All posts by KD

Our Financial Services Industry and More

April 18, 2016 KD 1 Comment

In my writings I intentionally try to avoid any references to political issues since for many years it seems that both parties had been working in tandem towards the improvement of our financial services industry. They have more or less always agreed on the major issues and both use the industry as an example to boast how successful they were at aiding and developing it. I have also avoided the issue since the main aim of this blog is to provide insights and educational notes based on facts while trying to avoid simply expressing opinions without basing them on facts. I respect everyone’s beliefs and opinions and I try to use my writing to better one’s understanding of investments and the industry in general.

However, the continued saga that has taken over the local media outlets this year has directly affected the industry I operate in and I cannot avoid pointing out a few facts that everyone should be keeping in mind. It has become even more apparent to me how little politicians know about how this industry works and how competitive it is. Through irresponsible and sometime immature antics, many a time presented through social media (of course), it is shocking to see how short sighted both parties are acting when it comes to this very important industry.

Proper use of Social Media

I understand that we are all human and we all make mistakes. No one is an expert in every field and sometimes people are ill advised and they unconsciously take the bad advice and think that they are doing the right thing. But then I also believe that people who are ministers, have a doctorate and/or are part of respected professions have common sense. For example, if you have an issue with the person who is the head of the regulatory body that supervises and regulates all entities involved in the financial services sector in Malta – I do not think you should express such issues through a social media post. Do not get me wrong, it is important to scrutinise everyone and to make it clear that everyone will be held accountable for their actions. However, when every foreign investor who is involved in any type of investment services business has to deal with the entity which that person oversees – it is not the best idea to attack him personally and so publically.

When I said that the financial services industry is a very competitive one I was mainly referring to the international competition that exists between the many jurisdictions which try to attract business to themselves. Publicly questioning the integrity of the head of the regulatory authority in this sector on social media is very irresponsible and petty. There are many other better avenues to address any concerns one may have that do not put our whole jurisdiction into a negative light.

Stop blaming others for your mistakes/short sightedness

Every member of parliament (MP) knows that they have to declare their assets publically. This in itself is a good thing that ensures that such MPs should think twice when it comes to their financial dealings since they know that they have to make their financial dealings public on a regular basis. If someone does not agree with this point or would rather not make their financial affairs public, then why would they become an MP at all I would ask? Everyone’s privacy should be respected and everyone is free to decide for themselves if they want to join the public domain and enter politics. However, you cannot try and play both sides. So if one had taken the decision to become an MP such person should have more common sense when it comes to their financial affairs. Blaming other people or entities for bad advice is not an excuse for taking bad decisions which one should have known would look dubious once they became public – even if they were doing nothing wrong.

Moreover, and what is most important to our industry, one must weigh the cost of their actions on the country they have decided to serve. If you are a public figure all your actions will have an effect on the public you are serving. So someone occupying such a position should always keep in mind the bigger picture and what is really at stake. Some people may well be surprised to know that certain foreign investors still think of Malta as an offshore centre with dubious setups. Anyone of these foreigners who has actually tried opening a company locally in the financial services sector would quickly realise that this is not the case. Sadly, however we are still battling this misconception. So having politicians publicly attack each other for one or the other’s mismanagement of their financial affairs is simply harming our reputation an increasing the misconception that some investors have.

Beware of the Power of the News

We live in a world where social media and the internet at large have made information available in seconds. If one had to search for Malta in the news online I am sure they would not be finding a very attractive jurisdiction to invest in at the moment. It is truly a shame that such an important industry that contributes so much to our local economy is being dragged into the political pettiness by both parties.

While it is important to hold people accountable, by organising public demonstrations and coming out with headlines aimed at scaring people into turning against one political party or another does nothing to help our industry. It may be surprising to some, but believe it or not we do not operate in a vacuum, Malta is not the centre of the world and we are in competition with much larger countries who might also have a better reputation. So having the two main political parties mud-sling each other is only benefitting their individual political aspirations and not our economy.

The Bottom Line

At the end of the day we are all trying to be better off on a personal level and an element of greed will always exist. I do believe that to a certain extent greed is a good thing since it motivates people to become better at what they do. However, one also has to keep in mind the bigger picture and not give into the temptation of short term benefits. If the industry does well there is a much better chance that you will do well, even if you are not directly employed in the financial services industry. All industries are to some extent or another interconnected to the financial services industry which encompasses many branches of finance including, but not limited to banking, insurance, investments and accounting.

Fixed Income

BOV Fails to Fully Subscribe its Subordinated Notes – No Surprise!

March 27, 2016 KD Leave a comment

Back in October 2015 Bank of Valletta Plc (“BOV”) had obtained approval from the listing authority to raise up to €150mln (or its currency equivalent) from a debt issuance programme. BOV has until October 2016 to raise this money based on the current approval and be the end of last year it had already raised half the amount (€75mln) through the first issue of 3.50% Subordinate Notes maturing in 2030. This month however, BOV attempted to raise a further €50mln of the same bonds and only managed to raise €35.59mln, representing a take up of around 73%. Should we be surprised by the fact that Malta’s largest bank has failed to fully subscribe its bond issue – not really!

I would like to start by referring to a previous post that I published back in November 2015 when BOV had issued the first lot of these bonds. In this post I had explained how EU banks where being forced to add a bail-in clause to any debt that they would like to issue if they would like such debt to be considered as part of their Tier 2 Capital. What this means is that if there is a situation where BOV is facing financial difficulties and requires a bail-in these bonds can be either written down or converted into common equity (shares). The idea was created in light of the difficulties faced by banks in the 2007/08 crisis which had to be bailed-out by the tax payer. We have already seen the mechanism of a bail-in work with the case of Cyprus a few years ago and it was not pretty.

Why the issue was not fully subscribed

It is important to point out that the failure to fully subscribe the issue is not due to the default risk of BOV. When we talk about risk we must keep in mind that there are many different types of risks and default risk (the risk that an issuer defaults on its obligation to pay back the bond) is only one type of risk. To understand why this issue failed we must discuss a bit further the issue itself to understand better the real risks involved which were mainly relating to liquidity, maturity and interest rate risk.

In my previous post relating to these notes I had explained how the bond was issued in two tranches and I had gone into detail about the features of the two tranches. In a nut shell, since these notes have this bail-in clause they are classified as complex products. As a result, the listing authority had imposed on BOV that certain measures be taken to safeguard investors, more specifically to safeguard the smaller retail investors. The restrictions were that Tranche 1 could only be sold with a minimum of 25,000 nominal and had to be accompanied by an appropriateness test while Tranche 2 had to be sold with a minimum of 5,000 and had to be sold following a full suitability test. This created a situation where investment service providers wishing to sell these notes were being asked to take on a considerable amount of responsibility for selling this bond – some may argue that the listing authority was being overly cautious.

Liquidity Risk

One of the first issues with these restrictions was the liquidity restrictions that were created. What I am referring to here is the ability to sell or buy these bonds on the market after they are issued. In normal cases it would not be difficult to sell an amount of 25,000 bonds on the market, but in reality when you sell on the market it is normally the case that the 25,000 you would have sold would have been bought in an amount of smaller lots. So for example investor 1 bought 5,000, investors 2 bought 10,000, investor 3 bought 2,500, and so on. Since Tranche 1 of these notes have to be traded with minimum of 25,000 this has severely restricted the chance of trading them on the market.

With respect to Tranche 2 the minimum is more manageable, but they come with a lot of onus on investment service providers whereby essentially these notes need to be sold ‘with advice’. This means that the investment service provider is advising the client to buy a long dated (15 year) bond that is fixed at 3.50% and which they know would be difficult to sell out of. Furthermore, the regulator had contacted the investment service providers specifically on the issue of these notes to warn them about the responsibilities that they would be taking on if they sold these notes.

Thus, as a result of the illiquidity of the issue, after the first batch of €75mln were issued they actually went down in value below the €100 mark they were issued at with barely any trading taking place. This applied for both tranches

Maturity and Interest Rate Risk

These two risks are interrelated and I will be discussing them concurrently. Due to the fact that the notes have a life of around 15 years this creates a maturity risk since they are long dated. This, coupled with the liquidity risk explained above means that investors may well be stuck with these bonds until maturity and they would not be able to sell them off easily before maturity. Now let us consider the 3.50% interest rate. Given the current interest rate scenario and comparable bonds on the international markets one may argue that the 3.50% is competitive with other similar fixed income investments. This, in my opinion, is a naïve perspective since this bond has to be compared with an illiquid fixed income investment maturing in 2030 and not with an international bond that can easily be traded!

