Category Archives: Other

Alternative Investment, Equities, Fixed Income, Other

Prospects MTF vs Main Listing – a Retail Client’s Perspective

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Many investors would have noticed an increase in local bond issues with a smaller total amount issued (typically in the region of €5 million) and with higher coupon interest rates compared to other regular market listings. These smaller issues are part of the what is called the Prospects MTF and are not subject to the main listing rules and regulations. There exist certain differences to having a main market listing and having a prospects’ listing and these differences are important for investors to understand before investing their money.

What is the Prospects MTF?

“The Prospects MTF is a multilateral trading facility (MTF) operated by the Malta Stock Exchange (MSE). It provides a cost-effective opportunity for small and medium-sized enterprises (SMEs) to raise capital by issuing bonds or equity.” – Malta Stock Exchange website. As such, a Prospects issue is not subject to the Listing Rules issued by the Malta Financial Services Authority and are not required to be compliant with the Prospectus Directive of the European Union.

Does this mean that Prospects issues are not regulated? No, although they are subject to less stringent requirements, the issues on the Prospects MTF must still abide by the Prospects MTF Rules and must still issue an admission document which in many aspects is similar to a main market prospectus. Furthermore, the Prospects issuer needs to appoint a Corporate Advisor which acts as a guide to the issuer and consistently ensure adherence to the companies’ continuing obligations as laid down in the Prospects MTF Rules. Moreover, an issuer has to submit supporting documentation and be approved to be admitted on the Prospects Market.

In a nutshell, the Prospects market is aimed at issuers who have a smaller amount of capital to raise and/or do not have a track record that would make them eligible to issue a main listing bond. So does this necessarily make them riskier?

Risks of Investing in Prospects Issues vs Main Listing Issues

Due to the smaller size of the issues and typical lack of trading record of the companies issuing on the prospects market these issues are inherently riskier. The size factor is quite important since it affects the opportunity to trade the issue after the initial offering. Since a Prospects issue is typically small, once these issues are admitted to the market there are typically much less trades executed compared to a main market listing of a larger size. The typical local investor would want to buy and hold, and thus secondary market trading is already quite limited, even for main market listings. Having a smaller issue will exacerbate this. Moreover, funds that invest into local market instruments would also have a problem with investing into Prospect MTF issues due to the illiquidity of these issues. This in itself eliminates a chunk of the market which adds further to the liquidity issue.

Although not necessarily the case, a Prospects Issuer would typically be a smaller company which could also still be in its start-up phase. This would make it riskier than a business that has a long track record due to the fact that it is untested. Although it is important to have capable people within the business and an amount of weighting should be placed on the level of knowledge and experience of the directors and management of the company, one must still factor in the untested nature of the business.

Should Retail Investors Disregard Prospects Issues and stick only to Main market Issues?

Definitely not. I have reviewed an amount of both regular market and Prospects issues and I would definitely not simply draw a line and disregard all Prospects issues. I have analysed Prospects issues that I have preferred over other regular market issues – so simply being a prospects issue does not automatically make me disregard the issue. As with any investment, each issue needs to be considered on an individual basis. The liquidity issue is definitely a factor one has to consider. Keeping in mind that interest rates are at rock bottom and that typical issues are for a maturity of 10 years one must not over invest into such issues. On the other hand, having an exposure to different market segments through prospects bonds whose issuers operate in different areas could add to the diversification of one’s portfolio.   

The Bottom Line

Like with any investment each issue should be considered on its own merits. Although securities that are issued on the prospects market are generally less liquid and generally riskier, not all issuers are the same. As part of diversified portfolio even these issues could be a good investment for clients. However, one should always seek professional investment advice when investing into these issues in order to better understand their specific characteristics and be able to assess better the specific risks involved.

KD

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The European Divide

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The European Central Bank (ECB) as the main monetary authority connecting the central banks of the euro area has celebrated its 20 year anniversary on the 1st of June 2018. Its remit is quite wide, serving 340 million citizens who live in the 19 countries that have decided to share a single currency. This is not an easy task when one considers the divide that exists between the different economies that make up the euro-block.

Monetary policy consists of the actions of a monetary authority (for example a central bank) that determines the size and rate of growth of the money supply, which in turn affects interest rates. Monetary policy is maintained through actions such as modifying the interest rate, buying or selling government bonds (quantitative easing), and changing the amount of money banks are required to keep in the vault (bank reserves). Check out the LINK for more on Monetary policy as explained on Investopedia.com.

For the last decade or so since the financial crisis of 2007-09 the ECB like many other monetary authorities has been on what is called an expansionary monetary policy stance. This means that it has been trying to stimulate economic growth by keeping interest rates low and buying government and certain corporate bonds which in turn would increase the money supply. If consumers and businesses can borrow at lower prices they will be able to afford to take on investment projects and spend more. This in turn would create economic growth and employment. There is a drawback though, that after a while there will be pressure on prices as the cost of living starts creeping up and inflation starts rising.

Inflation (the general increase in prices) in itself is not a bad thing but a kind of necessary evil. However, monetary authorities generally aim for a low and acceptable target level of inflation, for example “just below 2%”. This is all well and good that you have one currency and one ECB that controls the interest rate for all of the Euro area – after all the economies should be quite similar given their close geographical locations and similar cultures – Not Quite!

