CFI.co Autumn 2012 by CFI.co

Capital Finance International

Autumn 2012

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AS WORLD ECONOMIES CONVERGE

Nigeria’s Gordon Emefiele:

WINNING WAYS AT ZENITH BANK

ALSO IN THIS ISSUE // SMEs GO GLOBAL // WTO: TARIFFS NO LONGER IMPORTANT TEN EMERGING MARKET HEROES // WORLD BANK: STRATEGIES FOR GROWTH BRAZIL’S TECH TRIANGLE // THE BATTLES ENTREPRENEURS FACE

CFI.co | Capital Finance International

Autumn 2012 Issue

CFI.co | Capital Finance International

Autumn 2012 Issue

CFI.co | Capital Finance International

Autumn 2012 Issue

Letter from the Chairman Dear Reader,

London, Autumn 2012

In your hands is a small piece of journalistic history. This issue of CFI.co magazine is the first to be available in print from Capital Finance International. Prior to this, our editorial content was only available online. This publication comes to market at a time when part of the capitalist system has been judged to have failed many of its constituents. The system had not been properly accountable to stakeholders via the institutional framework. We at CFI.co believe in the capitalist system but want to see it working well and in accordance with liberal values. We believe strongly in personal freedom and champion private enterprise but call for social and environmental responsibility from all concerned. For capitalism to flourish it must be seen to benefit not just a favoured few – but all stakeholders. The team behind CFI.co always wanted to create something different to fill a gap in the business and finance magazine market. We have achieved this by providing a unique editorial style – with content direct from the source – often relying on the authority of material submitted by our distinguished contributors. One of our objectives was to transmit faithfully important messages from major multilateral organisations without mute, filter or undue interpretation by our editorial team. We want to avoid the interception and editorial high-jacking of the critical issues facing the world. For example, The World Bank Group, The United Nations, the European Union and the OECD have all contributed articles to this issue – and these articles are edited for style only. Another long term objective is to give young journalists a chance to be heard. The vehicle we use for this is the CFI Young Journalist Programme (YJP). We are actively encouraging young writers to make their views known to CFI.co. It is critical that young folks’ aspirations and insights are fully taken into consideration for the development of the business world to be sustainable. As a print quarterly, CFI.co sets out to be a worthwhile and value creating read. We provide a different perspective while unearthing trends and bringing news of interesting personalities, companies and institutions. These are times when change occurs at an ever accelerating pace with sudden hyper jumps and we are ready for such change. We are also ready to offer our encouragement and support to SMEs throughout the world in the knowledge that these companies provide the backbone for most national economies and will generate the majority of new jobs for the expanding global population. The readership of CFI.co is distributed throughout the world with content sourced from each corner. However, the emerging markets (using the broadest interpretation of “markets” to include regions, cities, cross-border consumer segments, products and people) are a prime focus because of their dynamism and great interest to our readers. The emerging economies are not only catching up with the “developed” ones as world economies converge, but are sometimes bypassing them and contributing novel dimensions. There is every chance that the next quantum leap will originate in what is now seen as a developing market. One of our challenges is to stay abreast of such developments and capitalise on these dynamic connections to create value for all stakeholders. We welcome reader feedback so that our experienced team can provide you with a continuously improving product. We shall do our utmost to ensure that this small piece of history in your hands will lead the way to much greater accomplishments and that CFI.co is always an interesting, relevant and informative read. CFI.co believes in good citizenry and the highest levels of corporate responsibility. We wish to demonstrate – in the words of Bob Corcoran of GE – that “the toughest problems in the world cannot be solved by any one sector or entity and for those things to happen it requires collaboration – it requires mutual trust and benefit.”

Tor Svensson Chairman Capital Finance International

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Contents

Editor Chris North

Assistant Editor Sarah Worthington

COVER FEATURES

Executive Editor George Kingsley Production Editor David Graham

Editorial William Adam David Gough-Price Diana French Jim Pearson Ellen Roland

SMEs Go Global (Page 64 – Page 66)

WTO: Tariffs No Longer Important (Page 26 – Page 27)

Distribution Manager Len Collingwood

Subscriptions Maggie Arts

World Bank: Strategies for Growth (Page 10 – Page 11)

Commercial Director Jon Gerben

Publisher Mark Harrison

Brazil’s Tech Triangle (Page 78 – Page 80)

Chairman Tor Svensson Capital Finance International 43-45 Portman Square London W1H 6HN United Kingdom T: +44 203 137 3679 F: +44 203 137 5872 E: info@cfi.co W: www.cfi.co

The Battles Entrepreneurs Face (Page 72 – Page 73)

Ten Emerging Market Heroes (Page 56 – Page 63)

Zenith Bank (Page 50 – Page 53) Printed in the UK by The Magazine Printing Company using only paper from FSC/PEFC suppliers www.magprint.co.uk

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Autumn 2012 Issue

Contents

FULL CONTENTS As World Economies Converge

Pages 10 – 39

40 – 55

Banco do Brasil Ernst & Young

64 – 80

82 – 106

120 – 135

World Bank Group European Investment Fund Brazil Venture Capital

DESERTEC Foundation NEPAD UN Economic Commission For Africa

Inter-American Bar Association Brazilian Institute for Corporate Governance Turkey Energy Hub

CFI.co 2012 Awards: Rewarding Global Excellence

Legal: Doing Things the Right Way Grant Thornton Baker & McKenzie

165 – 166

Small and Medium Size Enterprises: The Top Global Employers

Sustainability: The Only Option

136 – 164

Zenith Bank Africa’s Sovereign Wealth Funds

European Commission Africa’s New Metropolises Mona Vyas

108 – 119

George Soros Mohamed El-Erian Hans Martens

The Editor’s Heroes: Ten Men and Women Who are Making a Real Difference

Pier Carlo Padoan Bill Gross Joseph Stiglitz J. Bradford DeLong Nouriel Roubini

Banking & Finance: The Life Blood of Global Business

56 – 63

Janamitra Devan Jon Moynihan Michael Pettis Vijai Manoj Kamar Pascal Lamy

Investments: Where Next? World Bank Ernst & Young MIDA

Ernst & Young LEX Africa

AZPROMO MIGA EDFI

IBRI Invest KL Malaysia - OECD

Some Final Thoughts Christine Riordan

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As World Economies Converge

> World Bank Group:

Create Jobs by Focusing On Competitive Industries By Janamitra Devan

Focusing Investment in Industries Poised for Growth Can Help Generate Jobs, Income and Wealth.

ob creation is the top priority of governments worldwide, as countries large and small struggle to overcome the prolonged global economic downturn. Amid the euro crisis in Continental Europe, the abrupt slowdown in the United Kingdom and the United States, and the sudden sluggishness in many once-vibrant emerging markets, policymakers everywhere are urgently seeking activist pro-growth strategies. To energize their economies for the long term, both the wealthy West and the developing world would be wise to look toward countries where a disciplined approach to making strategic investments in specific industries has paid dividends. Such an industry-focused approach can be especially effective in developing countries, where about 1.5 billion “vulnerably employed” people are barely surviving on subsistence-level incomes – and where intensifying demographic pressures foreshadow an overwhelming unemployment threat. Propelling job creation will require a more comprehensive approach to focusing investment in integrated industrial ecosystems – networks of industries, innovators and investors that bring together all the creative elements that help economies thrive. The private sector must take the lead in organizing such industrial ecosystems, yet the public sector certainly also has a vital role to play. Sound policies must provide the enabling legal and regulatory frameworks that allow industries to compete – and not just by setting macro-level policies, but also by devising industryspecific strategies. This challenge calls for countries to focus investments in industries with strong potential for success. Pursuing such a strategy will require both business and governments to reach deeper into their policy toolkit. Supportive public policies must ensure that a strong and agile infrastructure is in place; that a well-educated workforce is equipped with flexible job skills; and that advanced industries are incubated and encouraged with positive incentives. Deciding where to promote jobcreating investment will inevitably be a complex

process, but policymakers can apply a range of targeted strategies, tailoring them for the particular conditions of each country. Such a pragmatic approach should aim to induce investment in industrial sectors where countries foresee that they can sustain a competitive edge, building on their distinctive but as-yet-unrealized comparative advantages in the global value chain.

way in fragile and conflict-afflicted states, where job creation is critical to stability and security. In Afghanistan, the Bank is helping the government leverage mining investments into a resource corridor. In the West Bank and Gaza, projects are focusing on the value chains in agribusiness and information technology. In Haiti, projects are helping develop tourism and textiles.

The World Bank Group is now actively helping our clients – low- and middle-income countries – make careful plans for focused investments through what we call the Competitive Industries approach. The Bank’s industry-focused efforts are now most active in Africa. In Burkina Faso and Niger, for example, the Bank is supporting an analysis of the agribusiness value chain to identify potentially jobcreating areas, prioritizing investments in industries and infrastructure while pursuing regulatory reforms and regional trade integration. Similarly, in Mozambique, the Bank is helping intensify the focus on expanding the country’s tourism industry and on developing its natural resources.

Responsiveness to market signals is a key factor in the Competitive Industries approach. Policymakers must be bold enough to double-down on early signs of progress – and must also be realistic enough to withdraw support when the marketplace sends signals that failure is likely. Transparency and good governance are essential to maintaining confidence in an era when instant informationflows provide real-time data about industries’ performance. Adjusting to trends in technological change is another priority that calls for agile decision-making by the public and private sectors, working in concert.

Competitive Industries engagements are also under

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Such coordinated public-private approaches have long been pursued successfully in Singapore,

Autumn 2012 Issue

As World Economies Converge

South Korea and Malaysia. Each country, in its own way, has made successful strategic investments – focusing on high-value industries, such as financial services and chemicals in Singapore, electronics and shipbuilding in South Korea, and semiconductors and electrical equipment in Malaysia. The same type of strategic analysis that these countries have applied to their industrial ecosystems can help inspire other nations to creatively focus their economic plans. Lower-income nations with limited resources are, in a sense, destined to make strategic choices about where to invest: Lacking the wealth to spread their bets too thin, they must conduct shrewd analyses about where to channel their limited resources to try to create jobs. The developing world is in a race against time, as outlined in the latest edition of the Bank’s “World Development Report.” At least 350 million additional jobs must be created in developing nations over the next decade – just to keep up with the pace of population growth, much less to reduce today’s level of unemployment.

take the lead in industry-level decisions, but, in recent years, the federal government has been pursuing a range of more activist approaches. The Obama Administration launched a publicprivate Advanced Manufacturing Partnership and a new Office of Manufacturing Policy in 2011, and created a new National Network for Manufacturing Innovation in 2012, aiming to foster closer alliances among manufacturing companies, universities and federally funded research laboratories. Public-private cooperation in shaping investment priorities does not amount to “picking winners and losers.” That approach, attempted in some countries in the 1960s and 1970s, sometimes merely propped up losers and cronies. Instead, the Competitive Industries approach considers such market-based criteria as agility, innovative capacity and responsiveness to global demand.

Many nations, both developed and developing, have come to grasp that shrewd industry-level interventions can help boost prosperity. Germany has long concentrated investments in high-valueadded electronics and machinery, and it now Taking a strategic approach to investment is enjoys an impressive lead over its competitors in increasingly important for wealthier countries, as many advanced energy systems. Brazil has made well. Even the West’s strong investments in most free-marketits aerospace industry oriented economies and clean-energy “… policymakers everywhere – including the United sector. China remains Kingdom and the the standard-bearer are urgently seeking activist United States – have for state-led dirigisme, pro-growth strategies.” increasingly been yet its strong growth pursuing activist in recent decades Janamitra Devan economic policies illustrates the to jump-start job impact of targeted creation in the private sector. Policymakers in the investment. U.K. are often candid enough to use the term “industrial policy” to describe their initiatives, Making successful investment choices is especially although that phrase sounds slightly off-key in the important for developing economies – such as Washington debate. Indonesia, Vietnam, Morocco or Jordan – where rapid population growth makes the employment Competitive Industries includes a somewhat imperative most urgent. Strategic analysis of each more robust role for the public sector than country’s best opportunities, especially in tradable Washington has been accustomed to, yet its goods that compete in the global marketplace, can logic is not out of step with the market-driven help policymakers calculate how to nurture the inclination of U.S. policymaking. Washington supportive innovation ecosystems that empower has traditionally preferred to let the private sector entrepreneurs.