Therefore, when you consider all the above risks and feature of these bonds it is not surprising that BOV failed to raise the full amount they issued in this second round. As I had stated when they issued their first batch – 3.50% is not worth the risks involved with this issue! The bank tried to take advantage of the low interest rate scenario and tie in investors until 2030 at a low interest rate and it did not work.

What Now?

So now we are in a situation where BOV has raised around €111.6mln form its total of €150mln, meaning that it has €38.4mln left to raise by October of this year. Technically they do not need to issue any more notes since the €150mln was a maximum amount they could issue, so they could discontinue the €150mln programme. But this still leaves a shortfall since the bank, like all the other banks, is continuously subject to tighter capital controls and thus still needs to continue raising more capital. Furthermore, BOV has bonds maturing in next 4 years, which across 4 issues total to €215.4mln.

In a statement made to the Times of Malta the Bank’s management has said that it will explore the possibility of selling the bond to institutional investors abroad – it will be interesting to see if they keep the terms the same for these institution investors. Will the bank be approaching fund managers or other regulated entities such as other banks and insurance companies? This would be a tricky thing for these entities since we are talking about an illiquid, unrated, subordinated bond issued by a Maltese bank and subject a bail-in clause.

So what other options could BOV consider for future capital raising?

· Issuing more notes – increasing the coupon

Let us consider the option that BOV decides to go ahead and attempt to keep issuing more subordinated notes with similar features. If BOV decides to increase the interest rate and issue new note at a higher interest rate than the ones it issued so far from this program it will have a worsening effect on the price of the current bonds in issue. BOV might reach its goal of raising the remaining €38.4mln, but it would have left holders of €111.6mln of its notes worse off for a long time.

· Issuing more notes – changing the maturity

BOV could issue more notes with a different maturity in order to make them more attractive. But it must be pointed out that these are subordinated bonds and in order for such notes to be fully considered as part of the capital of the bank they have to be long dated obligations. So issuing say a 5 year note would not really help the bank to meet its capital requirements as much as a 10 or 15 year note would.

· Making a rights issue

Another way to raise capital is for the bank to issue more shares through a rights issue. A rights issue is basically an offer to existing shareholders to buy more shares in the company. A firm will normally initially opt for a rights issue as opposed to an issue to the general public in order to allow existing shareholders not to be diluted. Remember that when new shares are introduced these shares will end up with a percentage of the ownership of the company. So if existing shareholder do not buy new shares the percentage of the total ownership of their holding will be reduced.

The largest shareholder of BOV is actually the Government of Malta with just over 25%. Therefore, if the government does not have the finances to invest more money into BOV and also does not want to lose its percentage of ownership it would be against a rights issue. So although this might sound like a good solution, it may not even be on the table if the government (as the controlling shareholder) does not allow it.

Did over-regulation play a part?

Another issue that led to the failure of this issue was what I have been referring to in many previous posts – that over regulation (for example the imposition of a high minimum or the imposition of carrying out a suitability test) will end up marginalising the small retail investors rather than help them. The pressure put by the regulator on local investment service providers that were considering selling these notes was high. It was a kin to asking the companies selling the notes to guarantee the issue since if something had to go wrong with the investment such companies would be heavily scrutinised. This pressure, coupled with the upcoming Arbiter for Financial Services Act that I reviewed in my previous post made little business sense for the investment service providers to sell this issue.

The Bottom Line

Although riskier bonds have been issued by other companies that were fully or over-subscribed these cannot be really compared to this issue. The reason this issue was not a success was not due to the default risk of the bank, but due to other factors particular to the issue itself. It will be interesting to see how it all develops and I am sure a solution will be found. Let us hope that it is the best decision for all investors and no political influence will come into play.

Legal, Other

Arbiter for Financial Services Act – A Review

March 18, 2016 KD Leave a comment

Currently the Arbiter for Financial Services Act is being finalised following a series of discussions between representatives of the government and the opposition. The Act, which will be coming into force in the coming months, will have an effect on any company that offers financial services from Malta. This act generally gives the authority to one person to settle a dispute between two or more parties which have an issue which is connected to financial services. The idea is to have a faster and more focused court-like setting where the Arbiter has the “power to mediate, investigate, and adjudicate complaints filed by a customer against a financial services provider.” So this act is going to give quite a bit of power to just one person and the Board of Management which would be managed by such person.

The idea looks nice on paper, but how will this all work in practice?

Here I have 3 main reservations

1. Independence of Arbiter

One of the first issues I am finding with this setup is that it is going to be quite difficult to find someone who has the competence required and at the same time is independent. The requirements to be appointed as an Arbiter are that the person should “possesses the necessary expertise in consumer related issues in respect of financial services, including a general understanding of law.” The draft Act also mentions some instances where a person cannot be considered as an Arbiter which again all look nice to have on paper.

So we are saying here that it has to be someone who has acquired an amount of knowledge and expertise in the financial services industry, specifically in consumer related issues. In my view this is not going to be an easy task since the issue of independence is going to be a problem for many potential candidates. Let us consider appointing someone who has been working with the regulator for an amount of years. Such a candidate would have been involved directly with consumer issues in the financial services industry which qualifies him/her for the post. However, if this person has never worked with a financial service provider or has not done so in a very long time, then that person would lack the knowledge and expertise of how things work in the field. 10, 15, 20 years of always hearing one side would not really allow that person to be independent.

What if we consider appointing a current or an-ex judge/magistrate who would possess the legal acumen to actually give a legal ruling – the problem here is finding one with expertise in financial services. Ok, let us consider finding a lawyer who is specialised in financial services. This may well be the best option however the issue of independence is going to come up more than once. Given the small size of the local industry, Malta’s financial services practitioners tend to use the services of a handful of legal firms which have expertise in this industry. So if an employee from such an entity was to be appointed as the arbiter it could well be the case that many a time such person would have a conflict of interest through his/her previous dealings with the financial services practitioner.

What about appointing someone who has been working in the industry in a senior position for many years and thus has the knowledge and expertise of dealing with clients, keeps up to date with financial services regulations and would have a deep knowledge of different financial services instruments. Two main problems here: i) Why would such a person leave his/her current position which is likely to be more financial rewarding and flexible? ii) How can such a person be independent when most financial practitioners know each other and may have done business together?

2. Excessive Powers of the Arbiter

Another very troubling issue is the excessive powers being granted to this one person (or office) which may be beyond the competence of such person and quite possibly anti-constitutional. Here I am referring to the fact that the Arbiter will have the authority (according to this Act):

“to consider complaints which are being dealt with or which have already been dealt with by the Malta Financial Services Authority, and its recommendations, rulings, directives or decisions shall not be considered as a res judicata of the complainant’s case and the consideration of such a complaint by the Arbiter shall not be construed as going against the principles of natural justice”

This is by far the most dangerous clause that exists in this act. It is being said that even when a complainant and a financial service provider have come to a contractual agreement on a settlement, the Arbiter has the authority to supersede such agreement. This creates a very dangerous precedent whereby the legal stance of previously settled cases which have been contractually agreed to by both parties is put into question!

According to the lawyers present during the discussions, up until now it has always been the case that any dispute about the validity of a contract would have to be scrutinised in the Civil Courts. Thus this clause is giving a dangerous and unprecedented authority to one person who is only required to have “a general understanding of law”. So we went from a formal well established procedure in the civil courts to being judged by a person who generally knows the law!

This very dangerous clause, coupled with the fact that the Arbiter can decide on cases going back to 2004 (and not anything earlier than that date) makes one wonder the exact reasoning behind inserting such clauses. It begs the question:

Is this law being enacted in light of the La Valette Multi-Manager Property Fund incident?

One cannot help but wonder about the above question and at the same time keep in mind that at the end of the day the Government (which is pushing for the enactment of this law) is the largest shareholder in Bank of Valletta (BOV) with its 25.23% shareholding. Furthermore, BOV is a publicly listed company with its shares trading on the Malta Stock Exchange. So wouldn’t it be only logical to consider whether one should sell his shareholding in BOV if this Act is passed through parliament as it currently stands?

What does this mean for the Insurance industry? Companies within this sector are involved in many settlements on a regular basis – such is the nature of their business. So if an insurance company can no longer bank on the legal validity of the claims it has settled – how does it provision for this in the policies it issues? Again, Mapfre Middlesea Plc, GlobalCapital Plc and all the publicly listed banks are involved in the insurance industry to one degree or another – so should one also sell all his holdings in such companies if this Act remains unchanged?

In a nut shell, saying that this dangerous clause would open up a Pandora’s Box would be an understatement.