The North versus Peripheral Europe

There exists a clear divide between the northern countries such as Germany and France and the outer peripheral countries such as Greece and Italy. Since they are all subject to the same ECB the all have the same base interest rate of around 0% at the moment. However, economic growth and inflation are not the same across the different areas. Taking the countries just mentioned, we see that Year on Year the Gross Domestic Product (GDP) which is a measure of the total output that a country has generated over a year currently stand at 2.30% and 2.20% for Germany and France respectively. The same figures for Greece and Italy currently stand at 1.90% and 1.40% respectively. If we look at inflation rates, German and France are reporting 2.20% and 2% respectively, while Greece and Italy are registering 0% and 1.10% respectively. Looking at an important measure of economic stability, the jobless rate in Germany and France currently stand at 3.40% and 9.20% respectively. At the same time the jobless rate in Greece and Italy are currently 20.80% and 11.20% respectively.

What the above is suggesting is that Germany is in a position where interest rates might need to start going up and the expansionary monetary policy needs to be toned down and possibly reversed slightly. This could also be true for France, however with such a high unemployment rate it may not be desirable to increase interest rates in France as high or as fast as in Germany. With the cases of Greece and Italy, increasing rates is definitely not the ideal situation, especially when considering that these two countries have a debt to GDP rate of 178.60% and 131.80% respectively. This means that the two peripheral countries are heavily indebted and an increase in interest rates would mean the cost of servicing that debt would increase. We even have a divide between Germany and France here as in Germany the debt to GDP rate is as 64.10% while in France it is 97%.

The Bottom Line

In the end it is always difficult to have one monetary authority across many countries which are constantly in such different economic situations. This is also true for the United States for example where the 50 states are not in the same economic condition, yet all are subject to the same Federal Reserve as the main monetary authority in the USA. We will have to wait and see how the situation will play out in Europe. The pressure from tariffs imposed by the USA are expected to affect Germany particularly since it generates a considerable amount of its GDP from exports, notably car exports (think of Volkswagen, Mercedes and BMW for example). The effects of Brexit also still need to be assessed as both Europe and the UK will be affected as a result.

There is one thing that is certain in all this, we are living in interesting times!

KD

(Source of figures:  tradingeconomics.com)

 

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Cost Averaging – A Strategic Tool for Investing into Current Markets

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Cost averaging or as it is better known Dollar Cost Averaging is a technique that can be used in order to ease into an investment and not commit a large amount of money at one go. Not every investor can afford a lump sum investment and at times an investor may be reluctant to invest a substantial amount of money when one is expecting a correction in the markets. This is where the benefit of cost averaging comes in. Given the current market conditions whereby equities appear to be correcting from a 9-year positive run since the 2007-09 financial crisis and interest rates have started to rise in the US and eventually expected to rise in the EU and UK, this technique could be a very useful tool at present for many investors.

The Basics

The idea is simple – an investor decides to invest a fixed amount of money on a regular basis, for example monthly or quarterly. The fixed amount may be a fixed Euro amount or a fixed percentage of one’s salary. The same amount is invested repeatedly over the same time intervals indefinitely or until a particular financial goal is reached.

The preliminary steps are the same as when approaching any investment, one has to set their investment objectives, establish their risk tolerance, agree on a time horizon, calculate an amount one can afford to commit to comfortably and invest into instruments one is familiar with. Hence, one does not simply start buying the first investment that comes to mind on a regular basis indefinitely, but a proper investment plan should first be decided. This is where the help of an experienced investment advisor becomes vital. If one does not have the time and/or expertise to do the initial as well as the on-going research themselves they should always seek the advice of a professional. Remember that small amounts invested on a regular basis will add up and may amount to a significant figure after just a few years. For example, investing €1,000 monthly amounts to €60,000 invested in just 5 years’ time.

The Importance of Re-Balancing

Just because the original plan is to invest ‘x’ amount of money every ‘y’ months indefinitely it does not mean that there are no changes taking place. One important aspect to keep in mind is to rebalance the portfolio as time goes by. Hence, if the initial plan was to have 33% of the money invested into each of 3 asset classes, as time goes by (although the same amount of money would have been invested into each class) the actual market value of each class making up the portfolio could be quite different. For example, if the initial plan was to have 33% invested into US equities, with the balance invested into EUR bonds and EUR shares, and the US equities experience much better growth in price, then the investors’ portfolio would end up having more invested into US equities than originally planned. This could eventually add too much foreign exchange risk for example if the US Dollar had to fall in value versus the EUR. Hence, it is important that from time to time the portfolio is rebalanced. Furthermore, as time goes by one’s investment objectives, risk preferences and time horizon may easily change. Therefore, the portfolio may need to be re-balanced and the initial plan would have to be re-visited from time to time.

The Importance of Cost Analysis

Another important piece of the puzzle required in order to setup and maintain a successful investment plan is to consider costs. Although the cost of buying an equity or an ETF can be low, for example 1%, there is normally a minimum charge to consider. Assuming that the minimum charge of buying an equity or ETF is €25, then unless one invests at least €2,500 in each instalment they would in fact be paying more than 1% per investment payment. Hence, it is vital to decide on a figure one can afford on a regular basis that is also cost effective. For example, if one can afford to set aside €1,000 per month it would be more cost effective to invest €3,000 every quarter than €1,000 per month. Keeping in mind that investments also carry on-going charges such as a management fee to the investment company maintaining one’s plan and/or custody fees for the brokerage firm to hold the investment on its accounts, plus the on-going expenses of funds and ETFs, it becomes even more important to consider the cost aspect in order to determine one’s ideal regular investment amount.

Other Advantages of Cost Averaging

Another advantage of using a cost averaging approach to investing is to instil a sense of saving. By having to commit to the regular instalments, as one would do when paying back a loan for example, one would become more disciplined in setting aside some money for a rainy day or to achieve a particular financial goal. As the investment instalment becomes part of one’s routine, a commitment, it becomes much easier to budget and save money. From research carried out, it is much easier to save money by setting a target of the amount of money one would like to save than to try to save money by trying to limit one’s expenses.  The amount of money committed to saving will automatically not be considered when it comes to deciding on the amount of expenses one can incur that month or that year.

