Monday, August 26, 2013

IIF Meeting in Paris (IV) – Changing landscape for institutional investors

On June 25 and 26, 2013, the Institute of International Finance held its spring membership meeting in Paris. During a fourth roundtable, the participants discussed the changing landscape for institutional investors.

Walter B. Kielholz, Chairman, Swiss Re

Walter B. Kielholz introduces the discussion by outlining the difference between a bank and a non-bank investor: Whereas the bank generates assets and then finances them, the non-bank investor takes the opposite approach: He has sources of funding and must invest them on a fairly long-term horizon.

When talking about non-bank investors, Walter refers namely to life insurance funds, pension funds, individual investments bundled in mutual funds, private equity investments, sovereign wealth funds (for example due to excess resources from natural resources), and hedge funds (using leverage as part of their investment strategy).

The definition of the long-term horizon is, in Walter’s view, not clear. In terms of time, it can consist of “everything from more than 1 week up to 50 years”. As a consequence, he prefers referring to the structured nature of investments to qualify investments as long-term.

When it comes to the importance of the media coverage, Walter pinpoints disproportionate media coverage of hedge funds. Contrary to the impression one might get when reading the financial press, the institutional investment industry consists, in decreasing order of importance, of life insurance and pension funds (50-60 % market share), mutual funds (25-30 % market share), and others (including sovereign wealth and hedge funds – remaining market share).

Finally, Swiss Re’s chairman selects two major issues the institutional investment community faces today, i.e. uncoordinated regulatory measures and treatment of investors' rights in restructurings such as Cyprus.


“Sometimes it seems, if we read the newspapers, that 99 % or 95 % of institutional investors are hedge funds because they make a tremendous amount of noise.”

Dr. Richard Clarida, Executive Vice President and Global Strategic Advisor, PIMCO

Richard gives institutional investors advice, “how to make money over the next 3 to 5 years”. At PIMCO, three investing principles currently apply:

  • Traditional rules of investing do not apply any more.
  • Both bottom up (micro-economic appreciation of markets) and top down (macro-economic appreciation of markets) views count.
  • Always think about the way in which you (as an asset manager) are getting paid.

As regards the economic outlook into the next 3 to 5 years, PIMCO expects

  • the US growing in the 2 % range,
  • a positive long-term evolution of the European economy, and
  • emerging economies growing at a slower pace.


“Rules of thumb about correlations, mean reversion, and typical behavior of credit spreads […] are economic history”

“In order to make money you are going to need both a bottom up and a top down view.”

“Many credit spreads available in the world now are compensating for the scarcity value of your balance sheet.”

“Liquidity, we [PIMCO] think, will be king.”

Michael Karpik, Senior Managing Director and Head of EMEA, State Street Global Advisors

Michael contemplates, on the one hand, the challenges imposed by new regulation on asset managers. The most critical issue here is the incremental cost for regulatory changes in the financial services industry.

On the other hand, he insists on the ongoing lack of liquidity in today’s financial markets.

Lastly, Michael criticizes the implementation of a financial services tax, saying that such tax will not make the financial services industry participate in crisis related costs: “We don't pay the [financial services] tax. This tax is actually coming out of the portfolio returns [of our clients].”


“We are in a much more complex world and also in a much more expensive world in a post-regulatory changed environment. It's forcing a lot of assets managers to change their business model.”

“I think fund rationalization [i.e. reducing the number of funds and get fund managers more focused] is not a bad thing.”

“The biggest impact for us is the draw-down in liquidity in the markets. Secondary liquidity has been pretty bad, especially in the fixed income market.”

“The primary concern is on liquidity.”

Stefan Meister, Chief Executive Officer, Partners Group

Stefan talks about the private equity industry as well as structural changes in national pension systems and their importance for the institutional investment community.

On the first topic, he stresses the benefits of private equity, not only in terms of top line growth but also in terms of job creation.