3. Who really benefits?

At the end of the day, no matter what ruling the Arbiter gives in his hastily 90 day target time the right of appeal from that sentence cannot be removed. Thus the end result would most likely be that both claimants and service providers would end up worse off and the people that have most to gain from all this are the lawyers and consultants appointed by both parties. Interestingly enough, it had been proposed in the discussions about this Act that there should be a cap established on the fees that a person representing a complainant can charge. The proposal was to have a cap amounting to the higher of €500 or 0.5% of the net proceeds won on behalf of the complainant. This would serve to protect the complainant from ending up paying exorbitant legal and consulting fees. To date I am not aware that the Government has introduced this clause as it was stated that it needed to be studied further.

The Bottom Line

Like I have said many times before, the best way to help consumers and protect them is to educate them. If consumers are better equipped to assess the products and proposals that service providers propose or recommend to them we will have a much better result. Increasing regulation ends up marginalising the small investors since they become uneconomical to service. The risk involved and the time involved to service the small investor would not make it viable to service them. So as a result they would end up only being offered the same few products and thus creating a concentration risk in those few products. This concept of educating investors has to flow both ways however, the industry and quite possibly to a certain degree the government should come up with ways of organising educational clinics, seminars, conferences, courses and other incentives about the subject to the investors. But from the other hand, the investors have to be make an effort to look for such learning opportunities and not simply play the fool that wants to shift all the responsibility to the service provider. In the words of many before me: “Knowledge is Power” and thus through more knowledge investors would possess the power (ability) to better decide on their financial matters with guidance from the financial practitioners.

Legal, Other

Regulating the Financial Services Industry – Finding a balance

February 12, 2016 KD 2 Comments

Why Regulate?

I recently watched the movie “The Big Short” which is about a few traders who actually predicted that the US housing bubble was going to burst and that the collapse of the sub-prime mortgage market was inevitable. These traders used financial instruments (mainly credit default swaps) to bet against the market and the major banks – which as we all know now, was a very profitable thing to do in the end.

The reason I opened with a reference to this movie is not to get into the merits of how they profited from the situation but to highlight a point that struck me the most while watching it. In the move the actor Steve Carell plays hedge fund manager Mark Baum who appears to be on vendetta against the big Wall Street banks who he describes are nothing but crooks. At first the character thinks that the big banks do not have a clue what they are doing and that they are being naïve by not recognising the problem and continuing to deal in sub-prime mortgages which are literally worthless. But at the end he finally comes to the realisation – which now with the benefit of hindsight is quite obvious to see – that the big banks knew exactly what they were doing and what’s more, they knew that they would have to be bailed out since they were too big to fail. So they deliberately made as much profits as possible until they would reach the point of no return and have the tax payer bail them out.

This notion that the banks know that they are too valuable to the financial system and that bank failures would be devastating on any economy puts them in a particularly advantageous position. In more technical jargon we would say that it creates a moral hazard situation. This is the main reason why the financial sector is so highly regulated. Thus, many would agree, especially many small investors who do not trust the big banks and believe they need to be protected from them, that regulating the banks and other financial services practitioners is very important. The more regulated they are, the better they would argue.

But…

Could too much regulation actually leave investors worse off?

More specifically, could the small retail investors that the politicians and policy makers so heroically swear to protect against these big bad financial practitioners, end up worse off?

Let us start with reviewing a bit the EU investment services rules since in Malta we are subject to the same/similar regulations & directives. So in 2007 we saw the introduction of the Market in Financial Instruments Directive (MiFID) which introduced much more pro-consumer rules and put much more onus on the service providers. What this means is that investment service providers had to start recording much more data in order to ensure that they were abiding by the many more procedures and regulations that had been introduced. This in turn lead to much more forms to be filled in and checks to be put in place to ensure that the sales staff were actually adhering to the rules and not putting the company they work for at risk of breaching any of them.

On the whole this is obviously a good thing since it ensures further that the investment service providers are acting fair and responsible in carrying out their business. At the same time, this increased regulation comes at a cost in the form of time and money that investment services firms have to spend per transaction. Furthermore, such firms also have to assess the risk and reward of entering into transactions with clients. Are the various risks of selling this product to this client worth the compensation that the company is earning?

In most cases the highest risk is when dealing with the smaller less knowledgeable investor, who is also the same investor that will generate the lease return for the service provider. So it is quite common for investment firms to exclude certain investors from certain products based primarily on the higher risk such investors pose. This in turn will leave these investors with lesser choice and higher concentration risk since they will only be offered a small choice of investments. So regulations that had the aim of protecting investors could actually be leaving them worse off by excluding them unnecessarily from certain investments. What is even worse is that such investors, who are the ones who would need investment advice the most, could be shun away altogether from investment advice due to the higher risk of offering investment advice to them.

You may think that I am exaggerating a bit here – which firm would reject business just because a product is classified as complex and presents more risk to the investment service provider? Let us look at real examples of how this is actually happening. Any HSBC Bank Malta Plc (HSBC) customer had been informed that a few years ago the bank decided that it would only be offering execution only transactions and would absolutely not be offering investment advice. Furthermore, the same bank has recently informed its customers that it would no longer be allowing its customers to hold investments on their nominee accounts. That is to say that HSBC would no longer be holding the custody of clients’ investments and has actually written to clients to transfer their holding to other providers (which are competitors of the same bank).

Some may argue that this is a one off case and that it is a direct result of directives by HSBC’s parent company to reduce risk as much as possible across the many subsidiaries, especially in the smaller jurisdiction such as Malta. So let us look at another example – the subordinated bond issued by Bank of Valletta Plc (BOV) late last year which is basically a Contingent Convertible Bond (Coco). Due to the nature of the bond it was rightly so rated as a complex instrument by our regulator. Under MiFID rules such instruments must be accompanied by more paperwork to ensure that it would be appropriate for an investor based on such investor’s knowledge and experience.

What happened in practice? A bond which from a scale of 1 to 10 in its complexity would be rated at less than 1 in my view, was made subject to more scrutinising procedures by the listing authority. It had to be sold in two tranches – tranche 1 imposed a minimum of €5,000 which had to also be accompanied by investment advice, thus putting the highest level of onus on service providers, while tranche 2 imposed a minimum of €25,000 and had to be accompanied by an appropriateness test. Our regulator argued that due to the vast network of retail clients that such a bond would have appealed to, such clients needed to be protected even further than MiFID suggests. The result – many investment services providers including other banks simply did not bother with the issue. The bond was sold by a smaller amount of firms which got back logged in the paperwork and the issue had to be prolonged until all the work by the investment firms had been carried out. Looking at the trading of the same bond on the secondary market – virtually non-existent. I went into much more detail in a previous post which focused specifically on the bond issue. Here I simply wish to highlight the negative aspect of too much regulation.

So how do you strike a balance?

I started the post by pointing out why regulation of this industry is such an important aspect. We then saw a few examples of how regulation could leave investors worse off by marginalising the smaller less knowledgeable ones. So how can regulators and policy makers stick a balance between these two opposing forces? In my view, the answer lies in being more pragmatic in the imposition of the rules and regulation governing investment services. The one size fits all approach of putting all complex instruments into the same basket is redundant and disruptive. While firms that are found guilty of negligence and misconduct should be properly dealt with, regulations should not be acting as an impediment to business.

Another very disruptive and damaging practice is having an ultra pro-investor approach when regulating investment services firms. As I have just stated, when found guilty of purposeful negligence and unethical behaviour the regulator should be given as much ammunition as possible to deal with such perpetrators. However, feeding the idea that if someone loses money when investing in a financial instrument they have a good chance of getting compensation creates a misconception that investment firms are guaranteeing every instrument that they sell. This is a very dangerous situation which will only lead to a negative situation for both the investors and the firms selling the investments.

Could there perhaps be a solution whereby staff that work with the regulator must spend a certain amount of time working with an investment service provider? Thus they would attain hand-on experience and would ultimately be able to implement the directives more effectively and efficiently. Moreover, this would have to be an ongoing exercise and not a one time thing. Just because someone worked in the industry 10 years ago and has been working for the regulator ever since does not qualify as still being in touch with reality.

On the other hand, should compliance officers and Money Laundering Reporting Officers (MLROs) be given training by the regulator on a regular basis for example? This would help to get the perspectives of both the regulator and the practitioners more in line. Here I am not talking about the usual boring courses that just present what is in the regulations. Anyone can read the regulations on their own and no presentation is needed for that. What I am speaking about here is offering real life examples of what the regulator is dealing with in order to create a more understanding environment between the regulator and the practitioners.

The Bottom Line

At the end of it all, it is always going to be a difficult task to find the ideal level of regulation. What is important is that both regulators and practitioners work towards the common goal and try to understand each other’s perspective. Both can learn from each other and both need each other whether they would like to admit it or not. Regulating by empowering is far more effective then regulating by imposing. Thus, I truly believe that more effort and resources need to be channelled towards the education of the investing public. After all education = power since by educating people you will empower them to be able to regulate the financial practitioners themselves.