As the name implies cost averaging helps with… cost averaging into an investment. Imagine the following scenario where an investor decides to:

  1. Invest €1,000 per month for a whole year, thus achieving cost averaging
  2. Invest €12,000 at the beginning of the year

Option a is shown in the schedule below:

By investing the €1,000 at the different prices throughout the year the investor accumulates 1,247.001 units which at the end of year have a value of €11 per unit amounting to a total value of 1,247.001 x €11 = €13,717.01. That represents an increase in value of 14.31%. If the same investor has invested the €12,000 at one go in the beginning of the year, that investor would have experienced an increase in value of 10% (since the price per unit increased from €10 to €11 over the year). Hence, through cost averaging this investor was better off by 4.31%.

Application to Today’s Markets

An important point to consider from the above exercise is that cost averaging will be more advantageous if the price of the instrument being invested into falls and the investor manages to purchase more of it at a lower price. If, however the price had to keep increasing, then investing a lump sum would have been more worthwhile. This is why cost averaging is considered to be quite an attractive method of investing given the current market situation.

If we look at equities we see that since the financial crisis that ended in 2009 the S&P 500 (which represents a portfolio of the largest US equities) has been on a steady upward trend. Between March 2009 and January 2018 the index has risen 324.65%, however since that peak until close of business on 12 April 2018 the index fell 7.27%. The reasons have been mainly centered on fears about trade wars between the US and other nations and the increasing interest rates. Hence, if we had to be cost averaging by buying a fixed amount every month in the S&P 500 (example through an ETF) since the beginning of this year we would be better off than if we had bought a lump sum in January.

On the bonds side, the US has already started increasing interest rates and it is expected that they will continue doing so over the coming months/years. Within the UK and EU things are bit slower, especially given the Brexit issue for the UK and the differences between the economic situation in Germany and the peripheral EU countries like Greece, Portugal and Italy. However, it is expected that interest rates will start to rise both in the UK and EU as time goes by and as inflation eventually starts creeping in. The relevance of interest rate expectations on the bond market is due to the fact that if interest rates go up bond price go down. Hence, in a situation that we expect interest rates to go up we also expect bond prices to go down. The big question that is difficult to answer is when this will occur. An option an investor has is to use cost averaging when buying into the fixed income market, so that if prices of the bond or bond fund had to fall the investor would buy at lower prices.

The Bottom Line

If used correctly cost averaging can be a very profitable tool for any investor. It is a method that lowers concentration risk by easing into an investment as opposed to committing a large sum at the outset. Its success will depend on how well the plan is constructed and adhered to and how well the investor considers the key aspects of cost analysis, regular re-balancing and others points covered in this post. As usual nothing in this post should be considered as investment advice and examples used were given for illustrative purposes and not intended as a recommendation to trade them.

Kyle Debono is the founder of FinancebyKD.com, a finance blog set up with the aim of providing financial education and investment ideas. Mr. Debono holds a Masters in Finance (University of London) and is a Business Consultant at Michael Grech Financial Investment Services Ltd. Mr. Debono also offers his services in a non-executive capacity with other investment services entities and is a visiting lecturer at the University of Malta, Banking and Finance Department. The views and opinions expressed in this post are solely those of Mr. Debono and do not necessarily reflect the views and opinions of any entity Mr. Debono is associated with.

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New Look for Finance by KD

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Dear Followers,

I would like to officially introduce you to the new look of Finance by KD. After some careful consideration I have decided to start offering my services on an outsourced basis. With over 10 years experience in the financial services industry in Malta covering various roles, I have decided to branch out into a free-lance/outsourced service, offering the following roles:

  • Non-executive Director
  • Independent Investment Committee Member
  • Compliance & Risk Officer
  • Money Laundering Reporting Officer
  • Company Secretary
  • Governance Consultancy
  • Personalized Staff Training

I have been performing all the above roles, in one form or another, for an amount of years now. Furthermore, I have been approved to perform all the roles that need the Regulator’s approval. Having worked with various entities concurrently I have experience in managing my time efficiently in order to meet required targets and give the best results I can to those who have engaged my services. The added value of hiring someone in my position is that you gain access to someone with a wide array of expertise in different fields, which many a time are quite related and are needed within any entity.

I understand that one may employ someone who has more focused/specific expertise in the various fields I cover, for example a lawyer focused on financial services regulation would be more knowledgeable than myself when it comes to the laws governing this sector. However, such a person would be more focused on the technical side of the role and less so on the practical side of doing business in this sector. Hence, my biggest strength is that I have experience working on both sides of the business – the management and control sides.

Despite focusing my time on these other roles,  I will still remain involved in the investment and portfolio management side of the business. Thus, I plan to continue posting articles relating to investment ideas and education when time permits. I will also however be uploading post related to the other area I am involved in.

To a certain extent my progression into the areas of Governance, Risk and Compliance (GRC) came along unintentionally. Over recent years the requirements in these fields has increased a lot within the financial services industry. Since I have been predominantly engaged with smaller entities throughout my career I have had to deal with various aspects of these fields through my various roles. As many of you know, when working within small and medium sized entities one tends to need to take responsibility of many tasks and not just what was on the job description. To someone like me who relishes the chance of learning new things and gets bored easily with the status quo this has lead me to gain expertise in different areas.

In reality, there are many similarities when it comes to analyzing an investment for a client (Investment Advice/Analysis and Portfolio Management) and being part of the GRC side of the business. All these areas involve getting to know the entity well enough to assess where the strengths, weaknesses, opportunities and threats lie. When it comes to investing your end decision would be whether or not the investment is worthwhile from a risk-reward perspective and how it fits into your overall portfolio, objectives and financial constraints. When it comes to GRC your end decisions will be on how to lower/manage the risk side and increase the reward side of the business in order for it to be more worthwhile for the owners of the entity and the other stakeholders. So the basic issue is always about analyzing the risk-reward trade off within the different contexts.

