A battle of perception

Colombia conjures up images of rampant kidnappings, brutal militias fighting vicious leftist rebels and an insidious global drug trade. It has been portrayed in the global media as a social volcano on the verge of erupting into more violence, as the system drowns in a cesspool of corruption, backward infrastructure and political warlordism.

The government has been faulted for its failure to eradicate kidnap gangs and drug cartels and to bridge the yawning divide between rich and poor.

It seems as though the death of über-druglord Pablo Escobar ten years ago, the deportation of other drug kingpins to the US and the government’s success against right wing militias have hardly made a dent in long held perceptions that the country is a dangerous and unusual destination, even for journalists.

Judging from the startled expressions this writer received on informing friends that a trip to Colombia was being arranged, perception still needs to catch up with reality.

Order returns

And that reality is that the Andean country has undergone vast changes and is now one of the world’s most promising emerging economies. The Asset recently visited the Colombian cities of Bogotá, Medellín and Cartagena to take a first-hand look. Bruce Mac Master Rojas, Colombia’s genial vice-minister for treasury explains that the country’s security situation has much improved in the last five years, following the government’s success against renegade militias and the dreaded FARC rebels, left-wing revolutionaries who have resorted to kidnapping prominent Colombians and foreigners to advance their political agenda.

Paula Alban, an ex-journalist who works with Proexport Colombia, vividly remembers what it was like ten years ago, when rebels controlled swathes of the country and drug cartels vied for control of key cities such as Cali and Medellín. In Bogotá, she recalls, it was virtually impossible to move around since a large part of city was controlled by the rebels.

Encouraged by the restoration of peace and order, new hotels are popping up in key cities whose infrastructure is struggling to catch up with the surging growth, resulting in traffic gridlocks that are common in emerging market cities anywhere.

The peace dividend

Other sectors too of the economy have seen investment inflows: oil and gold mining, textile manufacturing, audio-visual indiustries, shipping and telecommunications. In light of the improved security situation, multinationals have been streaming into Colombia to explore opportunities. Global mining companies have returned keen to tap the country’s untapped reserves of gold.

The vast opportunities in infrastructure building have attracted Chinese companies such as China Aviation Holdings which operates Beijing Capital Airport. (See story on TheAsset.com.) US companies, among them General Electric, are establishing call centres, tapping the pool of cheap but highly educated labour pool. Bogotá is considered one of the major centres of learning in South America and the city boasts over 100 universities and colleges offering high quality education.

The new government knows what needs to be done to sustain the mood of optimism that has swept though the country. “We need to create more jobs,” according to Rojas, the vice-minister. Securing the necessary investments from both local companies and foreign businesses to achieve this will depend on how welcoming the country’s investment and labour laws are going to be in the years to come.

Rojas acknowledges it won’t be easy, but with the new government that was inaugurated in August last year the Colombians are more hopeful of at least winning the battle of perception, and persuade foreigners that Colombia is a smart destination for their investments and a safe place to visit.

This was published in the February 2011 issue of The Asset

Colombia reaches out to Asia

The last eight years have seen veritable change in Colombia, thanks mostly to its former president Alvaro Uribe whose successful campaign against leftist guerillas created the environment for institutional confidence and a modicum of political and economic stability to return.

Uribe relinquished his post to his defence minister Juan Manuel Santos in August last year in contested but peaceful elections, providing the political continuity the country needed. Santos has vowed to hew closely to the reforms and initiatives the Uribe’s regime brought to the country.

On the right track

While he faces a plethora of problems moving the economy and addressing the widening inequality in the country, Santos enjoys the advantage of having a much improved security situation that had eluded Colombia for decades. The country’s growing confidence is reflected in its initiative towards creating a closer link with Asia and the government is pursuing a bid to join APEC that would accelerate its integration with the global economy.

The signs are everywhere that Colombia is moving in the right direction. Its capital Bogotá is a thriving metropolis snarled in traffic as new roads and flyovers are swathed across the city in a bid to relieve the congestion created by more middle and upper income families buying cars.

Boatloads of tourists are disgorged by luxury cruise ships regularly making their way to Cartagena, an old Spanish city port in the north of the country. The sight of a gaggle of overweight, baby-boomer American tourists making their way to the restored haunts in the oljavascript:void(0)d district of the city, is a spectacle that would have been unimaginable eight or ten years ago. Still, Colombia needs to attract more tourists and investment.

The country benefits from the excitement surrounding emerging markets such as Brazil and Chile, South American economies that have become economic superstars in their own right, but Colombia has not attracted the same attention as those two countries, although government officials believe that thanks to their emphasis on education and infrastructure, it won’t be long before the country achieves a similar momentum. The government’s financing plan calls for between 8 trillion and 10 trillion Colombian pesos to finance infrastructure spending in the period 2011-2014.

Woeful infrastructure

Colombia’s infrastructure has suffered from nearly two decades of neglect. As a trip to Medellín vividly illustrates, the government’s renewed emphasis on infrastructure cannot come too soon: landslides caused by torrential rains made the mountain roads leading to the airport impassable; visiting the beautiful Botero Plaza feels like stepping in a time warp with old hotels dotting a skyline which is a throwback to the architecture of the 50s and 60s.

For too long, investors shied away from investing in new buildings in this city as it became the centre of Pablo Escobar’s drug empire. Other parts of Colombia equally suffered from an underinvestment in infrastructure which was reversed only after the election of Alvaro Uribe transformed the country’s horizon.

The years of unrest and uncertainty have made it difficult for the country to attract investments and executives of companies who relocate here often express fear about their safety.

Vicky Garcia of Proexport Colombia says their job has proven to be challenging, even in times of relative stability. Her agency has been tasked to promote Colombia to the outside world. “It is a powerful agency focussed on promoting the commercial interest of the country. The agency promotes better cooperation between the government and the private sector.

Their promoting effort has been helped by a ringing endorsement from HSBC CEO Michael Geoghegan who identified Colombia as one of the more promising countries in the world and contributes the ‘C’ in the so-called Civets group that include Indonesia, Vietnam, Egypt, Turkey and South Africa. For decades the country’s major investors have been the US, UK, Spain and Mexico.

Roping in Asia

Garcia points out that the country is making an effort to attract more Asian investments especially from China, Korea and Japan. The country has offices in Japan and China to promote investment in Colombia and help penetrate those markets with its goods. In Colombia, Proexport is assisted by other investment promotion agencies across the country in helping smooth investors experience in the country. These agencies include Invest in Bogotá which promotes the attraction of the capital city and Agencia de Cooperacion e Inversion De Medellín y el Area Metropolitana, or ACI which helps facilitate investments into Medellín and the surrounding areas.

While Asian investments at present represent only a small part of the foreign direct investment (FDI) flows into Colombia, the government recognizes the need to engage Asia and is keen to encourage more investment to help its effort to rebuild and modernize infrastructure in which little was invested over the last two decades due to internal turmoil. Colombia has been astounded by Asia’s economic success and its progress in reducing absolute poverty, particularly by China, and hopes to emulate its success by following investor-friendly policies.


Rojas: As Asia is growing at a healthy clip, we have to go there
“We need to focus on attracting Asia’s attention,” acknowledges Bruce Mac Master Rojas, the vice-minister for treasury in an interview at his office. Rojas rues that his country depended so much on its neighbours for so long and that only now it is casting its eyes across a wider horizon. “As Asia is growing at a healthy clip, we cannot afford to focus only around the Americas. We have to go to Asia.” Rojas admits it took the country a long time to recognize this, which might explain Colombia’s sudden whirlwind of initiatives in Asia, concluding free trade agreements with Korea and Singapore late last year.

China eyes concessions

There is a buzz about Chinese companies exploring opportunities across Latin America as they have done in Africa. The buzz is real. Lucas Marulanda, a senior-vice president at Inverlink, the country’s largest investment bank, says his firm has noticed Chinese investors are keen on concessions in mining and infrastructure projects and would like to gain a toehold in major projects, such as Pescadero Ituango – the country’s largest hydro-electric dam, located in the state of Antioquia – and to invest in state-owned power generation company Isagen SA.

The Pescadero Ituango plant will have an installed capacity of 2.4 GW (representing 20% of Colombia’s installed capacity) and an average output of 14,000 GWh/year. Commercial operation is expected to begin in 2018. Empresas Públicas de Medellín (EPM), the largest provider of public services in the country, holds a minority stake in the project and is currently negotiating a BOOMT [build-operate-own-maintain-transfer] contract to undertake the project directly. “EPM is looking for partners and they expect most of the foreign financing to come from foreign investors, especially on the debt part.”

The country, Marulanda explains, remains highly dependent on outside money for financing despite a developed capital market where a host of corporates raise long-term financing with some bond issues having tenors of 20 to 30 years. “As investors in Colombia are reluctant to take on large-project risk, especially in infrastructure, the only option left to finance large projects is through banks or multilateral agencies.”

