EU News

The process to turn Basel III into law is showing difficulties. There are two main positions 1) French led block, 2) Britain. The bloc led by the French, including Germany is pushing for softer requirements on bank capital and leverage, while Britain is urging for a strict enforcement of Basel III and argue that the regulators should have the right to impose rules without the EU's approval (the ECB and the Basel committee lean for Britain’s views). There has been controversial tweaks made in a proposal published this summer – which would give the national authorities flexibility on the min/max level of bank capital.
EU set for clash on banking rules, Financial Times

The financial markets have lost confidence in political leaders across Europe (evidence in bond yields). The politicians are failing to set confidence building policies. William R. Rhodes, President and CEO of William R. Rhodes Global Advisors pointed out the need for bold programs to restore market access combining pro-growth actions with domestic support, reforms to enhance competitiveness, and medium-term budget plans to fix excesses.

Time to apply EM lessons to euro crisis, Financial Times

China Five Year Plan – in short

With a worrying growth gap, China Five Year Plan is focused on emphasising development over growth.  First the significant drop in the target GDP growth from 7.5% to 7% is a striking feature of the plan. Secondly, the target increase for household income growth from 5% to 7% is a significant step forward in tackling the perturbing low levels of household consumption. Furthermore, China has reoriented its policies priorities; “the income growth target under the previous FYP was much more modest than the GDP target”.

In 2011 the FYP has put down a target of 8% GDP growth and kept the target Consumer Price Index at 4%. It will also aim to create 9m jobs and keep a constant 41.6% of registered urban unemployment. Furthermore, the NPC   will focus on the overall transformation of the economic growth mode, boost domestic demand and focus greater efforts towards social progress.

The government is also actively trying to exit the stimulus cycle. A clear shift is outlined in monetary and fiscal policy from expensive to normalization, according to IHS. The ambition is to reduce the government deficit by 150bn Yuan, which represents an 18% drop since the 2010 targets.

China’s property situation – Yes; but

 In trying to grasp China’s financial potential, its property market is often put under the microscope. The consequences of the housing bubble in 2007 are still bitter for most. Is China heading for a bust worse then Dubai’s?

Greedy foreign investors, local bankers, and developers are partly to blame, along with local governments. First, western funds support local firms to build developments in order to reap a short term profit. Secondly, local bankers close their eyes on their client’s disposable income to grow their own loan books. Thirdly, developers are carelessly involved in speculation; one will acquire land with a 10% down payment, using that as collateral to purchase more land worth half of the first total land value. So far the assumption that the land can be sold making a profit when low on liquidity has been correct – this deliberate belief however, will not hold if the market were to turn down. Finally, land sales are a significant portion of the revenue of local governments; therefore accepting a 10% down payment is considered good enough.

In an attempt to avoid a property disaster, Beijing has put in place new laws to tame the wild frenzy. Concerning speculative activity, the following have been implemented; a restriction on mortgage(s) for investment purposes, a ban on state owned enterprises buying land, and pressure on developers to build and release properties quickly.

The government has also increased the interest rate to induce people to keep money in the banks,  raised the minimum down payment for first time buyers to 30% of the home value (up from 20% in 2009), added limitations on third time buyers to access mortgages, and applied a new property tax in Shanghai and in Chongqing.

Time will tell the effectiveness of Beijing’s measures. Nonetheless, in two critical respects, China’s future cannot be compared to Dubai’s past: First, China’s massive scale urbanization and income growth is the result of the underlying demand for fast property development; the Dubai model was “build it and they will come”. Secondly, leverage is not there; loans to developers and mortgages account for only 20% of outstanding loans in 2009, compared to 57% in America.

We saw in 2007, a housing bubble caused a debt crisis – the debt in China is still too low to cause a crisis; but it should be watched closely.

Easy Cash & Mergers

Many companies support the introduction of protection against a renewed recession. Central Banks are leading this movement by keeping interest rates low. Excessive risk taking is much to blame for the economy’s crash; yet low interest rates are a strong incentive for opportunists to prioritize risky investments over cash.

Easy money from low interest rates is boosting hubris actions. After months of planning bitter survival strategies, the idea of growth is sweet; especially with mergers. This optimistic trend is a sign of a growing economy. However, early warnings on low interest rates are emerging with attention flags on the risks of causing distorted allocation of capital and personnel, excessive risk taking, lopsided balance sheets and destabilising surges in capital flow. Another threat is that cheap money may hinder the necessary elimination of bad debt from the banking system.

