Sunday, November 29, 2009

The UK economy and signals from the CDS market.

According to David Oakley of the FT, the latest credit default swap price shows the cost of insuring UK government debt has increased by £20,000 to £70,000 a year for every £10m debt. An increase of 40% within a space of a month.

Why is the CDS market pricing in such a huge increase and why is the long end of the UK gilt market not following suit? Rather than see gilt prices move in tandem with the CDS market, we have seen yield on 10 years UK government debt head south? Are bond vigilantes asleep at the wheels or is this a short term phenomenon? What are bond vigilantes focusing on at the moment? Is it inflation, risk or the long term growth rate of the UK economy?

Below is the latest comment from standard and poors on the UK economy.
"We have revised the outlook on the UK economy to negative due to our view that even assuming additional fiscal tighthening, the general government debt burden could approach 100% of GDP and remain near that level in the medium"
David oakley further states ".........the UK is heading for a budget deficit this fiscal year of 12.4% and a net debt as a percentage of GDP of 55.4%."

Policy inconsistency:
It is our believe that the policy of quantitative easing (QE) being adopted by the BOE is the wrong approach. Interest rate of 0.5% and £200 billion spent so far have failed to lift the UK economy from its current state.

While we commend the BOE and the UK govt. for taking steps to stabilise the banking system, we however see the continued purchase of gilts in the name of QE as an exercise in futility.

The current recession in the UK is a balance sheet recession, where both firms and households have ever increasing liabilities with falling assets. Hence the astronomical increase in the rate of IVAs and bankruptcies within households and firms alike.

Rather than focus its monetary and fiscal policies in addressing these issues, the BOE and the UK govt have decided to keep pumping money into the banking system.
This so called balance sheet recession has destroyed aggregate demand and we expect monetary and fisscal policies to address these issues.

We expect the UK govt to reduce its vat rate to 10%, reduce basic rate of tax to 15% and the BOE should maintain an expansionary monetary policy for the next 2 years or so. These measures in the short run will increase government debt but will increase disposable income, which will then speed up the process of balance sheet repair by households and firms. Spending by households and firm will then increase. Aggregate demand will then return, investment spending will also increase and job creation will follow suit.

Anything short of this is a recipe for disaster and hence the reason why UK CDS prices are increasing. The hard nosed investors are beginning to smell blood and hence positioning themselves for the day of armageddon!!

Our recommendation:

1) Short the pounds: The cable is caught within a range of 1.64 and 1.68. We would establish a short if the the cable gets to 1.70. Why we believe this as a good trade is that the BOE is in no mood to see the sterling rise and for 2 reasons:
a) The BOE sees the export sector as the one sector that can get the UK out of its current state. Hence a devalued sterling is good news to exporters.
b) The BOE wants inflation back to its target range of 2%. An appreciating currency will negate this target.

2) Put in a curve steepner trade: We believe shorting the long end of the UK yield curve and long the short end is the right trade to place. If the CDS market is right, we believe investors will soon begin to demand higher yield for holding UK government debt.

3) Long UK CDS Debt: For those who have access to the credit market initiating a long UK debt CDS will be best option.

Please note these trades are medium to long term trades and should be implemented using the options market.

From Mr Olu Omidire (FCCA).

Wednesday, April 8, 2009

Global Economic Downturn - Part 2: Who is to blame?

In the last 18 months we have witnessed increase in number of company closures and rise in redundancy. Analyst and experts have predicted a longest recession in living memory, and confidence in the markets around the world is at the all time low. Everyone including the politicians do not want to take blame for this crisis. This crisis is really not a political problem as it turns out to be, as governments are bailing out big corporations from total collapse. At times like this, finger pointing, name calling, scapegoat are order of the moment. But who should we really blame for this crisis? Some argued that the CEO’s and the management of near-collapse banks should be responsible. Others said that the government should be blamed for lack of regulations. I think there is a fair legitimate argument from both sides.

In this article, I will take each argument in turns: Last week we witnessed thousands of demonstrators plotting a series of protests to exploit the disenchantment with City financiers blamed for dragging the economy into recession. The protesters aim was to show their concerns to world leaders at G20 summit in London that weekend. Their main concern is the excessive performance based bonus/incentive culture of the banking industry, which they argued was the main catalyst that leads traders to be reckless and “gamble” with investors monies. The have taken position in a rather complex financial instrument. These instruments are very difficult to account and report and sometimes do not appear on company’s balance sheet but revenue from these transactions appear on company’s book. It is these transactions that now threaten the entire Western economies and it’s spreading like a plague around the globe.