Hence, if you or someone you know are looking for an experienced individual to fill any of the roles I offer or would like to discuss anything related to these fields please feel free to contact me by email on kyle@financebykd.com, on Mobile (also through WhatsApp & Telegram): (356) 7985 1810, Skype: kyle.debono or LinkedIn

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How Regulation is Shaping the Technological Revolution in Finance

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We hear a lot nowadays about how Artificial Intelligence (AI), algorithmic trading, robo-advisors, blockchain and other technologies are shaping how investment services firms operate and even how investments are structured. There is no doubt that technology has had a considerable effect on virtually every industry and that new technologies will continue to develop and cause change and disruption to the “old way of doing things”. When it come to the financial services industry however, which is a highly-regulated industry for obvious reasons, one must keep in mind how the regulations will directly or (sometimes more importantly) indirectly allow the technology to operate.

You can have the best technology in the world, capable of reducing costs drastically, of improving productivity to new heights and capable of presenting the best returns for clients consistently – but you must never underestimate the restraints of regulation. Unfortunately, as more and more regulation is developed we see the concept of proportionality always decreasing and in some instances non-existent. Thus, if a start-up has managed to develop the best investment idea using the best technologically advanced method, but fails to get the regulatory approval to operate – it is essentially useless.

Getting Licensed

Some countries like the UK, the USA, Switzerland, Dubai and Australia have tried to bridge this gap by offering what is known as a “regulatory sandbox”. These initiatives aim to give a space where financial firms or more specifically Fintech firms can test their innovations in a less restrictive regulatory environment for a limited period. Although the initiatives a very good step, one should keep in mind the fact that once such companies would like to fully open-up for business they would still need to abide by the regulations just as other companies would. The initiative helps on the front of getting licensed and developing in a way that will get the entity compliant in a more efficient manner, however getting licensed is not the end of the process, but the beginning. Financial companies are subject to capital requirements, on-going monitoring, risk-management, internal audit requirements and must also abide by other regulations besides the ones directly applying to finance.

Beyond the Initial License

From a capital requirement perspective, the current situation is that a 3-person start-up has to abide by the same capital requirements of a multinational firm that holds the same type of license. There has been an initiative from the EU front to try to make a distinction between the systemically important entities and the smaller firms that pose a much lower market risk, however there have been no conclusive results yet and it could take years to ever get to a workable solution. An important feature of the capital requirements of such firms which is particularly punitive on Fintech and other technologically centred firms is the fact that intangible assets are deducted from the capital base of a company. For capital requirement purposes, the fact that firm has a highly valuable asset in the software and goodwill it has created through its technological advancement is actually penalised. This is a clear example of how regulation is going against the technological advancement of the financial sector.

Another factor to consider is that financial regulation is just one piece of the puzzle. Entities and individuals operating in the industry must also abide by other regulations. One source that continues to grow in importance is the tax regulation. Pressure is always growing for more substance, more tax reporting, more client details – these all add up to more costs. If a start-up fails to factor in these costs it could become insolvent due to the higher ‘un-exepected’ costs.

The Bottom Line

In conclusion, it is safe to say that regulation is having an effect on how the financial services industry can develop. Although certain technological advances are here to stay and will continue to develop as the years go by, their disruption to the more traditional way of doing things is severely hampered by the initial and ongoing regulatory requirements. Thus, the regulatory environment is a very important area to focus on for countries that would like to see the development of their financial industry embrace the technological advancements and take advantage of them. Only once this is done will we ever see the true potential of the Fintech revolution. This is not to say that regulation needs to be lax and more self-regulation is needed, however a more adaptive system is definitely a requirement. The system needs to still incorporate the basic overriding aim of safeguarding stakeholders, most importantly the clients. However, it must be adaptive enough to regulate different entities differently on a risk-based approach and in a proportional manner.

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Beyond Malta’s Financial Services Industry

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There has been a lot of news lately concerning the whole #MaltaFiles incident with a number of journalists, bloggers, industry experts and others covering this topic. I do not wish to get into the merits of the whole case but would like to highlight the strategic timing of the whole incident just as the country is in election mode and following the #PanamaPapers and corruption allegation at the highest level of governance of our country.

There is no arguing that our country has suffered a reputational blow over all these incidents. Regardless of one’s political views and who one blames for all this, the fact of the matter is that we are all affected by these incidents and we all must act collectively to restore our reputation.

With this post my main aim is to show how all industries are affected by our reputational damage and this is not simply something that has to do with the financial services industry in isolation.

The Multiplier Effect

First of all it is important to recognise the interconnection of industries and the multiplier effect that an industry has on the whole economy. If we take the financial services industry, one may read how it makes up around 15% of Malta’s Gross Domestic Product (GDP) – this means that statistically the income generated by this industry is roughly 15% of all income generated by Malta’s economy. That is just the direct effect – it is estimated that the indirect effect can raise the financial services industry’s contribution to GDP to as high as 30%.

But How?

Easy – think of the residential rental income and properties bought by foreigners working in this industry. Think of the commercial premises bought or rented by companies and practitioners working in this industry. Think of the money that clients and promoters of this industry spend on dining and subsequent personal holidays to Malta. Think of the people who have relocated to Malta entirely and the amounts they contribute across the board to our economy through their spending. The cars they rent to get around or the taxis they hire while visiting, the flights they pay for and accommodation they take up while here.