The positive or negative consequences of the low interest rates are balanced on a needle. However as the IMF said that interest rates should stay low “for the foreseeable future”; companies can continue to maximise the benefits of low rates without many restrictions.

John Kay - Finance System & Regulations

On Wednesday 12th (May 2010), John Kay gave a lecture on the finance system and regulations. One question from the audience was: If we went back in time with all our knowledge to 2006/2007, would we be able to prevent Lehman Brothers from declaring chapter 11? The answer was: “We don’t want to prevent Lehman Brothers to go bust, this is capitalism! We want the regulators to allow them to go bust without taking the entire system with them.”

This led to many questions on how to regulate such conglomerates? John Kay has the answer in favouring structural regulations. In conglomerates, different sectors as asset management, securities selling, market creation, etc... all have conflicts of interest. The new structural regulation will help to create non-interdependent small robust resilient networks which will form a big system. This will enable to regulate capital by removing the arbitrage element of spreading capital in different sectors that fall under different regulations. Furthermore, this will make it possible to increase accountability of the chiefs in big organisations.

A second question was regarding the stakeholder’s society growing stronger, and what impact would that have on the new regulations? John Kay talked about an un-focused public anger which creates the need to break the political influence on the financial market and vice-versa. Once more, the resolution is in separating and compartmenting the structure of conglomerates. An example would be to put in place narrow banking through segmentation: on one side, small individual investors, and on the other, ‘casino game floor’ for conglomerates.

A third question was how to solve regulation’s own problems of asymmetry and capture? The answer was once more in structural regulations: regulators would be experts in organisation’s structure rather than behaviour, they will be un-bias and consistent within different sectors.

Prudential caring for Asia

The success on the Prudential bid for AIA relies on more than finance.

AIG founded in Shanghai in 1919, is the only foreign insurance firm to have the privilege to operate independently, with not local joint-venture. Prudential on the other hand, in January 2005 acquired a 50:50 joint-venture with China CITIC.

With talks with China Regulatory Commission (CIRC), Thiam said he intends to keep its stakes in the joint-venture with China’s CITIC group. However, as both Prudential and AIA have separated JVs in India, the regulators made it clear that the company cannot have two licences.

The intention of Thiam to keep its stake with CITIC is well approved by China. This single, yet, important decision shows the understanding of Prudential towards China main goal: China’s local growth.

The successful story of L’Oréal is one of a few examples. L’Oréal professionally cherished and excelled at respecting China’s will: After moving to China, the French cosmetic company waited nine years before making local profit. Now it is one of the most successful brands in its type in China.

As numbers show, the Asian insurance market is about double digits growth through development and education. To maximise one future profit, it is vital for Prudential to work hand in hand with China’s government.

Bank of Communications - CSR report

In most conversations in the West regarding CSR, the same question is frequently asked: Is it really to do good actions, or simply to increase profits by pleasing ‘us’? In the end, the reason doesn’t really matter as there is nothing wrong in increasing profit, by for example, saving the environment.

In China, CSR doesn’t have that ambiguity. Bank of Communications’ (BOCOM) CSR report is fantastic for one reason; it sticks with its mission statement. Two quotes that stand out are: “First class public sharing bank” and “Best wealth management bank in China”. There is no notion of profit, higher dividends, attractive investment, etc...

The CSR report nicely follows the mission statement with 6 headings: Shanghai Expo 2010, Community Contributions, Education, Philanthropy & Charity, Environmental Protection and Culture.

The community section stands out with “Supporting national strategic projects” as one its socially responsible task. The sense of community in this instance is very aligned with the People’s Republic of China reform. It follows the logic of: by offering loans to national projects, BOCOM is directly benefiting the community.

This highlights the crucial importance of cultural differences. In the previous blog post, Investor Relation – China, this community responsibility comes out as a limitation. From an investor’s point of view, this created doubts of credibility.

George Bush’s ambition to imprint capitalism in China now seems foolish and perhaps embarrassing. It is strongly argued that the power is soon shifting away from the U.S. towards China. Therefore limitations such as above would have to be accepted and respected from the West.