General

Malta’s Financial Services Industry – Too big to Fail?

January 30, 2016 KD Leave a comment

At a seminar that I have recently attended one of the speakers referred to Malta’s financial services industry as having reached the point of becoming too big to fail. This should be viewed from the perspective that if the financial services industry in Malta had to suffer the ripple effects throughout the economy could be devastating.

Foreign vs Local Firms

To fully understand the importance of the financial services industry in Malta one has to look beyond the firms that cater to the local market and recognise that there are many firms registered and operating from Malta that cater mainly to foreign firms and customers. Taking a quick look at the quarterly statistics published by the MFSA one can easily appreciate how many operative entities in the financial services sector exist. For example, when considering the banking industry, although we all know of the big two and a handful of other smaller banks that service the local market, in actual fact as at 30^th September 2015 there were 28 credit institutions and 39 financial institutions licensed in Malta.

In the insurance sector for example, as at the end of September 2015 there were 62 licensed entities in the Non-Life, Life, Composite and Reinsurance categories. In the third quarter of 2015 there were 147 licensed Investment services firms in Malta, of which 108 had a Category 2 license. As at the same date, in the funds industry we had 26 recognised fund administrators. To add some EUR figures now, as at September 2015 the Net Asset Value (NAV) of the locally-based Collective Investment Schemes (including Professional Investment Funds and Alternative Investment Funds) was €9.69 Billion with a B! This figure is made up of the NAVs of 524 funds (including sub-funds). To put this figure in perspective, Malta’s GDP as at 2013 at market prices was €7.51 billion.

So it is not that difficult to see that there is a very large proportion of the local financial services industry which is made up of foreign entities that have registered in Malta. This is of course a positive thing and a good result of the efforts made by various entities such as Finance Malta which for years have been working to attract foreign companies to Malta. It also highlights the fact that we must ensure that we remain attractive for the existing companies to remain in Malta and for new ones to continue to come to Malta. Before going on to list our strengths and what we can do to safeguard/improve them I would like to point out some indirect positives of the financial services industry.

The Indirect Positives

One must keep in mind that besides the direct effect that the financial services industry has on the Maltese economy there is also a significant indirect effect. Some of the indirect effects connected to this industry are:

The taxes paid by these companies locally

Here we are not only speaking about the corporate tax effect that the business pay but also the income tax effects of the people who work for these companies and are resident in Malta. Moreover these companies pay indirect taxes both on services they purchase in Malta and many times on the services they purchase in the EU.

The effect on the property market

Promoters and top management of these foreign companies who relocate or decide to open shop in Malta are normally among the top income earners who would afford the top rents and top purchase prices of some of the highest valued property on the island.

The spreading of knowledge

When locals work with these companies they are exposed to a much greater network of professional people within this sector and beyond. The knowledge base of such workers will grow and such knowledge can then be shared with other people and firms within the industry.

The effect on tourism

When foreigners come to live/work in Malta they would spread the word with their families and friends about the Island which in turn will result in increased tourism for the Island. Even if they do not move to Malta, by setting up their companies here they necessarily need to travel to the Island on a regular basis.

The effect on other local businesses

Such foreign companies will inevitably need to employ other local businesses in various sectors from lawyers, accountants, and other consultants. They will also contribute to the hospitality industry through hotel stays and business meetings over a meal for example.

An Analysis of our Strengths

Many website of companies that operate in the financial services industry have a “Why Malta” section which list the various pros available to companies who setup shop in Malta. In this section I would like to analyse these strengths to see how much of a strength they really are and what can be done to improve or safeguard them.

Location

Our location is many a time listed as a strength of doing business in Malta. However, when one considers that a lot of foreign promoters that setup in Malta are from mainland Europe it would still be more convenient for them to setup in a place like Luxembourg. We do however have very good connections to mainland Europe so there is still a strength in being in our current geographical location. So short travel times would be a more appropriate strength.

Thus it is important to ensure that such good connections are maintained and improved. We know of the ailing national carrier which is supposedly going to be partially taken over by a larger counter party. The introduction of the low cost airlines which have helped in connecting Malta to other locations have also been a good help. The introduction of new carriers and new lines by existing carriers such as Ryanair’s inclusion of destination in Germany are all welcomed efforts as well.

Excellent ICT Connections

The website of Finance Malta for example states that “Satellite technology and high capacity fibre-optic submarine cables link Malta with Europe”. GO Plc boast about having “The only 4G network 100% fibre connected” while Vodafone Malta tells us “99% Network Coverage”. So yes coverage is very good in Malta, but what about the reliability of that coverage. Any customer of GO has experienced the lower than expected data speeds or being temporarily cut-off for a second or two which makes working through a remote location more difficult.

We also have to analyse the connectivity for foreigners when visiting Malta on a business trip. Are hotel wi-fi zones conveniently set-up or are they restricted just to public areas? Do they offer business facilities where one could operate a remote office? What about ICT maintenance, do we have enough qualified personnel to offer support services on the go and in the hotels?

EU Member State

This is definitely one of our strengths when compared to places like islands in the Caribbean, Mauritius and other known off-shore localities. When being licensed in Malta the companies can use the EU passport to use their license in other jurisdictions. How this is done will depend on the level of activities that they wish to perform in the foreign jurisdiction. But to simply promote their products (without operating an actual office abroad) all the license holder needs to do is to apply the simpler version of this passporting facility which involves our regulator informing the foreign regulator.

I would say that as a threat here we could list the fact that we cannot afford to passport licenses of entities that are not that reputable and honest. We cannot afford to make a bad name for our jurisdiction since in the end the foreign regulators can always refuse to accept Maltese licensed entities that are trying to passport their license. This would definitely create problems for the local industry. From first-hand experience I can say that our regulator is quite stringent in its authorisation process and local banks are also very strict on who they offer their banking facilities to. Although this can be a negative thing at times, it does in fact help us in the long term to maintain a reputable jurisdiction.

Small and Nimble

This advantage is also prominently argued when convincing entities to come to Malta. Since we are a small country where networks with people in influential places are easier to make and maintain it should theoretically be easier to do business in Malta. Of course there is the other side of this argument that since Malta is so small it cannot afford any major scandals. Hence the process to get a license and to open a bank account for foreigners is still not the quickest of processes by any measure.

So one has to be careful not to make it appear that since Malta is a small place that it easy to get any business setup. Also, we must ensure that we promote a reputable jurisdiction and change some people’s attitude that any business is good business. Financial practitioners have to realise that it does not pay to take on any business and that they have to be selective in their choices of whom they chose to endorse.

Knowledgeable Workforce

Another reason why companies come to Malta is the fact that all employees have a decent level of English and in most cases will also know another language. Our courses at University level when it comes to financial services are of quite a high level, especially in the honours courses. So overall we produce a workforce with a good knowledge level that foreign companies wishing to setup in Malta can employ. But is the amount of employees enough and is the level as good as it could be?

When you consider that all our graduates have been studying English from the age of 3 when they entered primary school – is our overall level of English as good as it should be? Here I am referring to people who graduate with a university degree who have spent 20 something years studying the language and/or studying other subjects using English. Should we introduce English proficiency tests across the board for all courses? Keep in mind that to enrol for the bachelor of commerce at the University of Malta your only requirement is an intermediate level pass in Mathematics. Another problem I see with our workforce, is the attitude problem that develops when the students know that they will definitely find a basic level job since there is so much demand for employees with their qualifications. If you take the accounting graduates and the banking and finance graduates – thanks to the progress made in the financial services industry these students know that they have a good chance of finding a job easily. So is this creating the situation where the student does not need to do his utmost? If so, could this not lower the over level and backfire on us?

What about availability? Are we in fact producing enough graduates in the financial services sector? In order to get the full picture here we need to think beyond the directly related jobs such as accountants and consider other such as software developers. If anyone has ever tried to hire a Java developer for example you would quickly find out that the demand for such jobs is far beyond the supply. Like with any asset, since the demand is above the supply the price for such an asset will be high. This is why a developer with little experience can command a high wage compared to other employees in a different department. This of course is good news for developers but in the overall perspective it is reducing our competitiveness.

Our Tax System

I purposely left this last point till the end. Undoubtedly one of the major reason that companies setup shop in Malta is the beneficial tax system we employ. Our system allows companies to legally avoid taxes in higher taxed jurisdictions by moving their business to our Islands. As many know, we have the 5/6ths rule whereby non-residents can claim back 5/6ths of the tax they would have paid on dividends at source. In Malta the corporate tax rate is 35% which means that dividends are paid out after 35% would have been deducted at source. Since non-residents can claim back 5/6ths of this they would effectively be paying 5%.