In coal mining, the major issue has been about securing the right infrastructure and logistics for countries such as China and Korea. “There is not much of an infrastructure you can speak of in Colombia,” Marulanda points out, “so when investors buy into mines and ports they are most likely starting from scratch, doing everything to make it work and that has proven to be daunting in attracting investors into the country.” For example, MPX, a Brazilian mining company, is planning to build a port and railroad to export coal. Drummond is thought to follow this initiative as well.

Vast natural resources

For Asian economies, Colombia’s key attraction is both the vast natural resources and the opportunities it offers infrastructure builders. In 2010, Colombia had 1.36 billion barrels of proven crude oil reserves, the fifth-largest in South America. The country produced an estimated 680,000 barrels per day of oil in 2009. About half of its oil production is exported, much to the US. The bulk of current crude oil production in the country occurs in the Andes foothills and in the Amazonian jungle located in the southern part of the country.

Colombia is rich too in deposits of gold and other precious metals. Investors from resource-hungry states such as China and India have taken an interest in the country that for long remained relatively closed to outsiders.


Marulanda: Asian investors want to buy important assets
Marulanda notes that Asian investors with whom Inverlink has had contact prefer to secure rights on valuable reserves of natural resources or gain a major stake in established concerns, in particular in telecommunications, oil, coal, power generation or transport.

“They want to buy important assets. Their ambition focusses on the highest-profile companies, including the country’s largest oil company. But what’s really only available are medium-size or small assets, or greenfield projects and that has become a major issue,” he confides to The Asset when we meet him at Inverlink’s office in Bogotá.

For the most part, remarks Marulanda, the government’s strategy has latched on to granting concessions to major investor groups to raise the required investments. This policy is expected to create multiple toll roads, ports, railroads and airports in the following years.

“We will need to attract more infrastructure funds, but if you are looking at a 25% or 30% yearly return from large-scale projects, then Colombia might not be the place to come.”

Economic challenges

Colombia, with a population of 43 million, is the third largest economy in Latin America. The new government faces the task of revving up an economic engine that has slowed in a vastly changed global economic environment.

To begin with, much of the demand for its goods in major markets such as the US and Europe have dried up as a result of the global financial crisis. Spain, one of its largest investors and markets, is suffering from an unprecedented financial and economic crisis that at the end of 2010 pushed up the unemployment rate to a 13-year record above 20%. The impact of the global slowdown has been mitigated by the economic pump priming of the Colombian government – especially directed to infrastructure and education.

The increased strength of the Colombian peso combined with competition from Asia’s low-cost exporters such as Vietnam and China has made it difficult to sell Colombian goods, such as textile, leather goods and cosmetics, in global markets. In the city of Medellín, factories have closed because they cannot compete with the goods and produce coming from China.

There are the long-standing complications arising from its military and political dispute with neighbouring Venezuela, which could dislocate exporters who have learned to rely on that market for years. Government officials tend to underplay the conflict, while some argue that the problems have, in fact, helped exporters by pushing them to be more resourceful in growing markets elsewhere in preparation of a contingency when the Venezuelan market would become too difficult to access.

And most recently, Colombia has been on the receiving end of its worst rainy season in history, which has hurt its poorest and most vulnerable people. The heavy rains, high levels of poverty, internal displacement and inadequate infrastructure have turned the floods into a major humanitarian disaster.

Fiscal prudence

Rojas is hopeful. Colombia is at an important juncture, he argues, in its search for greater stability and more equity for the Colombian people. “While countries in the developed world are suffering from economic contraction, the country is enjoying strong economic growth and a huge fiscal surplus that will help propel the economy to a new level in the coming years.” (Rojas is one of the bright lights who joined the new administration of Santos. Before becoming a bureaucrat, Rojas enjoyed a 20-year career as Colombia’s most successful investment banker, founding the country largest investment bank, Inverlink, which has initiated a string of successful deals in Colombia and across the region.)

A key challenge for the government, comments Rojas, is how to spend the fiscal surpluses it is accumulating on the back of the out-performance of the country’s oil and mining sector. “We have pursued a prudent fiscal policy for so many years and we are now reaping the benefits of those reforms. The country has had its share of good news too, such as the recent discovery of offshore oil reserves by giant oil exploration company Ecopetrol. We need to spend the money wisely, making sure that they are allocated to sectors that need them the most. Those sectors include education and infrastructure.”

In early 2011 the country’s finance minister Juan Carlos Echeverry sought to assuage concerns that the country is about to embark on a spending binge after the devastating torrential rains of late 2010. Instead of going over the budget or borrowing aggressively, the government plans to use tax collection, budget spending and a partial sale of state oil company Ecopetrol to finance its reconstruction efforts. Reports say the government’s tax intake is set to increase after President Juan Manuel Santos decreed that a financial transactions tax will remain in place until 2014.

In addition, the government’s tax collection is set to increase by the lowering of the threshold on a wealth tax. The expanded tax intake could allow the government to set up a 6.3 trillion Colombian pesos (US$3.38 billion) “calamity fund” for spending between 2011 and 2014. The government had previously secured approval to sell as much as 10% of Ecopetrol, but Echeverry suggested that the government could instead sell gradually between 5% and 6%.

The new government has remained cautious in the first six months, keen to gain an upgrade of the country’s sovereign credit rating. When visited in late 2010, Rojas described such upgrade as most welcomed as it would make borrowing abroad cheaper.

With the return of political stability across the country and the push of global capital towards emerging markets, Rojas believes this Andean nation stands a real chance of doing well.




Next station: Colombia

Its Nobel Prize-winning writer Gabriel García Márquez would be pleased. Colombia created a stir when it announced in mid-February the plan to build, with assistance from China, a railway to connect its interiors to the Pacific and Atlantic Ocean.

Bogotá was imaginative enough to describe the proposed railway as a possible alternative to the Panama Canal that for nearly a century has served as the transit route for cargo ships travelling from Asia to the US east coast.

The planned 220-kilometre long railway will run from the port of Cupica on the Pacific coast to the Gulf of Uraba on the Atlantic coast. From Uraba, the railway will extend to a new city near Cartagena on the northern Atlantic coast of Colombia.

If the railway is indeed constructed, the Colombian government will have pulled off a monumental engineering feat through rugged terrain and dense jungle.

It was Colombian president Juan Manuel Santos himself who announced the ongoing talks with China, claiming the railway proposal was at an advanced stage and had been shown to be feasible by Chinese studies.

Rich coal reserves

A senior investment banker in Colombia tells The Asset that the main driver for China’s interest in building the railway is to secure access to the rich reserves of thermo and metallurgical coal in the country, needed to fuel its fast-growing economy. The coal will reportedly be transported through the railway from the mines on the Atlantic coast to the port of Cupica, where it will then be shipped by sea across the Pacific Ocean to China.

Colombia is the world’s fifth largest coal producer. Its coal industry is dominated by global mining firms that include MPX, Glencore, Drummond, Anglo America, Xtrata and Cerrejon (a company owned by BHP Billiton).

The majority of its coal is currently exported via Atlantic ports. “Thermo coal production in the country is currently focussed on the Caribbean coast, although vast reserves can be found in the central part of the country where production levels remain low on account of the high transportation costs,” explains Lucas Marulanda.

Most of the thermo coal that is mined is transported by truck to local consumers, adds the senior vice-president at Inverlink, Colombia’s largest investment bank, while the metallurgical coal, which is used for steel making, ends up overseas. “If you ask me what railway project makes sense, I’d say that it has to be a connection between the central and coastal regions,” says Marulanda.

A lesson in geography

Marulanda notes that there is already an initiative by Ferrocarril del Carare to connect the central region to Fenoco, which is a railway concession that goes from the main production sites in the Caribbean to the port in Santa Marta. “It would make sense, in my opinion, to connect the central region to the Pacific coast in the port of Buenaventura if the intention is to export coal to Asia. So far, there is little interest on such project but I wouldn’t discard it.

Marulanda points to considerable challenges in making the project viable – given that the Panama Canal provides the most competitive way of shipping coal – and he is sceptical about the viability of building a railway connection to bypass the Panama channel.

“I would discard this option right away because it is a highly sensitive area in terms of biodiversity and the presence of indigenous reservoirs and second, the area is called “Tapón del Darien”, a very difficult geography for civil works and that explains why there is no road connecting Panama to Colombia and why the electric grid between countries ended up being submarine.”

This option would require the need to construct a port on the Caribbean side (Tarena) and the Pacific side (Tribuga), and build connecting roads to the central region, all of which will increase the capital outlay for such a project.

A second option which would make much more sense in his opinion, is building a railway connecting Cartagena, Medellín and Buenaventura.