But why should we make traders a scapegoat in all of this? The executives of these companies are far worse when you look at the average remuneration package of CEO’s of investment banks. An average salary of a trader in the city is around £60,000 to £90,000 but their annual bonus ranges from a quarter to 1 million pounds depending on revenue generated. So you can see why these traders would be motivated to take risk or try to make profit at all costs leaving investors at huge risk. The same argument goes with their executives who received stock options. With stock options to be exercise when top management are leaving the company, there is an incentive for these executives to want to increase the value of the stocks to receive maximum payout when their time in office is over. In 2008, an investment banker Andrea Orcel at Merrill Lynch was paid $38.8 million in cash and stock option.

In the mortgage sector, brokers whose salary depend on the number of property he/she sells also became reckless. They ignore the basic principle of risk management. Mortgage loan were offered to families with no secure job at 3 times their annual salaries. No one seems to care as economy booms, house prices rocketed. Average family in the UK and US has 3-4 credit cards on top of their mortgage loan. Our bank executives for their own greed encourage masses to be indebted.

So why government should be blamed for those actions described above? After all, it all happened in the private sector and we operate in free economy. Let me answer this in its simplest form. The governments are the ultimate beneficial of these malpractices. The economy enjoys the boom period and politicians were given praise for good policy. In the UK under Tony Blair, the financial system was deregulated. Banks became autonomous, the result of this independence we can see clearly today. In some quarters, some argued that government should have clamped down on executive pay and bonus and incentive culture.

From both set of arguments above, it is interesting to see where this debacle will lead us. Some of even suggesting it might be the end of capitalism and free market enterprise. I strongly believe that those who have been charged should look into their closet and decide where to mend what I will call reckless greed of the executives. On the other hand, our governments should also be proactive and vigilant in reading red flags. After all, they the one who have being left to clear the mess with taxpayer’s money.

Sunday, April 5, 2009

NAIRA - The way forward

We have seen a precipitous drop of the Naira in recent months and the problem it has caused policy makers, manufacturers and the whole economy as a whole.

Let’s take a look back and reflect on why the Naira gained strength in recent years.
The Nigerian economy saw a massive inflow of funds from Nigerians in Diaspora and foreign investors into the equity market. Also crude oil prices at record highs provided enough foreign exchange to meet pent up demand. It was boom time and hence the naira strengthened in the process.

However in the history of the world boom times don’t last forever hence with the onslaught of the global recession, there was a massive capital flight from the capital market, the price of crude oil headed south as global demand went into a tail spin and as with anything else, the naira followed suit heading south in the process.

There was absolutely nothing the Central Bank could do to save the Naira, it had to bow to the currents of market forces or else it would have been carried by the currents itself. Just ask the Russians who tried to defend the ruble. They had their fingers burnt. They spent almost half of their reserves in the defence of the ruble but to no avail. They should have lent from the Japanese. In that respect I want to congratulate Prof Soludo for not standing in the way of a fast moving train.

Having taking a bitter pill, what is the way forward for the Naira? Just as boom times don’t last forever, gloom times to last forever as well. How do we place ourselves in such a way we benefit when the naira is strong and when the naira weak?

There should be a massive investment in the non oil export sector. As governments around world increase there fiscal stimulus, I believe there would be an increase in the price of commodities (softs, precious and base). With a weak Naira and a well developed non oil sector we stand the chance of capitalising on this increase and providing employment for the masses in the country.

Policy measures should also focus on infrastructure development to provide a base for the export sector. It should be the government’s objective to bring down the cost of doing business in Nigeria. In so doing Nigeria will be another India or China as we have the resources (natural and human), good climate and a business friendly populace.

It is imperative that the CBN looks into the cost of borrowing in Nigeria. The current rate is a massive disincentive to doing business in Nigeria. While inflation is falling in most countries which are reflected in the long end of the yield curve, inflation in Nigeria has become a monster that successive governments have not been able to tame. Cost of borrowing will continue to be in double digits until this beast called inflation is tamed. I will discuss ways of taming this beast in another article.

Risk management policies are also lacking in the sale of our most precious foreign exchange earner. While well-informed countries with crude oil as Nigeria were hedging their exposure to price movement at $100.00, Nigeria simply sat on its backside, hands akimbo and did nothing. Buying a Put option would have ensured we still sold crude at $100 while the price of crude fell to $40.00. That is $60.00 per barrel more of revenue or the equivalent of $60m dollars a day!!!

In summary the political will and serious policy measures will see Nigeria navigate successfully this difficult period and put us in a better shape when global demand returns.

Mr Niyi Omidire is a global macro player (currencies, interest rate and commodities)


Thursday, March 19, 2009

Corporate Social Responsibility: A Policy to improve performance and sustain economic growth

In the last few years Nigeria’s economy has been on the upward trend with the banking sector leading the way. Political stability, a growing middle class and foreign investment in the country are part of the many reasons why Nigeria’s banks have done so well. Ask anyone in the banking industry where the next emerging markets is, I believe Nigeria would be within the top ten countries to be mentioned. This is an interesting time for those living in the country, Nigerians living abroad and international observers who see Nigeria as an important player in the growth of the Africa economy. However, a cautious approach is needed to avoid the repeat of the Asian Financial Crisis in 1998.

Nigeria must improve its standard of corporate governance to woo investors’ confidence both in the country and internationally. The Central Bank of Nigeria (CBN) has identified weaknesses in Corporate Governance of Banks in the country and as a result developed a Code of Corporate Governance for Banks in April 2006. Prior to this, the Securities Exchange Commission in Nigeria (SEC), the regulatory authority of the Capital Market and Corporate Affairs Commission established the Code of Best Practices on Corporate Governance. However, the current codes either fall far short of international standard or fail to address the key principles which underpin International Corporate Governance ethos.

The International Corporate Governance Network (ICGN) who represents institutional and private investors, companies, financial intermediaries, academics and other parties interested in the development of global corporate governance practices, offer criteria in setting up good corporate governance ( The ICGN approach aligns with Organization for Economic Cooperation and Development (OECD) Principles as a declaration of minimum acceptable standards for companies and investors around the world. Good corporate governance covers the following: Corporate Objectives, Communications and Reporting, Voting Rights, Corporate Boards, Board Remuneration Policies, Strategic Focus, Operating Performance, Shareholder Returns, Corporate Citizenship, and Corporate Governance Implementation.

According to estimates, as many as 8.6 million people in the country hold some bank equity. On current trend this is likely to rise as there are no alternative investments available. The main concern is that there is little or no investor’s protection. The focus of this report is on Corporate Citizenship and Corporate Governance Implementation. These two aspects of ICGN codes have not been taken seriously in the country. Banks in Nigeria are reporting impressive results but without appropriate corporate governance that addresses the adherence to all applicable laws of the jurisdictions in which they operate; the management that strive for active co-operation between companies and stakeholders and disclosure of policies on issues involving stakeholders, workplace and environmental matters, the ability to continue to create wealth, employment and to sustain a growing economy in the long run is at threat. Banks and other companies can improve the real economy by showing commitment to Corporate Social Responsibility (CSR) initiatives.

With more and more national firms going global, the importance of sound corporate governance is critical. Nigeria is not isolated on lack of sound corporate governance; this is a common occurrence in emerging markets. As you we recall, the 1998 Asian financial crisis demonstrated that the vital institutional architecture that underpins investor confidence simply did not exist in emerging markets as these markets offered little or no investor protection. Even in the developed economy, we have seen cases such Enron, WorldCom, Global Crossing and Long-Term Capital Management (LTCM). Adequate corporate governance policy will reduce the chances of such debacle to occur.

Operating locally or cross national requires corporate discipline. Concerns exist when companies are expanding into other territory, as without a sound ethics, social and moral responsibility, there is a risk of economy instability that may have long-term effect investor’s confidence. In the 1990’s the flow of equity into emerging markets which averaged $40 billion a year according to OECD, dived to zero in 1998. The capital flight carried enormous costs, not just for the investors who suffered substantial losses, but to the emerging markets themselves. This was a hard lesson to learn and it should be prevented from happening in Nigeria.

There are immense benefits for adopting and implementing CSR. Though from neo-classical economics paradigm, one could argue that organization main obligations is to optimize shareholders value by focusing on profit maximization. Also from accounting perspective, CSR may be considered as unnecessary costs that will reduce the bottom line profits as it can not be directly link to company’s performance. However, there are many benefits that can be reaped. These include but not limited to:
• Improved culture – increases motivation, loyalty and commitment of staff and reduces employee absenteeism for stress and illness. A motivated and committed workforce will have less appetite for fraudulent behavior.
• Reputation – CSR enhances the business image locally and builds a stronger brand image.
• Improved productivity – this comes from improved performance, innovation and creativity.
• Corporate responsibility – personal satisfaction from contributing to society.
• Customers/clients/investors – increases customer satisfaction and so they are more likely to repeat business.
• Personal development opportunities – leading to new skills and competencies being developed resulting in more staff being promoted from within and a reduction in recruitment costs.

James Wolfensohn the president of World Bank said that “Strong corporate governance produces good social progress,” he asserted. “Good corporate governance can make a difference by broadening ownership and reducing concentration of power within societies. It bolsters capital markets and stimulates innovation. It fosters longer-term foreign direct investment, reduces volatility and deters capital flight.”

Companies in Nigeria have proven ability to provide return on investment but at whose expense (employees, consumers and the environment). These are the question that needs to be answered and dealt with before expanding internationally. There is say that charity begins at home. To address this issue, public needs to be educated and be made aware of their rights. A focus group needs to be enacted to monitor non-compliance of code of best practices, and punish (financially) those firms that do not comply. Organizations that act on behalf of consumers, investors and employees rights would be a start to adopting adequate governance in the country.

There is no one perfect corporate governance codes, just there is no one perfect financial structure. The ultimate aim of a corporate governance structure is to be continually re-evaluated to adapt to changing times and needs. Foreign investors, Nigerian living abroad and international organizations are watching the development in Nigeria with interest. Nigerian government is working hard to eradicate corruption from the system at the macro level. This attitude and approach must be replicated and implemented at the micro level. The economic reform should not be left to the government alone. The banking industry as well as other corporate institutions needs to take initiative to promote corporate governance culture and focus on some of the issues addressed in this article in order to continue the growth in the country.

Global Economic Downturn - Part 1: Implications for Africans

In the last edition of the publication I wrote on the importance of corporate social responsibility and how this may improve performance and sustain economic growth in Nigeria. I hope you have enjoyed reading it. In this edition I have outlined briefly some of the impact of current global economic downturn on sub-Saharan African countries economy especially in Nigeria.

Background to current economic crisis: The current economic slowdown, triggered by the sub-prime mortgage collapse in the United States (US) is likely to have far-reaching implications for African countries. People may be wondering what a sub-prime mortgage is. That will not be a surprise as mortgage of any type is still alien to many of us on this part of the world (Africa). In Africa, we took pride in buying own land and build a house to our taste and size. This is contrary to that in the Western society, we property developer buys land from the government build houses of the same shape and sizes and then sell them to the public. So to buy one of these properties, you will need a loan from the bank. A mortgage is the pledging of a property to a lender as a security for a loan. A sub-prime mortgage is a type of loan granted to individuals with poor credit histories, who, as a result of their deficient credit ratings, would not be able to qualify for conventional mortgages. Government policies and competitive pressure among banks in the last decade had led to high risk lending. Some estimated the value of sub-prime mortgage in the US was to be around $1.3 trillion. So you can imagine the impact this will have on the US economy if there were defaults.

So what led to the crisis? There mortgage defaults were increases at alarming rate. This was caused by rise in interest rate which makes borrowing to become expensive. As a result, refinance of mortgages became difficult leading to decline in demand for US properties. Rise in interest rate also increases loan repayment, the main catalyst for default in loan repayment. The above two consequences lead to the fall in value of properties in the US.

So how do all these affect global economies? During the property boom in the US, financial product called mortgage-backed securities (MBS) which derive its value from mortgage payments and housing prices were “essential” securities to purchase for institutional investors around the world. Major Banks and financial institutions around the world had borrowed too heavily to invest the US housing market. As property prices starts to fall, so was the value of mortgage-backed securities. The effect of this on major household names in banking was critical, as balance sheet starts to shrink. Banks and institutions holding MBS saw their value receded. This resulted in banks not lending to each other (credit-freeze), which later triggered a liquidity crisis that has negative effects for global economy. The impact of credit crisis on other economies is so viral due to globalization.

So how will the crisis affect Nigeria and other sub-Saharan countries? So often I have heard people said, “That the current crisis is American and European problem” and should not be brought to our shore. I think this assertion is coined with naivety and it underestimated the effect of globalization. The current crisis is an impediment that comes at a time when sub-Saharan African countries are beginning to experience steady economic growth. Below are some ways in which some African countries can be affected:

The last few years Nigeria as well as other sub-Saharan countries’ economy has attracted private and institutional investors’ money from abroad. The current crisis means those investors will now struggle to raise funds in their countries to invest in African projects and subsequently pull back the supply of money.
There will be reduction in demand for African exports which will push the prices of commodity down, and place restrictions on inflow of capital from foreign investors. This will lead to fall in value of local currency.
For countries that import more goods/services to sustain economic growth, these imported goods and services will now become expensive to purchase.
As local currencies depreciated due to lack of demand for export goods, fall in local currencies means fewer holidays abroad. For those parents with children in foreign countries, this means they have to work harder to finance college and universities fees.
Some African banks and financial institutions will be badly affected as most have deposits with troubled foreign correspondent banks. Therefore, for those who have invested with banks who have reserves in foreign banks this is a worrying times.
Another way this may impact is through capital repatriations by troubled parent banks/companies. Foreign banks/companies operating in sub-Saharan countries may start to pull back investments which may lead to close-down and subsequently job losses.
Slowdown in trade and fall in Oil prices will reduce government revenues especially in Nigeria where government fiscal policy is largely dependent on Oil revenue. What this translate into are; there will be lack of money to complete projects. The growing expectations among populations that infrastructure will improve will be dampened.
In Nigeria States governments and their affiliates should expect a challenging times ahead as plenitude allocation of funds from the Federal governments will eventually decline.

In the last few years African continent has seen economic growth and this created lot of job opportunities and return of middle class. This growth has now been challenged and governments in this region need to rise above the global economic downturn. In the next edition of this magazine, I will write about ways to raise finance for a start-up or and existing business.