The problem of focusing too much on this factor is twofold in my eyes. One is the negative image we could portray whereby we could be attracting the wrong type of investors looking to avoid tax at all costs. The other is the fact that there have been a lot of talks at EU level to introduce measures of fiscal integration across the Union. This would effectively mean that the government would lose its ability to determine its own tax rates and a more harmonised approach would be introduced. This would practically eliminate our tax advantage. Both government and opposition are in agreement that they will fight this at all costs, however only time will tell how this will all fold out.

My input here would be not to focus too much on the tax issue. All the above points I mentioned in this section of strengths are all independent of the tax issue. So we have much more to offer foreign investors than the tax incentive. This is the message I believe that Malta has to portray in attracting more business to the financial services sector. When I say that Malta has to do this I do not mean just the government and the entities setup to attract foreign investors, but also the financial practitioners who ultimately end up working with these investors. So the consultants, lawyers, accountants, directors – they all must work together to present a better picture of Malta. The tax issue is a very nice perk of doing business here, but it not the only one. We have far more to offer and this is how I believe our approach should be.

The Bottom Line

We are all aware of the importance of the financial services sector to our economy. I hope this post has highlighted some of the aspects that were not so apparent. I also hope it gets people thinking on the points I raise and how we can all contribute to a better sector altogether.

Personal Finance

Budgeting for Personal Financial Management

December 30, 2015 KD 1 Comment

Have you ever looked at your income tax bill year at the end of the year and see that you earned “x” amount of money, but you have no idea where all that money has gone? Have you ever asked, if I earned all that money, why are my savings and investments still around the same level as last year? In this week’s post I would like to visit the very basic step of budgeting. Before anyone can think about investing they should first think about budgeting. Budgeting is simply about building a plan, very similar to a diet plan, where you can review what you are currently doing and see how you can improve your financial health.

Many people overlook this step and think that it is too technical for them or too artificial. This post will aim to give an insight on some easy steps one can take in order to become more financially responsible.

Step 1 – Record Keeping

The first step to budgeting is definitely NOT to set artificial targets on how much you would like to spend on things. That exercise is tedious, irrelevant and discouraging. The best way to start a budgeting plan is simply to start recording your monthly expenses. Thanks to internet banking and the increased use of credit and debit cards we are lucky to have most of the work done for us when it comes to the recording of our financial transactions. All you need to do is to create a simple excel file in which you record you income and expenses for each month. Since every month will have some different expenses and for some even different incomes, it makes sense to have at least a 3 month view of your income and expenses patterns.

A good way of recording your expenses is to categorise them. When it comes to budgeting it is never a one-size-fits-all science. Although certain tips can be applied across the board, each person needs to apply their own personal settings to arrive at the best plan for them. Some examples of categories could be “Utility Bills” in this category you would include items like water and electricity, phone bills, internet bills and the like. Another category could be “Eating Out” in which you would list the amounts paid for meals bought from restaurants and take-out places. So you basically keep creating categories until you cover all your expenses of the past month.

Step 2 – Analyse the Data

After listing all the expenses in their respective categories you should then get sub-totals of all the categories. This will give you a clear picture of where your money is going. Once you have this info it is much easier to see where you could realistically trim a bit of your expenditure. You might be surprised how much you are spending on clothing for example or on eating out. By analysing the data you can start to appreciate where your annual income is going and how you could spend less and save more.

Step 3 – Make a Spending Plan

Now that you have all the info, you should start setting some realistic goals. It is important that you do not try to trim too much, one has to be practical in their approach and also see what is important to them. For example, if Friday night drinks with the friends is very important to you, then do not set any high targets here but simply aim to maintain a reasonable amount of expenditure. In other areas you may find that by making some small lifestyle changes by for example buying in bulk, making less trips with your car or eating in more, you may start spending less. A lot of small changes will eventually add up to a bigger total so do not try to set large targets that are unrealistic in order to have a high goal. But rather start by making baby steps and trimming expenditure gradually in the areas where you would prefer to cut-back.

Step 4 – Review Your Plan on a Monthly Basis

A budget plan is not a static one-time thing but is something that evolves as one’s personal circumstances and priorities change. After you have made your initial plan it is important to see how you did. You should not be surprised to see that you did not meet all your targets and in fact might have spent more than the previous month rather than less in certain categories. The aim is to lower the overall spending so just as long as the total spending is less than that of the previous month you are still pretty much on track.

By reviewing your plan you can get a better understanding of where you are lacking. What you need to work more on. You could also use the review to change your cost-cutting sources – perhaps you might prefer to save money by spending less on online shopping but still go out to eat every weekend. So do not be afraid to change the parameters from month to month. Some months would have more expenditure on many of the categories, such as December. One could for example aim to spend less in October and November to have more leeway in December.

Step 5 – Beyond Spending Less

Once you have been actively tracking your spending habits and have found ways to better manage your financial affairs you should end up with “extra” money each month which was not spent. One may ask, what should I do with these funds which I have managed to shore up through my work and sacrifices? A prudent initial step is to set up an emergency fund. This emergency fund is nothing but money set aside into a savings account that is there to be used in the event that quick cash is needed. From time to time, we all experience unexpected events that would require a cash outflow at short notice. Therefore it is important that before one even considers doing anything else they should first set aside around 5%-10% of their annual income into an easily accessible venue. A fitting product would be a simple savings account with a reputable bank.

Once the safety net is in place then one can start considering other ventures. Again this next step will depend on the priorities of the person. Whether extra money should be used to pay down outstanding debt, to increase one’s savings or to invest the money for future returns is a personal issue. I will be tackling the issue of paying down debt vs investing the money in a separate post in 2016. The focus of this post is to first arrive at the point where one has this option by first learning how to be more financially responsible.

Additional Tips

Setting up standing orders or automatic bill payment facilities are a good step towards achieving one’s budgetary goals. These automatic payments are normally used for loans, such as your monthly home loan or car loan payment. However, they can also be used for savings. You may want to open a separate savings account for example into which you deposit automatically €100 each month. Should you afford to deposit a bit more you can make a manual transfer, but at least you know that as a minimum you would be saving €100. This new savings account can act as your emergency fund and eventually as a source of money to invest for the future.

Another good tip is to look at saving as an expense. What is meant here is that you should get into the habit of saving and investing. Just like you would save up money to buy a new car, you should also aim to save up money to place a new investment. Just as you would allocate for example €100 per month for on-line shopping you should allocate €100 per month for saving. So you should put savings into your “must-do” category. So just like you must pay your monthly loan payments, your electricity bill and so on, you also must deposit a minimum amount each month. Once you accept this psychologically it becomes much easier to save more and more.

The Bottom Line

Finding the right budget plan is something that will be different for everyone. We all have different circumstances, different priorities and different obligations. Moreover your plan will undoubtedly change as your personal circumstances change. So do not look at the budget exercise as a one-time plan for the whole of your life. If you need help in this exercise do not be afraid to seek it. Unfortunately when it comes to such personal matters it could be a bit awkward to discuss it with people you know – fortunately there are professional financial advisers that you could consult that could easily help you in this task.

ForEx, Historical Financial Events, Personal Finance

The Fed Increased its Base Rate – Should You Care?

December 18, 2015 KD Leave a comment

In this week’s post I will be focusing on the increase in interest rates that has just been announced by the US Federal reserve which is the central bank of the USA. The Fed increased its base rate from the current 0%-0.25% range to a 0.25%-0.50% range. For 7 years we had witnessed a near 0% base rate making money cheap to borrow. The post will aim to focus on how this affects Malta and the broader Euroland countries. I will first be focusing on the effects of an interest rate rise in general and then move on to focus more on how we as Maltese and other countries that use the Euro as their main currency will be affected. Should we care about what the US is doing?

First, some basic economics to help you understand better the rational for manipulating interest rates. Having low interest rates is expected to lead to cheap money that would in turn cause consumption and private sector investment to go up which would lead to a higher gross domestic product. In simpler terms this means that if households and business can borrow at cheaper rates they would be more inclined to do so. When they have access to the cheaper funds they will spend more, for example on new housing or on building a new factory. In turn this will generate more income for other economic participants and everyone is better off.

On the other hand, if too much money is present in the economy this will lead to a general increase in prices, or inflation. Thus, in order to avoid having too much inflation the central banks can increase interest rates in order to reduce spending and private investment – in technical words they would be tightening. It must be kept in mind that in the real world things are not as simple as I have just described since there are undoubtedly a lot of variables being affected at once. The following video is great to help understand better how the Fed manipulates interest rates:

Who Wins When Interest Rates Go Up?