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Public policy may play only a supportive role in guiding each nation’s decisions about investment, with the private sector continuing to drive growth. Nonetheless, governments should play their role effectively rather than only grudgingly. Nations can make strategic investments consciously, or they can take their chances blindly and hope to blunder into success – but, one way or another, the economic future will be shaped by those who analyze market forces and organize themselves strategically. Applying a pragmatic approach that targets a country’s comparative advantages through the lens of its industries is a promising way for each nation to strengthen its competitive assets. In a global economy that will relentlessly cull the losers and reward the most productive competitors, the winners will be those who anticipate events rather than merely react to them. i

ABOUT THE AUTHOR Janamitra Devan is a Vice President of the World Bank and International Finance Corporation, leading its network on financial sector and private sector development. Since joining the World Bank Group in 2009, he has focused on working with the Bank’s client countries to strengthen job creation; promote innovation and entrepreneurship; improve the climate for investment; provide broader access to finance for the poor; and oversee resilient banking systems and capital markets. Devan also represents the Bank on the Financial Stability Board in Basel.

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to The World Bank or IFC.

As World Economies Converge

> Jon Moynihan, Executive Chairman, PA Consulting Group: Frugality, Education, Infrastructure and Attitude Change is Needed in the West: We Should Not Rely on Keynesian Nostrums to Pull Us Through The West’s economic dilemma will not be solved until those countries have not just restructured their balance sheets, by significantly lowering expenditure, but have also significantly changed the mix of that expenditure.

n the UK and the US, and across most of Europe, the debate about national economic woes is framed as ‘austerity’ versus ‘growth’. This Keynesian vocabulary, assuming as it does a static environment, and therefore that there is all the time in the world to turn things around, ignores the steadily mounting debt of most Western countries. Worse, it obfuscates a far wider problem that has led to the debt in the first place: the vast disparity in wages that exists between the developed and the developing economies, and the jobs drain that has resulted from it (Chart 1).

The average worker in developed countries (‘the West’) earns around $135 a day. The average trained worker in developing countries (‘the East’) earns around $12 a day; a non-trained worker in the East, between $1 and $2 a day. With globalisation, it becomes impossible to ring-fence most work so as to preserve the jobs for these privileged workers in the developed countries. As a result, not only are jobs draining from the developed nations, but that in turn forces significantly lower wages on those whose jobs have not yet moved to developing nations (Chart 2).

Chart 1

For decades, since 1945, job growth in the western economies was around 2% a year, and annual growth in real wages (for the same job) was around 3% a year. This became, as it were, a democratic ‘right’ for the workforce; there will be jobs as my kids seek them, and I will earn more at my own job each year, for the same effort. This paradigm, lasting for the last fifty years of the twentieth century, was abruptly broken with the abandonment of Marxist and socialist economic policies across the developing world, and their replacement by capitalism, in the period 1990-2000. The change did not take long to have massive effect; the new paradigm since the year 2000 has been for growth, in both the number of jobs and the annual growth in real wages, to be negative (Chart 3, Chart 4).

Chart 2

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Autumn 2012 Issue

As World Economies Converge

In the western economies, with few exceptions, GDP (and job) growth over the cycle has disappeared, whilst at the same time, the size of China’s economy has quintupled. Five years after the 2007 crash, US employment is still six million jobs below the 2007 number. (Chart 4) This job loss is of a different order of magnitude to previous recessions, and speaks of a different reality (Chart 5). Real wages, too, have plummeted, although much of that impact is concealed behind the steady pernicious tick of inflation, devaluing static wages. This dynamic has been apparent since at least 1995, yet ignored –so that for almost two decades the western economies have been “fiddling while Rome burned”. With workforces that expected –and in many cases, particularly in the public sector, received– significant real rises in wages every year, and a public and commentariat that was unable to envisage anything but a steadily increasing standard of living, the consequence of trying to stay with that prior, broken paradigm is that the western economies have been, year by year, increasingly living about their means. The consequent build-up in debt – corporate, individual and government – has now become an enormous overhang, the servicing of which will –as has been shown by the systematic analytic work of Carmen Reinhardt and Ken Rogoff– drain wealth from Western societies and lead to further, and much greater, impoverishment.

Chart 3

“… if a country does not recognise that its overall standard of living is unsustainable, the market brutally enforces that fact on the country, leading to major economic disruption and widespread immiseration …”

Chart 4

The UK’s total debt of all sorts –Personal, Corporate, Financial and Government– is now, as a percentage of GDP, lower only than Japan’s and Ireland’s – higher than that of Greece, Spain or Italy (Chart 6). In any event, apart from the obvious exception of Germany, most developed countries are much in the same boat: the fact that the West has been living above its means for so long means that its situation is qualitatively no different to that of Greece and Ireland, countries who have recently learned to their cost what happens when reality is ignored. Sooner or later, if a country does not recognise that its overall standard of living is unsustainable, the market brutally enforces that fact on the country, leading to major economic disruption and widespread immiseration, of a sort that most in the West currently find unimaginable, despite the chaotic scenes being played out in Euro fringe countries in recent months.

Chart 5

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The failure to recognise the problem, or do anything about it, over the years was exacerbated by commentariats who by and large took a Keynesian view, asserting that the issue was to get the economy back into full employment through kick-starting it into ‘growth’. The trouble with this view is that for ‘growth’ one only has to substitute the words ‘continuing to live above our means, without any expectation of being able to pay for it’ and the fatal flaw is seen. The consensus, against all the lessons of economic history, is clear: We should spend our way out of this. Since 1987, when Alan Greenspan took over the Federal Reserve, the response to any economic downturn has been to flood the system with cheap money so that governments, corporates and consumers could continue to live above their means. As a result, the Fed Funds rate declined from the mid-teens in the ‘80s, to now one quarter of one percent. Since the beginning of the 1990s, the US and the UK have had only 3 years (out of 22) each in which (very small) surpluses were achieved: the Euro area has run a deficit in every single one of those years.

Chart 6

The need to keep consumption high led to everdiminishing investment in western economies (apart from the notable example of Germany). For example, in the most recent Spending Review, capital investment by the UK Government has been massively cut – 30% less in real terms in 2014 than in 2010, even though Government’s running costs are increasing slightly over the same period. To keep people in jobs, and preserve entitlements in the short-term, the long-term is being made even worse than it would otherwise be. When a company in the Private Sector goes badly wrong, and is no longer financially viable, the bankruptcy code (particularly Chapter 11 in the US) has proved effective in getting the failing organisation out of the hands of those who led it into failure, and into the hands of those who have demonstrated a better understanding of the problem, and an ability to solve it. Bankrupt organisations in the US tend to carry on after reorganisation with very little loss of the underlying assets, since the process is swift and the chief change is that those managing the assets are replaced.

Chart 7

In the UK national context, the failing institutions and organisations who have led our economies into failure are the governments, regulators, central banks, and commentariat who, over decades, failed to spot these trends, or speak out against the polices that led us to now. It’s not surprising that acceptance of the need for radical change has been so slow in coming, because those running these institutions are strongly entrenched, and captive to the status quo. In the UK and even more so in continental Europe, the governing castes have an iron grip on the policy levers, and it is unrealistic to expect them to even recognise that the policies that they pursued for 14

Chart 8

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Autumn 2012 Issue

As World Economies Converge

poses enormous societal and economic questions. Even at that equilibrium, there is no reason why the West’s wages will not continue to slide further, through inflation or currency collapse, if existing policies are continued with and our barriers to competition continue to erode (Chart 9). Our existing physical and intellectual capital base is disappearing fast, eroded by technological advance, the internet, to some extent cyber-theft of much of our IP, and the fact that our best universities are (arguably quite correctly) educating the future business and economic leaders of the developing countries. Our propensity to invest new capital is lower than the East; our encouragement of venture capitalists and entrepreneurs is not notable (in the alleged words of Deng Xiaoping, “Zhifu Guangrong” – “to get rich is glorious”; we can compare that with the UK’s Nick Clegg: “we need to get tough on irresponsible and unjustified top remuneration” and the UK’s general focus on increasing taxes rather than incentives).

Chart 9

The pioneering work of Daron Acemoglu and James Robinson at MIT has shown that in every society, ‘extractive’ groups emerge over time to take an unfair share of society’s wealth, thus diverting it from more productive uses (see their book, ‘Why Nations Fail’). In the UK, for example, we have a variegated group, ranging from bankers to civil servants to middle-class and other benefit claimants, who arguably fall into this category. These entitled groups will kick very hard against losing their hard-won privileges. But freeing up that extractive share of the national wealth that they have their hands on is an essential part of restructuring the economy to be competitive with the East.

Chart 10

decades were wrong, and that radical change is essential. Yet the vast majority of discussion is still about how to preserve our current standard of living – a standard of living which is unsustainable. In the words of Herb Stein: “that which cannot go on forever . . . won’t”. Basic industries – steel production, and the like – have already been taken over by China and other developing countries. More advanced industries, such as car production, are going the same way. With each stage of advancement up the industrial ladder in the East – from low know-how, to medium and high capital intensity, to scientific and creative, and on to professional services and other high know-how businesses (Chart 7) — there is a corresponding jobs drain from the West to the East. And while the West focuses on spending money to sustain existing standards of living, with capital investment dropping year after year, China’s investment levels (however

misdirected some of those investments may be) have risen to almost 50% of GDP (the West is at around 15%, and falling). The barriers with which the West has been able to keep the East and South at bay are disappearing, and for the first time in centuries we have to compete on an even playing field with the rest of the world. It is infeasible that we will be able to offer competitive wage rates – you are not going to get to Eastern levels of wages without a complete collapse of the economy, and general destitution. Even as wages in developing countries increase (a slow process, given all those workers on $1 a day waiting to join the industrial workforce, and exerting downward pressure on industrial wages), any equilibration of Western with Eastern wages will result in an average level well below the west’s current $135 a day: our preliminary analysis indicates a crossover, in the 2020s or 30s, of around $60 a day (Chart 8) –a number that

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In the UK, as in Europe, government is such a large part of GNP that the need to tighten our belts, which in the private sector most families have already been doing, is crucial for the public sector –both for public sector employees, and for recipients of benefits. Productivity in the public sector has declined over the past decade, while in the private sector it has massively increased, yet wages in the public sector have gone up significantly more than in the private sector. On the recipient side, the economy has grown fourfold in real terms since the 1950s: welfare spending has increased tenfold. We all want a compassionate society that seeks to help the disadvantaged. But if that is done in unaffordable ways, it defeats itself – when the economy craters, there will be no tax monies available to pay over-large benefits. Indeed, many benefits paid out by the government are not at all to the needy, and are far more a function of the perceived need to capture voters. Nearly 80% of maternity pay goes out to middle class households in the UK: over 40% of child benefit, and 40% of student support. Why do middle class pensioners need winter fuel allowances, or free bus passes? How can that be justified when our public finances are in such disarray? There will of course be real choices to be made, beyond removal of such fringe benefits. One choice that has been made in the UK since the 1950s has

As World Economies Converge

been to grow health expenditure at a much faster clip (nearly 5% a year, real terms) than education (3% a year); over 60 years, due to the magic of compounding, this has been a huge reallocation of resources (Chart 10). It has been said that 22% of health care is spent in the last year of life. Which is more important for our future: the last year of life, or the first twenty? Indeed, education, particularly the shrinkage of science teaching both in schools and in universities, is at the heart of the dilemma we face. 60% of current STEM (Science, Technology, Engineering, and Mathematics) graduate students in universities across the UK have come from abroad and most of them will leave again after graduating (particularly given the UK’s unwelcoming approach to immigration). And yet, it is in a highly educated workforce, particularly but not just in the sciences, that our future lies. Almost 20% of our children leave school without having attained “the essential reading skills to participate productively in society” (OECD 2009). The comparison statistic in Shanghai is, by the way, under 4%. It is the least educated who suffer the most in terms of low pay. Again from the OECD, the two things a government can spend money on that have the most impact on the long-run growth of an economy are education, and infrastructure. With an educated population, we can develop the technologies and companies that can give employment and continue to grow the economy.