Not Just Financial Services

It is also very important to keep in mind that the country’s reputation has a direct effect not just on the financial services industry but on any industry that is in some way or another linked to foreign direct investment. So this will include the manufacturing industry, the export and tourism industry, the meetings and conferencing industry, the software development and IT network servicing industry, the gaming industry and so forth. In turn, all these industries have a multiplier effect on the economy. What this means is that even the store keeper of a hotel, the maintenance man of a manufacturing company (like the large semiconductor manufacturer in Kirkop), the checkout person at the supermarket, the cleaning staff of a restaurant and so many other jobs are all affected.

One must also keep in mind the large amount of direct and indirect taxes employees and owners of these entities pay. Thanks to the collective contribution, Malta is boasting a budget surplus, low unemployment and a growing economy. These things do not develop following a short term initiative but are the fruits of medium to long term collective efforts. As many will appreciate, reputation is something that takes years to build but days to ruin. Thus, in these challenging times it is of the utmost importance to give this matter serious recognition and devote all necessary resources to maintain our good name.

The Government’s Role

Although it is true that the government of the day has a bearing on the overall progress of the country and its reputation we must not fool ourselves by thinking that it is solely the government’s role to do so. The private sector has to be proactive at its own initiative to safe guard the name and reputation of our country. One has to see beyond the political noise and mudslinging that only benefits the few and not the many. Regardless of one’s political views, having a situation where the Police Commissioner, the Attorney General, the Financial Intelligence Analysis Unit (FIAU), the Malta Financial Services Authority (MFSA) and other high ranking institutions, as well as the rule of law itself, coming into question, is highly unacceptable. Whoever is in power after June the 3rd should give this the utmost importance and work with industry experts (from the many different industries) in order to have a public-private initiative that can truly benefit the whole economy.

The Bottom Line

It must be recognised that as a country we are constantly in competition with other jurisdictions. If Germany can attract a company to open shop or expand its operation in Germany, then it will do its utmost to attract such business. To whine and complain that other jurisdictions are targeting us and playing dirty is futile. It is a competition, so one must expect the other players to be competitive and use whatever opportunity they get to make us look bad and make themselves look good. Of course this does not mean that we just sit back and accept whatever is thrown at us. We must be prepared for the competition and have strategic plans to defend our name. The current political scenario is putting us at a disadvantage for sure, but every country goes through political issues and no political system will ever be free from its drawbacks.

The upcoming general election has made the situation worse by increasing the political barrage and giving more ammunition to our competition who seek to portray us as an offshore country with shady practices. I will however end on a positive note, we all know that the allegations against us in relation to Malta being an offshore financial centre are untrue and hence we can defend our good name with the truth and with facts. Governance issues can be rectified by replacing the people who have caused the issues and the country’s reputation can be restored. One powerful tool all citizens have is their vote and they must use this tool in a conscientious way to choose the party and political representatives that they feel can best help us on our mission to continue developing our economy and restore our good name.

KD

Alternative Investment, Equities, Other

Attracting FinTech and other new Business Models to Malta

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There has been a lot of hype over the last years to attract new types of businesses to Malta such as the FinTech (Financial Technology), WealthTech (Wealth Management using Technology), Algo-trades (investing using algorithms) and more recently Investment-based Crowdfunding Platforms. Rightly so, entities such as FinanceMalta have held several seminars and initiatives to attract these types of business and in fact their 2017 annual conference will be focusing on this theme.

Through this post I would like to give a brief description of these types of entities and to also provide some thoughts on the factors which could deter these types of entities from seeking to be registered in Malta. From personal experience of being involved in a start-up Fin-tech, Wealth-Tech and Algo-trading company Novofina I would like to shed some light on the difficulties faced in attaining a suitable license and remaining compliant to rules and regulations which are based on a one size and one type fits all regime.

FinTech/WealthTech/Algo-Trading

FinTech can describe any financial services entity that uses technology to perform its service or offer its products. The technological innovation can be applied in different parts of the process from research, retail banking, investment selection and even crypto-currencies such as bitcoin. Technologies can include things like Artificial Intelligence (AI) that could be applied to investment instruments selection or to research gathering for estimating market sentiment for example.

Originally FinTech referred to technological innovations applied to the back office of banks and investment firms, nowadays it refers to a wider variety of technological interventions in the retail and institutional markets. The level of technology used varies depending on the type of company and the services it seeks to offer. It can range from mobile wallet systems to robo-advisor services. Even within a category of firm types the technologies applied can be wide ranging. For example, if we take the robo-advisory firms, you could have companies that simply use online data entered by the client to determine their risk profile, financial bearability and knowledge and experience in order to offer a bundled Exchanged Trade Fund (ETF) solution. You can also have so called forth-generation robo-advisors that use algorithm based trading in combination with AI in order to trade different investment strategies on behalf of clients.

An Algo-trader would use a mathematical algorithm that would be pre-programmed with certain rules in order to trade large amounts of instruments (example shares) on the market. The algorithm would be programmed to trade a particular trading strategy and configured in a specific way relating to price, position sizing, timing and risk-mitigating techniques. Thus, not all robo-advisors are the same and even more so not all FinTech or WealthTech firms are the same. This makes it even more difficult to fit into the local financial services regulatory framework and categories of licenses.

Investment-Based Crowdfunding

Crowdfunding, as the name suggests involves the process of gathering a lot of small amounts from a lot of people in order to collectively raise a larger amount. This can range from a simple project such as raising the funds to finance the publication of a book to more complex issues such as using the funds to invest into a new FinTech start-up through an equity stake. So far in Malta investment-based crowdfunding is not really possible since the current regulatory framework dose not really provide for this form of investment. However, we have seen some progress here with a donations-based crowdfunding initiative being launched that raises money against donations and can give back certain perks. There has also been a consultation paper issued by the regulator late last year which period had closed in March 2017. So we are beginning to see some progress here. A very interesting article for anyone looking to find more information on investment-based crowd funding can be found on the latest publication of the Malta Business Bureau here.