“Coal coming from the Caribbean shore and from new mines in the central region could be shipped through the Buenaventura port to Asian markets.” Nonetheless, he concedes that the capital needed for a project of this magnitude must be huge. An additional railway would be needed to connect the project to Bogotá and the coal reserves placed in Boyaca, Cundinamarca and Santander around the surrounding areas.

“A smaller project connecting Bogotá to Buenaventura would be more attractive since it is Bogotá that consumes most in the area,” maintains Marulanda. At present, most of the country’s imports are transported by truck from Buenaventura to Bogotá. “One could have imports coming by railway thus saving a lot of money in transportation costs and coal going to Buenaventura from the central region.”

Panama not worried

The administrator of the Panama Canal dismisses suggestions that the new rail link across northern Colombia could pose a threat to its canal through which about five percent of the world global trade now passes.

Alberto Aleman Zubieta, the head of the Panama Canal Authority, says that the Panama Canal remains a crucial freight shipment hub, and that shipping by sea remains the most efficient method to transport good between South America and Asia. Marulanda seems to agree: “Moving around a container through two ports and a railway would cost US$400 to US$500 compared to the cost of using the Panama channel at US$100.”

Marulanda says the planned railway is targeted to have a 40 million-tonne per year capacity versus the 500 million-tonne capacity of the Panama Channel once the expansion is finished. “I’m assuming therefore that there will be idle capacity.”

The China connection

The Chinese Development Bank would help finance the US$7.6 billion cost of the railway project. There has been a growing buzz over Beijing’s intentions in the wake of aggressive forays by Chinese state-owned enterprises across the developing world to gain more efficient access to raw material. The announcement that such a project was brewing between the Chinese and the Colombians came as a surprise. Bankers in Bogotá were keen to point out that neither the Ministry of Transportation nor the Colombian Chamber of Infra­structure showed any knowledge about such possibility. “That is definitely a bad sign,” remarks Marulanda of Inverlink.

The growing cooperation between China and Colombia comes amid growing disenchantment in Colombia with the US, its leading trade partner, for failing to ratify a free trade agreement that will gain unhampered access for Colombian goods in the US. Colombians have given up hope that such a treaty will be ratified at all in the near future in light of the unemployment problems facing the US.

“It [the free-trade agreement] is a non-starter,” says the banker. The problems facing the US and the rest of the developed world, however, leave Colombia with very little choice but to explore relationships with far-flung markets, particularly China, where its trade has grown from a low US$10 million ten years ago to a robust US$5 billion last year.
This was published in the February 2011 issue of The Asset.

Probity in the board

The problems besetting a slew of corporates worldwide as a result of executive abuses and the surfeit of stories in the media about corporate indiscretions and executive overcompensation have sharpened a sense of cynicism among the public.

Hong Kong offers a fair sample of companies that have succeeded in establishing a strong corporate governance culture.

Edward Chow Kwong-fai has served as an independent non-executive director at Cosco Pacific for the last five years and is gratified to be serving on the board of a company that is the listed port and container leasing and manufacturing arm of one of the largest state-owned enterprises in China, even if it means putting in long hours.

The Hong Kong-listed and China-owned container-leasing company has been a busy outfit in recent years. Its major expansion has included taking control of the Greek port of Piraeus near Athens, and the purchase of a 10% interest from Maersk in the Yantian port in Shenzhen. Last year the company sold its 20% interest in Chong Hing Bank to a sister company.

The Yantian transaction was a connected transaction, which explains why the independent directors were asked to form a committee to determine whether (i) the price for the targeted asset was fair and reasonable and (ii) the deal would redound to the interest of all shareholders. What mattered in such deals such as Yantian, according to Chow, was that the conflicted directors did not play any part in the process.

Smooth operation

The board is committed to ensuring that all transactions remain above board and that often poses particular challenges in view of the short timetable for approving certain major transactions. “As the windows for approval of deals tend to be short, we often feel the strain,”

Chow admits. “Those not used to pressure cooker situations may buckle, while the right person and board may consider such demanding requirements to be more interesting and worthwhile. There is ever the danger that the board does not possess the ability to understand the gist and the content of the deal.”

He describes Cosco’s independent directors as high-calibre professionals. “We are there for the challenge, not the fees, and what is even more significant is that the company’s mission is part of China’s state policy for that industry.”

While there was an initial period of familiarization between him and the directors and senior management, Chow assures us that any hitches in the communication among board members have long since been ironed out. “The gears of our interaction are well synchronized.”

Heavy workload

The board has adopted quarterly reporting. Despite the resulting increase in their workload, the audit committee has never baulked.

“We readily accept the challenges and the duties that present themselves and we get things done.” What is most gratifying at the end of the day, he confides, is when independent shareholders vote overwhelmingly to approve a deal or measure vetted by his committee.

But given that he has his own business – and a myriad of commitments – how does he find the time to do all this? Chow acknowledges that the process and commitment eat up a lot of time. He pans his arms expansively around his office which is located near Hong Kong’s Central business district. “I can tell you this room is relatively clean now, but there were more Cosco and China Merchants Bank papers in this room than my own company materials. Stacks and stacks of board papers, and audit committee papers. Always a lot of things for me to look into.”

Governance is teamwork

In the last two decades Chow has been active in promoting good corporate governance. “I am keen to see Hong Kong grow more familiar and aware of good corporate governance practices.” Chow was in a good position to help along the agenda, since he used to chair the corporate governance committee at the Hong Kong Institute of Certified Public Accountants (HKICPA). When the HK Institute of Directors (HKIoD) was established more than ten years ago, Chow became involved with the leadership council and the HKIoD award is in fact his brainchild.

When he overheard late last year that he had been nominated, he let it be known that he did not want to be given the award in his personal capacity but, instead, in the name of the whole audit committee. The HKIoD overruled his wish, noting that his involvement in the organization had lightened already, and that it wanted to recognize the major role he has played in enhancing corporate governance across Hong Kong in general and in Cosco Pacific specifically.

Winning the award as a member of the non-executive board and as chairman of the audit committee, Chow expressed the wish that there should be recognition for audit committees as well, rather than individuals, considering that the practice of good corporate governance is all about teamwork.

Capitalism has had its days

Chow is of the the view that the traditional capitalist free market economy model started showing signs of decay up in 1997 and recounts the plethora of plagues that have confronted the system – the Asian financial crisis in 1997-1998, the dot.com bubble, Enron, Lehman Brothers, the subprime crisis. “The whole capitalist system might have worked for 30 to 40 years but it has been cracking up and since then we have seen widespread abuses that have spawned doubt about the future and stability of the capitalist model.”

State capitalism, he opines, offers an alternative model. “The model is not perfect but exists in major emerging markets such as China, India and Brazil and in fact in a few EU countries where a lot of state-owned companies have become listed companies.” Chow believes that China has proven to be quite successful and offers a fresh perspective on how the world economy should run. “There really is a need to provide a balance to the excesses of global capitalism.”

Chow notes how there has been much talk about the G2 offerings and of initiatives in blending both systems, and how this has made it convenient to be on the board of state-owned enterprises, observing how things are done. Cosco Pacific’s senior management has been highly transparent to the board, claims Chow.

“They keep things open to us. If we need specific information relevant to our duties we only need to ask and it is given to us. Though there was a period of learning from one another, eventually the management began to discuss with us what is really on their mind and it has been open and candid. Connected transactions, monitored by independent commitees and independent shareholders’ vote, have proved to be in the interest of all shareholders.” Composed of a high proportion of non-executive directors with a wide range of skills and expertise, the board of directors of The Link Management has been cited for its unfailing pursuit of good corporate governance.

George Kwok Lung Hongchoy is proud of his company’s board of directors. “It is good board with a diverse professional and business background,” the CEO of The Link says approvingly. The quality of its board of directors at The Link contrasts with some listed companies where CEOs may bring in a few of their friends and acquaintances to serve as directors even if those individuals lack the right qualifications for the position to which they were appointed.

In The Link’s case, the directors sitting on the board were all carefully considered and vetted by a nomination committee and a key consideration for their selection was their expertise in the various aspects of the real estate business.

A strong range of skills

“We have a top-notch architect, a banker, an accountant, a lawyer, a property surveyor, a politician, and ex-CEO of Hong Kong Land. The powerful cast of talent in the board includes ex- Hong Kong Land chief executive Nicholas Robert Sallnow-Smith; Wing Hang Bank chairman and chief executive Patrick Fung Yuk Bun; Ian Keith Griffiths, chairman of Aedas Limited, a leading architectural firm; Professor Richard Wong Yue Chim, the deputy vice-chancellor and provost of Hong Kong University; and legendary Hong Kong entrepreneur Allan Zeman.