“… the tax mix needs to be reformed, away from corporate and personal income taxes and more towards consumption and property taxes …” The government has a central part to play. Apart from reorienting government spending, the banking sector clearly needs to be transformed (and that, with currently planned legislation and regulation, is not happening); the tax mix needs to be reformed, away from corporate and personal income taxes and more towards consumption and property taxes (again, from the OECD, shifting to the latter two improves GDP per capita; to the former two reduces it). Moreover, support must be given to the development of new technologies; and an integrated industrial policy needs to be driven through, that focuses on the building of technology ecosystems across the country, ties into innovation centres near to universities, and focuses on the multiple technologies (in current cod parlance, bio/ nano/info/neuro/cogno/anti-carbo) where future economic growth is going to be found. It’s particularly essential to reduce welfare-type distribution from government, if only because to grow the economy in the longer term, significant infrastructure investments need to be made in the UK, and our debt situation is such that we 16

cannot borrow further to make those investments. Lord Wolfson’s ‘brain belt’ (the Oxford to Cambridge motorway/science park ecosystem); local bypasses; universal WiMAX or other ultrahigh speed broadband; ‘Boris Island’ (a Thames estuary-located airport); a Manchester to Sheffield motorway; university/science/business ecosystems; all these are crying out to be invested in, and each should grow the economy significantly.

ABOUT THE AUTHOR Jon Moynihan Executive Chairman

“… a 15% immediate decline in living standards is needed just to balance Western economies today …” But above all, a national consensus is needed on what is necessary to implement the above vision, and in particular to accept that we have been living above our means. Until such time as we have grown the economy through the above vision, an increasingly lower standard of living for most is inevitable. OECD and World Bank numbers indicate that something like a 15% immediate decline in living standards is needed just to balance Western economies today, never mind what happens in the future as more jobs slip away to the East – 15% is a level that many private households have already implemented, but with government spending so large, private retrenchment alone cannot accomplish that over the entire economy (and of course with the inevitable knock-on effect that retrenchment will have on the economy, the shorter-term shrinkage is likely to be larger). This restructuring of consumption should by gradually managed, as otherwise it will be forced on us, in more brutal fashion, by the markets. We cannot expect Government or opposition to stand up and say this to us unless we all of us start being prepared to accept the fact and say it ourselves. This is the alternative to the Keynesian “growth” story. It’s a bleak view, but it contains the truth in it that all of us in our hearts know – that in order to recover, you have to pull back. In order to grow, you have to invest. Capitalism works by creating surpluses and investing them in productive ways, not by borrowing monies and squandering them on consumption. There are still major issues that would face us even if we were able to get a national consensus behind this idea –for example, I challenge anybody to show an existing, carefully worked-through example of how the US or the UK are going to unwind Quantitative Easing without enormous pain and possibly disastrous disruption– but if the West is to avoid more generally suffering the fate of countries such as Greece and Ireland, and even before them, Argentina (a hundred or so years ago, one of the richest countries in the world), we have to make a start by owning up to our true situation, and the fact that the current consensus and approach is only digging us even further into trouble. For reasons of space, this article focuses on the UK as an illustration, but its points are intended to apply to the developed economies overall. i CFI.co | Capital Finance International

PA Consulting Group Jon has been first, Chief Executive Officer and now, Executive Chairman of PA Consulting Group, overseeing PA’s worldwide activities. Prior to working with PA Consulting Group, Jon worked with First Manhattan Consulting Group in New York, Strategic Planning Associates in Washington, McKinsey and Co in Amsterdam, Roche Products in London. Jon has written and been quoted in publications ranging from the Economist to the Financial Times, the American Banker, Barrons and Newsweek. Jon has lectured at Wharton, University of Michigan, Massachusetts Institute of Technology. Jon was educated at Balliol College, Oxford University; North London University – MSc Applied Statistics; Massachusetts Institute of Technology – SM

ABOUT PA CONSULTING GROUP

PA Consulting Group (PA) is a management and IT consulting and technology and innovation organisation with specialist expertise across sectors: financial services, life sciences and healthcare, government and public services, defence and security, energy, telecommunications, consumer goods, automotive, transport and logistics. Founded in 1943, PA has annual turnover of approximately US$ half billion. The 2,154 employees (PA is employee owned) operate globally from offices across Europe, the Nordics, the United States, the Gulf and Asia Pacific with headquarters in London. See www.paconsulting.com.

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> Michael Pettis:

Europe’s Depressing Prospects

ormally I don’t like to write about European prospects in the midst of a very rough patch in the market because in that case there isn’t much I can say that isn’t already being said. I find it more useful to wait for those recurring periods in which the markets recover and optimism rises. Still, given the conjunction of political uncertainty in Beijing, low Chinese growth numbers, and another round of deteriorating circumstances in Europe, I will spend most of this issue of the newsletter trying to outline the possible paths countries like Spain must face. For several years I have been saying that Spain would leave the euro and restructure its external debt. I should say that I specify Spain because it is the country in which I was born and grew up, and so it is also the country I know best. When I say Spain, however, I really mean all the peripheral European countries that, like Spain, are uncompetitive, have high debt levels, and suffer from low savings rates that had been forced down in the past decade to dangerous levels. Spain had a stronger fiscal position and healthier bank balance sheets than many of its peers when the crisis began, so any argument that applies to Spain is likely to apply more forcefully to its peers. As an aside I will add that France is for me the dividing line between countries that will be forced into devaluation and restructuring and those that won’t – in my opinion France could go either way and we will get a much better sense of this in the first year of Hollande’s presidency. There are two reasons why I was and am fairly sure that Spain cannot stay in the euro (or, which amounts to the same thing, that Germany will leave the euro instead of Spain). The first has to do with the logic of Spain’s balance of payments position, and the second has to do with the internal dynamics that drive the process of financial crisis. To address the first, I would start by noting that thanks to excessively loose monetary policies driven primarily by German needs over the past decade, Spain has made itself wholly uncompetitive in the global markets and in so doing has run large current account deficits for nearly the entire past decade. Its fundamental problem, in other words, has been the process by which its savings rate has collapsed, its cost structure forced up, its debt levels soared, and a great deal of investment directed into projects, mostly real estate, that were not economically viable. As I have discussed often enough in previous issues of this newsletter, I think all of these problems are related and are the automatic consequences of the same set of policy distortions implemented in Spain and in Germany.

Until Spain reverses its savings and consumption balance and drives down its current account deficit into surplus, which is what a reversal of these distortions would imply, it should be pretty clear that Spain will continue struggling with growth and will continue to see debt levels rise unsustainably. But the balance of payments mechanism imposes pretty clear constraints on

“GERMANY HAS A POTENTIALLY HUGE DEBT PROBLEM ON ITS BALANCE SHEET”

the process of adjustment. In that sense there are really only three ways Spain can regain competitiveness sufficiently to raise savings and reverse the current account: Germany and the other core countries can take steps to reverse the policies that led to the European crisis. They can cut consumption and income taxes sharply in order to reduce domestic savings and increase domestic consumption. These would lead to a reversal of the German trade surpluses and higher inflation in Germany, the combination of which would allow Spain to reverse its trade deficit and regain competitiveness via lower inflation relative to that of Germany and a weaker euro. Spain can force austerity and tolerate high unemployment for many more years as wages are slowly pushed down and pricing excesses are ground away. It can also take measures to reduce costs by making it easier to start businesses, reducing business taxes, and by improving infrastructure, but these latter provide too little relief except over a very long period, especially given the difficulty Spain will face in financing infrastructure and reducing taxes. Spain can leave the euro and devalue. This would leave it with a problem of euro-denominated debt, whose value would soar relative to GDP denominated in a weakening currency. In that case Spain would almost certainly be forced to halt debt payments and restructure its debt. I want to stress that these are, practically speaking, the only three ways for Spain to regain competitiveness. There are other ways that could in theory also work, but they are too unlikely to consider. One could assume for example that the rest of the non-European world – most importantly the US, China and Japan – take steps to stimulate their domestic economies sufficiently to force up consumption and run in the aggregate large

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and growing trade deficits. These deficits, whose counterpart would be a very large European trade surplus, would then bail out the whole eurozone by generating GDP growth rates that exceed the debt refinancing rates. I think most of my readers will however agree that this is pretty unlikely. The rest of the world is also struggling with growth and in no hurry to run large trade deficits. Another possibility is that we suddenly see a rapid and dramatic move towards full fiscal union in Europe, in which sovereignty, for all practical purposes, is fully transferred to Brussels (or Berlin). But that probably won’t happen either – the rise of nationalism throughout Europe has made this always-unlikely prospect even less likely. So we are left largely with these three ways of allowing Spain to regain a cost structure that makes it competitive and allows it to amortize its debt while growing. Anyone who rules out two of the three ways listed above must automatically imply that Spain will follow the third way. So which will it be? HUMPTY DUMPTY ECONOMICS The first way is for Germany to reverse its surplus and begin running large deficits. This is by far the best way, but I think it is very unlikely. Berlin has made no indication that it is prepared to do what would be necessary for it to run large deficits and, on the contrary, it is even talking about the need for more austerity. In part this is because Germany has a potentially huge debt problem on its balance sheet. As a consequence of its consumptionrepressing policies during the decade before the crisis, Germany’s domestic savings rate was forced up to much higher than it otherwise would have been and Germany has had to export the excess capital. Not surprisingly, given European monetary dynamics, this capital has been exported largely to the rest of Europe in order to fund the current account deficits of peripheral Europe that corresponded to the surpluses Germany so badly needed to grow. It did this not by accumulating euro reserves, which it could not do anyway, but rather by accumulating loans to peripheral Europe through the banking system. As a result of all of these loans, Germany is rightly terrified that a wave of defaults in Europe will cause its own banking system to require a state bailout if it is not to collapse, and so it does not want to cut taxes and reduce savings because it believes (wrongly) that austerity will make it easier to protect its creditworthiness. But German’s anti-consumption policies are

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leading it towards a debt problem in the same way that similar US policies in the late 1920s created an American debt crisis during the next decade. In that light I thought this very illuminating quote from then-presidential candidate Franklin Delano Roosevelt might be apposite: Humpty Dumpty’s grasp of the balance of payments, it turns out, is no more naïve than that of many European policymakers, and I suppose Germany will follow the historical precedent set by the US – and so many other countries that confuse trade surpluses with moral vigor. By refusing to take steps that seem on the surface to undermine its creditworthiness, Berlin will only ensure the

A puzzled, somewhat skeptical Alice asked the Republican leadership some simple questions: “Will not the printing and selling of more stocks and bonds the building of new plants and the increase of efficiency produce more goods than we can buy?” “No,” shouted Humpty Dumpty, “the more we produce the more we can buy.” “What if we produce a surplus?” “Oh, we can sell it to foreign consumers.” “How can the foreigners pay for it?” “Why, we will lend them the money.” “I see,” said little Alice, “they will buy our surplus with our money. Of course these foreigners will pay us back by selling us their goods.” “Oh not at all, “said Humpty Dumpty. “We set up a high wall called the tariff.” “And,” said Alice at last, “how will the foreigners pay off these loans?” “That is easy, said Humpty Dumpty. “Did you ever hear of a moratorium?” And so alas, my friends, we have reached the heart of the magic formula of 1928.