Barriers to Entry and Operate

It is a great initiative to attract the most technologically advanced financial services companies to Malta. However, there are certain issues that are hindering their entry and once operative, their operational viability. One of the largest barriers is the regulatory issue. Our current regulatory framework was not designed for these technologically advanced firms and the current situation is that these firms either fit themselves into an existing license category or else they are not welcomed. This is a major issue since it could be forcing firms to have in place certain items which are not applicable to their business model, are costly to maintain and would lead to deterring a potential newcomer from setting up shop in Malta.

To put it more simply, if a FinTech company would like to attain a license to provide services A B and C, why does it still have to apply for a license that caters for services A to G? Although there is some flexibility in the license application process and certain derogations may be applied it is still far from being an attractive preposition balancing investor protection and the reputation of the local financial services industry on one side and attracting the right players that could take the Maltese financial sector to a whole new level attracting cutting edge, niche market firms. On the other hand, the current regulatory framework may present certain loopholes for certain types of FinTech companies since the current regulatory requirements may not fully appreciate the different risks such firms pose to investors and the financial sector in general which could be quite different compared to more traditional financial services entities. Having said that, risk management has taken a much more prominent role nowadays.

With respect to the ongoing obligations of such entities once they have been licensed it is not logical that their capital requirements should be the same as those of other more traditional firms. To put it simply, certain investment services providers are subject not only to minimum initial capital requirements but also to on-going minimum capital requirements. This capital requirement is not simply a calculation of asset less liabilities, but involved certain amendments to arrive at the regulatory capital requirement. One of the deductions from an entity’s capital figure is its intangible assets figure in its balance sheet. Given that FinTech, WealthTech, Algo-Traders, Robo-Advisors and all the rest of these firms invest heavily in software and licensing of such software, and software is an intangible asset, they are currently being penalised for doing so. So on the one hand we want to attract the most technologically advanced firms and on the other hand we are telling them that their software is worth nothing and must be deducted from their capital. To be clear, this is not simply imposed by the local regulator but comes out of the EU Capital Requirement Directive. Simply blaming the EU legislation is not a solution however and when it comes to these technologically advanced firms it is even more so that we are not simply competing just with other EU countries but the whole world. Being online based makes it even easier to setup anywhere in the world with a decent internet connection.

Another problem we are facing locally is the shortage of talent. The gaming industry has brought many benefits to Malta, however it has also created a shortage in IT developers. Administrative staff is also becoming a problem for some firms, especially since most FinTech firms are start-ups and thus have a higher risk of going bust compared to the larger players in the industry. Another problem I see locally is the lack of promotion and support for being an entrepreneur. This last obstacle may the most difficult to overcome since it could be considered a cultural issue. However, with proper incentives and moral support from a young age there is no reason why we cannot produce more students who desire to become business owners. Interestingly enough, investment-based crowdfunding could be a very good avenue where such budding entrepreneurs could find funding to start off their project until they get to a level where other sources of finance could become available to them.

The Bottom Line 

All-in-all I truly believe that Malta has the potential to become a major player in the FinTech arena. It has already proved itself in the fund industry and the online gaming industry for example and there is no reason why a market for FinTech and other technology based financial services firms should not also be successful. However, to reach such a realisation there must be more support and initiatives for such firms to choose Malta. Some barriers like certain regulatory issues are not entirely under our control. However, if our regulator decides to gold plate an EU directive this would hurt our chances of attaining success in this sector. One such example that comes to mind is the “holding and controlling” of clients’ money requirement locally, when the EU directive speaks only of “holding” clients’ money.

KD

The views expressed are the personal opinion of the writer and do not necessarily reflect the opinion of any entity the author is associated with.

Other

Algorithmic Systems Trading – The Modern way of Trading

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Algorithmic Systems Trading is sometimes confused with some impossible to understand formula that is too complicate to trust. In reality it is just a fancy way of describing the combination of trading using the advantages of computers, mathematics and statistics. It is a scientific approach to investing based on technical analysis and is typically characterised by many trades held for short periods of a few days. Thus, using what is called the law of large numbers, enough wining trades will end up outweighing the losing trades leading to a positive return for investors.

Is this high level of trading available to everyone?

An initial concern investors may have is that this type of high-end investing would only be available to high net worth clients having millions to invest. In reality companies like Novofina which are so called FinTech (Financial Technology) and WealthTech (Wealth Management through Technology) companies make this type of investing available to investors willing to allocate at least €30,000. These sort of companies are bringing high-end investing previously reserved just for elite clients to the retail space.

Novofina, which is licensed by the Malta Financial Services Authority, applies algorithmic systems trading to investing in US large capital stocks, the so called blue chip companies. These are the largest companies quoted on the US stock markets, companies like Amazon, McDonalds, Apple, Exxon Mobil and the like. The company combines different systems that trade based on different criteria such as stochastic systems, Bollinger bands and other technical analysis schools. It combines these different strategies to make up its two main products which clients can invest into. So as opposed to trying to invest on their own based on some gut feeling or long term expectation that may never come to fruition clients get access to cutting-edge computer based equity selection. Best of all the systems operate on their own without the need for client intervention except to decide on how much to invest and what level of risk they are prepared to take on.

Is this a get rich quick scheme?!