On the second topic, he outlines the shift of pension systems from defined benefit to defined contribution systems, namely in anglo saxon countries. In Stefan’s view, this is problematic because it leads to a focus on the portability of pensions and their daily valuation. As a matter of fact, this contradicts the long-term view on pension return generation. Another phenomenon is the increasing outsourcing of pension systems by corporates which leads to corporates feeling less responsible for their employees’ pensions and, ultimately, contracts the long-term nature of managing pension investments.


“Private equity, indeed, is really long-term.”

“[Private equity] really focuses on developing assets – developing companies – much more than on buying and selling companies.”

“As corporates increasingly get the impression that they are no more responsible for the pensions of their employees, they outsource it.”

Donald M. Raymond, Senior Vice President and Chief Investment Strategist, Canada Pension Plan Investment Board

After describing the Canadian pension system and the activity of the Canada Pension Plan Investment Board, Donald talks about increasing disintermediation in the institutional investment process: For him, this is a positive evolution because

  • it reduces agency risk;
  • eliminates wrong incentives caused by the presence of intermediaries (A third party investor needs liquidity to calculate his fees and this contradicts the long-term investment approach.);
  • origination capabilities of a third party manager are not necessary for sizeable investment projects.


“Disintermediation and removing a layer of agency risk gives an opportunity for much better alignment of overall long-term objectives.”

“You don't need the origination capabilities of a third party manager in infrastructure [projects]. These [projects] tend to be very large. […] If you can find them, they can find you.”

“The process can be very long and time consuming. There is no standardized process for going through an infrastructure process. In a few cases, we spend up to a year […] for going through the due diligence process.”


If you work for a member institution and register with the Institute of International Finance, you can watch or download the speeches here.

Sunday, August 18, 2013

IIF Meeting in Paris (III) – Global Outlook and Risks

On June 25 and 26, 2013, the Institute of International Finance held its spring membership meeting in Paris. The third discussion dealt with the current state, outlook, and risks for the major economies in the world.

Axel A. Weber, Chairman, UBS AG


Axel Weber delivers a very fact-based, if not unemotional speech. He introduces the discussion by quickly mentioning the major current evolutions in the world economy:

  • The Euro is still in an extended recession, although its financial markets have stabilized.
  • The US is closer to “self-sustainable recovery” and debates about unwinding exceptional monetary policy measures.
  • Unprecedented steps of the Bank of Japan and a slower growth momentum, especially in China, mark the Asian economy.

What’s more, the world economy today shows divergent economic policies in different countries, triggered by varying stages of the economies’ business cycle.


The economic outlook has improved since last year but the recovery is still fragile.”

Currencies ideally should reflect economic fundamentals and the relative strengths of the economies and should actually act as a stabilizing mechanism in the world economy. But in a condition of extreme monetary policy measures in many jurisdictions, this may distort the picture and, going forward, it might also distort the way exchange rates move between major trading partners.”

Dr. Olivier Blanchard, Economic Counsellor and Director, Research Department, International Monetary Fund


Olivier begins his speech strikingly by describing 3.5 stages of today’s economic recovery:

  • Emerging markets are doing best.
  • The US is doing ok.
  • Europe is doing poorly.
  • Japan is somewhere in-between.

Even though emerging markets currently show the best economic performance, it is getting less strong than we are used to. Dr. Blanchard is wondering – Is this decrease cyclical? – and doesn’t give a clear answer: “Although there are differences from country to country, the bottom line is: It is a decline in potential growth with some cyclical components.”
As regards declining Chinese exports, they have been compensated by increasing investments: As a matter of fact, the Chinese investment rate has moved from 39 % in 2007 to 45 % today. The question is, however, whether such a high rate will be sustainable.
A decreasing growth of the BRICS should also worry the USA and the Eurozone: The IMF predicts that a 2 % decrease in BRICS’ growth would lead to a 0.5 % growth decrease in the US and the Euro area.

In the US, “recovery is there, private demand is strong, and fiscal consolidation is at break“.

Olivier Blanchard’s appreciation of the European economy is best described by the term “hope”. Above all, periphery countries still need to improve their competitiveness and increase internal demand.