Hongchoy recognizes the essential role the board plays in keeping senior management grounded. “They provide the check-and-balance mechanism that the company needs if it is to remain dynamic in its approach in building the business. The board has been extremely helpful to senior management in providing professional advice, he argues, attributing the high-quality discussions on the board to the stature and experience of the members. “The board constantly challenges us in the way we think.” Given the calibre of the board, the senior management cannot go to the board unprepared.

As such, the board performs an important role since The Link doesn’t have a controlling shareholder as other companies normally have.” The Link is listed on Hong Kong’s stock exchange and is wholly owned by unit shareholders.

Fresh insights

Hongchoy says the frequency of board meetings is much higher than that stipulated for the company in the Securities and Futures Commission (SFC) guidelines. In 2010, the board met 11 times. The nomination committee which is required only to convene once a year did it three times. Even better, the serving directors turn up regularly at board meetings.

Fresh insights and suggestions emanating from the board have proved invaluable to management. For instance, when the board suggested in 2010 that senior management look at transforming the company into becoming an employee of choice in Hong Kong, the company started allocating more resources to staff training. “Last year we started hiring trainees from universities and that was something we had not done before. We looked too at engaging more of our staff to build a company culture. The Link as a going concern, explains Hongchoy, is confronted with issues facing any large company – considering that it has enjoyed a major asset injection from the Hong Kong government in the form of shopping malls and car parks – yet it suffers too from problems facing start-ups as it is only five years old and lacks a distinct corporate culture.

Continuous enhancements

Hongchoy says the company is constantly enhancing its operation. The company’s success as an enterprise is evident from the strong financial performance year after year. The company which had 250 staff at the time of its IPO now has around 900. Hongchoy joined the company in January 2009 as CFO and was promoted last year to CEO.

The company’s business model is recession-proof, he notes, because most of its properties are small, are located in residential neighbourhoods and rely on non-discretionary spending that is less affected by the cyclical fluctuations. Revenues have much improved after significant renovations to shopping centres. “The upgrades made a major difference to the people who lived nearby and they now have a much better shopping environment. As a landlord, all that we can do is to provide a good operating environment for tenants . So people like to go and shop there.”

More improvements are on the way, he adds. “There are still a lot of shopping centres that we need to upgrade.”

This is a condensed version of three separate articles that run in the January 2011 issue of The Asset

Wealthy Koreans turn cautious

The 2008 global financial crisis had a major impact on Korea’s private banking market. As in Hong Kong and Singapore, the most tangible effect of the crisis was to considerably reduce the number of wealthy people in Korea. The crash in domestic and foreign stockmarkets brought vast losses to investors and prompted them to adopt a more conservative investment approach.

Lee Hyung Il, division head and executive vice-president for private banking at Hana Bank, says the numbers of Korean US dollar millionaires only began to recover in 2010, after consistently falling until the end of 2009.

Individuals with financial assets in excess of US$500,000 are considered by Korean banks as belonging to the high net worth individual (HNWI) category. By comparison, the Capgemini & Merrill Lynch World Wealth Report consider those with assets worth over US$1 million as HNWIs. In Korea, individuals with more than US$3 million in financial assets are placed in the ultra-HNWI bracket, which in Capgemini’s view only comprises those with assets of US$30 million.

Conservative attitude
Numerous HNWIs who got burnt in the stock crash still lack faith in the investment products in 2010 and prefer to park their money instead in less risky products, remarks Lee. “They are opting for stability, although it is not surprising that, in view of the low interest environment, the appetite for interest rate guaranteed products has yet to pick up.

Private banks have a relatively young history in Korea, explains Lee, and hardly a decade has passed since major banks in Korea began to roll out a full-scale service offering to private banking clients. "This probably explains the conservative attitude of most clients towards investment."

According to the 2010 Wealth Report, except for HNWIs in Australia – where there has been a sharp increase in house prices – Korean HNWIs showed the largest increase in their average exposure to real estate investment last year: an average portfolio having an exposure of 37%, although this is projected to decline in light of the cooling of the real estate market in Korea.

At the height of the financial crisis, Hana Bank responded to the clamour for safety by providing investment products that guaranteed slightly higher returns compared to regular term deposits. Clients, Lee asserts, have been flocking to the safety of bonds and to emerging-market equities, the latter gaining respect as an asset class offering high potential returns, in view of the pessimism still affecting developed markets such as the US and Europe. The popularity of emerging-market equities can only continue to grow in the near and medium term, believes Lee, considering the vast amount of liquidity flowing into Asian assets from cash-rich pension funds and sovereign funds, both from the region and the rest of the world.

Hana Bank has succeeded in doubling its number of HNWI clients this year from the previous year, Lee enthuses, by coming up with relevant private banking investment products and providing more skilled advice. "The bank has made major readjustments in the way it sells products in the aftermath of the global financial crisis," Lee points out, "because the crisis necessitated a stronger focus on the bank's role as a guardian of wealth." (It used to be common, with a promise of high returns, to push structured products that turned out to be toxic.) “The focus has been to retain the trust by the investors by emphasizing the advisory nature of the relationship and so help protect wealth rather than promising to aggressively grow it. Our emphasis has shifted to providing “guaranteed” and “safety” products.”

Limitless competition
With the implementation of the Capital Markets Consolidation Act (CMCA) in 2009, plenty of Korean financial institutions transformed themselves into megabanks to meet mounting competitive challenges at home and abroad, explains Lee. Key changes in the fund transfer system and bank investment systems too served to heighten the aggressive streak of various types of financial institutions to expand their business operations. This presents both danger and opportunity, according to Lee. “The volatility of markets, the intense competition, and a plethora of risk and compliance issues all combine to increase the vulnerability of private banks in Korea, which is why a broader perspective and lucid thinking are required in assessing the true risks facing the operation of private banking institutions in the country.”

Lee says the implementations of the Overseas Fund Transfer Act and Bank Investment Advisor Act further blurred the boundaries separating banks, securities firms and insurance firms in the servicing of HNWIs and sparked an even intenser competition.
“We have arrived in the age of limitless competition. With various reforms to ease financial regulations, we can only expect competition to accelerate. I believe that, as a bank, we are the most prepared to compete in this fierce environment,” Lee states confidently.

Investor protection has become essential to Korean private banks. “More attention has been given to the oversight and review of risk management policies and procedures. Most banks have redesigned their risk management systems to reduce incidents of fraud.” In addition, CCTV surveillance systems have been upgraded across branches at a fair number of private banks to monitor how relationship managers transact and behave with clients.

Below the surface
Korea has about 127,000 high net worth individuals and their total assets reached US$340 billion at the end of 2009, according to the 2010 Asia-Pacific Wealth Report. Hana Bank’s “Gold Club” private banking services, catering to individuals with account balances of more than US$500,000, currently has 16,000 clients with a total of US$21.3 billion in assets. While their number is a mere 0.2% of the bank’s customer base, they accounts for more than 40% of total assets held by the bank.

The private banking industry is still in a nascent stage, stresses Lee. The investments poured into personnel and infrastructure have been considerable, though, and Korea has consequently witnessed the proliferation of private banking centres that spoil clients with various perks. On the surface, it looks as though a host of banks indeed provide superior services. But if one looks deeper and examines the insides of internal branch operations, a different pictures emerges and the wide difference in the service quality becomes apparent.

Lee says Hana Bank is proud of being the first private bank in the country. It was the first Korean bank too that established a global private banking service at a branch in Hong Kong to provide diverse private banking services targeting regions in the Asia-Pacific. In 2007 the bank established a subsidiary in China, providing financial services to Korean companies and Chinese companies that have Korea-related trading business. Hana Bank (China), has been looking at upgrading its licence to be able to expand its customer base to the top Chinese companies and provide private banking services to HNWIs in China.

Lee believes that the quality of Hana Bank's service remains unparalleled. “We have the requisite tools and resources to design and customize the selection of talents and we have intensive training programmes, offering specialized solutions and products, professional tax advisory services and real estate advisory services, and unique life-care services.” In addition, Hana Bank offers discretionary investment management services, backed by in-house investment experts, a highly disciplined team of portfolio managers, real estate analysts, and tax specialists.
“As competition intensifies in the private banking market in Korea, the banks are naturally forced to extend their competitive advantage through better customer services, a broader range of investment products that meet the needs of clients and finally win both old and new clients.” Merely giving away free gifts or additional bonus interest rates on term deposits, asserts Lee, no longer suffices to retain clients.

The haunting

More than two years since the meltdown in the value of their assets, high net worth individuals (HNWIs) remain haunted by the trauma of the global financial crisis and approach investment markets with great caution.

Despite the lifting of gloom since 2008, asserts Marcel Kreis in an interview with The Asset, a substantial amount of client assets are parked in cash, instead of long-term securities. “We have not seen a broad-based streak of clients going after cash investments beyond six to nine months,” the Credit Suisse managing director and head of private banking for the Asia-Pacific points out. Kreis has more than 20 years’ experience in the field of private banking in Asia. He joined Credit Suisse in 2007 from UBS, and since 1990 has been based in Singapore.