Banks

The obvious winners as a result of increased interest rates are of course the banks. For a traditional bank that is mainly concerned with taking deposits and making loans their bread-and-butter is their Net Interest Margin (NIM). This is simply the difference between how much the bank is earning from the interest rates on its loans and how much it is paying in interest rates on its deposits. So if interest rates go up the banks can start increasing the interest rates they charge on their loans and this will lead to increased income for the bank.

Insurance Companies

Insurance companies typically invest their money in fixed income assets such as bonds from the higher quality end of the market. As any fixed income investors knows the yields on bonds has been low for quite a while now and hence the income insurance companies can earn on their investment will increase as interest rates go up. Of course there exists the other side to this argument that as interest rates go up the prices of bonds will go down and thus insurance companies would suffer in terms of the value of their capital. Although this is true, one must keep in mind that insurance business is long term business. So if the insurance company has bought bonds with the intention of holding them until maturity, the price drop experienced before maturity does not really affect them. Such companies would use a combination of strategies such as keeping a portion of the portfolio in short dated bonds which would be less affected by interest rates rising.

The US Dollar

In simple terms since the interest rate one could earn from a US dollar investment is now going to be higher than the interest one could earn from a Euro denominated investment, the demand for the USD would increase. This would lead to a higher USD value and lower EUR. Things get a bit tricky however when you consider that the increase in the interest rate has been anticipated for months now and the USD has already appreciated quite a bit now. So one could argue, is the increase in the interest rate already priced into the USD?

Who Loses When Interest Rates Go Up?

Oil

Since the price of Oil is quoted in USD and the USD has gone up in value versus other currencies it has just become more expensive to buy oil. The oil industry itself is already suffering from a situation of over-supply, so an increase in the price of oil just because the USD got more expensive could be lead to lower demand which would in turn hurt the oil companies.

Gold

Gold also stands to lose value with an increased USD value, like many other precious metals gold is quoted in USD. Just like with oil, the cost to buy gold would have just gone up simply because the USD went up. This could in turn lead to a fall in the price of gold to counter the increased cost of acquiring it. What makes it even worse is that gold does not earn any interest and in fact it cost money the longer you hold gold since insurance costs and storage costs have to be considered.

Home Buyers

With increased interest rates new home buyers will face higher home loan rates and thus will be able to borrow less or will have to pay more for the same level of borrowing. Even existing home owners who have variable rate home loans will have to start paying more in interest, thus increasing their monthly loan payment and thus decreasing their disposable income.

Issuers of USD debt that operate outside the US

Many countries and companies which do not use the USD as their base currency also issue many bonds denominated in USD. With an interest rate increase this means that if they want to borrow new funds in USD they would also have to offer higher rates since the base rate on which all other rates are built has gone up. Furthermore, their outstanding debt has just become more expensive to service. Although the majority of bonds are issued with a fixed interest rate, since the USD would have appreciate against the currency the issuer uses as its base currency it would cost them more to pay the same amount of USD in the form of interest payments and eventually capital repayment.

How are You affected as a person living in Malta/Europe?

One may argue that the above is all well and good, but it does not affect him/her since we are situated in Malta and our interest rates are determined by the European Central Bank (ECB) and not the Fed. Although this last point is true that our interest rates are determined by the ECB which does not plan to raise interest rates anytime soon, this does not mean that we are immune to what is happening abroad.

The biggest effect that Malta will have from the increase in the Fed rate is the effect on the currency, specifically the USD/EUR exchange rate. So if the USD has gone up and is expected to go up even further this will have an effect on individuals as well as businesses. Let us take a look at some specific areas where we will be affected:

Traveling abroad

The cost to travel to the USA will now be higher. So even though you might still have to pay $1,000 for a few days of accommodation in a New York hotel that $1,000 which used to cost you around €715 in 2011 will now cost you around €915. That is close to a 30% increase in the cost. When you consider the total cost of a holiday in the USA this difference would add up to quite a bit of change. This will be true not just for travelling to the USA of course, but to anywhere that prices in US Dollars as a main currency. So for example going on a cruise that accepts only US Dollars would become more expensive as well.

Fuel Costs

As previously discussed, the price of oil is denominated in USD. So any other derivative of oil such as diesel and petrol for motors, fuel for airplanes and so on will also be affected by the price of the USD. Luckily for us we are in a situation where oil prices are very low due to oversupply. Hence, the increase that one would expect in the oil price is being counterweighed by the supply side keeping the price down. But if the supply had to be reduced or the demand would somehow increase the price of oil would in fact go up.

Cost of Precious Metals

Like oil, the prices of precious metals is denominated in USD. So the cost to acquire these precious metals will be higher, even if the prices had to remain unchanged.

Importing of goods in USD

Besides oil, many other items are bought in USD. Anything we import in USD will now be more expensive than it was just a few years ago. So importers will be negatively affected by the fall in the EUR which came about as a result of increased interest rates in the US. This also affects individuals who are used to buying items online for example.

Exporting of Good to the USA

It is not all bad news however, the exporters will benefit, specifically the ones that export to the USA. Since in dollar terms EUR items will cost less, the items that are exported to the US would be considered cheaper and be more competitive versus other US made items. So for example the European car manufacturers will now be able to price their vehicles more competitively against their US counterparties. Unfortunately for Malta we do not export many goods to the US. But we do compete with the US in certain services industries. So the higher USD would mean that it would be cheaper to do business through Malta (and other Euroland countries) rather than through the USA.

The Bottom Line

At the end of the day, how we are going to be affected by the Fed rate cut will take quite a while to be seen. Although there will be an immediate effect, the total effect of the move will take months to come to fruition. It all boils down to expectation and real economic indicators in the end, although the Fed said that it will continue to increase interest rates it also said that this will be gradual and it did not commit to any hard target. Jobless rates in the US are still not at desired levels so if we should have weak economic indicators in 2016 the pace of the internet rate hikes will be very slow or stopped completely. What is certain is that whatever happens in the USA will definitely affect us in Euro-land, and not just on the investments side.

Other

Teleworking – A Financial Perspective

December 12, 2015 KD Leave a comment

Teleworking refers to the work arrangement whereby employees work from home and do not physically commute to a central work location as is normally the case. This post will aim to highlight the financial aspect of this arrangement to argue why it makes financial sense to use such an arrangement.

First of all it must be understood that just because a company introduces a teleworking program it does not mean that employees who decide to use this option have to decide between always working from the usual workplace or always working from home. In fact a mixture of the two would be the most beneficial in many cases. Certain tasks would require an employee to visit the place of work by their very nature, such as when a face-to-face meeting with a client needs to be held. However a lot of other office work can be done more productively when the employee remains at home.

The Benefits

Improved Productivity

The obvious benefit is the increase in productivity that would result when one does not need to leave the comfort of one’s home to work. Consider commuting time for example. If you consider that on average people in Malta take 30-45mins to commute from home to work and the same time back from work to home that means that on average a person would use up 1-1.5hrs per day just commuting. This means 5-7.5hrs per week. This does not include time used up for parking in both locations and preparation time to go out in the morning. So when you add this all up a person could save easily 20% of his time by working from home and dedicating those hours to his normal 40hr work week.

Less stress due to commuting would result in better productivity as well. It is no secret that stress is the cause of many other psychological and physiological illnesses such as eating disorders, insomnia and depression. By reducing the stress caused from commuting the individual would be able to be more focused on their work and produce better work in less time. Other stress factors related to the work place would also be reduced and would in turn improve productivity.

Reduced Costs

This is another important benefit. From an employer’s point of view, when less employees are physically present in the office less overheads are incurred. For example less electricity is consumed through a lesser use of electronic devices such as PC/laptops, heating/cooling devices and so on. From the point of view of the employee he/she would have higher electricity bills on a personal level since they are using their own space. However there would be the reduced costs in the form of transportation costs for example. Especially if an employee was used to eating out everyday during their lunch break they could easily now eat for less by eating from their own kitchen.

More Flexibility

This is perhaps my favourite benefit. When one is working at his own pace it is much easier to work flexibly. So if the goal is to work 40hrs in a week or to get x amount of tasks done by this week, the individual can choose when best to work on those tasks. One may have to attend to a personal matter during the day that would occupy him/her between 10am and noon, which he can make up for at a different time. There is no restriction to when one can work on certain tasks. Of course there will be certain daily tasks that might need to be done by a specific time each day. However there will also be overall tasks that one might feel more comfortable working on at 9pm or on a Saturday afternoon.

This feature is perhaps the most beneficial for people with young children who would like to return to their job but cannot commit to the usual working times. Tied to the benefit of reduced costs and better productivity, employees with young children who would have to take leave days without much notice or sick leave due to their children feeling unwell could still work from home in such instances. Thus the employer does not lose a full work day and the employee can still meet his/her targets by working more flexibly.