In Japan, the central bank currently tries to grow aggregate demand through lowering real interest rates. In Olivier’s view, it will actually take a long time for this monetary policy (“abenomics”) to prove successful. In the meantime, it generates a lot of volatility in Japan and, by implication, in the world economy.


We clearly have a world with divergent [economic] evolutions.”

Uncertainty is part of the game.”

[The USA] is an economy that is recovering.”

The right word [to describe the state of the European economy] is still working progress.”

In the core, the numbers are really bad, but there are some reasons to believe, going forward, that they are getting better.”

It's going to be a long time before we actually know whether “abenomics” work.”

Dr. Ethan Harris, Co-head of Global Economics Research, Bank of America Merrill Lynch Global Research

Ethan draws a positive picture of the US economy, saying that the US is close to a self-sustained economic recovery, namely driven by a stronger housing market.

In his view, the main recovery factor in the US is the accommodative monetary policy of the FED, because it has allowed households and companies to improve their balance sheets. Dr. Harries believes that an exit from the current monetary policies will not be made quickly, at the earliest by the end of 2014.

Today, the main challenge in the US is to cut government spending; Ethan calls this the “fiscal shock”. This leads the speaker to a blunt critique of US politicians: Ethan says that politicians have repeatedly made abrupt shifts in economic policy which were and are very bad for the confidence in the US economy.


There is no question that we [the US] are getting closer to a self-sustained [economic] recovery.”

The most bullish sign in the US is the recovery of the housing market.”

Washington will become less of a negative factor.”

I sometimes tell clients that the best thing that could happen to the US would be to cut off Washington and to push it into the Atlantic Ocean. But I don't want it to go too far and make it to Europe.”

My hope is that – well – Washington won't be very productive –, at least, it won't be counterproductive.”

I think that the message the markets will get [from the FED as regards exiting accommodative monetary policies] in the coming months will be: We're in no hurry here!”

Dr. Otmar Issing, President, Center for Financial Studies


Otmar Issing concentrates on the situation in Europe and identifies interest rate spreads between companies in the center of Europe and the periphery as the most decisive challenge Europe faces today. However, those spreads are not linked to monetary parameters of the common European currency but to national economic policies and sovereign risk. Therefore, significant reforms at member state level are necessary today. But carrying out necessary reforms is subject to moral hazard: All too often, individual countries neglect the need for reforms unless they are faced with unsustainably rising interest rates.

In the second part of his talk, Otmar turns to a fundamental lack of the common European currency that he calls a “currency without a state”. In this view, Eurozone member states will have to transfer more elements of sovereignty to the EU level to provide democratic legitimacy to a common monetary policy. However, he takes a rather critical position on the question whether member states will be willing to do so.


In my interpretation, the Euro area is at a fundamental crossroads.”

When the Euro started, it was called a currency without a state.”

As soon as taxpayers' money is included, you come to the question of sovereignty and monetary policy.”

It's [monetary decisions on interest rates] taxation without representation. […] This is not the way Europe should go.”

I'm not sure how many countries will finally be ready to transfer fundamental elements of sovereignty to the European level.”

We are in a crucial moment of the [European] institutional setting.”

Stephen King, Group Chief Economist, HSBC


Stephen analyzes the economic situation in the UK and China.

His opinion on the UK economy is very negative; pointing out that no significant recovery has taken place over the last years. Obviously, the main basket of the UK economy, the financial sector, experiences currently low or even negative growth rates and this affects other key sectors in the UK, namely construction and the public sector.

As regards the Chinese economy, its tremendous growth was, prior to the financial crisis, driven by growing exports. After the financial crisis, falling exports have been compensated by increasing government spending, namely in the infrastructure sector. In the speaker’s opinion, this increases the risk of financial bubbles as well as the realization of tail risks. Ultimately, China’s growth will shift from a purely quantitative growth to a more qualitative (meaning growth based on market-based prices for inputs) growth.


The UK is actually an emerging market in some way or another.”

For the UK, there have been elements of wishful thinking over the last few years – optimism bias.”