debt moratorium that will probably demolish its creditworthiness anyway. And of course without a major reversal of German’s current account position the balance of payments constraint absolutely prevents net repayments from peripheral Europe. This game will go on as long as the core countries continue financing the periphery, but once they finally stop, the peripheral countries will almost certainly default or restructure their debt. To take a brief detour before returning to discussing the three paths Spain can take, I think Berlin is betting that if they can prolong the crisis

long enough, while pretending that the problem is one of liquidity, not solvency, they can recapitalize the German (and other European) banks to the point where they eventually are able to recognize the obvious and take the losses. This was, after all, the strategy followed by the US during the LDC Crisis of the 1980s, when it waited until 1989, seven or eight years after the crisis began, to arrange the first formal debt forgiveness (the Mexican Brady Bond). During that time a steep yield curve engineered by the Fed allowed the US banks to earn sufficient profits to recapitalize themselves to the point where they could finally formally recognize what had long been obvious. There are at least two reasons however why this strategy won’t work for the European banks. First, the hole in the European banks’ balance sheets dwarves the equivalent hole in the balance sheets of the American banks during the LDC crisis. It would take them much longer then seven or eight years to fix the problem. Second, postponing resolution of the debt crisis is extremely painful for the debtor countries, who have to bear the full brunt of the adjustment that both debtor and creditor countries really need to make together. This reduces maneuvering space for Europe because the political system in Europe is less able than that of Latin America during the 1980s to accommodate this very painful process. Well-functioning democracies, after all, make it harder for bankers and elites to force the cost of the adjustment onto the middle and working classes. CAN SPAIN ADJUST BY ITSELF? This is also the reason why Spain cannot follow the second of the three paths described above. The second path requires that Spain bear the full brunt of the economic adjustment, which in reality Spain and Germany should bear together. Spanish voters, however, will not permit (and rightly so) that Madrid force such economic pain on its citizens in the name of an ideal of “responsible behavior” (i.e. remaining within the euro) that is both mistaken and extremely painful. The adjustment will require that Spanish wages and prices are forced down substantially until Spain can reverse the higher price differential relative to Germany from which it suffers. Figuring out how to do this is not very hard – we have plenty of historical precedents upon which to draw. To simplify substantially, there are basically two things that have to happen in order to force a relative decline in prices. First, unemployment must remain very high for many years so that wages either decline, or rise by less than inflation and relative productivity growth. This is pretty straightforward. Second, there must be some way to deal with the real increase in the domestic debt burden. Why? Because there are two ways relative prices can be forced down, and both of these result in a real increase in the debt burden. First, high inflation in Germany can exceed lower Spanish inflation, and second, Spain can deflate. In both cases the real cost of debt must increase substantially – in the former case because high German inflation CFI.co | Capital Finance International

will force up euro interest rates so that Spain’s refinancing cost will exceed its domestic growth rate, and in the latter case because deflation automatically increases the real debt burden. How will we deal with the rising debt burden? Typically we do so by confiscating the wealth of small and medium enterprises or by confiscating the savings of the middle classes, and usually we do both. So for Spain to adjust we need both very high unemployment for many years and we need to undermine the middle classes. Any policy that requires an enormous and unfair burden on both the workers and the middle classes is unlikely to be rewarded at the polling booths. The huge unpopularity of the newly elected Prime Minister Mariano Rajoy, in that context, should not be a surprise. I wrote last year just after the election that this would happen, although I thought it would take a year or two before the population really turned on him and made it impossible for him to govern. But Spaniards, from business leaders down to workers, are furious at the Rajoy government and this anger will continue until either the two major parties eject those of their leaders who continue to demand that Spain behave in a “responsible” way, or harder line extremist parties replace the two parties themselves. I place the word “responsible” in quotation marks not because I am opposed to responsible behavior but rather because the attempt to tighten the budget and impose austerity in the name of remaining on the euro is being presented as the “responsible” thing to do. It is, however, no more responsible than the policies France used in the 1920s to revalue the franc to pre-War parity, which were also sold to the French public as the “responsible” thing to do. In both cases (and in many other deluded attempts to protect hopelessly overvalued currencies underpinned by rising eternal debt), policymakers did not understand that their policies were guaranteed to fail and were based on a misunderstanding of the causes of the underlying crisis. The responsible thing to do is to acknowledge that the euro is indefensible and that Germany’s refusal to share the adjustment burden, after it absorbed most of the benefits of the mismanaged monetary position it imposed on the rest of Europe, means that Spain will be forced to take on far more than its share of the cost. But whether or not everyone agrees with my analysis of what really is “responsible” behavior, I think it most people will agree that, rightly or wrongly, Spanish voters are unlikely to accept high unemployment and an assault of middle class savings for many years without rebelling at the polls. Spain simply cannot accept the full burden of adjustment. This means that the first two of the three paths I listed above cannot be followed. If I am right, we are automatically left with the third. Spain (and by extension many other countries) must leave the euro. It will be very painful and chaotic for them to abandon the euro, but the sooner they do it the less painful it will be.

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THE DEATH SPIRAL I said at the beginning of this newsletter that there were two reasons why I was certain Spain would leave the euro, the first of which has to do with the logic of Spain’s balance of payments position and the second with the internal dynamics that drive the process of financial crisis why I was certain that Spain would leave the euro. To address the second, I think Spain will leave the euro because it seems to me that the country has already started on the self-reinforcing downward spiral that leads to a crisis, and there is no one big enough to reverse the spiral. How does this process work? It turns out that it is pretty straightforward, and occurs during every one of the sovereign financial crises we have seen in modern history. When a sufficient level of doubt arises about sovereign credibility, all the major economic stakeholders in that country begin to change their behavior in ways that exacerbate the problem of credibility. Of course as credibility is eroded, this further exacerbates the behavior of these stakeholders. In that case bankruptcy comes, as Hemingway is reported to have said, at first slowly, and then all of a sudden, as the country moves slowly at first and then rapidly towards a breakdown in its debt capacity. What is key to understanding the process is to see that stakeholders will behave for perfectly rational reasons in ways that politicians and moralists will decry as wholly irrational. Rather however than respond to appeals that they stop behaving irrationally, stakeholders will continue making conditions worse by their behavior as they respond the distorted incentives created by the erosion of sovereign credibility. To do otherwise would almost surely expose them to disaster. To summarize what the self-destructive and automatic behavior of the stakeholders is likely to be, it is worth identifying some of the major stakeholders and to suggest how they typically react to a rise in the sovereign’s default risk: Private creditors. As Spain’s credibility deteriorates, private creditors will demand higher yields on their loans to Spain even as they change the form of their lending to reduce their own risk, for example by shortening maturities. This has a double impact on making conditions worse. First, higher interest rates mean that debt rises more quickly than it otherwise would. Second, shorter maturities and other changes in the loan structure mean greater balance sheet fragility and a rising probability of default. Official lenders. As they are forced into providing liquidity facilities, official creditors typically demand and receive seniority. This of course increases the riskiness for other lenders and creditors by pushing risk downwards, and so worsens balance sheet fragility and increases private sector reluctance to lend. Depositors. As the probability rises that Spain will leave the euro, and that bank deposits will be frozen and redenominated in the weaker currency before any abandonment of the euro is announced,

depositors respond rationally by taking money out of the banking system. As they do, banks are forced to contract lending, to increase balance sheet liquidity, and to reduce risk, all of which act as a drag on economic growth. Workers. Rising unemployment and the prospects for an unequal sharing of the burden of adjustment cause unions to become increasingly militant and to engage more often in various forms of industrial action, which, by raising uncertainty and costs for businesses, force them to cut output and employment. Small and medium businesses. One of the sectors most likely to be penalized in a debt crisis is the small and medium enterprise sector. Owners of small and medium businesses know that they are vulnerable during a crisis to an expropriation of their wealth through taxes, price and wage controls, and other forms of indirect expropriation. They try to forestall this by disinvesting, cutting back on expenses, and taking money out of the country. Political leaders. As time horizons shorten and politics becomes increasingly radicalized, policymakers shift their behavior in ways that reduce credibility further, increase business uncertainty, and raise national antagonisms. It is important to recognize the almost wholly mechanical nature of credit deterioration once a country is caught in this kind of spiral. Deteriorating creditworthiness forces stakeholders to adjust. Their adjustment causes debt to rise and/or growth to slow, thus eroding creditworthiness further. The combination of these and other actions by stakeholders, in other words, can’t help but reduce GDP growth, increase debt, and increase the fragility of the balance sheet, all of which of course undermines credibility further, so reinforcing the suboptimal behavior of stakeholders. All of the exhortations by politicians, the church, public intellectuals, bankers, etc. – and there will be many – that stakeholders put personal self-interest aside and act in the best interests of the nation will be useless. Slowing this behavior is not enough. It must be reversed. But how can it be reversed? No one is big enough credibly to guarantee the creditworthiness of all the afflicted countries, and without a credible guarantee the downward spiral will occur, more or less quickly, until it is clearly unstoppable. ONLY CONNECT… It is pretty clear that all of this is already happening in Spain and it is also pretty clear that every few months when the government announces the latest batch of economic and debt data, these numbers always turn out to be worse than expected and much worse than originally projected, which is, ironically, exactly what we should expect under the circumstances. Here is an article from Saturday’s Financial Times that shows just how bad it is: It is interesting that Garcia-Magallo is openly discussing the possibility of the “passengers” not being saved. Usually in the beginning of a sovereign

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debt crisis we spend an unfortunately long time in which policymakers insist that the market is overreacting to bad news and that the problem – inevitably a short-term problem driven largely by illiquidity – can be resolved with patience and hard work. There is no discussion of contingency plans because the contingency is unimaginable. At some point however it becomes possible at least to acknowledge formally that policymakers might be forced into the contingency. Once this happens, the debate becomes much more intelligent and the resolution of the crisis is speeded up. I have no idea if we have reached that stage in Spain, but in that light I found an articlelast month, by Ambrose Evans-Pritchard of the Telegraph, both very worrying and, at the same time, comforting. In the article he says: As recently as six months ago one didn’t discuss in polite company in Madrid the possibility that Spain would leave the euro and restructure its debt. The prospect was unthinkable and like many unthinkable things it could not be discussed. This made it very unlikely that anyone except

Nearly one Spaniard in four is unemployed, according to data released on Friday, as the country’s economic and financial predicament prompted a government minister to talk of a “crisis of enormous proportions”. The data from the National Statistics Institute showed 367,000 people lost their jobs in the first three months of the year. That means more than 5.6m Spaniards or 24.4 per cent of the workforce are unemployed, close to a record high set in 1994. The data, which follow a sovereign credit rating downgrade, prompted José Manuel García-Margallo, foreign minister, to say that they were “terrible for everyone and terrible for the government”. He compared the European Union to the doomed liner Titanic, saying that passengers would be saved only if all worked together to find a solution. the radical parties of the left or right would be able to control the discussion and of course this was likely to lead to a more disorderly resolution. But now perhaps things have changed. If responsible policymakers, advisors, the press, and public intellectuals are indeed discussing and debating the future of the euro now, I am pretty sure that a real and open debate about Spain’s prospects will quickly move the consensus towards abandoning the euro. And that is why the article is comforting. The historical precedents suggest that typically policymakers postpone the decision to reverse the monetary straightjacket for as long as they can, and in the process they erect barriers towards such a reversal in the name of shoring up credibility. These barriers work by increasing the cost of a policy reversal, and the point of this is to improve credibility in investors’ eyes by increasing the cost of “misbehavior” by policymakers. Mexico did this for example in 1994 when, in order to convince an increasingly skeptical

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As World Economies Converge

Brussels

Articles calling for Spain to withdraw from EMU – or at least exploring the idea – are no longer rare. They are appearing every day. …What is striking is the response on the comment threads of such pieces. My impression over the last month is that a large bloc of informed Spanish opinion has reached the conclusion that EMU is dysfunctional, and increasingly destructive for Spain. Many posters seem extremely well-informed, using terminology such as “debt-traps”, “internal devaluations”, and “relative unit labour costs”. Many point the finger directly at Germany, correctly stating that Berlin seems to think it can lock in a current account surplus with Club Med in perpetuity. Clearly, such as an arrangement is mathematically impossible within a currency union – unless Germany is willing to offset the surplus with flows of money for ever, either through fiscal transfers or loans or investment. These flows have been cut off. Opinion is divided, of course. The pro-euro camp is still a majority. But the smothering conformity of past years has been obliterated.

investor base that the central bank would not devalue the peso against the dollar, the Ministry of Finance shifted its domestic borrowing from peso-denominated funding to dollar-denominated funding, which of course would increase the debtservicing cost of a devaluation for the government. Unfortunately, when policy is reversed anyway, as was the case in Mexico in 1994, the cost indeed ends up being much higher, and it takes longer for the economy to recover. In that sense the sooner Spain prepares for an abandonment of the euro the less painful it will be. But of course it won’t be painless. Whenever an analyst predicts that Spain will soon leave the euro he is almost always countered by someone who earnestly explains that Spain cannot leave the euro

because the process will be too painful. In 199394 of curse we were told that this was why Mexico could not possibly devalue, and in 2000 and 2001 this was why Argentina could not possibly break the currency board. It would have been too painful to devalue. But of course Mexico and Argentina both did devalue and, yes, it was a very painful experience but they did it because the alternative was worse. And likewise while it is true that Spain cannot leave the euro without experiencing a very painful process, the point is not that anyone is arguing that Spain should willingly and irrationally choose to endure pain. Spain will leave the euro because the alternative is worse. i

ABOUT THE AUTHOR Michael Pettis is a Senior Associate at the Carnegie Endowment for International Peace and a finance professor at Peking University’s Guanghua School of Management, where he specializes in Chinese financial markets. He has taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business. He is also Chief Strategist at Guosen Securities (HK), a Shenzhen-based investment bank. Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups. He has also worked as a partner in a merchant banking boutique that specialized in securitizing Latin American assets and at Credit Suisse First Boston, where he headed the emerging markets trading team. Besides trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system, the Republic of Macedonia on the restructuring of its international bank debt, and the South Korean Ministry of Finance on the restructuring of the country’s commercial bank debt. Pettis has been a member of the Institute of Latin American Studies Advisory Board at Columbia University as well as the Dean’s Advisory Board at the School of Public and International Affairs. He received an MBA in Finance in 1984 and an MIA in Development Economics in 1981, both from Columbia University. He can be contacted at michael@pettis.com

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> Manoj Kumar Vijai, Partner, KPMG India: Indiaâ&#x20AC;&#x2122;s Financial Sector: Defying the Global Trend and Emerging Stronger

ndia has witnessed an excellent growth over past two decades. Indian economy has expanded at a CAGR of 6.9% during this period. Besides economic growth, the country has prospered in a number of other areas as well. Its professionals have made significant contributions in the areas of medical science and business globally. A number of multinational companies today are headed by people of Indian origin. Indiaâ&#x20AC;&#x2122;s influence in various international forums has increased significantly. While the 22

countryâ&#x20AC;&#x2122;s claim for a permanent seat in the United Nations Security Council is still debated, it continues to be an active contributor to the peace and rehabilitation efforts in many countries. After the balance of payment crisis in 1991, the Indian Government embarked upon the road of economic liberalization and globalization. The economy expanded at a CAGR of 7.8 percent during the last ten years. India has globalized at a faster rate with its gross capital inflows and CFI.co | Capital Finance International

outflows growing five times during the last 30 years. The country also witnessed strong savings and investment rates of 32.3 percent and 35.1 percent respectively, in 2011 (quick estimates) which has helped in attaining high per capita income. The services sector grew exponentially especially after the economic liberalization in early 1990s and emerged as the prime driver of this growth. Its share in GDP has consistently increased from 42.7 percent in 1990-91 to 59.0 percent in 2011-12 (advanced estimates).[1]

Autumn 2012 Issue

The pace of the economic growth could be imagined from the fact that while it took nearly 40 years for the real per capita income to double from the level achieved in 1950-51, it increased 2.5 times in the next 20 years in the post-reforms period. More importantly, the per capita income crossed the crucial level of USD 1,000 in FY11, which is considered to be the level beyond which an economy grows exponentially.[2] A GLIMPSE OF INCREASING INVESTMENTS OVER THE LAST DECADE This growth story has made India an attractive investment destination. India’s share of foreign direct investment (FDI) and foreign institutional investment (FII) has been increasing consistently since the last decade. FDI equity investments during April 2000-February 2012 were pegged at USD 246.6 billion and net FII investments (both equity and debt) were USD 111 billion during April 2000-November 2011. India’s increasing investment attractiveness was also acknowledged in the World Investment Prospect Survey – 2010-2012 by the United Nations Conference on Trade and Development (UNCTAD) which placed India as the second top destination to receive foreign investments. However, the last couple of years have witnessed a slowdown in the economic activity in India due to a combination of global and domestic factors. The global financial crisis in 2008 and the subsequent trouble in some of the European countries have impacted the foreign inflows into the country which, in turn, affected the equity, currency and exports markets. These global factors resulted in a slowdown in investment activity and exports which increased the cost of capital and declined capital expenditure. The country’s high fiscal deficit, accentuated by the governments’ profligacy, could also impact the growth in medium term. Allegations of corruption against the Government, weakening business confidence, delay in many of the reforms process and weak infrastructure have made the macroeconomic environment look gloomier. All these have resulted in Indian economy growing at much below its potential during the last couple of years.

The Taj Mahal, Agra, India

“India’s share of foreign direct investment and foreign institutional investment has been increasing consistently since the last decade.”

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During the global financial crisis, India got impacted primarily due to a decline in FII and exports but financial services (FS) sector remained insulated from any direct impact of the crisis. However, there was an indirect impact due to the economic slowdown and NPAs. Some of the foreign banks also deferred their growth plans in India due to turbulence in their home country. The equity markets witnessed a sharp decline due to a decline in foreign investment. However, the impact on the FS sector remained temporary. Though the growth rate of bank credit marginally declined from a CAGR of 22.8 percent (during 2000-01 and 2009-10) to a CAGR of 20.4 percent (during 2009-10 to 2011-12), it 23

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FDI and FII investments 45.0

41.9 37.8 34.8

(in INR billion)

35.0

34.8

30.0

31.9 25.9

22.8

25.0

16.4

15.0 5.0

9.9 4.0

6.1

2.2

1.8

5.0

6.1

4.3

10.2 9.0 9.4

6.8 1.8

0.6

-5.0

was still one of the fastest in the world. [3]Domestic demand for loans, insurance, mutual funds and other FS offerings helped the sector avert any significant downfall due to global turbulence. Besides a strong domestic demand, strong regulatory landscape and conservative approach to economic integration and financial innovation helped India avert a crisis in the sector. The Indian FS sector is a unique blend of Government and private partnership. On the one hand, the Government ownership of a significant portion of the Indian FS sector provides the sovereign guarantee and keeps people’s trust in the system. On the other hand, private sector participation and private savings, which are increasingly becoming more important, are fuelling the growth of the FS sector. Private players run some of the well-managed financial institutions and are driving innovation in the sector. As stated above though there has been a bit of overall slowdown off late due to uncertainties/ delays on the passage of crucial pending reforms bills, corruption charges against the Government, coalition politics’ compulsions, there is definitely a scope for the individual sub sectors of the financial sectors to grow eventually. The following paragraphs highlight the key aspects of each sub sector. BANKING The banking sector has registered high growth

FY12

FY11

FY10

FY08

FY07

FY06

FY05

FY04

FY03

FY02

FY01

# FDI for April 2011-February 2012; FII for April 2011-November 2011 Sources: DIPP, SEBI

FDI

FY09

-9.9

-15.0

FII

rates and has supported the growth of the Indian economy during the past two decades. Although there was a marginal decline in bank credit CAGR to 20.4 percent between 2009-10 and 2011-12, it was still one of the fastest growing across the world. The sector also faced headwinds with increased NPAs due to an economic slowdown.

and overseas markets. On the other hand, a large number of growing small and medium enterprises (SMEs) are gaining significance and contribute more than 40 percent of exports and 17 percent of GDP in 2011.[5] All this would translate into a huge opportunity for banks to increase their retail and corporate lendingbusiness.

Although faced with these short-term challenges, the sector holds huge long-term growth potential. With a population of approx. 1.2 billion, India has one of the largest and fastest growing middle class. India is also one of the youngest countries in the world with an average age of 25 years and is likely to get younger. Further, the country’s workingage population is expected to increase by 240 million over the next 20 years. All this coupled with increasing income levels and high savings rate is expected to result in a huge demand for retail banking services.

INSURANCE The insurance sector is hugely underpenetrated with a penetration of 6.72 percent during 200910 (measured as total premiums as a percent of GDP). The sector witnessed significant changes after the regulator Insurance Regulatory and Development Authority (IRDA) allowed the entry of private sector players. The sector was completely transformed and today features 48 players offering a variety of products through multiple channels. The life and general insurance sectors witnessed robust growth of 35.9% and 19.0%, respectively, in total premiums during 2001-02 and 2010-11.[6]

Besides a strong middle class, India also has a strong population of high net worth individuals (HNWIs). Its population of HNWIs registered a strong increase of 20.8 percent in 2010 and figured among the top 12 countries in the world.[4] All this is expected to result in a high demand for wealth management and portfolio management services. India also boasts of a buoyant corporate sector. On one hand, big industrial houses require huge funds to increase their operations both in domestic

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However, the growth of the sector was affected during the last 3-4 years, primarily due to some regulatory directives and guidelines including the gradual detariffication in motor insurance, capping agents’ commission, curb mis-selling and promote traditional insurance over unit linked insurance plans (ULIPs). Though these steps have affected the growth of the sector in short-term, unarguably, these are expected to become the basic groundwork on which the sector will witness a long-

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term growth. Further, some of the intrinsic factors such as under-penetration of insurance products, a young population and increasing workforce and the Government’s emphasis on micro-insurance will enable the sector to sail through.

western countries where the AUM accounts for 20 – 70 percent of GDP.[9] So though we may witness some consolidation in the near term, again no one can deny that there is significant potential for this sector to grow.

ASSET MANAGEMENT Similar to the insurance sector, the asset management sector also witnessed a robust growth during the last decade which was stifled by some high handed regulations during the last couple of years. While the sector’s total assets under management registered a robust growth at a CAGR of 23.7 percent during 2000-01 and 200910, it witnessed a growth at a CAGR of only 4.1 percent during the subsequent two years.[7] Some of the regulations such as removing the entry load, removing the exit load on investments of more than a year and capping companies’ expense ratio have proved to be detrimental to the growth of the sector.

NBFCs Efficient, competitive and deep financial markets are a pre-requisite for any economy to prosper. The Government along with the capital market regulator Securities and Exchange Board of India (SEBI) has been at the forefront of taking timely decisions to protect investors’ interests. While India has done well on equity, commodities and derivative markets, its debt markets still lack the depth and breadth. Equity markets with nearly 100 percent dematerialization and T+2 settlement system compare favourably with those of many developed countries. India was the first country to launch a demutualized stock exchange, National Stock Exchange, in 1992. Increasing foreign investments have been a testimony to the performance of equity markets. However, the debt market which is dominated by government bonds, still lack long term bonds and participation of private and retail sectors. The Government has been taking various steps to further deepen the equity markets and develop debt markets.

However, the asset management sector is quite small in India and is in nascent stage. The companies’ reach have been primarily limited to top 20 cities. With an increasing disposable income and equity investment culture, the country offers immense potential to bring in innovation (both at the product and channel level) to take mutual funds to masses in a profitable manner. With a little more policy impetus, the sector is bound to witness huge growth. The ratio of AUM to India’s GDP called as MF penetration was 11% in 2009, up from only 6% in 2005.[8] Though the AUM in India is expected to increase by 57.2% by 2014 but it remains significantly lower than

The country has a significant parabanking sector through non banking finance companies (NBFCs). These NBFCs adopt flexible business models to offer loans, distribution of insurance and mutual funds, wealth management, retail and institutional brokerage and investment banking services. These entities have been instrumental in extending the

reach of the FS sector in far flung areas and have contributed immensely in the inclusive growth agenda of the country. Overall, the global and domestic factors have impacted the growth rate of Indian economy during the last couple of years. Though there has been a delay in implementing some of the key reforms, the Government is fast progressing to implement key reforms like deregulation of diesel prices, implementation of Goods and Services Tax and Direct Tax Code. The Government constituted the 11-member Financial Sector Legislative Reforms Commission (FSLRC) in March 2011 to examine and harmonise more than 60 regulations governing the FS sector and arrive at the most appropriate means of oversight over regulators and their autonomy from the Government. The commission is expected to submit its report by March 2013. Meanwhile, we may see action on a number of key bills including the amendments to the Banking Regulations Act, amendment to the Insurance Act and a bill to empower the pension regulator in the coming days. Regulators for the FS sector continue to be supportive of the growth. Recently, the banking regulator Reserve Bank of India decreased interest rates in order to boost the economy. IRDA and SEBI are considering ways to balance the customer interest with the sector’s growth. Despite strong headwinds and global downslide of the FS sector, India’s FS sector defies the global trend and is expected to emerge stronger. i

[1] The Economic Survey 2012 [2] The Economic Survey 2012 [3] Reserve Bank of India [4] World Wealth Report 2011 [5] “Empowering SMEs for Global Competitiveness,” by SME Chamber of India [6] Insurance and Regulatory Development Authority [7] Quarterly bulletins of Association of Mutual Funds in India (AMFI) [8] KPMG Mutual Fund report, 2009 [9] AMFI, CSO and “Indian Asset Management Profitability 2011,” released by Cerulli

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Pascal Lamy, Director-General of the World Trade Organization

The Changing Nature of Global Trade A

lthough global supply chains have been with us for several decades, their increasing prominence is rapidly changing the landscape of international trade in ways which will require fresh thinking about how trade affects national economies and how this impact should be assessed. Today we trade in “tasks” and can no longer rely solely on gross trade flows as a measure of international trade. We need to think in terms of where the value is added in the production process. For example, a casual look at gross trade statistics could easily lead to the impression that an Apple iPhone imported from China is simply made in China and that all the jobs necessary to produce this good are Chinese jobs. But China 26

adds a small fraction of value to such a product — as reflected in the final price — usually at the assembly stage. China’s share is well below 10 per cent. Meanwhile, many other countries, including Japan, the United States and Korea will have added value and created jobs through design, component production, branding, marketing and a range of other services that go into the product. For a number of products where after-sales service or after-sales software products can be incorporated, the supply chain lives on after a product has been retailed. Measuring bilateral trade flows in value-added terms casts a decidedly different light on the way we consider surpluses or deficits. Seeing things this way can alter the trade policy debate. In valueCFI.co | Capital Finance International

added terms, China’s trade surplus with the United States in recent times, for example, is some 40 per cent less than the gross trade figures would have you believe. The increasingly integrated nature of production has implications for trade policy too. To properly shape trade policy one needs to have a better handle on the data. One challenge is how to disaggregate the elements of complex supply chains into the individual components, both goods and particularly services. Some services are embedded in physical components and counted as goods. Others are part of the pre- and postmanufacturing stages of production. Together they are a large part of total production costs. Understanding services inputs better not only

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makes it possible for governments to think about how producers can capture more value-added along supply chains, but also how to set the best possible policy framework for services. Another challenge concerns assessing and managing risks along supply chains. Cost minimization may entail risks that need to be addressed. A third challenge is how to encourage the participation of small and medium sized enterprises in supply chain production, bearing in mind that it is the SMEs that have proven to be among the most successful creators of jobs. We are already tackling part of these issues in the Trade Facilitation Agreement negotiations. But probably more could be done in increasing transparency, through proper data bases. Seven decades of trade-opening has significantly diminished the importance of tariffs. Today trade rules weigh heavily on the minds of exporters: Sometimes regulations, standards and administrative procedures act as trade barriers. Such rules are not necessarily designed to reduce or complicate trade. Some are just a matter of seeking out greater efficiency and improving governance. Preferential trade agreements (PTAs) have contributed significantly to increasing trading opportunities, going beyond what has been attainable in a multilateral setting. But they have also given rise to multiple, criss-crossing rules of origin that can prove a veritable barrier to trade in their own right.

â&#x20AC;&#x153;Seven decades of trade-opening has significantly diminished the importance of tariffs.â&#x20AC;? - DG Pascal Lamy

Divergent regulatory approaches within PTAs may also create confusion and higher costs for businesses that must adapt to a myriad of different regimes across such agreements. Where supply chains are concerned the impact of unnecessary obstacles to trade, especially at an early, upstream stage in the chain, will be magnified as affected components or services cross borders. Obvious questions arise from the way politics, technologies and business practices have transformed production internationally. Clearly, we need to update our approach to negotiating greater co-operation among nations. Does it make sense, for instance, to negotiate goods and service along separate tracks, under separate agreements, as we do now? We have learnt enough about how supply chains work to appreciate how intimately linked policies are in the fields of goods and services. Could we develop innovative ways of managing rules of origin, in cases where these are deemed necessary, so as to reduce or eliminate their inhibiting and costaugmenting effects on trade? Moreover, as non-tariff measures have become such a prominent part of the trade policy tool box, how should we address the necessary convergence of regulatory regimes? Harmonization? Mutual recognition? What is the proper forum to address such as convergence? Given the organic links between trade and investment, should we continue to compartmentalize these two ways of accessing markets? Does it make sense to separate trade policy and competition policy? Considering the nature of inter-dependency among countries along supply chains, should we rethink the motivation and utility of trade remedies such as antidumping or countervailing duties? The tectonic shift in trade patterns and practices confronts businesses and policymakers with a spate of new challenges. To meet these challenges means changing the way we think, the way we act and the way we govern. i

About the author: Pascal Lamy is the fifth Director-General of the WTO. His appointment took effect on 1 September 2005 for a four-year term. In April 2009 WTO members reappointed Mr Lamy for a second four-year term, starting on 1 September 2009. CFI.co | Capital Finance International

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> Pier Carlo Padoan, OECD:

A New Era for the Euro Area

he euro area is entering a new era. The importance of [approval by the German constitutional court of the European Stability Mechanism (ESM)] and the European Central Bank’s (ECB) new Outright Monetary Transactions (OMT) programme set out recently cannot be overstated. These should help create the conditions for stabilisation of the euro area crisis in the near-term. This would allow time for the imbalances of the past decade to be resolved. In the future, these instruments can be building blocks in a more stable monetary union. IMBALANCES IN THE FIRST DECADE OF THE EURO ENDED IN CRISIS The first decade of monetary union since 1999 was an era that began with great stability and strong growth in many countries, but ended in a debt crisis and severe recession. The prevailing assumption was that countries had done enough in the years running up to monetary union to live with the discipline of a single currency. In fact, fiscal discipline was patchy and poor structural policies were holding back productivity and employment growth. At the same time, EU capital markets were liberalised, creating a new dynamic in capital flows. By the start of the crisis, there had been a large build-up of excessive financial, fiscal and economic imbalances in the euro area. There were big and sustained current account deficits and surpluses. Countries such as Greece, Ireland, Portugal and Spain became heavily indebted, Growth in Germany was unbalanced between a strong export sector and feeble domestic demand.

THE EURO AREA HAS FACED A NEGATIVE SPIRAL Strong pressure from financial markets has called into question whether euro countries will have the time they need to adjust. Three powerful negative feedback loops have pulled euro area countries into a “bad equilibrium” where financial fears and weakening growth feed off each other.

“Strong pressure from financial markets has called into question whether euro countries will have the time they need to adjust.” First, fears of government default led to rising state borrowing costs. These are self-reinforcing because rising interest costs makes it harder to rebuild the public finances. At the same time, market pressure forced the pace of fiscal consolidation, increasing the downward pressures on growth. Second, rising yields reduced the value of bank’s sovereign debt holdings, adding financial stability risks. In turn, this increased fears of further government bail outs of the banking system, thereby pushing borrowing costs up further. Third, some market participants began to call into question whether countries would stay inside the euro, raising the borrowing costs that then make it more costly to stay in the monetary union. Strong policy measures by EU leaders and countries failed to restore market confidence. This

The global financial crisis in 2008 triggered the end of the good times. Banks reassessed the risks of the peripheral economies and cut back their lending. This led to banking crises and rising borrowing costs for governments. Housing bubbles burst, leaving a large overhang of debt. These economies need to shift from relying on housing and government demand to exports while domestic balance sheets are being repaired. Resolving the imbalances built up over the past decade will take time. This will be require fiscal consolidation over many years, the cleaning up of banking systems and deep reforms to make peripheral economies competitive in European and world markets.

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includes the massive fiscal consolidation efforts underway. The EU fiscal rules were strengthened through the “six pack” reforms to the Stability and Growth Pact and a new treaty, the “Fiscal Compact”, which commits countries to put strong budgetary rules into national law. Many countries are undertaking deep structural reforms to labour markets and liberalising their product markets. THE NEW ERA – MONETARY UNION WITH A BACKSTOP What was missing was a credible “backstop” for euro area governments. Bond markets, nervous about developments, could not see how governments could finance themselves during the fiscal consolidation and to support their banking systems. The architecture of the euro area did not allow for this problem – the monetary union had no accompanying fiscal union. This contrast with the United States, where the federal government transfers resources across states and provides the backstop for the banks. Furthermore, there were no “rescue mechanisms” for countries that are solvent but unable to access market funding. During recent years, the euro area has been surviving through a temporary backstop. This started with the loans provided to Greece in 2010. A new body – the European Financial Stability Fund (EFSF) – was set up and financed joint programmes with the IMF in Ireland and Portugal. At the same time, the ECB has provided large scale funding to banks through its expanded monetary operations and set up a Securities Market Programme for government debt.

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European Central Bank Headquarters.

Mr. Pier Carlo Padoan took up his functions as Deputy Secretary-General of the OECD on 1 June 2007. As of 1 December 2009 he was also appointed Chief Economist while retaining his role as Deputy Secretary-General. In addition to heading the Economics Department, Mr. Padoan is the G20 Finance Deputy for the OECD and also leads the Strategic Response, the Green Growth and Innovation initiatives of the Organisation and helps build the necessary synergies between the work of the Economics Department and that of other Directorates. Mr. Padoan is an Italian national and prior to joining the OECD was Professor of Economics at the University La Sapienza of Rome, and Director of the Fondazione Italianieuropei, a policy thinktank focusing on economic and social issues.

The problem with these temporary backstops is that they were too small and limited in scope. EFSF resources amounted to only EUR 440 billion

“This was enough to help smaller countries but would have been stretched by assistance to Spain and Italy.” (4.5% of euro area GDP), even after various safeguards in the original scheme were removed. This was enough to help smaller countries but would have been stretched by assistance to Spain and Italy. An attempt to “leverage” these funds failed and by 2012. The ECB Securities Market Programme (SMP) only reached just over EUR 200 billion and lacked a clear commitment to extensive intervention. The new framework is much stronger. The first pillar is the European Stability Mechanism (ESM) that will replace the EFSF. It has EUR 500 billion in funds with paid in capital of €80 billion. This strengthens its ability to raise funds in the markets. The second pillar is the ECB Outright Monetary Transactions (OMT) programme that will replace the SMP. Subject to conditionality being met, this makes an unlimited commitment to intervene to purchase sovereign bonds to ensure the effective functioning of monetary transmission and to dispel euro “break-up” premia.

The back stop mechanisms have not developed in isolation: they are only possible because of European commitments to undertaking necessary economic adjustment and to long-term changes to the architecture of the monetary union. The reforms of the Stability and Growth Pact and the “Fiscal Compact” reduce the risk of moral hazard that the ESM could otherwise create. Equally, direct ESM intervention in the banks in the future will be supported by the proposed “banking union” and a common supervisor. THE NEW ERA – THE EURO AREA WITH A BACKSTOP The euro area is now beginning a new era. The European Stability Mechanism and the willingness of the ECB to intervene through the OMT create a necessary backstop for euro area governments. This should allow time to resolve the imbalances and crisis coming from the imbalances that built up during the first era of the monetary union. This puts the euro area on a more stable footing. But, there is much unfinished business to resolve the short-term problems, including completing fiscal consolidation and restoring the banks to health. A major effort will be needed to create an effective “banking union”. Europe still faces huge challenges to make the structural reforms needed to create strong sustainable growth. i

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From 2001 to 2005, Mr. Padoan was the Italian Executive Director at the International Monetary Fund, with responsibility for Greece, Portugal, San Marino, Albania and Timor Leste. He served as a member of the Board and chaired a number of Board Committees. During his mandate at the IMF he was also in charge of European Co-ordination. From 1998 to 2001, Mr. Padoan served as Economic Adviser to the Italian Prime Ministers, Massimo D’Alema and Giuliano Amato, in charge of international economic policies. He was responsible for co ordinating the Italian position in the Agenda 2000 negotiations for the EU budget, Lisbon Agenda, European Council, bilateral meetings, and G8 Summits. He has been a consultant to the World Bank, European Commission, European Central Bank. Mr. Padoan has a degree in Economics from the University of Rome and has held various academic positions in Italian and foreign universities, including at the University of Rome, College of Europe (Bruges and Warsaw), Université Libre de Bruxelles, University of Urbino, Universidad de la Plata, and University of Tokyo. He has published widely in international academic journals and is the author and editor of several books.

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> Bill Gross, Managing Director, PIMCO:

Damages October 2, 2012

• • •

The U.S. has federal debt/GDP less than 100%, Aaa/AA+ credit ratings, and the benefit of being the world’s reserve currency. Studies by the CBO, IMF and BIS (when averaged) suggest that we need to cut spending or raise taxes by 11% of GDP and rather quickly over the next five to 10 years. Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow, and the dollar would inevitably decline.

THE RING OF FIRE In last month’s Investment Outlook I promised to write about damage of a financial kind – the potential debt peril – the long-term fiscal cliff that waits in the shadows of a New Normal U.S. economy which many claim is not doing that badly. After all, despite approaching the edge of 2012’s fiscal cliff with our 8% of GDP deficit, the U.S. is still considered the world’s “cleanest dirty shirt.” It has federal debt/GDP less than 100%, Aaa/AA+ credit ratings, and the benefit of being the world’s reserve currency – which means that most global financial transactions are denominated in dollars and that our interest rates are structurally lower than other Aaa countries because of it. We have world-class universities, a still relatively mobile labor force and apparently remain the beacon of technology – just witness the never-ending saga of Microsoft, Google and now Apple. Obviously there are concerns, especially during election years, but are we still not sitting in the global economy’s catbird seat? How could the U.S. still not be the first destination of global capital in search of safe (although historically low) prospective returns? Well, Armageddon is not around the corner. I don’t believe in the imminent demise of the U.S. economy and its financial markets. But I’m afraid for them. Apparently so are many others, among them the IMF (International Monetary Fund), the CBO (Congressional Budget Office) and the BIS (Bank of International Settlements). I hold on my lap as I write this September afternoon the recently published annual reports for each of these authoritative and mainly non-political organizations which describe the financial balance

sheets and prospective budgets of a plethora of developed and developing nations. The CBO of course is perhaps closest to our domestic ground in heralding the possibility of a fiscal train wreck over the next decade, but the IMF and BIS are no amateur oracles – they lend money and monitor financial transactions in the trillions. When all of them speak, we should listen and in the latest year they’re all speaking in unison. What they’re saying is that when it comes to debt and to the prospects for future debt, the U.S. is no “clean dirty shirt.” The U.S., in fact, is a serial offender, an addict whose habit extends beyond weed or cocaine and who frequently pleasures itself with budgetary crystal meth. Uncle Sam’s habit, say these respected agencies, will be a hard (and dangerous) one to break. What standards or guidelines do their reports use and how best to explain them? Well, the three of them all try to compute what is called a “fiscal gap,” a deficit that must be closed either with spending cuts, tax hikes or a combination of both which keeps a country’s debt/GDP ratio under control. The fiscal gap differs from the “deficit” in that it includes future estimated entitlements such as Social Security, Medicare and Medicaid which may not show up in current expenditures. Each of the three reports target different debt/GDP ratios over varying periods of time and each has different assumptions as to a country’s real growth rate and real interest rate in future years. A reader can get confused trying to conflate the three of them into a homogeneous “fiscal gap” number. The important thing, though, from the standpoint

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“I fell into a burning ring of fire – I went down, down, down and the flames went higher.” of assessing the fiscal “damage” and a country’s relative addiction, is to view the U.S. in comparison to other countries, to view its apparently clean dirty shirt in the absence of its reserve currency status and its current financial advantages, and to point to a more distant future 10-20 years down the road at which time its debt addiction may be life, or certainly debt, threatening. I’ve compiled all three studies into a picture chart perhaps familiar to many Investment Outlook readers. Several years ago I compared and contrasted countries from the standpoint of PIMCO’s “Ring of Fire.” It was a well-received Outlook if only because of the red flames and a reference to an old Johnny Cash song – “I fell into a burning ring of fire – I went down, down, down and the flames went higher.” Melodramatic, of course, but instructive nonetheless – perhaps prophetic. What the updated IMF, CBO and BIS “Ring” concludes is that the U.S. balance sheet, its deficit (y-axis) and its “fiscal gap” (x-axis), is in flames and that its fire department is apparently asleep at the station house. To keep our debt/GDP ratio below the metaphorical combustion point of 212 degrees Fahrenheit, these studies (when averaged) suggest that we need to cut spending or raise taxes by 11% of

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my example, it just so happens that the $60 trillion comes not in the form of promises to pay bonds or bills at maturity, but the present value of future Social Security benefits, Medicaid expenses and expected costs for Medicare. Altogether, that’s a whopping total of 500% of GDP, dear reader, and I’m not making it up. Kindly consult the IMF and the CBO for verification. Kindly wonder, as well, how we’re going to get out of this mess.

GDP and rather quickly over the next five to 10 years. An 11% “fiscal gap” in terms of today’s economy speaks to a combination of spending cuts and taxes of $1.6 trillion per year! To put that into perspective, CBO has calculated that the expiration of the Bush tax cuts and other provisions would only reduce the deficit by a little more than $200 billion. As well, the failed attempt at a budget compromise by Congress and the President – the so-called Super Committee “Grand Bargain”– was

“Bonds would be burned to a crisp...” a $4 trillion battle plan over 10 years, worth $400 billion a year. These studies, and the updated chart “Ring of Fire – Part 2!” suggests close to four times that amount in order to douse the inferno. And to draw, dear reader, what I think are critical relative comparisons, look at who’s in that ring of fire alongside the U.S. There’s Japan, Greece, the U.K., Spain and France, sort of a rogues’ gallery of debtors. Look as well at which countries have their budgets and fiscal gaps under relative control – Canada, Italy, Brazil, Mexico, China and a host

of other developing (many not shown) as opposed to developed countries. As a rule of thumb, developing countries have less debt and more underdeveloped financial systems. The U.S. and its fellow serial abusers have been inhaling debt’s methamphetamine crystals for some time now, and kicking the habit looks incredibly difficult. As one of the “Ring” leaders, America’s abusive tendencies can be described in more ways than an 11% fiscal gap and a $1.6 trillion current dollar hole which needs to be filled. It’s well publicized that the U.S. has $16 trillion of outstanding debt, but its future liabilities in terms of Social Security, Medicare, and Medicaid are less tangible and therefore more difficult to comprehend. Suppose, though, that when paying payroll or income taxes for any of the above benefits, American citizens were issued a bond that they could cash in when required to pay those future bills. The bond would be worth more than the taxes paid because the benefits are increasing faster than inflation. The fact is that those bonds today would total nearly $60 trillion, a disparity that is four times our publicized number of outstanding debt. We owe, in other words, not only $16 trillion in outstanding, Treasury bonds and bills, but $60 trillion more. In

INVESTMENT CONCLUSIONS So I posed the question earlier: How can the U.S. not be considered the first destination of global capital in search of safe (although historically low) returns? Easy answer: It will not be if we continue down the current road and don’t address our “fiscal gap.” IF we continue to close our eyes to existing 8% of GDP deficits, which when including Social Security, Medicaid and Medicare liabilities compose an average estimated 11% annual “fiscal gap,” then we will begin to resemble Greece before the turn of the next decade. Unless we begin to close this gap, then the inevitable result will be that our debt/GDP ratio will continue to rise, the Fed would print money to pay for the deficiency, inflation would follow and the dollar would inevitably decline. Bonds would be burned to a crisp and stocks would certainly be singed; only gold and real assets would thrive within the “Ring of Fire.” If that be the case, the U.S. would no longer be in the catbird’s seat of global finance and there would be damage aplenty, not just to the U.S. but to the global financial system itself, a system which for 40 years has depended on the U.S. economy as the world’s consummate consumer and the dollar as the global medium of exchange. If the fiscal gap isn’t closed even ever so gradually over the next few years, then rating services, dollar reserve holding nations and bond managers embarrassed into being reborn as vigilantes may together force a resolution that ends in tears. It would be a scenario for the storybooks, that’s for sure, but one which in this instance, investors would want to forget. The damage would likely be beyond repair. i

Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material contains the current opinions of the author but not necessarily those of PIMCO and such opinions are subject to change without notice. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein are based upon proprietary research and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Pacific Investment Management Company LLC. PIMCO and YOUR GLOBAL INVESTMENT AUTHORITY are registered and unregistered trademarks of Allianz Asset Management of America L.P. and PIMCO, respectively, in the United States and elsewhere. ©2012, PIMCO. (c) PIMCO www.pimco.com The article has been reduced. Source: www.advisorperspectives.com

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SOME THOUGHTS ON THE EUROPEAN CRISIS In Europe we have been given a sharp reminder of the need for a sustainable financial system. In this issue we bring you the thoughts of several commentators that may have solutions to the financial crisis. Stiglitz, Roubini , Delong , El-Erian and Soros are names you are familiar with and we identify their key views on the issues facing Europe and as a result the rest of the world. If you find what they have to say interesting explore their ideas further at www.project-syndicate.com.

> Joseph E. Stiglitz:

Monetary Mystification

n traditional economic models, increased liquidity results in more lending, mostly to investors and sometimes to consumers, thereby increasing demand and employment. But consider a case like Spain, where so much money has fled the banking system – and continues to flee as Europe fiddles over the implementation of a common banking system. Just adding liquidity, while continuing current austerity policies, will not reignite the Spanish economy. In Europe, monetary intervention has greater potential to help – but with a similar risk of making matters worse. To allay anxiety about government profligacy, the ECB built conditionality into its bond-purchase program. But if the conditions operate like austerity measures – imposed without significant accompanying growth measures – they will be more akin to bloodletting: the patient must risk death before receiving genuine medicine. Fear of losing economic sovereignty will make governments reluctant to ask for ECB help, and only if they ask will there be any real effect. For both Europe and America, the danger now is that politicians and markets believe that monetary policy can revive the economy. Unfortunately, its main impact at this point is to distract attention from measures that would truly stimulate growth, including an expansionary fiscal policy and financial-sector reforms that boost lending. The current downturn, already a half-decade long, will not end any time soon. That, in a nutshell, is what the Fed and the ECB are saying. The sooner our leaders acknowledge it, the better. i

ABOUT THE AUTHOR Joseph E. Stiglitz, a Nobel laureate in economics and University Professor at Columbia University, was Chairman of President Bill Clinton’s Council of Economic Advisers and served as Senior Vice President and Chief Economist of the World Bank. His most recent book is The Price of Inequality: How Today’s Divided Society Endangers our Future. Highlights from an article by project-syndicate.com

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> J. Bradford DeLong:

Stage Three for the Euro Crisis?

outhern Europe adopted an economic configuration in which its wage, price, and productivity levels made sense only so long as it spent EUR 13 for every EUR 12 that it earned, with northern Europe financing the missing euro. Northern Europe, meanwhile, adopted wage and productivity levels that made sense only as long as it spent less than one euro for every euro that it earned. Now, if, as appears to be the case, Europe does not want its south to spend more than it earns and its north to spend less, wages, prices, and productivity must shift. If we are not to look back in a generation and bemoan “lost” decades, southern European productivity levels need to rise relative to the north, and wage and price levels need to fall by roughly 30%, so that the south can pay its way with exports and northern Europe can spend its earnings on those products.

If the euro is to be preserved, and if stagnation is to be avoided, five policy measures could be attempted:

1. Northern Europe could tolerate higher inflation – an extra two percentage points for five years would take care of one-third of the total north-south adjustment; 2. Northern Europe could expand social democracy by making its welfare states more lavish; 3. Southern Europe could shrink its taxes and social services substantially; 4. Southern Europe could reconfigure its enterprises to become engines of productivity; 5. Southern Europe could enforce deflation.

But if Europe does not adopt some combination of the first three options as policy goals over the next five years, it will face a stark choice: either lost decades for southern Europe (and perhaps northern Europe as well), or continued northsouth payment imbalances that will have to be financed through fiscal transfers – that is, by taxing the north. i

ABOUT THE AUTHOR J. Bradford DeLong is Professor of Economics at the University of California at Berkeley and a research associate at the National Bureau for Economic Research. He was Deputy Assistant US Treasury Secretary during the Clinton Administration, where he was heavily involved in budget and trade negotiations. His role in designing the bailout of Mexico during the 1994 peso crisis placed him at the forefront of Latin America’s transformation into a region of open economies, and cemented his stature as a leading voice in economic-policy debates. Highlights from an article by project-syndicate.com

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> Nouriel Roubini:

Hard to be Easing

ven if the US avoids the full fiscal cliff of 4.5% of GDP that is looming at the end of the year, it is highly likely that a fiscal drag amounting to 1.5% of GDP will hit the economy in 2013. With the US economy currently growing at a 1.6% annual rate, a fiscal drag of even 1% implies near-stagnation in 2013, though a modest recovery in housing and manufacturing, together with QE3 (Third Round of Quantitative Easing), should keep US growth at about its current level in 2013. Meanwhile, the main transmission channels of monetary stimulus to the real economy – the bond, credit, currency, and stock markets – remain weak, if not broken. Indeed, the bond-market channel is unlikely to boost growth. Long-term government bond yields are already very low, and a further reduction will not significantly change private agents’ borrowing costs. The credit channel also is not working properly, as banks have hoarded most of the extra liquidity from QE, creating excess reserves rather than increasing lending. Those who can borrow have ample cash and are cautious about spending, while those who want to borrow – highly indebted households and firms (especially small and medium-size enterprises) – face a credit crunch. In short, QE3 reduces the tail risk of an outright economic contraction, but is unlikely to lead to a sustained recovery in an economy that is still enduring a painful deleveraging process. In the short run, QE3 will lead investors to take on risk, and will stimulate modest asset reflation. But the equity-price rise is likely to fizzle out over time if economic growth disappoints, as is likely, and drags down expectations about corporate revenues and profitability. i

ABOUT THE AUTHOR Nouriel Roubini, a professor at NYU’s Stern School of Business and Chairman of Roubini Global Economics, was Senior Economist for International Affairs in the White House’s Council of Economic Advisers during the Clinton Administration. He has worked for the International Monetary Fund, the US Federal Reserve, and the World Bank.