This flexibility feature could also be used so that both parents could spend more time with their children. It is not only the mothers that could work remotely, but also the fathers could do so. If both parents are working from home there would be more family time and more participation from both parents in their children’s lives. Other setups could be used of course whereby either the parents work on alternative dates from home or just one works from home when the other needs to go to the work place.

More Free Time

From the point of view of the employee, time saved from commuting to work and the added benefit of working more flexibly would free up time for other things. One could use such time to practice a sport, go to the gym at off-peak hours, take up a new hobby or simply spend more quality time with their family at times when they would have otherwise been at the workplace. Another possibility is to pursue other career enhancing initiatives such as pursuing further studies or doing something that would generate additional income.

The Requirements

Of course it must be recognised that not all jobs could be done remotely. For example you would not expect a pilot to try to work remotely or a chef to cook from home. But in today’s age many people have office jobs which could in fact easily be done remotely. Even teachers could easily give lectures remotely with the help of some simple technology – so one should not assume that his/her job could not be done remotely, but should brainstorm on some form of compromise that could work.

Life is not black and white and there will rarely ever be a definitive no or yes response to doing something. Most of the time even office jobs require the employee to meet clients face-to-face so it might be the case that a combination of remote and on the job working could be used. One should not exclude having non-physical meetings with clients such as through conference software such as Skype. This might actually be preferred by certain clients who are also usually quite busy and could appreciate the benefit of not having to leave their workplace.

There are certain requirements that must be put in place in order to have a good teleworking programme:

Use of Technology

One of the first things any entity considering teleworking should consider is the upgrade or better use of its software. The obvious choice here is a form of cloud technology whereby all hardware is setup in a remote data centre. This is good for business continuity and it adds more layers of security by adding additional login barriers that would make it less likely for hackers to access. A secure remote connection setup must be established and all files and virtual spaces that the employee would normally need access to should be made available to them whether they are working from home or from the workplace.

Technology can also be used to address another major concern of employers. The usual complaint when I discuss this subject with managers and employers is that they would not have direct oversight on what their employees are actually doing. First of all it must be pointed out that just because an employee is working a few meters away in the same building does not mean that they are not slacking off. No manager or employer can afford to be checking up on their employees at all time, regardless of where the employee is working from. So in my view, this argument is quite flawed. Secondly, believe it or not one can invest in software that tracks the progress of employees. So whether the employee is working form an office, from the beach or from their own home the software will track their progress on the tasks assigned to them.

Definitive Tasks and Procedures

In order for the whole operation to work well there should be a definitive course of action set in writing. If it is for daily tasks this process is easy since a simple procedures manual could be drawn up explaining what tasks the employee is responsible for doing. So called “How to” lists also help and these add to business continuity since if an employee needs to be temporarily or permanently replaced their daily tasks would be documented and could more easily be taken over by someone else.

In the case of tasks that are specific to a project, such as an IT software development project, the tasks of each employee need to be clearly marked. The tracking software can then be configured around this plan to keep better track of each employee’s progress. In most cases such detailed plans are already used and thus the basis is already set.

Clear Consequences and Responsibility

Responsibility for ones actions form the point of view of the employees is the key to any successful teleworking setup. Employees need to be knowledgeable, responsible and act fairly in order for such a setup to be possible. Furthermore, failure for one to meet his/her targets should have clearly defined consequences and need to be respected. Besides doing the work, such work also has to be up to standard so the employee must still ensure that they can work from a suitable environment. A home office would be the ideal setup in most cases. Furthermore the employee needs to ensure the security of the data they are accessing so that no unauthorised person can also access it accidentally for instance.

The Bottom Line

I hope this post has highlighted the possibilities that one could apply to their own work situation. Of course the initiative should not only be taken up by employers and managers but also by the employees themselves. One should assess their own situation and consider whether such a setup could work in their own situation. Many a time the solution is not necessarily a straight forward one and a combination of different setups could be the ideal solution.

General, Legal

Have I received Investment Advice?

November 27, 2015 KD 1 Comment

In this week’s post I would like to discuss the concept of Investment Advice. Unfortunately there is a big misconception on what a financial advisor’s role is in modern financial markets. Some investors have the incorrect idea that a financial advisor is there to tell you exactly what to do with your money and that every time they speak to an advisor it means that they have received advice.

In reality most investors do not even receive advice from their advisor but information. From a legal point of view there is a specific definition for what financial advice is and just because your broker told you that he/she has been selling the bond of XYZ limited lately it does not mean that he/she gave you advice to buy that financial product. Just because the features and characteristics of the product are explained to a client it does not mean that such client received advice to buy that product.

To go a step further, even if the advisor carries out an appropriateness test on a client whereby the advisor asks the client certain question to establish the knowledge and experience of the client in relation to a particular product, it still does not qualify as giving financial advice.

Financial services providers in Malta and across the EU are subject to the Market in Financial Instruments Directive or MiFID in short. This directive defines investment advice as follows:

“‘Investment advice’ means the provision of personal recommendations to a client, either upon its request or at the initiative of the investment firm, in respect of one or more transactions relating to financial instruments”

Thus, the directive is quite specific in what actually amounts to investment advice as opposed to other things such as promotion and sell or simply the provision of information. In order to clarify the concept further, the CESR (Committee of European Securities Regulators) in October of 2009 had published a consultation paper entitled “Understanding the definition of advice under MiFID” (Ref. CESR/09-665). In this paper it was established that for a service to amount to investment advice ALL of the following 5 tests had to be met:

Does the service being offered constitute a recommendation?
Is the recommendation in relation to one or more transactions in financial instruments?
Is the recommendation at least one of the following: a) presented as suitable?; b) based on a consideration of the person’s circumstances?
Is the recommendation issued otherwise than exclusively through distribution channels or to the public?
Is the recommendation made to a person in his capacity as one of the following: a) an investor or potential investor?; b) an agent for an investor or potential investor?

In the rest of the post I will be going through the above 5 tests to elaborate more on what is being meant in more detail.

Test 1: Does the service being offered constitute a recommendation?

In specifying that a service will only amount to investment advice if it constitutes a recommendation, the Directive draws a distinction between providing advice and simply providing information. Advice requires an element of opinion, in contrast to the provision of information that does not make any comment or value judgement on its relevance to decisions which an investor may make.

Hence, when an advisor simply provides facts about a product such as the interest being promised, the maturity date, who the issuer is and what its business is, there is no element of advice yet. Even if an advisor explains to a client that the current interest rate scenario is one where investing into a long dated bond makes the investment more risky than investing into a short dated bond, this is still an element of fact and not an opinion.

In theory a recommendation not to buy a particular financial instrument could also amount to investment advice. However, all of the 5 tests mentioned also have to be met. Moreover, the recommendation not to buy a product has to be based on an opinion and not simply facts. Case in point, the recent Bank of Valletta Notes that are being issued at a rate of 3.50% fixed for 15 years. As I explained in a previous post (see link here), the fact that the bond is likely to be illiquid, and is long dated with a low fixed interest rate means that based on facts, and not simply an opinion, the bond presents a big liquidity and interest rate risk.

Test 2: Is the recommendation in relation to one or more transactions in financial instruments?

Both generic advice and general recommendations are not investment advice under the Directive. In the case of generic advice, the consultation paper explained that this is owing to the fact that they do not relate to a particular financial instrument. So as an example, if a financial advisors tells a client that based on what the client has explained to the advisor such client should invest in bonds – no financial advice has been given. The terms bonds, shares, commodities are too generic in nature and can relate to many different instruments at once. For example, buying a bond issued by the government of Venezuela and a bond issued by the Republic of Germany are both transactions in bonds, but it is easy to understand that they are quite different in terms of risk.

In contrast, general recommendations are not investment advice because, being addressed to the public in general, they are not by definition presented as suitable for, or based on an evaluation of the personal circumstances of, a particular investor. So if a client sees a billboard on the side of the road that is promoting the sale of a particular financial product this cannot be construed as being advice.

Test 3a: Is the recommendation presented as suitable?

If the presentation of the information seeks to influence the client’s choice then the firm might be making an implied personal recommendation. If a disclaimer does not change the nature of a communication, meaning that the communication would still create a reasonable expectation by the client that he/she is being advised, the firm may be viewed as providing investment advice. Thus, disclaimers cannot be relied upon, on their own, to ensure that a service does not involve presenting a recommendation as suitable.

If a person places special emphasis on the advantages of one product over others for a client, in a way that would tend to influence the decision of the recipient to select that particular product over others presented, this could well amount to investment advice. Again, it must be stressed that all the other 4 test must also be satisfied for the service to be deemed as being classified as investment advice. So if an elderly client who is retired and is reasonably assumed to be interested in fixed income products is presented with a product that offers a fixed income, this alone does not mean that investment advice has been given.