Neither has there been much of a pickup in the volume of institutional money flowing back into discretionary portfolios with a long-term investment horizon. “The flow has not recovered from where it was before the financial crisis and insecurity among investors is prevalent.” With bond prices vulnerable due to the fluctuating fortunes of several European sovereigns and with cash rates at zero – which translates into a negative return once inflation is factored in – investors are starved of investment alternatives.

A more transparent future

The repercussions of the global financial crisis will continue to reverberate across the region and is reshaping the way the industry and its army of relationship managers work, according to Kreis. “As a result of the crisis, investment advisers have been subjected to much more intense scrutiny, sparked by the grave losses incurred by clients as a result of Lehman Brothers’ bankruptcy and share accumulators’ large exposure at the height of the financial crisis – to mention only a few of the events that have rocked the industry since 2007.”

“Given the impact on a host of private individuals, the debate became politicized and there was pressure on regulators to take a closer look at the advisory industry in the financial service sector. This has resulted in new guidelines and rules on how products are marketed and sold.” More transparency was demanded from the industry, Kreis adds, including disclosures in some cases on how much was being charged for services. “What has been made clear is that much of the burden of responsibility for advice has shifted to the advisers themselves and the institution that they represent.”

Banks have been forced to initiate processes that are regularly audited internally and externally, explains Kreis. Regulators, he points out, now require extensive audit trail to establish whether the bank has fully and accurately assessed a client’s risk profile and the suitability of an investment. Much attention has been brought to asking questions to ascertain that clients are aware of the risk they take when sinking their money into an investment product pushed by their banker.

“A lot of bureaucracy was created to ensure that such processes are not given temporary lip service and that they are here to stay.” He does not think this is merely cosmetics to ward off public wrath against lax private banking practices. “What we are seeing is what it will look like in the future. I don’t believe there will be much of a deviation of the current relatively strict interpretation of a bank’s responsibility in case investment advice backfires.”

All this makes a lot of sense, Kreis points out and is something that a good adviser would have done all along, even without the meltdown and regulatory backlash to prod him.


Shih: Compared to Europe and the US, Asia is a less mature wealth market
Kathryn Shih argues that the environment in which all parts of the financial services industry – including wealth management – operate has changed dramatically over the last 36 months. “It is an environment characterized by new liquidity requirements, product regulation, selling and suitability norms, more robust adviser certification coupled with more cooperative, uniform and consistent regulation of cross-border businesses,” remarks the CEO of UBS wealth management for the Asia-Pacific. “Rather than simply collecting assets, wealth managers will need to focus more on investment and product performance. Satisfying this demand will require wealth managers to make heavy investments in education, compliance and technology, because the new environment will prompt clients to demand much higher levels of technical and market competence from their advisers.”

Better risk absorption

The question remains whether tighter requirements and other regulatory developments can insulate people from market mishaps and meltdowns. Kreis says the more disciplined advisory process takes into consideration the product’s risk profile as well as the clients’ risk profile and their ability to absorb risk. By themselves, those considerations are no guarantee that investments will not backfire and that investors will not suffer potentially heavy losses. The only way for financial institutions to protect their reputation and regain the confidence of their clients is to become more transparent.” Kreis recalls that in the heydays of accumulators – when everything was going up – nobody really paid much attention to the potential downside.

“We have seen this with other investments as well. Consider gold which has been steadily climbing since it traded for less than US$300 an ounce, a long time ago.” The volatility of commodity prices has always been there, believes Kreis, and no one will ever be able to ring the warning bell when it’s time to get out and no one will ring the bell when it is time to get in.

“Investment advisers will simply have to make the necessary calibrations about the level at which clients are comfortable exposing themselves to fluctuations in commodities or currencies, but the debate about how much you can lose is an important one for them to explore with clients. The amount of risk taken is often directly correlated to the degree of leverage. If you buy stock and pay cash for it, the shares of the company can go up or down and you can lose a lot, but the maximum that you can lose is the cash you put in. It is an altogether different ballgame if you have leveraged your position. These are the kind of conversations that need to take place.” If you pursue an options strategy, there is a certain time when the option loses its value as you approach the strike date.

Kreis feels that since 2008 clients have become more aware of the potential downside of investments. “Investors are generally optimists who tend to look at the upside, but 2008 destroyed an enormous amount of wealth both with financial institutions and with private individuals. This has reshaped their investment behaviour.”

Wooing talent

A major challenge to UBS reaching its growth ambitions across the region, Shih agrees, is the war for talent. “Our major competitors have announced aggressive growth targets for the Asia-Pacific – which are normally coupled with aggressive hiring targets. But there is a limited supply of high-quality private bankers in the markets in which we collectively operate.” UBS experienced a flight of senior talent during and after the financial crisis, but has since begun a recruiting drive across all markets. The demand for talent has jacked up remunerations for experienced private bankers.

In countries such as China, the drive to recruit is reaching fever pitch with all the major banks keen on offering services catering to the wealthy segment of the population. China Merchants Bank, for instance, in 2010 began an all-out recruitment drive for talent. Unless there is a concerted effort to keep the talent pipeline flowing, Shih of UBS believes that there will be a shortfall of around 900 relationship managers around the region.

Kreis acknowledges the vast changes that have swept through the industry and have made private banking more challenging. But citing the region’s surging potential and accelerating growth in the number of HNWIs, he has nonetheless set ambitious goals for growing the business in the coming years.

Compared to Europe and the US, Asia is a less mature wealth market in which most of the wealth – which was created after World War II – remains in the hands of the first and second generation, notes Shih. “The typical client is an entrepreneur aged over 50 who runs/owns a business.” The bulk of a typical client’s wealth in the region is linked to the business and there is a tendency to reinvest heavily back into the business. In addition, there will be family and business succession issues to be addressed. Historically, the investment behaviour of HNWIs in Asia-Pacific has been characterized by a high risk appetite and straightforward asset allocation.

There is no great shift in the offshore and onshore private banking businesses on account of the strong domestic economies in the region, says Kreis. Credit Suisse recognizes that it is fully on board domestically and operationally in Japan and Australia in order to adequately manage the needs of clients. The franchise is growing because clients recognize the valuable contribution the bank is making to make them even wealthier. “One of the key differentiators between us and our key competitors is our ability to offer investment banking services as well as wealth management services,” Kreis points out.

An underserved market

Although there are regional differences, tangible domestic asset classes, such as direct investments in private equity and real estate, have been preferred sometimes with the use of leverage. Furthermore, in the liquid part of the portfolio, HNWIs have tended to focus on a limited number of asset classes, typically, cash, equity and forex (or structured products replicating these exposures).

In light of the entrepreneurial background of the majority of HNWIs in the region and the preference of most entrepreneurs to be “in charge of their own destiny”, they tend to be actively involved in the management of their investments. However, Shih asserts that the situation is changing and increasingly sophisticated clients in Asia demand that wealth managers maintain a wide range of products and services to cater to their specific needs. But the sharpest difference between the potential evolutions of wealth management in Asia relative to that in the rest of the world is the sheer scale of the market. “We believe that only between 10% and 15% of bankable assets held by HNWIs and ultra-HNWIs are currently managed by traditional private banks. In other words, the opportunity is immense.”

According to the Credit Suisse Global Wealth Report, economic expansion in the Asia-Pacific means that growth in the average household wealth per adult is up to 10 times the global growth rate. China stands out in particular having become the third-largest wealth generator in the world, with total household wealth of US$16.5 trillion, behind only the US with US$54.6 trillion and Japan with US$21 trillion. Household wealth in China is set to more than double by 2015. China’s wealth is 35% greater than that of France which has US$12.1 trillion, the wealthiest European country, and is almost five times that of India.

One major performer is Indonesia whose average wealth per adult has grown the fastest in the Asia-Pacific, by 384% to US$12.112 trillion since 2000. That is the fourth-fastest growth rate in the world.

Stefano Natella, global head of equity research at Credit Suisse, says global wealth could grow 61% to US$315 trillion by 2015. He says their study shows that the middle segment of global wealth has been replacing indebted US households as the global growth locomotive.

New loans reflect confidence

Kreis says the industry has learned its lesson from what happened to rivals. In Europe and in Switzerland, recognition has grown among private banking institutions to be more selective about the clients they work with. “For us to provide investment services, the clients must have met their financial obligations, including paying taxes and other obligations to their respective governments and taxation authorities. There is clearly some money leaving the banking system in Switzerland as a result, but “net net” the country continues to grow.”

Kreis credits this to Switzerland’s status as an international banking centre, driven mostly by tax-declared money rather than cash squirrelled away to be hidden from tax authorities. “You will be hard-pressed to find a location in the world that has such an expertise in international finance. Switzerland has always been cosmopolitan and the Swiss have always been confident about dealing with currencies.” The wall of money entering Switzerland with renewed vigour is coming from emerging markets such as Asia and the Middle East, explains Kreis, and not from mature markets. “It is coming from countries such as Russia that have benefited more recently from the resources and commodity boom. It is still growing.”

A fair number of clients borrow, he adds. “In 2008 we saw deleveraging across the board. Whatever could be sold was sold and whatever loans could be repaid were repaid. So clients in the Asia-Pacific deleveraged to a large degree in 2008, but two years on, our lending activities have grown beyond the original level we had in 2008.” The loan book of the private bank has regained momentum since then and now has more loans outstanding than it had in 2007. He is quick to assure that the bank has not adopted a more risky profile, pointing out that, in the case of the private banking clients, the loans are fully collateralized. “We don’t do cash flow lending but lend against stocks, bonds and property.”

Despite the cautious investing tack adopted by a majority of HNWIs, Kreis has seen confidence returning across all countries, driven more by fundamentals than by speculation.

“The borrowing clients tend to invest the proceeds in their own business and, in some cases, we want them to use the money to make investments with us as well,” notes Kreis.

“It has been quite entrepreneur-driven, because 2008 clearly did not destroy everybody. There were clients who were sitting on a pile of cash looking to take advantage of opportunities that arose and expand their business activities across markets. When they are a little bit cash strapped and have most of their wealth in stocks, depending on the liquidity of their stocks, we can assist them in monetizing the assets.”


A real private banking DNA

Credit Suisse’s managing director and head of private banking for the Asia-Pacific, Marcel Kreis, explains to The Asset what sets the bank apart in the private banking sphere.

Where do you see most of the wealth coming from?

It is virtually in all markets across the Asia-Pacific. With the exception of Japan, economic growth has resumed. Where you have economic growth, there is wealth creation.

Greater China remains a key growth market in the region. Look at the IPO pipeline for 2011: it looks quite strong and a lot of Chinese entrepreneurs are taking their companies public. Because China is such a growth engine for North Asia, the key beneficiaries have been Hong Kong and Taiwan.

There are strong cross-border business and investment flows from China to Taiwan and Hong Kong and back to China. It is becoming one major economic and investment theatre, irrespective of the fact that they are administratively distinct entities. China’s strong economic engine is helping generate a lot of the wealth flow into North Asia.

In addition, we look at Australia and Indonesia which are two of the main beneficiaries of the enormous demand for natural resources. Those countries are showing a strong potential for growth.

Wealth is being created in the mining sector. Last century you had the gold rush in Canada and Australia. Now, it is much broader based for industrial activity in a resource-rich country.

Are there differentiations in advisory fees?

Fundamentally, as clients become more active in their investments, they will pay for the private banking service they receive.

The increased regulatory pressure on compliant behaviour demands more resources and if these resources add cost, we need to find ways to defray the cost of those services through fees for services that are perceived as value-added. The counterargument to that is that fees will inevitably come under pressure with the numerous private banking newcomers expanding into Asia.

Credit Suisse is a financial institution that has been strong in wealth management and in the classic asset management area. We take a client’s money and we try to stretch it as much as we can within parameters that work with the client. We need to make the money work for the client.

In addition, we have a strong investment banking division helping clients raise money in the equity market and in the fixed-income area. If we can help them draw their business more successfully through corporate business activities, then this could be built into a private banking relationship.

Where lies your strength?

We have a strong platform. We continue to grow our footprint in Asia and make the necessary investments where we think clients want us to be better and stronger. We have probably one of the cleanest balance sheets of any financial institution and we are in the business of helping our clients thrive.

When I see how well we work together as a team in terms of analyzing and approving credit or getting an investment solution tailor-made for a client, we are not really sidetracked by internal managerial challenges as a result of the problems in 2008. There are few institutions with real private banking DNA. There are only two large international players that have private banking as part of their DNA – and that’s not badmouthing the competition at all.

The platform on which we operate and our business model are attractive to senior bankers. The career opportunities at Credit Suisse are pretty unlimited, really, which explains why we have been able to hire more senior bankers. The hiring comes from a diverse set of banks. It is quite a balanced picture.

We have reached a challenging stage. There are a number of strong institutions and most of our large and medium-sized clients have more than one institution that they deal with and that’s healthy because it keeps the industry honest. It forces everyone to excel and give clients a broader choice.
This article was published in the January 2011 issue of The Asset

Currency jitters

With currency wars brewing, corporates in the region have grown more nervous about their currency exposures. An HSBC survey in the third quarter of importers and exporters in the region shows that currency exposure has become an overriding concern.

The slide of the US dollar, the currency in which most trades are denominated, means Asian exporters are receiving less for their goods, although in some cases the weaker dollar can translate into cheaper raw materials.

Of the Vietnamese traders polled by HSBC, 76% – a 26 percentage point (pp) jump from the previous quarter – viewed their foreign exchange (FX) risks as worrying, citing fears about the impact on trade growth and demand. In Hong Kong, mainland China and Australia, respectively 62%, 49% and 45% expressed concerns.

This was before the announcement of the US Federal Reserve during its September policy meeting which opened the door to a second round of quantitative easing (QE), compounding concerns over the direction of the US dollar.

Liz Ann Sonders, chief investment strategist at Charles Schwab, explains that when the US Federal Reserve purchases assets, it credits the account of the seller in electronic dollars, thereby “printing” money. By expanding the supply of money, the Fed is devaluing the dollar. “Although a weaker dollar will benefit US exports in the short term, it translates into higher commodity prices worldwide,” explains Sonders.

“Since exports represent a mere 12% of the US gross domestic product and consumer spending 70%, the hit the US consumers take by rising commodity prices could outweigh the benefits to US exporters,” says Sonders.

“While the US dollar slides, other countries are unwilling to sit idly by and allow their goods to become more expensive.”

Obstacles to smooth trade

Simon Constantinides, Asia-Pacific head of trade and supply chain at HSBC, feels it is only natural that entrepreneurs are preoccupied with inherent risks, such as FX and trade regulation. The focus on currencies will intensify in the coming months, as rhetoric on protectionism and unfair trade practices reach a crescendo – especially at the G20 summit meeting on November 11 in Seoul.

While at the time of the HSBC survey, monetary authorities in the region were holding the harness as far as an interest rate hike was concerned, in the fourth quarter China and Singapore changed tack and raised interest rates.

Constantinides notes that corporates face a multitude of issues which hinder the smooth and profitable flow of goods. He cites the lack of infrastructure in parts of Asia and the emerging world; the rise in the costs for shipping, logistics and storage; the squeezing of profit margins by demands for higher wages; and the higher factory operating costs in the region. Around the world, the survey reveals, the following factors were cited as cause for concern: (i) cost of shipping and logistics, by 40% of respondents in Saudi Arabia, 21pp more than in the previous quarter; (ii) insufficient profit margins by 37% of those in the UAE, a 16pp rise; and (iii) supplier risks related to meeting trade commitments by 24% in Germany, an 11pp rise and 14% in the US, a 6pp rise.

New global trade paradigm

As the US dollar declines further in value and a US economic recovery is not assured, corporates in the region are changing the way they conduct business. While the US dollar remains the undisputed trade settlement currency globally, more regional traders expect to settle larger volumes in renminbi in the next six months: 56% in Hong Kong, 49% in Malaysia and 24% in mainland China. Those exporters and importers who plan to use the renminbi as their primary currency in the next six months, made up 19% in Hong Kong, 17% in Singapore, 10% in Indonesia, 7% in Vietnam, 3% in Australia and 1% in India.

Trade between Greater China and Asia continues to perform robustly, notes Chris Lewis, HSBC head of trade and supply chain for Greater China, and the fast-paced developments in renminbi internationalization is creating a shift in the region with greater exports and import volumes expected to be settled in renminbi. Emerging markets continue to drive global trade confidence but developed markets are showing increased optimism, Constantinides points out, and the positive market means trade will remain a major driver of economic growth globally. The new global trade paradigm will be increasingly characterized by stronger prospects of emerging markets trading with each other and the developed world finding more opportunities to stimulate trade with the emerging world markets.

This was published in the December 2010 issue of The Asset

Hedging liquidity risks in China

Concerns in late 2009 and early 2010 that a further souring of the global trade environment could jeopardize the ability of Chinese companies to honour their payment commitments to suppliers dissipated somewhat when global trade volumes recovered in a major manner, even if problems in more developed economies have persisted.

But Chinese firms continue to face challenges, as the government introduces macroeconomic measures with a view to addressing imbalances.

Peter Wong, the founding chairman and president of the International Association of CFOs and Corporate Treasurers (China) discusses with The Asset the various ways in which corporate treasurers across the country are coping and how best they can hedge the risks facing their companies.