Each year, the forecast [for the growth of the UK economy] is virtually the same: Next year is the first year of recovery. It's just that next year never arrives.”

The quality of growth [in China] has been declining [since the financial crisis].”

The intention to reduce tail risk in the longer term certainly leads to lower short-term growth rate [in China].”

From the point of view of the global economy, there has been a kind of increasing dependence on the assumption of China being strong. […] That raises new risks for current account funding in some parts of the emerging world.”

François Pérol, Chief Executive Officer and President of the Management Board, BPCE


Francois emphasizes the importance of common policy measures in Europe. In his view, the absence of a common budget and a common economic policy is a huge bet on the Euro.

On the negative side,

  • Francois wonders whether economic imbalances within the Eurozone (for example full employment in Germany vs. very high unemployment in Greece and Spain) are tolerable, from a social point of view.
  • Recessions are deepening in Eurozone periphery countries.
  • Even in the core of the Eurozone (namely Germany and France), economic activity is slowing down.

On the positive side, financial markets are less nervous since Mario Draghi’s “Whatever it takes” announcement and seem to think that the risk on the common currency has now faded away.

Towards the end of his speech, Francois Pérol specifically comments on the European banking regulation. In his view, reforms are highly important but focus too much on capital markets. As Europe still finances its economy predominantly through banks and a transition towards a capital-market based financing model will take time, today’s regulation should not ignore the necessary transition period.


No common budget, no common economic policy, but a common currency. Maybe we did not know that at that time, but it was a huge bet.”

Is this level [of differences in unemployment rates within the Eurozone] socially tolerable?”

It is not possible to make fundamental institutional moves [in Europe] without the agreement of the people.”

We need a fully loaded and full-fledged banking union, meaning a single supervisory mechanism and a single resolution rule.”

It must be reminded that the Eurozone is still a credit-based economy. It is not yet – not yet – a capital market based economy.”

[The European banking] regulation is mainly made for a capital-market based economy – But this is not the state of the art [in Europe] and we need a transition.”


If you work for a member institution and register with the Institute of International Finance, you can watch or download the speeches here.

Sunday, August 11, 2013

IIF Meeting in Paris (II) – Removing structural impediments to growth in Europe: Taking stock and the road ahead

On June 25 and 26, 2013, the Institute of International Finance held its spring membership meeting in Paris. Unfortunately, I wasn't invited. To be honest, I wasn't even aware of the meeting before it took place. Anyway, the content is on-line and this is actually enough to write a short summary about it.

The second discussion was about economic growth prospects in Europe, to be achieved through structural reforms.

Joaquin Almunia, Commissioner for Competition, European Commission

Joaquin Almunia introduces and leads the discussion. He pinpoints major economic topics which have been discussed in Europe since the introduction of the Euro in 1999:

In the first decade since 1999, economists talked about combating low growth by improving productivity, employment levels, and common product and services markets. Key reforms addressed the sustainability of social systems, harmonized labor markets, and fought for common financial markets.

Since 2008, we discuss predominantly the levels of indebtedness of member states. To bring debt levels down, governments introduce structural reforms. At European level, hot topics include the banking union and the stabilization of the common currency through deeper economic integration and better economic policy coordination.


“If we have to discuss these issues at length and in depth, we can spend the whole day and we will only be analyzing the challenges we have.”

“We [Europe] are not yet there.”

“De-leveraging is taking place [in Europe] in both the public and the private sector.”

“We need to cut this link between the sovereign risks and the balance sheets of the banks.”

“This economic and monetary union needs a second step forward with new governance and new economic solidarity mechanisms.”

“Without adequate mechanisms to resolve banks, the single supervisory mechanisms [in Europe] and the Basel III rules will not work in an efficient way and will put the burden of a solution of banking crisis on the shoulders of our citizens.”

“[We must] preserve the European social model to offer [the European member states] which suffer high levels of unemployment a better future.”

“Competition enforcement is the most efficient and cheapest structural reform.”

Olivier Garnier, Chief Economist, Société Générale

Olivier compares the German and French economy.

He stresses four key success factors of the German economy today:

  • Corporate profit margins above historical average
  • Low real labor costs, especially in the service sector
  • Strong manufacturing sector
  • Efficient use of the global value chain, namely through global distribution of work-flows

French companies experience pretty much the opposite of the above, namely low profit margins and high real labor costs. As a result, French SME’s lack pricing power.

Turning to necessary economic reforms in France, Olivier emphasizes the need for France to cut government spending. In the end, only a smaller government budget can lead to lower social contribution and other taxes. Generally speaking, he believes that too much resource is allocated to the French public sector.

On a positive note, Olivier outlines two key strengths of the French economy:

  • Demography: Contrary to the German population, the French population will increase in the future.
  • Large pool of domestic savings: The French household sector is in good financial health. As a consequence, there is room for re-balancing of financial positions between the corporate and the household sector.


“In a few years, structural reforms can pay off. It's better to start sooner than later.”

“Before looking at competitiveness, I prefer looking at profitability. The key problem, right now, of the corporate sector in France is profitability.”

“Germany has been very good in taking advantage of [cheap] imports of intermediate goods and some kinds of outsourcing while this has not been done in France.”

“At the end of the day, the reason why social contribution taxes are higher in France than in most other countries is due to the fact that government spending is higher in France than in other economies.”

“The only way to cut labor costs [in France] is to cut government spending.”

“It's very important to convey that reforms can succeed.”

David Mackie, Head of Western European Economic Research, JP Morgan

David explores the reasons for Europe’s recent poor economic performance:

On the demand side of the economy, he believes that ECB’s monetary policy constitutes a structural impediment to growth in the Euro area. As a matter of fact, the ECB has been less aggressive than central banks in the US, the UK, and Japan, both to limit moral hazard and to avoid fiscal redistribution. David especially criticizes Germany's insistence on dealing with economic problems first and foremast locally as opposed to finding common European solutions.

On the supply side of the economy, David affirms Europe’s slower growth in labor productivity and utilization. In his view, such slowdown is not only a cyclical phenomenon but a structural impediment.

Finally, political governance issues within the European Union also cause substantial difficulties.


“Growth in many countries has been constraint in recent years by having to adjust to prior excesses.”

“The clock is now been set ticking on the ultimate exit from this very extraordinary monetary stance.”

“Over the last four years or so, the US economy has performed better, on average [compared to the European economy], because of the FED's monetary stance.”

“The ECB has under-delivered relative to a standard reaction function.”

“The [European] central bank has taken on responsibility for managing moral hazard in the region.”

“The ECB seems to believe that governments need to be under a certain amount of pressure, whether that's from markets or from growth, in order to make appropriate adjustments.”

“For the Euro area to achieve a growth potential – even in the region of something like 1 % – we need to see a significant recovery in productivity growth and/or significant fall in the actual rates of unemployment. And it is pretty hard to see how those things can happen without a significant amount of fairly traditional kinds of structural reform.”

“It's [structural reforms] not just about legal structures but also about bureaucracy and how laws are applied and interpreted.”

Carlos Moedas, Secretary of State to the Prime Minister, Portugal

Carlos uses Portugal’s recent economic history to underline the importance of structural reforms for economic growth.

He starts off by highlighting three difficulties Portugal faces today:

  • Structural reforms require important up-front costs and their benefits arise only over time. Reforming competition law serves as a good example here.
  • Any structural reform embodies a fight between insiders, who are against reforms and don't want change, and outsiders.
  • The world of twitter and facebook – “You cannot explain a structural reform in 140 characters!”

How can Portugal tackle its problems?

  • Quantifying reforms is important and should be done more often and in further detail: For example, economists should strive for quantifying the effect of reforms on potential GDP.
  • Feedback loop: “Go and see if the reforms are really working […] and if [they are] not working, change the law again.”
  • Finally, structural reforms should be carried out consistently in all European countries. For example, a services directive implemented in Portugal, but not in Spain, France, or Italy would clearly disadvantage Portugal.


