the author concludes: "Each of the last four presidents – George H.W. Bush, Bill Clinton, George W. Bush and Obama – promised to bring the country together. They all failed. There is little prospect that either Clinton or Trump – two of the most divisive figures in U.S. politics – can heal the divide. Two Americas, two interpretations."

And that sad prospect is way more significant, more important than the actual outrun of the November 8 vote.

Saturday, October 22, 2016

22/101/16: Cashless Society: Efficiency 1 : Privacy 0

My comments on the dangers associated with the idea of the 'cashless society' where traditional money is replaced by fully captured (by data flows) and de-privatized electronic accounts:

22/10/16: Watering Down Budget 2017 Promises?

My article on the Irish Finance Bill for Budget 2017 is now available on Sunday Business Post website:

22/10/16: Irish 12.5% Tax Rate and Someone's Loose Lips

It has been some time since I commented here on the matters relating to Irish corporate taxation. For a number of reasons not worth covering. But one piece of rhetoric in the post-AppleTax ruling by the EU Commission has caught my mind today: the statement from the Taoiseach Enda Kenny on the issue of 'Loose Lips Sink Ships'.

Here's what happened: as reported in the Irish Independent, the Taoiseach "warned that "loose talk" about taxation in Ireland was potentially damaging in the face of the Brexit threat. "Ireland will obviously debate these things constructively but to be clear about it, our 12.5pc corporate tax rate is not up for grabs... It's always been 12-and-a-half and it will remain so."" The statement was prompted by the rumours (err... reports) "the European Commission has not ruled out examining 300 more of Ireland's tax rulings."

Mr Kenny said that "The commission have never stated that there are other impending state aid cases against Ireland and to suggest otherwise is mischievous, is misleading, and is wrong... And that type of loose talk is potentially very damaging to our country. It does impact upon companies looking - particularly given the Brexit situation - as to where they might want to invest."

So here's the problem, Mr. Kenny: no one is seriously suggesting that the problem with Irish corporate taxation is 12.5% headline rate. I have not seen any reasonably informed source commenting on this. The problem - as as subject of investigations by the EU Commission in the recent past - is the granting of preferential loopholes that went well beyond the 12.5% rate.

So what grave 'threat' to Ireland's tax regime is Mr. Kenny addressing by setting up a straw man argument about 12.5% rate 'rumours'? Answering that question would likely expose whose lips are loose on the matter. My suspicion is that Mr. Kenny deliberately creates confusion between the discussion of the headline rate (which is not happening) and the discussion of the loopholes (which is probably on-going, because (a) things might not have stopped with Apple; and (b) global tax reforms - e.g. BEPS-initiated process - are still rolling out. If so, then it is Taoiseach's lips that might be doing Ireland's 12.5% headline rate some damage.

Personally, I believe Ireland's 12.5% corporate tax rate is just fine. And I also believe that special, individual company arrangements on any tax matters are not fine. I also believe that Ireland should phase the latter out in a transparent fashion, instead of creating another maze of non-transparent and gamable by the larger corporation 'knowledge development box' incentives. Incidentally, tax personalization for Irish entities continues, it appears, with the publication of the Finance Bill this week, where tax procedures for Section 110 companies valuation of inter-company loans was left largely a matter for individual arrangements. BEPS will take care of the rest, or it might not, but that would no longer be a matter of Ireland's failure and it won't challenge our 12.5% tax rate.

Tuesday, October 11, 2016

11/10/16: BRIC Manufacturing PMI: 3Q 2016

With all PMI data in (China Services data delay was a strange aberration this month), we can tally up 3Q 2016 PMI results. Based on 3mo averages, here is the summary for Manufacturing sector:

Brazil: Over 3Q 2016, Brazil’s Manufacturing sector continued to post sub-50 readings, indicating a strong pace in economic contraction. Overall, 3Q 2016 average Manufacturing PMI came in at 45.9, which is a single of slower economic contraction compared to 2Q 2016 (42.5), but basically the same rate of decline as in 1Q 2016 (46.0). 3Q 2016 was 10th consecutive quarter of sector contraction in Brazil. Worse, PMI for Brazil’s manufacturing has now averaged 49.9 over the period from 1Q 2007 through 3Q 2016. In other words, average quarterly PMI has been consistent with zero growth for 10 and a half years now.

Russia: In contrast to Brazil’s misfortunes, Russian manufacturing PMI strengthened from 49.7 in 2Q 2016 to 50.5 in 3Q 2016, reaching above 50.0 level for the first time since 4Q 2014. Still, at 50.5, the reading is not statistically different from 50.0 and signals weak turnaround in the sector. 3Q 2016 level of PMI breaks a string of 6 consecutive quarters of sub-50 readings. The depth of Russian downturn is self-evident: the last time Russian Manufacturing PMI reached above 50.0 on a statistically significant basis was in 1Q 2013. However, for all the troubles with the economy, Russian performance is significantly stronger than that of Brazil across recent years. In addition, 3Q 2016 reading for Russia is the second strongest in BRIC group, after that of India. To keep things in longer term perspective, however, Russian Manufacturing quarterly PMI averaged just 50.2 since 1Q 2007, hardly a sign of any serious growth over the last 10 and a half years.

China: Chinese Manufacturing PMI averaged 50.2 in 3Q 2016, up on 49.1 in 2Q 2016 and the strongest reading in 8 quarters. As with Russian Manufacturing PMI, Chinese reading for 3Q 2016 is not statistically different from 50.0, and once adjusted for the strong positive skew in the historical data probably underlies continued major slowdown trend in the economy. Again, for comparative purposes, since 1Q 2007, Chinese Manufacturing quarterly PMI averaged just 50.7 - a figure ahead of both Brazil’s and Russia’s, but still a reading that is too weak for the rapidly growing economy dependent on Manufacturing. 

India: India’s Manufacturing PMI averaged 52.2 in 3Q 2016, which represents a substantial rise on 51.0 average in 2Q 2016 and marks the fastest pace of sector growth in the country since 4Q 2014. 3Q 2016 also marked 12 consecutive quarter of above 50 readings for Manufacturing PMI. In contrast to all other BRIC economies, India’s Manufacturing PMI averaged 51.7 reading consistent with growth for the period between 1Q 2007 through 3Q 2016.

Overall, BRIC Manufacturing PMI did firm up in 3Q 2016, with three out of four BRIC economies reporting nominal above-50 readings for the index for the first time since 1Q 2014. As the result of improving conditions across all BRIC economies, BRIC Manufacturing PMI reached 50.4 in 3Q 2016, up on 49.0 in 2Q 2016. The rise is broadly in line with Global Manufacturing PMI improvement from 50.4 in 2Q 2016 to 51.0 in 3Q 2016.

Table below summarises recent changes:

Chart below highlights key dynamics in Manufacturing PMIs: