Is Haberler’s theory of the business cycle still relevant today?

22 Dec

Gottfried Haberler

‘Money and the Business Cycle’

Haberler believed over-ambitious expansion funded by easy credit would not create sustainable growth, as after the initial expansionist drive the factors of labour would return to the less complex strands lower down in the production chain and demand for, as well as volume of, the products which are more costly and complex to produce would slacken.

During the time taken to construct these new-fangled production processes, the labour employed in so doing would spend more on traditional consumer goods, thus stimulating demand for these and eventually causing a shift in production and in the factors of labour back towards manufacture of these less complex products.

Haberler strongly critiqued solely monetary theories of the boom and bust cycle, seeing inflation and deflation in the first incidence as being responses to the volume of production and demand. His was primarily a structural explanation, which conceded that once a recession had set in and investor confidence was set back, the value of capital would fall in isolation to the assets it was tied to as no one wanted to be left holding risky debts.

These days in our highly developed economies, we might argue that this is a deterministic view, and demand for ever more sophisticated gimmicks and technology is such that the market for innovative and complex products is unlikely to dry up simply because they used leverage to kick-start their idea. But it could prove instructive in trying to explain the lack of uptake for things like ‘smart’ homes and gadgets.

The Internet of Things was lauded as the next ‘big idea,’ but it was not certain it was meeting a clearly demonstrated consumer need, and security oversights by ‘smart’ gadget manufacturers have made some question the point of linking things like burglar alarms and cars to a worldwide web where any user can potentially hack into them.

The Austrian School in a Nutshell

8 Dec

nutshell

The Austrian School’s theory of credit and capital has a reputation for being complicated, and some posit that the reason Keynes’ ‘General Theory of Employment, Interest and Money’ holds such weight with policymakers is that it draws on the psychology of lending. Keynes saw the amount of capital channelled into investment as being inherently uncertain, a product of employer confidence in demand for goods, which depended on wider factors like the level of employment, income distribution and wage levels.

Austrians have been caricatured as prophets of the ‘efficient markets’ hypothesis, which essentially holds that artificial credit injections mess with the natural pattern of investment. They believe investment should stem naturally out of normal saving behaviour, as this creates sustainable demand for the goods and services produced through borrowing; loans or debt instruments initiated by banks which are backed on margin and not fully offset by the bank’s stock of available capital represent ‘artificial’ credit whose long-term effect is to cause price increases.

Austrian School economists are sceptical about policymakers’ belief that they can engineer optimal market conditions, believing that artificial intervention causes market inefficiencies. Broadly speaking, the argument runs that inefficient loan allocation to companies which are not sufficiently equipped to use them, or for whose products there is not enough demand, may in the short-term stimulate ‘growth’ – employment and consumption.

But the consequence of this ‘growth’ – the increase in wages and concordantly prices – will be priced into existing and future loans. The unregulated growth of credit will eventually cause a systemic shock, as confidence fails and many of the riskier debt instruments shed as investors try to exit their positions en masse. The value of higher-risk instruments plummets further, as some of the underlying assets – e.g. homes in the case of sub-prime mortgages – undergo foreclosure and are sold at a discount at auctions. Sound familiar?…

Disciples of Haberler, who was more concerned with the structural allocation of credit across the ‘vertical’ chain of production – from commodity mining and production to equipment manufacture to the factories where this equipment is used – would focus more on the credit tied up in cap ex by companies investing in new technology or expansion.

The central bank is supposed to moderate growth, preventing unsustainable expansion and stimulating consumption and/ or investment. Setting a minimum interest rate is just one of many ways in which it does this. Asset purchase schemes, and quantitative easing, are two others. Note in support that the ‘inflation premium’ detailed by economist Irving Fisher is priced by default into interest rates by commercial issuers; the government traditionally just provided a benchmark.

These asset purchase and what we’re going to nickname ‘capital injection’ schemes (when the government creates bonds it then buys back from banks, creating liquidity but also increasing the public deficit) have the net result of more reserves ending up deposited with the central bank.  As more capital is circulating, some of it inevitably ends up in current accounts with the banks and they are required to hold a certain ratio of this capital as reserves with the central bank for security.

If and when the central bank decides to raise interest rates, in fairness it must apply the policy rate to its own reserves, effectively paying interest on its own debt at the taxpayer’s expense. If it does not, this will act as an ‘opportunity cost’ – effectively a tax – to banks who could have invested the money elsewhere at a profit. This trend has been analysed in more depth by those such as Claudio Borio, Head of the Monetary and Economic Department of the BIS. For a brief introduction to the argument, see the speech given by him and the Bank of Thailand’s Mr Piti Disyatat on ‘Helicopter Money’. https://www.bis.org/speeches/sp160906.htm

One of those historical Austrian economists, transported to the present day, might find that their essential doctrine that when tampered with interest rates can have a distorting effect on growth, still has relevance. Unquestionably, QE has boosted spending, and new, sometimes innovative investment. But the cost has fallen on those financial institutions that must take the new risks, as they are forced to chase ever higher yields; pension funds which are struggling to climb out of their own deficits, as former ‘safe-haven’ assets provide insufficient income to meet their liabilities.

The rise of alternative finance seemed for some time to provide another option to the legislation-hampered banks, whose rigorous screening tests and core capital obligations prevented them from extending loans to all comers. But the marketplace lenders’ models which were heavily reliant on ‘diversifying’ the risks they did not properly analyse, by aggressively seeking new loan applicants to replace the loans that had gone bad, are now looking likely themselves to face the price of over-expansion.

The USA’s Lending Club is a prime example, and has suffered losses of $36.5m in the third quarter of this year – though up from $81.4m in the second quarter – as it confronts the need to tighten up its due diligence operations and tackle non-performing loans.

Reversing the secular and government-sponsored decline in interest rates may not be a painless process, but the alternative is to enshrine a borrowing climate which is not profitable for the majority of lenders, or investor in the resulting securities. Can the market rely forever on the government to prop it up, even as the government’s own debt must increase to fund its stimulus measures? Does this rhetorical question even need a response?…

 

Ludwig von Mises

The ‘Austrian’ Theory of the Trade Cycle

Borrowed the capital theory developed by Carl Menger and elaborated by Eugen von Bohm-Bawerk. Mises attempted to prove that when, in an unsustainable credit expansion, interest rates are forced down, capital is allocated inefficiently. Because loans are granted in an indiscriminatory fashion, the production process ties down capital for too long a period in relation to ‘the temporal pattern of consumer demand’. In the end, the discrepancy means the market for both consumer and capital goods (loans) readjusts to counteract the misallocation.

 

Friedrich A. Hayek

Can We Still Avoid Inflation?

Plotted series of right-angled triangles to show the two factors of time and money, as capital flows through the production process. It is agreed to have been overly simplistic in imagining capital as ‘tied down’ in development loans when in reality it still circulates fairly freely. But Hayek pioneered the use of time as a vital factor in analysing the boom-and-bust sequence.

 

 

 

 

What a time-travelling Austrian might think of today’s economy

16 Nov

The Austrian School’s theory of credit and capital has a reputation for being complicated, and some posit that the reason Keynes’ ‘General Theory of Employment, Interest and Money’ holds such weight with policymakers is that it draws on the psychology of lending. Keynes saw the amount of capital channelled into investment as being inherently uncertain, a product of employer confidence in demand for goods, which depended on wider factors like the level of employment, income distribution and wage levels.

Austrians have been caricatured as prophets of the ‘efficient markets’ hypothesis, which essentially holds that artificial credit injections mess with the natural pattern of investment. They believe investment should stem naturally out of normal saving behaviour, as this creates sustainable demand for the goods and services produced through borrowing; loans or debt instruments initiated by banks which are backed on margin and not fully offset by the bank’s stock of available capital represent ‘artificial’ credit whose long-term effect is to cause price increases.

Austrian School economists are sceptical about policymakers’ belief that they can engineer optimal market conditions, believing that artificial intervention causes market inefficiencies. Broadly speaking, the argument runs that inefficient loan allocation to companies which are not sufficiently equipped to use them, or for whose products there is not enough demand, may in the short-term stimulate ‘growth’ – employment and consumption.

But the consequence of this ‘growth’ – the increase in wages and concordantly prices – will be priced into existing and future loans. The unregulated growth of credit will eventually cause a systemic shock, as confidence fails and many of the riskier debt instruments shed as investors try to exit their positions en masse. The value of higher-risk instruments plummets further, as some of the underlying assets – e.g. homes in the case of sub-prime mortgages – undergo foreclosure and are sold at a discount at auctions. Sound familiar?…

Disciples of Haberler, who was more concerned with the structural allocation of credit across the ‘vertical’ chain of production – from commodity mining and production to equipment manufacture to the factories where this equipment is used – would focus more on the credit tied up in cap ex by companies investing in new technology or expansion.

The central bank is supposed to moderate growth, preventing unsustainable expansion and stimulating consumption and/ or investment. Setting a minimum interest rate is just one of many ways in which it does this. Asset purchase schemes, and quantitative easing, are two others. Note in support that the ‘inflation premium’ detailed by economist Irving Fisher is priced by default into interest rates by commercial issuers; the government traditionally just provided a benchmark.

These asset purchase and what we’re going to nickname ‘capital injection’ schemes (when the government creates bonds it then buys back from banks, creating liquidity but also increasing the public deficit) have the net result of more reserves ending up deposited with the central bank. As more capital is circulating, some of it inevitably ends up in current accounts with the banks and they are required to hold a certain ratio of this capital as reserves with the central bank for security.

If and when the central bank decides to raise interest rates, in fairness it must apply the policy rate to its own reserves, effectively paying interest on its own debt at the taxpayer’s expense. If it does not, this will act as an ‘opportunity cost’ – effectively a tax – to banks who could have invested the money elsewhere at a profit. This trend has been analysed in more depth by those such as Claudio Borio, Head of the Monetary and Economic Department of the BIS. For a brief introduction to the argument, see the speech given by him and the Bank of Thailand’s Mr Piti Disyatat on ‘Helicopter Money’.

One of those historical Austrian economists, transported to the present day, might find that their essential doctrine that when tampered with interest rates can have a distorting effect on growth, still has relevance. Unquestionably, QE has boosted spending, and new, sometimes innovative investment. But the cost has fallen on those financial institutions that must take the new risks, as they are forced to chase ever higher yields; pension funds which are struggling to climb out of their own deficits, as former ‘safe-haven’ assets provide insufficient income to meet their liabilities.

The rise of alternative finance seemed for some time to provide another option to the legislation-hampered banks, whose rigorous screening tests and core capital obligations prevented them from extending loans to all comers. But the marketplace lenders’ models which were heavily reliant on ‘diversifying’ the risks they did not properly analyse, by aggressively seeking new loan applicants to replace the loans that had gone bad, are now looking likely themselves to face the price of over-expansion.

The USA’s Lending Club is a prime example, and has suffered losses of $36.5m in the third quarter of this year – though up from $81.4m in the second quarter – as it confronts the need to tighten up its due diligence operations and tackle non-performing loans.

Reversing the secular and government-sponsored decline in interest rates may not be a painless process, but the alternative is to enshrine a borrowing climate which is not profitable for the majority of lenders, or investor in the resulting securities. Can the market rely forever on the government to prop it up, even as the government’s own debt must increase to fund its stimulus measures? Does this rhetorical question even need a response?…

 

Ludwig von Mises

The ‘Austrian’ Theory of the Trade Cycle

Borrowed the capital theory developed by Carl Menger and elaborated by Eugen von Bohm-Bawerk. Mises attempted to prove that when, in an unsustainable credit expansion, interest rates are forced down, capital is allocated inefficiently. Because loans are granted in an indiscriminatory fashion, the production process ties down capital for too long a period in relation to ‘the temporal pattern of consumer demand’. In the end, the discrepancy means the market for both consumer and capital goods (loans) readjusts to counteract the misallocation.

 

Friedrich A. Hayek

Can We Still Avoid Inflation?

Plotted series of right-angled triangles to show the two factors of time and money, as capital flows through the production process. It is agreed to have been overly simplistic in imagining capital as ‘tied down’ in development loans when in reality it still circulates fairly freely. But Hayek pioneered the use of time as a vital factor in analysing the boom-and-bust sequence.

 

 

 

Interest rate risk? What interest rate risk?

27 Oct

 

Growth in the third quarter of 2016 seems to be on track to remain consistent with that of Q2, at the identical figure of 2.1%. Which will doubtless engender much self-congratulatory patting of backs among the BOE’s Monetary Policy Committee, for steering the country through a potential capacity surplus and dip in employment. Do they really deserve this round of applause?

There is an opinion held in some quarters that central bank control is the main obstacle standing in the way of the perfect equilibrium that would be achieved if interest rates were allowed to compete in a free market. While I do not necessarily believe that free-market capitalism always acts in favour of the greatest good of the greatest number of people, the tried-and-tested sticking plaster of QE does not reach the deeper systemic problems – something the BOE itself admits.

As well as announcing the continuation of its asset repurchase policy (quantitative easing), the BOE’s Monetary Policy Committee decided in August to cut bank rate to a growth-stimulating – at least in theory – 0.25%. The negative effect this would have on bank’s lending profit margins they hoped would be countered by the Term Funding Scheme (TFS) they were offering to institutions affected.

They elaborated in the August Inflation Report that “the Term Funding Scheme (TFS)… will provide funding for banks at interest rates close to Bank Rate.  This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions.  In addition, the TFS provides participants with a cost-effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets.”

This is all very good and of noble intention, but it is doubtful this alone would counteract the many factors acting against the free lending by banks to needy applicants. For one, the alternative finance market is proving serious competition, as the nimbler new competitors are far more proactive in sourcing customers, using sophisticated data analysis to find leads; and their pricing algorithms bypass the more thorough risk profiling traditional banks undergo. In addition, they often avoid taking direct liability for issuing the loans, doing this instead through partner banks. By keeping their balance sheets free of these liabilities, they avoid the imposition of different tiered capital ratios along the lines of Basel III.

Let’s get Specific

Interest Rate Risk in the Banking Book (IRRBB) is a quantified metric which is itself the subject of constant, international regulatory scrutiny. In a report released April 2016, the Basel Committee on Banking Supervision succinctly explains the complex relationship between different loan products:

IRRBB arises because interest rates can vary significantly over time, while the business of banking typically involves intermediation activity that produces exposures to both maturity mismatch (e.g. long-maturity assets funded by short-term liabilities) and rate mismatch (e.g. fixed rate loans funded by variable rate deposits). In addition, there are optionalities embedded in many of the common banking products (e.g. non-maturity deposits, term deposits, fixed rate loans) that are triggered in accordance with changes in interest rates.”

An option is linked to a specified contingency which, if occurring, gives you the right but not the obligation to exercise that option. For example if you end up stuck with a loan at 4% interest which was originated when base interest rates were at 1.2%, and then base interest falls to 0.5%, your interest payments will be overpriced relative to the rest of the market. The option might specify that if interest rates fall below a certain point, you can choose to switch to a floating-rate linked to a benchmark like LIBOR. (London Interbank Offered Rate, administered by ICE or IntercontinentalExchange group)

Definitions, definitions, definitions

‘Option risk’ is just one of three defined types of interest rate risk that can occur; the others being ‘gap risk’ and ‘basic risk’. Automatic option risk is when an optionality is included as part of a synthetic product, be it an asset, liability and/ or off-balance sheet item. Behavioural option risk is where the change in cash flow results from the autonomous human decision to exercise an option.

So-called gap risk describes the shortfall that arises when banks’ debt instruments undergo rate changes which occur at different times. Some loans, particularly for construction or infrastructure projects, are staggered so interest payments increase towards the end of the loan’s duration, as during the early set-up phase there is little to no cash flow or income.

Basis risk is classified as the impact of relative changes in interest rates between instruments which are linked to different pricing benchmarks; say for EM bonds over Treasuries, which are priced by different market factors and whose basis points might change at different rates, though their tenors are the same. One might even be used to hedge the other, and basis risk quantifies the effectiveness – or not – of this hedge.

The regulator admitted it was having difficulty persuading banks to fully assess the IR risk on their books, as in their internal assessments they tended to focus on earnings measures over the period under review, rather than economic value measures which examine assets and liabilities right until their expiration. In their guidance the Basel supervisory committee stressed the importance of having both types of assessment compliment each other.

If the late troubles of Deutsche Bank are any indicator, it is that banks can struggle to reconcile their regulatory obligations with taking on high enough risk assets to turn a viable profit. That, and the importance of having a smoothly running infrastructure and back-end. On the other hand, JP Morgan’s recent triumphant quarter shows you can make a killing out of trading bonds, if you know what you are doing.

interest_rate_risk

Why Recycling is the new Moisturising.

19 Oct

Of all the business workings you must archive and report, ‘waste’ is probably the least appetising. Trying to tot up the margin of product that fell off the production line, the bits you’d like to pick back up off the scrapheap… it’s not an auditor’s most exciting way to spend a day.

 

There are a number of different regulations in the UK currently, which as many are derived from EU guidelines might change over the course of the Brexit negotiations. They govern aspects as diverse as a ‘tax’ on packaging for prolific producers of paper, polyethene and cardboard hybrid coffee cups, glass, etc. And punitive fines and even jail-time for companies which engage in unlicensed disposal of ‘controlled waste’.

Wrapping-paper Tax

Any UK-listed or operating producer which emits more than 50 tonnes of packaging a year, and which has a turnover of over £2million, is obligated to submit a Packaging Tax Return to HMRC. They then have to offset their obligation by funding a commensurate amount to the government’s packaging recycling programme.

The private sector too has cashed in on the packaging sector, with a wealth of innovative initiatives to minimise waste. Probably the greatest expansion has been in devices to prevent food wastage, from the now fairly commonplace ethylene absorbers to special types of bacteria-fighting film. Ethylene is a hormone produced by metabolism in most fruit.  It initiates and accelerates the ripening of fruit and causes vegetables to start decomposing. Several companies now provide packaging with ethylene absorbers to increase produce shelf life.

Still more exciting are some of the patented inventions now seeking corporate sponsorship. For example, the wrappers with built-in anti-microbial properties recently developed by the Fraunhofer Institute for Process Engineering and Packaging IVV in Freising. Sorbic acid is the active component of the bacteria-fighting film; which in clinical trials reduced the size of an E.coli colony cultivated on day-old pork loin for the experiment to around a quarter of its initial size. Crucially, in the concentration of the laquer applied to the film, sorbic acid is neither poisonous nor allergenic and virtually odourless and tasteless.

http://reid.wrap.org.uk/item.php?id=26  )

Dodge the Plastic Bag Tax

The resource-efficiency bar has been raised still higher in the compostable plastic department, where a number of global competitors jostle for supremacy. In the UK there are several competing providers of biodegradable plastics, including Scotland-based BioBags, and Biopac, the self-described ‘leading developer’ of a very wide range of eco-friendly food packaging and catering disposables.

In Australia, where ‘sustainability’ is a buzzword even for the big mining companies, one player dominates the market. Publicly listed ‘Secos’ was formed in a reverse merger of Cardia Bioplastics Ltd with Stellar Films Group Pty. Ltd. In April 2015. Post-merger, its preliminary annual report for December 2015 showed total assets including cash, trade and other receivables and prepayments, was $9,076,829. The most recent figures available from investment.com.au show that the Australian stock market looks favourably on its prospects, as its P/B (price-to-book) ratio is 2.33, compared to 1.43 the market benchmark, and 1.54 for the sector.

UK-based Biopac’s impressive range of products enable catering and hospitality companies to proudly declare their green credentials; not only can they cite their sustainable container purchases on their annual reports, it is also often branded on the product itself. There is the ‘I am not a plastic cup’ made from renewable cornstarch that also carries the government approved CE marking (£130 for a case of 2100).   And the 12oz single use* ‘I’m a Green Cup,’ made from certified FSC (Forest Stewardship Council) board with a starch material, which is actually 100% compostable (£57.45 for a case of 1000). Various PLA (polylactic acid) clear tumblers …

If you needed further proof that this was a growth trend that has become impossible to ignore, there’s even a site called ‘Biodegradable Plastic Glasses’ (insert domain name here).

Or, if you prefer a more official stamp of approval, a market research report by Markets and Markets entitledBiodegradable Plastics Market by Type (PLA, PHA, PBS, Starch-Based Plastics, Regenerated Cellulose, PCL), by Application (Packaging, Fibers, Agriculture, Injection Molding, and Others) – Global Trends & Forecasts to 2020  states that the biodegradable plastics market is projected to grow from more than USD 2.0 Billion in 2015 to USD 3.4 Billion by 2020, at a CAGR of 10.8% between 2015 and 2020.

That’s a nice return on your investment.

 

plasticbags

 

Networking Dos and Don’ts

9 Oct
  1. If you’re the only girl in a group of 5 boys, it’s dark and everyone else is drinking, don’t let the conversation turn to sex if you want to retain your professional veneer. That includes attempts to start conversations about ’embarrassing sex stories’, ‘what robot sex would be like’, and ‘what if they made robot sex really painful, to stop them reproducing and taking over the world’?

2. If you’re going to hand out your business card, make sure you take some contact details back. Don’t leave the ball in their court. They might be too lazy to pick up the racket.

3. Try not to mix business with dancing.

4. Always introduce the PhD particle physics student and his real estate mate to the hilariously honest tech guys who talk like they’re on drugs. How else does a networker get the party started?…

Why ‘Defined Benefit’ should become ‘Pre-Defined Benefit Re-Defined in Light of Changing Conditions’

4 Sep

 

A recent well-intentioned but technically inaccurate FT article laid out the pitfalls of employers continuing to offer Defined Benefit (DB) schemes, in light of the recent bout of QE and interest rate revisions. Briefly, in a separate article it reported that consultancy Hymans Robertson had conducted research analysis which hypothesised the BOE’s announcement of a £70bn QE programme would lead directly to another £70bn DB shortfall.

The BOE also announced it would cut interest rates by 0.25%, which will hit all fixed-income returns by reducing the value of gilts and ‘safe haven’ government securities, and correspondingly increase the demand for, and price of, riskier fixed-income products. Pension trustees had better make some shrewd investment choices.

The writer argued that in order to solve the deficit overhang, the government needed further legislation to prevent the proliferation and even the continuation of DB schemes. He stopped just short of saying they should be outright banned.

A Lighter Touch

What the government has done, under the 2014 Pensions Act, is more of a soft-touch approach which controls market incentives to withdraw money from schemes, and window-shop continually for better ones. This provides more security for scheme managers, in terms of the available capital for investment.

To issue a ban on Defined Benefit schemes would be a hostile move, which might be resisted by certain interest groups and create a conflict both sides are surely keen to avoid. When a legislator has a choice between prohibition measures and providing incentives for industry participants to behave a certain way, a collaborative approach is usually more effective.

Though that is not to say that the government hasn’t laid down some firm rules on scheme governance and providing Value for Money.

Can Members Leave a Scheme if they Want to?

Although members are technically free to leave the scheme at any time, there are a number of barriers which impede them from doing so. Many funds impose exit fees, to try and keep investments safely enclosed in the fund and prevent a deficit from occurring.

Another barrier is that administrative provisions for transfer of their pension pot might be insufficient or incomplete. Scheme member data storage and integrity has recently been the subject of widespread audits and reforms, because so much information was missing or compromised. For example, employees would be classed as ‘absent’ from the scheme and hence the records, when in fact they had a Personal Pension Plan that the employer made regular contributions to.

Pre-existing pension legislation held that if you had been in the scheme less than 2 years, and the scheme rules permitted it, you were entitled to a refund of the contributions already made. Though having received the refund you would not be entitled to any benefits for the period to which the refund relates. However, the Pensions Act 2014 made it harder to leave or withdraw money from a scheme in several new ways, one of which was the abolition of these ‘short service’ refunds, for people who leave a money purchase occupational pension scheme after the mandatory 30-day period, and within 2 years of entering the scheme.

Mandatory Disclosure

Money purchase schemes are simply Defined Contribution (DC) by another name, where an employee contributes an agreed percentage of their salary at set intervals, with no guaranteed level of return. Targets and benchmarks are shared with scheme members, and indeed it is a legal requirement that trustees provide members with an annual statutory money purchase illustration (SMP), which states the likely pension at retirement based on in-house assumptions about market conditions including inflation. Also with details of contributions credited (before deductions) to the member in the preceding scheme year.

So a major advantage of DC schemes is that the governing directors’ expectations and projections of expected returns are continually revised. In the current fixed-income investment climate, with the BOE still steering interest rates on a tight rein particularly in the uncertainty surrounding Brexit, to make the kind of gold-plated promise to employees which Defined Benefit schemes make does not seem… prudent.

This enhanced level of disclosure was also introduced in the recent reforms governing trustee accountability. Not that I’m biased, but the now fairly stringent requirements on trustees of money purchase schemes seem to make them the better option. Among the other provisions are that:

–              Investments made with each contribution should be documented, recording the date of each. Best practice is that every new contribution be invested within five working days; where a member’s contributions are invested in more than one fund, and “the total amount contributed in a period is recorded explicitly”, verify the sum of the individual transactions elements equals the total contribution.

–              To this end, there should be a record of every investment sold, date sold and amount realised. This does not have to be recorded separately for each contributor, but must be categorised by investment fund.

Reasons not to Shop Around

The 2014 Pensions Act contained a number of other measures relating to private pensions, many of which strengthen existing legislation. Many seem calculated to try and ring-fence the contributions to existing schemes. They include provision for:

  • a new power to make regulations to prohibit the offering of incentives to transfer pension scheme rights
  • the introduction of a new statutory objective for the Pensions Regulator, to minimise any adverse impact on the sustainable growth of sponsoring employers when exercising its functions relating to scheme funding
  • measures to restructure the Pension Protection Fund compensation cap to better protect long serving scheme members
  • an amendment to the Public Service Pensions Act 2013 to allow smaller public body pension schemes to transfer accrued rights into one of the larger public service schemes

So in conclusion, measures have been taken to make DB schemes vastly less attractive. But to outright ban them would itself be infringing on the rights of those existing DB scheme-holders whose right not to have their scheme fold due to insufficient funds these lobbyists are defending in the first place.

The important thing is for DB scheme managers to have the freedom to adjust their expectations and projected returns to a level which is compatible with their income stream and all their liabilities. Which I suppose would mean they were no longer ‘Defined Benefit’ but ‘Pre-Defined Benefit Re-Defined in Light of Changing Conditions’. If only someone would outline the circumstances in which this decision would be permissible.

 

 

Are Crypto-Currencies more Democratic?

28 Jun

The internet, as I’m sure you know, is formed of millions of connections between nodes, or access points for all its users.

Concurrent with, or alongside, this network a new network has sprung up, consisting of the Bitcoin miners and its payment system. This is supposedly money at its most ‘democratic’ because supposedly no one entity can gain control of a majority of the miners on which this consensus rests.

(for an explanation of the Bitcoin creation mechanism, see https://jessking1311.wordpress.com/2015/10/01/what-is-the-real-problem-with-bitcoin/  )

A fintech explosion

Goldman Sachs’ widely read ‘Future of Finance’ report cited three trends which two of its authors, Heath Terry and Ryan Nash on the Global Investment Research team, expanded on further in a podcast. These were: regulation, technology, and changing consumer habits.

The financial crash and ensuing regulation “effectively created a greenfield opportunity during the recovery… following Facebook’s IPO in 2012, a lot of opportunists asked themselves, ‘What sectors don’t have a Facebook, a Google, an Amazon yet. And financial services was the only one of those.”

A friendly credit environment also contributed to the exponential growth in ‘shadow banking’, – here defined more narrowly than the Fed which has tracked a recorded $15 trillion in liabilities by non-bank lenders like private debt funds – as so-called P2P or marketplace lenders.

The Goldman Sachs analysts predict $10-12 billion could move out of the traditional sector and into shadow banking. Marketplace lenders have been quick to adopt innovations like risk pricing algorithms, and analytics to predict consumer demand for loans. Thus they benefit from ‘lower cost of customer acquisition’ and ‘efficient delivery channels’, where banks are hampered by due diligence restrictions which give loans applicants offputting mountains of paperwork.

The third factor cited is regulation. Where Basel III imposed rigid capital adequacy ratios, the Dodd-Frank stress test limits made bank lending even more restricted, because they needed to consider also the value at risk of certain assets under stress scenarios. This severely limits the type of assets they can hold on balance-sheet.

Finally, the Credit Card Accountability Responsibility and Disclosure Act of 2009, or Credit CARD Act of 2009, created a unified pricing standard which also meant credit providers’ losses were absorbed to some extent. And profits in the industry as a whole became more attractive, spurring innovation and start-ups to capitalise on the benign regulatory environment.

Crypto-currencies are more ‘democratic’ than fiat currencies

Bitcoin is a new currency but unlike sterling or the dollar it is not controlled by a national government, which can intervene to buy and sell the currency to preserve its value. And which are traded on mass by foreign exchange funds.

This means Bitcoin’s value depends almost entirely on how much it can be exchanged for in terms of goods and services on the internet. Or, to be more accurate, what people believe these items to be worth in Bitcoin at any given time. Which depends on the amount of Bitcoin in circulation.

For an explanation of the historic issue of the ‘capacity crunch’ and the competing plans to increase the size of transactions and transfers to scale up the payment system, again see my previous post on the issue.

But more important in revolutionising the way money is lent in the modern world is the Distributed Ledger Technology used to record Bitcoin transactions. Everyone in the Bitcoin network has access to this record, and its only alterable by mutual consensus or agreement.

democracy-means-everyone

So no one can fraudulently claim they have made or recorded a transaction, because the online ledger called the blockchain shows exactly who had made and received the transaction. Many companies and governments, like that of Estonia, are adapting this technology because it is a secure way of record-keeping for other purposes, such as health records, marriage and birth certificates, taxes and property.

The new distributed ledgers would have different rules. For example, there would likely be an administrator who would have overall control over access and permission to transact. Each system would also have its own encoded rules of conduct.

Some Real-life Examples

Some payment systems like Coinify already use the blockchain to enable consumers to make guaranteed payments, via small businesses which act as merchants.  Within some payment networks, such as Lending DApp (see https://jessking1311.wordpress.com/2016/01/13/back-to-the-future-bitcoin-blockchain-and-how-marketplace-lenders-are-using-technology-to-overtake-banks-in-the-race-to-attract-new-lenders/), ordinary people can act as intermediaries to guarantee that the terms of a contract have been fulfilled. Or the computer programme can be designed such that it recognises e.g. when a certain number of hours have clocked on a timesheet.

It occurs to me that this could be the solution to many of the problems in the banking system. Processing payments by the big banks like HSBC, RBS, Barclays et al. can take several days, even need, your money right away. Because they have to comply with so many regulations, banks have to do a lot of checks to make sure the payment is for legitimate activity and by a legitimate entity.

Alternative, more immediate providers like Paypal charge a transaction fee for every payment they process. But a pretty insignificant one. And Paypal seems to be cornering the market in micropayments. What does blockchain and DLT have that existing providers don’t?

It struck me the other day that the systems in place to connect us with the money we have earned or need to conduct our life and business are grossly inefficient.

I was waiting for a sum of money I had collected from a crowdfunding platform, Indiegogo. But when I tried calling HSBC, I had to wait on hold for 20 mins. When I finally got through to someone, he did not speak enough English to process my request. Three times I told him I was waiting for a transfer to my account and if he could put me through to whoever was responsible for bank checks, that maybe the depositor was concerned it was an individual not a business account.

Three times he asked me ‘If I would like to make a transaction’? When I tried to contact Indiegogo to ask the same question, initially I couldn’t find the contact form. Eventually I got a response, and my money, after I Twitter-bombed the crowd-funder. But the point is that I couldn’t access my money when I needed it. I had to pay it out of my own pocket and then be tardily reimbursed.

Now I’m not saying we need to overhaul the entire financial system, but if the service is flawed it would make sense to encourage competing providers, like those using the blockchain network, to let individuals like you or me moderate payments for a fee that corresponds with their efficiency and success rate at doing so.

And I’m not the only one this thought has occurred to.

Take Measures to Limit your Liability

24 Jun

If you have to ask yourself the question, “Does my organisation engage in data processing?” the answer is “probably.” Any marketing or sales analysis you do on information collected from customers is classified as data processing.

Article 2(b) of the Data Protection Directive defines said activity as anything included in the following: collecting, retrieving, recording, organising, storing, disclosing and making available data. And new EU legislation is about to tighten the screw on unauthorised uses of customer data. For this read anything for which the customer did not give their unambiguous consent.

And be vigilant about which third parties you pass on the data with which you have been entrusted. Be aware of its intended use, and be sure if you are selling database information that the organisation is licensed. Selling personal data without an ICO licence can constitute a criminal offence.

Just One Example

The famous case of Google Spain SL v Agencia Española de Protección de Datos (hyperlink) showed just how easy it is for a plaintiff to find a corporation liable for misuse of an individual’s data. Google’s search engine spiders, in the automatic process of indexing websites and connecting them with what it deems their keywords and subject, picked up an unflattering article about the original plaintiff Mario Costeja González.

Google Spain SL v Agencia Española de Protección de Datos

When his name was searched for on Google, pages appeared from La Vanguardia newspaper announcing a real estate auction as a result of proceedings for recovery of social security debts owed by Mr Costeja Gonzalez. He argued successfully that this was a misuse of his personal information; though the complaint against La Vanguardia newspaper was not upheld, even when Google appealed the verdict, as it had published the information lawfully.

While this finding by the European Court of Justice was an unusual event, it did set an important legal precedent. There is increased scrutiny on companies to hold themselves accountable for all the uses which personal data is put to, and take measures to prevent emotional or financial damage to the individuals concerned. If not, they lay themselves open to civil lawsuits as well as punitive fines when the General Data Protection Regulation (GDPR) comes into force in 2018.

Changing Legal Obligations

Think about whether your terms and conditions, and your privacy statement, cover every contingency in case of the possibility that someone claims an infringement of their rights, or a breach occurs.  These legal documents will need updating soon to remain compliant with the new provisions of the GDPR.

Any website which collects a customer’s financial data lays themselves open to responsibility for identity fraud. Any website collecting personal data such as that pertaining to medical or relationship history is potentially problematic. And even, now, fitness levels, with some US employers starting a trend of providing healthcare perks in return for workers’ submitting to fitness tests. The results are submitted in a ‘random, anonymous sample’ for data analysis by specialist companies such as 23&Me in Mountain View, California. Castlight, based in San Francisco, offers employers predictions as to the probability of workers’ getting pregnant or requiring expensive surgery, based on healthcare searches and insurance claims on its app.

If all that is not enough to scare you into doing your due diligence, this story of an ICO raid (hyperlink) on a house in Sheffield should persuade you that illegal data usage is a real threat. The organisation under suspicion emailed countless companies and institutions offering to buy and sell databases – including the ICO! But it was doing so without a licence, and to companies which would use the information to make nuisance calls.

(https://ico.org.uk/about-the-ico/news-and-events/news-and-blogs/2016/06/ico-investigators-raid-house-for-evidence-of-illegal-data-selling/)

It is so easy to inadvertently violate data protection regulations. So protect yourself now.

 

 

 

 

Complying with the law on data protection is not as easy as ‘click this box’ consent forms.

17 Jun

Complying with the law on data protection is not as easy as ‘click this box’ consent forms.

The free-for-all in data sale and collection will be cut abruptly short in two years, when all companies involved in data collection and processing will have to comply with the General Data Protection Regulation (GDPR).

The British version of the EU-mandated General Data Protection Regulation (GDPR) will apply from 25 May 2018 onwards. Although the GDPR was technically in force from 24 May 2016, EU member states have until 6 May 2018 to transpose it into their national law.

What has changed?

In addition to the requirements already in place under the Data Protection Act, companies will have additional responsibilities regarding minors. For example, they will need to get parental consent to collect children’s data.

And crucially, the privacy guidelines and terms and conditions will need to expand. Under the GDPR,  where individuals give consent to use of their data they must be informed of their right to withdraw this consent at any time. Where they are giving up sensitive data, this consent must be “explicit.”

Data controllers must be able to demonstrate that when consent was taken it was “freely given, specific, informed and unambiguous, shown either by a statement or a clear affirmative action which signifies agreement to the proceeding,” according to Article 4 of the GDPR.

Potential problems

There are some additional considerations from a compliance perspective which companies must factor into their privacy statement and terms and conditions. This paper by Allen and Overy (hyperlink) summarises the key issue.

 

http://www.allenovery.com/SiteCollectionDocuments/Radical%20changes%20to%20European%20data%20protection%20legislation.pdf

 

‘The agreed text states that in assessing whether consent has been freely given, account shall be taken, for example, of whether the performance of a contract is made conditional on the consent to processing data that is not necessary to perform that contract.”

It points out that this could affect a number of e-commerce services. Simply requesting any additional ‘demographic’ information other than contact details will have to be justified. If creating a login to a site, or establishing a profile, is dependent on the individual’s stating, for example, if they prefer tea or coffee and if they are a custard cream or a chocolate digestive person, would not be permitted unless this information was relevant to their application.

If the privacy notice stated the organisation – say a PR firm – was trying to assess the applicant’s personality type and suitability for a job position, and had a legal basis for setting a series of seemingly random questions about their consumer preferences, that might be ok. If no explanation was made, say, and the website sold an unrelated product like hardware and home appliances, it would be assumed they were collecting the data to sell to a third party without the individual’s consent.

The fines for breaching the conditions of the GDPR could gouge out up to 4% of a company’s annual worldwide turnover, for major offences like those relating to international transfers, or the essential principles of processing like conditions for consent. This could affect your margin. Other specified breaches could exact a fine of up to 2% of annual global turnover.