Is China suffering from a major credit crunch?

The credit availability may be tight for certain industries, such as real estate, where excessive price escalation is to be curtailed. The fundamentals of China remain solid with inflow exceeding the outflow of capital. While the new Five-Year Plan [from 2011 to 2015] is expected to be positive to the credit market, the emphasis will be more on the quality rather than pure quantity of economic growth.

What should treasurers do today to better prepare their companies for growth in China?

Treasurers should develop a renminbi and foreign currency cash pool inside China to efficiently centralize the control of cash. In so doing, there is a need to rationalize bank relations. The currency mismatch between revenue and expense and that between asset and liability should be managed properly in light of the continued appreciation of the renminbi. To improve financing flexibility, treasurers should develop a renminbi corporate bond programme both offshore in Hong Kong and onshore in China.

How is the global economic recovery changing the outlook of corporates in terms of managing their working capital and liquidity position?

The additional round of quantitative easing in the US suggests that the recovery will take time. The high fiscal borrowing in the US and Europe may crowd out the bond market. Treasurers have larger cash balances as there is no urgency in capital expenditure in a recession and the desire to build a buffer against liquidity risk.
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How active should treasurers be in hedging risk?

The liberalization of domestic interest rates in China and inflation expectations will increase refinancing risks for treasurers. The future development of the renminbi corporate bond market is important. In 2010, foreign companies have been permitted for the first time to issue offshore renminbi corporate bond in Hong Kong. In 2007, the China Securities Regulatory Commission began to approve domestic corporate bond issuance.

We wish CSRC can start allowing foreign companies to issue bond as well next year. The long-term trend of the renminbi strengthening is difficult to hedge. The recent liberalization of trade finance settlement with renminbi may help exporters to bill and receive payment in renminbi to offset their cost base in the same currency.

What changes and enhancements are treasurers making in their regional and global treasury operations?

There is increasing use by treasurers of a treasury management system to centralize the control of cash and risk management. Treasurers are taking steps to realign their bank relations in light of the impact of the financial crisis on the banking system.

What’s the appetite among Chinese treasurers for outsourcing more functions and processes?

The first challenge is to centralize the cash management responsibility to the central treasury operations before outsourcing can be seriously considered. Such treasury transformation requires serious management commitment and expertise to be successful. The introduction of the Basic Standard for Enterprise Internal Control (aka China-SOX) by the Ministry of Finance will be a catalyst for the change in mindset of centralizing operations to minimize treasury risks.

The treasurers want to have the process and system to efficiently centralize their cash either regionally or globally to reduce unnecessary borrowing cost and control unmatched currency exposure to the minimum. Second, they want to achieve an efficient mix of in-house treasury processes which they need to control and those which banks or vendors can perform better due to scale and technology. Third, treasurers want a seamless connectivity between their ERP and TMS as well as that between their in-house system and the banking system.

This was published in the December 2010 issue of The Asset

Pushing to the clouds

It has become increasingly difficult for companies to cold-shoulder buzzwords in enterprise computing. ‘Cloud computing’, ‘virtualization’ and ‘standardization’ are crowding into the vocabulary of senior executives, be they in an organization’s treasury, data manage­- ment, human resources or logistics department.

The ultimate goal is to apply those technologies that serve the corporate bottom line, because this is an age where – as one executive puts it – the ability to leverage cost-cutting technologies defines the most competitive companies.

More and more enterprises are keen on taking advantage of new technologies that allow them to capture opportunities in a business environment where the outlook for growth has improved, according to Natalie Wan. This has led to more consultancy-led and business transformation projects proliferating around the region, in particular for cloud-related initiatives, which is the reason why the senior research manager of IDC’s Asia-Pacific services research group expects the IT services market in the Asia-Pacific ex Japan to continue to do well after the strong recovery in 2010. She forecasts a 9.4% year-on-year growth for the market in 2011.

A fair number of larger corporates around the region are oozing cash, like chocolate from Willy Wonka’s factory, making them prime candidates for investments in enhanced IT capabilities and platforms. Yet, the heightened level of corporate board scrutiny and worries about the possibility of a sudden turn for the worse in the economic environment necessitate a degree of prudence in spending the cash which leads the corporates to ex­plore the options provided by technology outsourcing which, in turn, has translated into a strong growth momentum for various types of IT services in the region.

Andrew Sampson says the cloud computing buzz has certainly caught on among corporates and financial institutions in the region in a bid to cut IT costs and respond to the more dynamic business environment. Under a cloud computing environment, the general manager for Hitachi Data System for Hong Kong and Macau explains, applications and services are not tethered to specific hardware components and processing is handled across a distributed, globally accessible network of resources, which are dispensed on demand, as a service.

As IT budgets continue to be stretched, cloud computing is enabling CIOs to do more with virtualization, standardization and other fundamental features of cloud computing that lower the cost of IT, simplify IT service management and accelerate service delivery. In doing so, CIOs can leverage available infrastructure more effectively to support the business goals of their company. By lessening the drag on data centre resources, cloud computing is enabling IT to hone in on real value creation, namely innovation.

Sending them up to the clouds

According to Sampson, the goal of a technology provider such as HDS is helping enterprises to better manage the storage of critical data in a way that will make it easier for them to take advantage of the cloud computing environment. When asked about the rationale of taking a bevy of journalists and clients on a helicopter ride to offer them a dramatic view of the towering Hong Kong cityscape, Sampson offers: “We are trying to send them to the clouds.”

His group launched an enterprise data storage platform in October 2010 that was a vast improvement from the one launched back in 2007. “We are in a world of data and information and the volume of data that enterprises have to cope with has been growing rapidly. Hospitals, for instance, create magnetic resonance imaging (MRI) scans and X-rays, most of them in three dimensions (3D), which patients may want to keep for a long time. Corporates too need to find ways to keep such records for a long time. In the financial services industry, banks are not allowed to delete data and may be required to keep records of their transactions for years.”

The whole social networking phenomenon has led to more data being created and stored. This has prompted companies such as Hitachi to respond with new products that can handle growth in data storage requirements and make the process more cost-effective, Sampson notes.

In Hong Kong, the group counts among its multinational customers distribution companies and manufacturers in almost any imaginable industry, including banks with large regional data centres in Hong Kong. Such large companies have to continually increase their storage capacity. Local Hong Kong companies too make up a major client segment and while their requirements are of a smaller magnitude, they still have to deal with a lot of the complexity. Smaller companies spend more time dealing with performance issues.

Sampson admits that technology glitches can cause a great many problems. “If a company’s e-mail system is not working, employees become frustrated. In quite a number of companies, once the e-mail system fails, everybody stops working to chat and idle away their time, wandering about the office. Not only does productivity come down but the company faces legal issues as well when customers are not served.” This explains, he points out, why Hitachi aims to provide every corporate with a high-performance platform where data are amply protected and secured.

Sampson says the new platform enables corporates to enhance performance by as much 30% to 40% and results in a 30% to 40% reduction in both power and floor space requirements. “There are plenty of corporate customers who spend more on power to run their date centres than they do on actual service or storage. Not only do they pay for electricity to power the hardware, they need air-conditioners to cool the computers too. More often than not, they end up paying more for power than for storage and service.”

The new storage platform introduced in the region in October is the industry’s first 3D scaling platform, according to Sampson, allowing organizations to become more efficient operationally and cost-wise in virtualized data centres.

Dynamic data centres

Hitachi virtual storage platform (VSP) helps transform data centres “into dynamic information centres where access to blocks, files and content is seamless and resides in a fluid and virtualized environment”, as Sampson puts it.

He argues that the data migration capabilities of the platform greatly reduce outage windows. The 3D scaling – scaling up in performance, scaling out in capacity and scaling deep with external storage connectivity – delivers extreme performance and capacity for robust disaster recovery and high availability systems.

Sampson believes there is no doubt that today’s data centres are reaching an inflection point, evolving into something that is more agile, more scalable and more efficient, with storage vendors delivering on the critical requirements. “Enterprises are looking to transform their data centres into an infrastructure that meets the demanding needs of today’s virtualized environment.”

Wan of IDC holds that the growth in demand for IT services in the region will be largely driven by outsourcing and project-oriented services, as well as an uptake of cloud services. The explosion in outsourcing of a large proportion of corporates’ technology needs has been motivated by a search for alternatives to traditional outsourcing models, triggered by the availability of IT-as-a-service and pay-as-you-go models.

This has resulted in increasing interest in hosted application management as a transition to a public cloud, along with data centre consolidation and virtualization projects, according to Wan. Server, storage and desktop virtualization, along with transition to next-generation data centres, have continued to fuel the growth of network consulting and integration services.