“Portugal has proven today, that it is actually possible to adjust under a monetary union.”

“The solution [for growth] is not about spending.”

“The structural reforms are the ones that can actually bring growth back. The problem with structural reforms […] is that they are very difficult to explain and very difficult to sell to your constituents.”

“Europe is there to help us [Portugal] but we are actually also there to help Europe.”

Pier Carlo Padoan, Deputy Secretary-General and Chief Economist, OECD

Pier Carlo starts his speech praising current structural reforms in and outside Europe. However, equally important will be how those structural reforms are implemented. Obviously, this requires an efficient administration and a strong civil justice system.

Structural reforms are indispensable for long-term growth. In addition, they entail positive side-effects in that they facilitate and improve the current account balance and fiscal consolidation. What’s more, they have a positive impact on income distribution and inequality.

Another focus is on the difficulty to implement structural reforms, namely due to the time difference between implementation and effects. It might actually happen that structural reforms further deepen a recession and increase unemployment in the first place.

With regards to the geographic scope of structural reforms, Pier Carlo advises Europe to work simultaneously on a supranational and on a country level.


“A good qualitative long-term fiscal consolidation supports structural reforms but also the other way round.”

“Of course, in a recession, things are more difficult to see.”

“You need a better macroeconomic and financial environment.”

“When the cycle will get stronger – hopefully not too much down the line – the impacts of [today’s] reforms will become [clearer].”

“We are not seeing the results [of structural reforms] in Europe yet. But we might see them sooner than we expect, once the cycle and the credit system get better.”

“Structural reforms are very important but they are also country specific.”

Jean-Claude Trichet, Honorary Governor, Banque de France

In a forthright commentary, Jean-Claude Trichet highlights the importance of structural reforms, defends ECB’s monetary policy, and shifts responsibility to the EU governance structure.

As regards structural reforms, Jean-Claude draws a disappointed conclusion: “We [both the EU and the G20] know what we have to do […] and we do not deliver.” This is all the more surprising as examples for successful structural reforms don’t lack: During the financial crisis, the most resilient advanced economies were Canada, Sweden, and Germany and all of them had carried out bold structural reforms previously.

As its former president, Jean-Claude Trichet defends ECB’s monetary policy:
In his view, as the central bank’s action during financial crisis has shown, the often criticized indecision of the ECB actually does not exist.
Beyond, ECB’s focus on refinancing banks is actually due to the very structure of Europe’s financial markets: Whereas the US economy is financed 80 % through financial markets and 20 % through banks, the opposite is true for the European economy. Jean-Claude points out that, in this context, you virtually cannot compare the monetary policy of the ECB and the FED.
As a final comment on monetary policy, the former ECB president distinguishes between standard measures (i.e. interest rates) and non-standard measures (i.e. purchase of treasuries and securities): In his view, only standard measures constitute monetary policy as such. Non-standard measures are only additional instruments to implement monetary policy and to substitute to an intermediation that is not functioning.

The governance structure in the European Union is the roots for its economic problems: “Putting the blame on the central bank is not appropriate. I would put the blame on governance of the Euro area.” – says Jean-Claude Trichet. A cornerstone of this critique is the lack of respect of the European stability and growth pact. A healthy European economy would also require monitoring and correct macroeconomic imbalances among member states. Finally, implementing the European banking union is absolutely necessary for the Eurozone to be successful.


“We [the ECB] were the first central bank to embark on highly non-standard measures on the 9th of August 2007, in giving liquidity on an unlimited basis at a fixed rate.”

“We [the ECB] are supplying liquidity on an unlimited basis provided we have the appropriate collateral.”

“The main problem why the real economy is disappointing in some respect is […] that several countries absolutely had to adjust. And this was unavoidable because the rest of the world was very clearly saying: We will not finance your deficit eternally.”

“We trusted the competitive channel would correct those imbalances [in the Euro area], but it did not.”


If you work for a member institution and register with the Institute of International Finance, you can watch or download the speeches here.