Definitely not. Investing in shares has historically been the best form of investment time and time again. However, it is still a long term investment for clients having a minimum 5-year investment horizon. Looking at the returns on equities versus bonds (gilts) versus retail prices between 1899 and 2011 (thus including the great depression, the world war periods and the 2007/09 financial crisis), as reported by Barclays Bank, it is clear how much better off equity investments are over the long term:

By investing smartly into the equity market using such systems employed by Novofina you will not turn €50,000 into €500,000 within a year. That sort of return is not sustainable and would be too risky to attempt to achieve in a short period of time. Nonetheless, turning €50,000 into €500,000 over a ten year period for example is very much possible. This is particularly interesting given the current interest rate scenario whereby we are finally starting to see central banks increase interest rates following a prolonged period of virtually 0% rates. Keeping in mind that prices of bonds move inversely to interest rates, should there be an indication that the European Central Bank could be increasing its base rate all local bonds (especially the longer dates ones) would suffer a fall in price. We have already started to see some “risk-on” movement with the prices of Government Bonds across the EU countries falling in price. This appears to be happening due to an improved appetite for risk whereby investors are selling their government bonds and opting for investments that are perceived to be riskier, such as shares.

Therefore, considering a shift into an equity based investment such as the algorithmic systems based products mentioned in this post could prove to be a well-timed investment decision. Adding equities to one’s portfolio has been proven historically to offer a better balance and overall higher average return. By doing it wisely, using statistically proven methods which are objective as opposed to a human traders’ subjective tendencies, one has a better chance of managing the downside and benefitting from the upside.

The Bottom Line

Algorithmic systems trading is nothing to fear and is based totally on statistical real returns. It is considered by many to be the best investment method available since it uses the latest stock-selection methods which consider many important characteristics of trading successfully such as entry points, profit targets, maximum holding periods and batch sizes. Combining all this and achieving lower risk through diversification of the investment portfolio should prove to be a long term winning formula for any investor. Best of all, such products are already available locally through Novofina starting from a low minimum investment of €30,000.

* This post was issued by Kyle Debono, Managing Director and Portfolio Manager at Novofina Ltd. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Novofina Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this link. Please refer to usual general disclaimer here.

General, Historical Financial Events, Other

Non-Performing Loans – an EU perspective

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The bread and butter of a traditional bank is the provision of loans. Although banks have reduced their dependency on this main source of income by branching out into other fields of the financial services world, the creation of loans is still a very important economic service. These loans are granted to households, business and to other banks, can be short or long term in nature, having a fixed, flexible or no interest rate and will be subject to different assurances such as collateral.

What is common between all loans is that they all carry a risk – the most basic of which is the risk that the loans become bad-debts or non-performing because the person or entity that took the loan can no longer service it. Non-performing loans will always be a problem for all banks since no model can ever cover all the risk involved and from time to time some borrowers will inevitably be faced with situations that were thought unlikely to happen.

From a regulatory point of view, a loan becomes a non-performing loan once more than 90 days elapse without the borrower paying the agreed instalments. Sometimes the banks can manage to agree new terms with such borrowers but at other times the bank would simply have to write off the loans and try to collect on the collateral and guarantees it would have secured before granting the loan. Banks also have the option of selling off the loans, but this will be at a discount and is dependent on finding someone to take on that debt.

What is the cost of non-performing loans?

It should be kept in mind that the cost of non-performing loans is a direct burden on the bank but an indirect burden on potential borrowers. As a bank is faced with more and more non-performing loans it would inevitably have to tighten credit and thus lend out less money. It must do this since its profits will start getting eaten away by the cost of managing the non-performing loans. Although loans are an asset for a bank they also come at a cost. The cost is not just the opportunity cost of using the same money for a different venture, but also the regulatory cost of keeping the loan on its books.

Therefore, as the number of non-performing loans rises the greater economy will suffer as loans become more expensive and less available. The expense could be in the form of higher interest rates, higher requirements for collateral and more stringent terms for the borrowers. As these factors come into play it would automatically become more difficult to obtain credit from a bank and thus some people and entities will be rejected for a loan. As credit becomes more difficult to obtain businesses will invest less and private individuals will take on less projects. So the effect on the whole economy is multiplied since less work is generated.

How do EU countries compare on Non-Performing Loans?

The below chart depicts the amount of non-performing loans as a percentage of total loans for the EU countries as at March 2016:

npl-mar2016
As expected the countries with the biggest economic problems have the highest percentage of non-performing loans. Countries like Cyprus which experienced a banking sector crises in 2012/13 and the so called PIIGS (Portugal, Ireland, Italy, Greece & Spain).

If we focus on the worst two countries (Greece and Cyprus) we can see that almost half the loans that have been issued are not being serviced. This of course is a very worrying situation for these two countries which is very difficult to get out of. These two countries are quite apart from the rest of the pack with the next worst country having a percentage of around 20%, which is still worrying. Ireland has started to improve as an economy but the percentage of non-performing loans is still quite high at around 15%. Having said that, the figure has gone down from the 20% registered in September 2015. Malta is sitting around mid-table, however it is worrying to see that over a period of 6 months the figure went up from 3.7% to 6.8%.

The below figure shows the same rates 6 months earlier as at September 2015:

npl

The Bottom Line

Non-Performing loans are an indicator of economic health. The higher the percentage of such loans to total loans the more difficult and more expensive it is to obtain loans. This has a ripple effect on the economy as less investment and private consumption is registered. This is why the regulators place great emphasis on the measurement and management of these loans. Supervisors monitor the overall level of non-performing loans across euro area banks. They also check whether individual banks adequately manage the riskiness of their loans and if they have appropriate strategies, governance structures and processes in place. This is part of the common supervisory review and evaluation process (SREP) that is carried out for each significant bank every year. Furthermore, the European Central Bank regularly carries out coordinated exercises to review the asset quality of the banks it directly supervises.

KD

Legal, Other

MLRO: Friend or Foe?