Business analytic solutions are growing fast as more enterprises are demanding predictive capabilities to capitalize on the value of information and enhance competitiveness and time-to-market. IDC analysts say the transformation of IT infrastructure, modernizing applications, as well as streamlining of business processes, are driving enterprises to increase their investments in IT.

This is why initiatives remain to reduce pressure from demand for capital expenditure. IDC believes such initiatives will continue to fuel innovation in outsourcing services over the next 12 months, as governance and IT service management take centre stage in the value proposition for outsourcing services.

This was published in the December 2010 issue of The Asset

Islamic finance pushes for liquidity

Conventional financial institutions find it hard to manage liquidity in volatile times, especially when their confidence to lend to each other is at a low end. During the global financial crisis two years ago, the liquidity contraction in certain structured products and interbank markets led to funding strains for banks and forced central banks to intervene and inject the needed liquidity into markets.

Since they were generally more liquid than their conventional counterparts, a number of Islamic financial institutions were spared much grief during the global liquidity crunch. But the liquidity seizure did not spare Islamic finance and impaired the ability of a few high-profile corporates and Islamic financial institutions to meet their obligations. Several of these were forced to scramble for more expensive liquidity.

The crisis served as a wake-up call for Islamic finance – in the same way it was an eye-opener for the conventional finance industry – and helped to highlight the importance of liquidity to the banking sector.

Overcoming constraints

The case of Dubai World which had issued sukuk to raise equity for its ambitious and often outlandish property project in Dubai is one telling example. If a global financial crunch happens again, there is no telling how tough it would be for corporates and financial institutions. If liquidity is considered to be the ability to fund increases in assets and meet obligations as they come due, then the implied assumption is that such obligations will be met at a reasonable cost. For this reason, liquidity management is an everyday reality that Islamic financial institutions contend with.

In view of the dearth of Shariah-compliant instruments where available liquid assets can be parked to generate stronger returns, it is arguably tougher for Islamic financial institutions to manage liquidity than for conventional banks.

In addition, there is often a maturity mismatch in terms of their assets and liabilities: they have locked most of the funds in long-term investments such as sukuk, project finance and real estate, while most of their liabilities are of a short-term nature, because most of their funding comes from short-term deposits.

Islamic finance experts are working to address these types of constraints. Shariah’s prohibition of riba, the lending of money at interest means that the scope for liquidity management has long been limited. International products in the money markets may be off limits to Islamic banks since those instruments rely on the payment or receipt of interest rates. It has not helped that only a few countries have active interbank markets in Islamic instruments. Malaysia is one exception and it boasts an active interbank market for Islamic negotiable instruments of deposits, negotiable Islamic debt certificates as well as mudaraba and wakala interbank placements.

Islamic bankers acknowledge that the dearth of Shariah-compliant short-term liquidity management instruments is a challenge for Islamic financial institutions and that they hope to see the entry of more liquidity management products in the market. This is the reason why the creation of a corporation set up by central banks and financial institutions in the Islamic world to help Islamic banks and other asset managers better manage liquidity has been described by bankers and ministers as “a major breakthrough” in the history of Islamic finance.

Filling a gap

The various players (including Bank Negara Malaysia) signed the articles of agreement setting up the corporation on October 25, during the Global Islamic Finance Forum (GIFF) conference, which attracted over 1,500 delegates to Kuala Lumpur. The following day Malaysia chaired the first board meeting of the International Islamic Liquidity Manage­ment Corporation (IILM), set up by central banks and financial institutions in the Islamic world to help Islamic banks and other asset managers better manage liquidity. Bank Negara Malaysia governor, Tan Sri Zeti Akhtar Aziz, says the entity will enable effective liquidity management for both Islamic financial institutions and managers of Islamic portfolios.

The goal of the corporation, according to Zeti, is to bring together regulators and key banking participants so they can establish a mechanism that will help reduce risk for a slew of Islamic institutions, especially during volatile periods. Earlier proposals have urged for the widespread adoption of Islamic repo agreements to ensure sufficient liquidity when institutions need it.

As the global financial crisis two years ago demonstrated, Islamic finance is not insulated from problems facing conventional banks.

While Islamic banks have been somewhat resilient to the global financial crisis, the supply shortage of Islamic instruments has nevertheless affected the effective management of liquidity within Islamic banks. KFH Research believes that IILM will fill this gap by providing the Islamic markets with new and innovative products that will allow Islamic financial institutions to better manage liquidity and risk.

Bankers say IILM could help asset managers better manage their portfolios with a cross-border flavour. Several stock exchanges already list Islamic funds, including ETFs, on their board. During the conference, Shariah scholars and other experts urged the industry to focus less on real estate and focus more on infrastructural development to enhance the development of the industry.

The evolution of the Islamic finance industry continues apace with more countries expected to issue sukuk in the near future. Participants at the Islamic conference say Thailand, Korea and even Australia could issue sovereign sukuk.

Dheerasak Suwannayos, president of the state-run Islamic Bank of Thailand, tells The Asset that the Thai sovereign sukuk can tentatively reach the market in June next year with the guidelines from the finance ministry expected to be issued in the fourth quarter this year.

Baljeet Kaur Grewal, managing director and vice-chairman of Kuwait Finance House and Research, told delegates on October 25, the first day of the conference, that global sukuk issuance could reach US$30 billion this year compared to US$24.7 billion in 2009, on the back of the recovery in global economic activity.

Clamouring for greater coordination

Francis Yeoh, managing director of YTL Corporation, says Islamic finance provides a golden opportunity for countries in the region such as Malaysia and Indonesia to enhance their prospects for growth by investing in each other’s infrastructure.

KFH Research says a number of jurisdictions have already come up with their own liquidity management tools, but industry players have clamoured for a more coordinated approach. This is required if the industry is to develop further and remain competitive.

In this regard, adds the research house, IILM has a concrete collaboration commitment by 12 regulatory authorities to establish a mechanism for more efficient management of liquidity across borders. The proposed short-term papers will be structured in such a way that they are easily accepted by investors and therefore intensely traded. “These efforts will serve to contribute towards the continued resilience of the global Islamic financial system.” The establishment of IILM is expected to enable Islamic banks and asset managers to be better equipped to face any liquidity crisis and thus support the systemic development of the Islamic finance industry.

It had been noticed that industry participants use a limited number of products to assist with management of short-term liquidity.

Baljeet says the IILM’s new products, due to be launched early next year, will be designed to directly assist asset managers in their task to maintain their institutions’ balance sheets and provide avenues to invest excess liquidity in short-term Shariah-compliant instruments.

The Islamic financial institutions will therefore be able to reduce liquidity risk by better matching their short-term liabilities with short-term assets. “With the development of Islamic finance spreading throughout the world and into non-Muslim jurisdictions, the need for liquidity management tools has deepened,” according to Baljeet.

She explains that in a conventional setting, institutions offering Islamic financial services are faced with a much greater challenge. For example, there are no liquid assets which Islamic banks in the UK can hold because there is no basis for the placement of short-term assets with the Bank of England on a Shariah-compliant basis. Without an efficient inter-bank market and the support from central banks, market forces have driven Islamic banks towards an increasingly sophisticated replication of conventional banking techniques. There is obviously a trade-off between efficiency and distinctiveness of Islamic finance, asserts Baljeet. Given the conceptual preference for profit and loss or risk sharing, much more fresh thinking and radical innovations are needed in order to engineer efficient instruments for participatory financing.

More short-term push

Islamic institutions today are heavily dependent on a small number of liquidity management instruments. Among the most commonly used is commodity murabaha with a tawarruq structure which acts as an inter-bank lending mechanism similar to the conventional lending arrangements. Such structures have faced troubles on a global scale with not all jurisdictions fully subscribing to the products. Baljeet feels that in order to develop cross-border liquidity it is important to get the structure right. One of the major challenges is to identify suitable assets that can be the basis for the underlying transactions and that are tradeable on a cross-border basis with full recourse to the law of the land.

The push towards more short-term instruments is merely one part of the initiative to enhance liquidity management. As the Bank of International Settlement (BIS) writes in a report on liquidity management at conventional banks, global financial market developments have transformed the nature of liquidity risks in recent years and the challenges facing financial institutions have grown in complexity.

It cites, among others, how the funding needs of banks have shifted towards greater reliance on the capital market, which is a more volatile source of funding than traditional retail deposits.

It notes too that the complexity of financial instruments has increased and that this had led to heightened demand for collateral and additional pressure on prospective liquidity from margin calls.

The increased cross-border business means that events in one market can quickly affect another, BIS notes. More banks face greater challenges in their intra-day liquidity management in relation to both their own activities and the activities of their customers. According to BIS, such challenges have been compounded by recent changes in the design of payment and settlement systems, which have become increasingly real-time in nature.

This article was published in the DEcember 2010 issue of The Asset magazine
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