Test 3b: Is the recommendation based on a consideration of the person’s circumstances?

If a firm has information about a client’s circumstances, including information on areas like his investment objectives or financial situation (i.e. investment advice or the service of discretionary portfolio management had previously been given to the client), it might reasonably be expected that the information is being used to create a picture of the client’s needs and wants to form the basis of a recommendation.

In some cases, it would not be reasonable to expect that a firm will access and use all of the information that it may happen to hold about a client’s circumstances. However, if information on a client was collected recently, or indeed over time as part of an established relationship, a client returning to the firm for follow-on advice can reasonably expect his previous information to be taken into account.

A related issue is that some marketing activities could be inappropriately classified as investment advice, if they are distributed to existing clients on whom the firm holds information. In situations where those activities either involve the presentation of a financial instrument as suitable for an investor or where the firm is making a recommendation based on the consideration of a person’s circumstances, investment advice would have been provided.

It has to be stressed here that the recommendation must relate to something specific. So if for example all the clients of a firm who have previously invested in bonds are sent a mailshot about a new bond that is coming to the market, this alone does not necessarily classify as investment advice. If a letter is sent specifically to a client there would for sure have been a solicitation of the product by the investment service provider to the client. Thus an appropriateness test would need to be filled in since the service would not have been at the initiative of the client. However, this does not necessarily mean that investment advice was given.

Test 4: Is the recommendation issued otherwise than exclusively through distribution channels or to the public?

Not all messages to multiple clients would automatically constitute advice, but there are circumstances in which they could. Three elements that should be taken into account:

the target audience (if the personal circumstances that led the individual to be contacted are highlighted);
the content of the message (e.g. if it contains a solicitation or judgement regarding the advisability of the transaction); and
the language used (e.g. the tone and the way it could be understood by the client).

Test 5: Is the recommendation made to a person in his capacity as an investor or potential investor?

Where the client’s primary purpose for seeking advice is in order to generate a financial return or hedge a risk, the client’s objective is patrimonial in nature and if advice is provided such advice would be deemed investment advice. Conversely, where the client’s primary purpose for requesting the advice is for an industrial, strategic or entrepreneurial purpose, the objective of the client is industrial, entrepreneurial and strategic in nature and the advice provided would be corporate finance advice and not investment advice.

The Bottom Line

The aim of this post is to clarify what is understood as investment advice from the perspective of MiFID. There is a big misconception about this topic in the local market and I hope this post helped to clarify issues that might not have been known to investors. As always please refer to my general disclaimer and note that this post was neither investment, legal or any other form of advice. Anyone interested in further discussions about this or any other topic covered in my posts can contact me on kd@financebykd.com.

Alternative Investment, Equities

Ethical Investing – Where do You draw the line?

November 22, 2015 KD Leave a comment

According to Invetopedia.com, the definition of Ethical Investing is the use of one’s ethical principles as the main filter for investment selection. The idea can be applied by either eliminating certain industries altogether, for example gambling, alcohol and tobacco, or by over-allocating into industries that meet one’s ethical guidelines.

There are many funds that use this principle when it comes to choosing the investments (mainly equities) that they allocate their clients’ funds to. But at the end of the day, should one really care where the money is invested, as long as it is profitable? This question will be answered different for every investor since every investor will have his/her own criteria as to what is or is not appropriate. I am just simply trying to ask – where do you draw the line?

One may argue that investing in a company that manufactures tobacco or alcohol for example is not a really big issue. People who consume such products know of the negative effect that these products have and they choose to consume them anyway. On the other hand the products are addictive and hence they also have an immoral control over the consumers, especially addicts. Furthermore, it may be highlighted that such firms invest a lot of money into lobbying and propaganda and so they are not really playing fair and thus tricking people into consuming their products. So should I eliminate these companies from my portfolio?

To be honest, shouldn’t we really think the same of fast food producers? They are the cause of a lot of health issues, yet we do not restrict the intake of fast food consumption for people under a certain age as we do for alcohol and tobacco consumption. So should I not invest in the shares of McDonalds or The Coca Cola Company based on my ethical thinking?

With the legalisation of the personal consumption of Marijuana in certain US states one can now invest in companies that produce this product. The same arguments brought up for the tobacco and alcohol industries can be used here. By investing into such a company am I indirectly causing people to consume more of the product?

Reasons to invest in these industries.

Such industries that invest in addictive product such as alcohol, gambling and tobacco tend to be less affected by economic trends. The reasoning is that even in an economic downturn, people will still gamble, they will still smoke and they will still drink. Thus, having equities of companies that offer these products in one’s portfolio will add to diversification and theoretically lead to less of a downturn when the majority of shares are going down.

But this is not the full story of course. Yes these shares can lead to a less risky portfolio and potentially better returns, however they do not come without certain other negative features. If you take the tobacco and alcohol industries these are frequently subject to lawsuits and new regulations that limit their ability to market their products. When we have a new research paper come out that this product or that product causes more harm than we previously thought, these shares will suffer.

On the gambling side, if we take for example casinos, all the large casino shares have interests in Macau which is the “Las Vegas of China” (although it is much larger than Las Vegas to be fair). This means that these stocks are affected by the news coming out of China which is still a volatile market. A quick look at the shares of companies like Wynn Resorts Ltd and Las Vegas Sands Corp will easily allow one to appreciate the volatility of such shares.

What about the fire-arms, ammunition and military supplies industry?

Now let us take it a step further. For argument’s sake, let us assume that with the industries that produce addictive products that have detrimental health issues an investor argues that one cannot save someone from their own foolishness and hence they should not eliminate these companies from their portfolio. In other words, these companies pass the ethical criteria for this investor. What if we now consider arms and ammunition companies? What if we consider companies that develop jet fighters, missiles and other military supplies?

With the current tensions around the world following many terrorist attack incidents, the most recent being the Paris Attacks which have led to France declaring war on ISIS some investor are backing companies like Boeing, Lockheed Martin and BAE Systems to do well. These companies sell the supplies that would be used by military and hence the current scenario is looking very profitable for them. So this begs the question – Should I invest in this industry to profit from the conflict in Syria? How much is too much?

The shares of these three companies are up an average of 10% over the past 3 months alone. With tension very high and more countries signalling their intentions to join France the potential for these shares to keep doing well is easy to see. This is not to say that the risk is low with these sort of companies. These is still no clear plans regarding the continued war on terror that the US had initiated back in 2001 following the twin towers events. There is nothing to say that these shares are not already overvalued in the sense that people have already pushed up the prices of these shares in the knowledge of the potential for future profits.

The Bottom Line

The aim of this post was not to argue in favour or against the concept of ethical investing. The aim was to create awareness and make investors question how much they are willing to accept from an ethical point of view when it comes to choosing the products they invest into.

Proper use of Social Media

Stop blaming others for your mistakes/short sightedness

Beware of the Power of the News

The Bottom Line

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Why the issue was not fully subscribed

What Now?

· Issuing more notes – increasing the coupon

· Issuing more notes – changing the maturity

· Making a rights issue

Did over-regulation play a part?

The Bottom Line

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The idea looks nice on paper, but how will this all work in practice?

1. Independence of Arbiter

2. Excessive Powers of the Arbiter

3. Who really benefits?

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Why Regulate?

Could too much regulation actually leave investors worse off?

So how do you strike a balance?

The Bottom Line

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Foreign vs Local Firms

The Indirect Positives

An Analysis of our Strengths

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Step 1 – Record Keeping

Step 2 – Analyse the Data

Step 3 – Make a Spending Plan

Step 4 – Review Your Plan on a Monthly Basis

Step 5 – Beyond Spending Less

Additional Tips

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Who Wins When Interest Rates Go Up?

Banks

Insurance Companies

The US Dollar

Who Loses When Interest Rates Go Up?

Oil

Gold

Home Buyers

Issuers of USD debt that operate outside the US

How are You affected as a person living in Malta/Europe?

Traveling abroad

Fuel Costs

Cost of Precious Metals

Importing of goods in USD

Exporting of Good to the USA

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The Benefits

Reduced Costs

More Flexibility

More Free Time

The Requirements

Use of Technology

Definitive Tasks and Procedures

Clear Consequences and Responsibility

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Test 1: Does the service being offered constitute a recommendation?

Test 2: Is the recommendation in relation to one or more transactions in financial instruments?

Test 3a: Is the recommendation presented as suitable?

Test 3b: Is the recommendation based on a consideration of the person’s circumstances?

Test 4: Is the recommendation issued otherwise than exclusively through distribution channels or to the public?

Test 5: Is the recommendation made to a person in his capacity as an investor or potential investor?

The Bottom Line

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