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Money Laundering

A Money Laundering Reporting Officer (MLRO) is responsible to ensure that the company they work for is compliant on aspects of Anti Money Laundering (AML) and Countering the Financing of Terrorism (CFT). Having just attended a 2 day seminar on AML, which for a change was not a total waste of time, I was inspired to write a post on the position of an MLRO. A person occupying this role can be considered as both a great friend and a great enemy by their colleagues.

Friend

The friend part comes from the point of view that a good MLRO will ensure that the business is abiding by the AML laws and regulations. Besides meaning that the entity would be compliant, it also means that the business is not taking on any unnecessary business risks. An effective MLRO would have in place robust systems and procedures to ensure the entity they are working with is covered from all angles. This involves detailed written procedures that everyone in the organisation is made well aware of. It is useless to have the best system possible for your particular business but then the people who have client contact are not made aware of the system. Thus, regular and effective internal training is necessary in order for the MLRO to explain to the people working in the organisation about their duties and responsibilities from an AML point of view.

In order to have an effective system the MLRO has to be approachable and people have to be made aware of who the MLRO actually is. Although the MLRO must be a senior officer within the company, they cannot be just sitting in a head office with nobody on the ground floor knowing who they are. Also, simply sending an email with the company’s AML manual or giving an employee a copy of such manual is not enough. Most people would simply ignore it or read it once and just dismiss it. So the MLRO must find a way to get people interested in the work they do and get them to understand its importance.

An easy way to do this is to simply explain how an AML breach could be detrimental to the person’s job and the whole organisation’s existence. The fine that the entity might receive if it is in breach of AML rules and regulations is just one aspect – the reputational risk of the entity could perhaps be the largest risk factor. So if colleagues see their MLRO as the one who helps them stay in check and avoid costly risks they will see them as a friend.

Foe

Of course, like with anything to do with compliance it is much more common to look at the MLRO as the enemy. From the point of view of directors and shareholders the MLRO, like the Compliance Officer could easily be regarded as being an extra expense that causes more expenses and disruption of potential business. While senior management might want to take on a risky client and try to justify the risk-reward trade off of doing so, the MLRO would be the person to highlight the risk part and perhaps seen as exaggerating this aspect.

From the point of view of the people who are actually in contact with clients the MLRO could be the one that would bar them from pursuing certain potentially lucrative client accounts. They could also look at the MLRO as the person who is forcing them to get a stack of useless paperwork on a client that they have known for years that could cause the business to lose such a client.

To be fair certain MLROs do not make it easy on themselves and tend to be too strict and annoying in their pursuit of carrying out their duties. Just because an MLRO needs to be sure that absolutely everyone is covering all aspects of the AML rules it does not mean that they should be policing their colleagues in an antagonising and perverse manner. If people see their MLRO as the enemy the system will not work effectively and mistakes and oversights would be inevitable.

Furthermore, if an MLRO is over-reaching and going over and above the requirements then they would definitely be seen as the enemy. Over stepping and being extra safe is also bad for business. No profits can be made without certain risks and if an MLRO is holding back business due to over-reaching and trying to be holier than the Pope, then it will ultimately back fire through loss of good business. I am a great opponent of over-regulation, which can be either brought upon by regulators or by the people who are in charge of enforcing the regulation within organisations.

Finding a Balance

The key is to finding a balance. Unfortunately being seen as an enemy and a necessary evil that comes with the job. The MLRO must recognise that it is not his/her responsibility to decide what degree of risk a company would like to take. That decision remains always at the discretion of the directors who are responsible for the overall direction of the business. However it is the MLROs job to notify top management about the risks involved from an AML perspective and to work with them to develop the best working environment.

A very interesting exercise that was undertaken during the seminar I recently attended was to divide participants into groups and work on a case study. The case study involved coming up with a scheme on how to launder €150Mln for a multi-national consortium. The beauty of the exercise was that it put people who are responsible for counteracting money laundering on the other side of the situation. The game helps one appreciate the level of complexity that is needed and the mind frame that launderers would be in. It ultimately will help in finding loopholes in the system of the company that each participant works in. So the exercise helps people learn by putting themselves in their counterparty’s situation. I believe this is an interesting and effective method that an MLRO could use in getting the AML message across to people.

Does the Regulator play a Role?

The Malta Financial Services Authority (MFSA) and the Financial Intelligence Analysis Unit (FIAU) are the regulators that authorise and monitor the work of MLROs. Do they have a role to play in the effectiveness of the work of the MLRO? The simple answer is yes, but one must not end up “depending” on the regulator to do something. Although there is a requirement for the MLRO to present an annual report to the FIAU which also includes training received and conducted there is no specification of what is actually required. So in November and December it is a common practice to see many AML “training” programs which would suffice for the purposes of filling in the MLRO training requirements.

Of course one can argue that from year to year they would still remember the laws and regulations and if there are new ones they can easily read up on them on their own. With this I agree 100% and find the “training” courses that simply go through the legislation as utterly boring and useless. In my view, it would make much more sense if the training required involved something more. Something with practical examples, case studies and something that is more interesting than watching paint dry on a humid day! It would make sense to use practical examples that have actually happened locally and training has to be targeted depending on the type of business. An MLRO of a bank has a totally different situation compared to an MLRO of an investment service company or and MLRO of a real estate agency. So having group training sessions is definitely not the ideal setting.

The Bottom Line

Whether we like them or not the MLROs do play an important role in the organisation. There is no secret formula that works for every organisation, but each MLRO has to adopt a risk-based approach to cover the issues that affect their organisation. Undoubtedly the MLRO needs to understand their organisation very well and they need to identify the weaknesses that exist from an AML perspective. However this is not enough, any system and procedures they develop are only as good as far as how they are implemented. Thus, MLROs need to find a way to monitor and incentivise the people with client dealings and transaction processing so that they actually implement the AML measures.

KD