Highlights from an article by project-syndicate.com

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> George Soros:

Why Germany Should Lead or Leave urope has been in a financial crisis since 2007. When the bankruptcy of Lehman Brothers endangered the credit of financial institutions, private credit was replaced by the credit of the state, revealing an unrecognized flaw in the euro. By transferring their right to print money to the European Central Bank (ECB), member countries exposed themselves to the risk of default, like Third World countries heavily indebted in a foreign currency. Commercial banks loaded with weaker countriesâ&#x20AC;&#x2122; government bonds became potentially insolvent.

The euro crisis is a complex mixture of banking and sovereign-debt problems, as well as divergences in economic performance that have given rise to balanceof-payments imbalances within the eurozone. The authorities did not understand the complexity of the crisis, let alone see a solution. So they tried to buy time. As the strongest creditor country, Germany has emerged as the hegemon. Debtor countries pay substantial risk premiums for financing their government debt. This is reflected in their cost of financing in general. To make matters worse, the Bundesbank remains committed to an outmoded monetary doctrine rooted in Germanyâ&#x20AC;&#x2122;s traumatic experience with inflation. As a result, it recognizes only inflation as a threat to stability, and ignores deflation, which is the real threat today. Moreover, Germanyâ&#x20AC;&#x2122;s insistence on austerity for debtor countries can easily become counterproductive by increasing the debt ratio as GDP falls. Since all of the accumulated debt is denominated in euros, it makes all the difference who remains in charge of the monetary union. If Germany left, the euro would depreciate. Debtor countries would regain their competitiveness; their debt would diminish in real terms; and, with the ECB under their control, the threat of default would disappear and their borrowing costs would fall to levels comparable to that in the United Kingdom. The same result could be achieved, with less cost to Germany, if Germany chose to behave as a benevolent hegemon. That would mean implementing the proposed European banking union; establishing a more or less level playing field between debtor and creditor countries by establishing a Debt Reduction Fund, and eventually converting all debt into Eurobonds; and aiming at nominal GDP growth of up to 5%, so that Europe could grow its way out of excessive indebtedness. i

ABOUT THE AUTHOR George Soros is Chairman of Soros Fund Management and Chairman of the Open Society Institute. A pioneer of the hedge-fund industry, he is the author of many books, including The Alchemy of Finance and The New Paradigm for Financial Markets: The Credit Crisis of 2008 and What it Means. George Soros is the founder of the Institute for New Economic Thinking www.ineteconomics.org Highlights from an article by project-syndicate.com

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> Mohamed El-Erian, PIMCO:

Europe: Heading Towards Deadly Waterfall

n his article, “Will Europe Be Willing but Disabled?”, the award winning (and $1.4 trillion fund manager) Mohamed El-Erian, nails the difficulty of putting Europe back on the path of economic growth, job creation, and financial stability as long as she remains a collective of nation-states with notable divergences in economic, financial, and social conditions; cultural differences; with political cycles far from synchronized; and with too many regional governance mechanisms. He asks: by the time Europe is ready and willing to accept the tough decisions, will it be too late? “Private-sector activity is slowing, and it is nearing a standstill in the eurozone’s most vulnerable economy (Greece), where a bank run is in full swing. Elsewhere, too, depositors are beginning to transfer their savings to the strongest economy (Germany) and to safe havens beyond (Switzerland and the United States). Weaker companies are shedding labor, while stronger firms are delaying investments in plant and equipment. And global investors continue to exit the eurozone in droves, shifting countries’ liabilities to taxpayers and the ECB’s balance sheet.” The PIMCO CEO goes on to use a metaphor: “The eurozone’s leaders are on a raft heading towards a life-threatening waterfall. The longer they wait, the more the raft gains speed. So the outcome no longer depends only on their willingness to cooperate in order to navigate the raft to safety. It also hinges on their ability to do so in the midst of natural forces that are increasingly difficult to control and overcome. The message is clear. The current crisis might indeed eventually break eurozone leaders’ inherent resistance to compromise, collaboration, and common action. But the longer they bicker and dither, the greater the risk that what they gain in willingness will be lost to incapacity.” i

ABOUT THE AUTHOR Mohamed A. El-Erian is CEO and co-Chief Investment Officer of the global investment compamy PIMCO, with approximately $1.4 trillion in assets under management. He previously worked at the International Monetary Fund and the Harvard Management Company, the entity that manages Harvard University’s endowment. He was named one of Foreign Policy’s Top 100 Global Thinkers in 2009, 2010, and 2011. His book When Markets Collide was the Financial Times/Goldman Sachs Book of the Year and was named a best book of 2008 by the Economist.

Highlights from an article by project-syndicate.com

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> European Policy Centre:

Good Governance & Economic Development By Hans Martens

ry to make a correlation between two well-known indexes, namely the World Economic Forum’s Competitiveness Index and Transparency International’s Corruption Perception index, and a positive correlation is clearly demonstrated. But is there any causality behind the correlation, and does that mean that fighting corruption is a solid prescription for increasing productive investments? Firstly it should be noted that the corruption index is about perceived corruption in the public sector, but it anyway gives a good general idea about the effectiveness and level of transparency in the societies in question. The answer to the causality question is most probably that it is not high competitiveness that gives a corruption free society, and neither that low corruption in itself enables a high level of competitiveness, but rather that the factors behind a status of low corruption are the ones that increase competitiveness and thus make a country more likely to receive inward investment and enjoy good business development. Perhaps corruption levels can be seen as a proxy for other things that promote economic development, such as a fair and efficient legal system, a public sector that functions efficiently and fair, and a general tendency towards openness and transparency in societies. All of these factors are contributing to economic development, but can you also have good

economic development if these factors are not present in societies? Paolo Mauro from the IMF stated in a study from the IMF (Why Worry About Corruption?, International Monetary Fund, February 1997) that “Regression analysis indicates that the amount of corruption is negatively linked to the level of investment and economic growth, that is to say, the more corruption, the less investment and the less economic growth.“ This supports the general thesis on the negative effects of corruption on economic development, and it is based on several hypotheses. An overall consideration behind this is that public spending does affect the investment climate, and this has become even truer since Mauro’s article was written as a consequence of the general pattern of growth in the role of public

The working of customs administrations has become a major obstacle for running business in areas where corruption is widespread. Hans Martens

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budgets. Policies on infrastructure, on education, on research, etc., are directly influencing the investment climate, and if carrying out the contractual work for governments is based on who bribes best and most rather than on a fair competition, there is obviously a big risk that government does not get the advantages that are connected with proper procurement procedures. Certainly government policies that are not directly linked with spending also affect the business climate and thus investments. First and foremost there is the issue of the overall political stability. A stable political system does not mean that there is no change in the political systems – that follows the working of democracies – but rather if the political system in itself is stable so that changes that occur after elections are not revolutionary but rather means a change in tone rather than in the political system itself. Another, and related, issue is the stability and workings of the legal system. A stable legal system with long established procedures, which has been modernized to cope effectively with changes in society, meaning being able to cope fairly and effectively with an increased use of the legal system, is clearly preferable to most business investors, who then can expect acknowledgement of their property rights, be is to land, to buildings, and to the protection of intellectual property rights. The workings of customs administrations have become a major obstacle for running business in areas where corruption is widespread. Holding back deliveries, constant change in the rules for treatment in customs services, and the outright expectation of receiving bribes before consignments are released are amongst the practices that hamper the business climate. Also other forms of public regulation can have strong effects on the way business is run. Social and labor market environmental legislation, education policies, research policies, etc. all have a strong impact on the business and investment climate. The effect is not always as straightforward as it could look. In Europe the Nordic countries, for example, have proven to enjoy a high level of competitiveness despite large public sectors and subsequent high levels of taxation. So the point is not the size of the public sector, but whether it is efficient, and whether it works for or against business

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and investments. Social expenditures in the Nordic countries, for example, are quite high, but they don’t directly put a strong burden on businesses, firstly because the business taxation rate is generally low and secondly because social systems are helping to ensure flexible labor markets without direct burden on companies – a part of the flexicurity system. In the same way most empirical evidence suggests that there is a positive correlation between investments in efficient education and research systems and wealth creation. Furthermore, as Mauro concludes: “Statistical analysis of the data sources identified in this paper in fact shows that government spending on education as a ratio to GDP is negatively and significantly correlated with corruption (the more corruption, the less spent on education). Analysis also shows that if a country moves up the corruption index from, say, 6 to 8 (it improves its respectability by one standard deviation), government spending on education increases by around a half a percent of GDP.” There are several examples of how stable democracies and better organized public governance increases economic growth and wealth creation.

One striking example is the comparison between North and South Korea. The two parts of Korea started off in a very similar situation after the Korean War, and actually North Korea was in a period overtaking South Korea in GDP per capita. Hans Martens

Hans Martens has been Chief Executive of the European Policy Centre since 2002. Born in Denmark, Hans studied Political Science at Aarhus University and went on to become Associate Professor in international political and economic relations. In 1979, he joined the Danish Savings Bank Association as Editorin-Chief and Head of Information. From 1982 to 1985, he was Head of the International Department of the Salaried Employees Federation, a Danish trade union, where he took charge of the organisation’s international relations, including with the OECD and the ILO. In 1985, he joined the Copenhagen Handelsbank, initially in charge of the Economic Department and later as Head of the International Private Banking Department. There, he was responsible for economic analysis and forecasting, and for developing the bank’s investment and capital market products. In 1989 he set up Martens International Consulting. Hans is a regular lecturer at Universities and Business Schools in Europe and in the US. He is an expert on European competitiveness issues, monetary and macroeconomic issues, demographics and the Digital Economy, including eGovernment.

Today the GDP per capita is 20 times higher in the south that in north, and while North Korea remains a very isolated and nontransparent part of the world run by the prop type of a dictatorship, South Korea is a main global competitor, not only in traditional industries but at the cutting edge of new technologies. The gradual transition of Turkey in the direction of a fully-fledged open democracy has also boosted the country’s’ competitiveness and economic growth, and there is still a great potential to exploit, which government policies seems to be directed at. But there are also examples of thriving economies that have not embarked on the road to openness in political systems, and the most noticeable one is China, where economic openness and a market based system has not been accompanied by a similar development in the political and administrative world. This shows that there is no direct and exclusive proof of the hypothesis that openness, democracy and absence of corruption leads to economic growth. Other factors play a role, and in the case of China obviously the scale of the market in the world’s most populous country plays a role in itself, but while businesses are often praising the market opportunities, they complain equally frequently about corruption, about the workings of the legal system, and of an unpredictable regulatory system, which could indicate that even the impressive economic growth rates of China over the last many years are not an expression of a full exploitation of the economic potential, that reforms could actually boost the economy further, and that this could indeed be a way forward for compensation of lack of competitiveness that may occur with the system as it present itself today. The conventional thinking that this will come by itself, so that when the economy starts to pick CFI.co | Capital Finance International

up, a broad middle class develops and begins to demand political influence, is not guaranteed and is in fact contested by many. But even if that may be true, the positive correlation between absence of public sector corruption and competitiveness stands as an empirical fact, and a common sense consideration works in the same direction. Obviously if a company just moves into a market for a quick and perhaps risky business to get a quick profit, the same considerations need not apply, but for the normal business that either wants to make major investments in assets (for the long haul) or invests in human assets (well educated people) a stable environment with a stable and fair legal system, with an efficient and uncorrupt public sector that rests its decisions on a rules based system, must be preferable for making investments – all other things being equal – and thus is a good prescription where there are problems in these areas. i

The European Policy Centre (EPC) is an independent, not-forprofit think tank, committed to making European integration work. The EPC works at the “cutting edge” of European and global policy-making providing its members and the wider public with rapid, high-quality information and analysis on the EU and global policy agenda. It aims to promote a balanced dialogue between the different constituencies of its membership, spanning all aspects of economic and social life. In line with its multi-constituency approach, members of the EPC comprise companies, professional and business federations, trade unions, diplomatic missions, regional and local bodies, as well as NGOs representing a broad range of civil society interests, foundations, international and religious organisations.

> A Special Report:

Banco do Brasil HISTORY OF THE INSTITUTION Founded on October 12th, 1808, Banco do Brasil S.A. was the first banking institution to operate in the country, and in more than 200 years of existence it has accumulated many experiences and produced many innovations, participating in a lively manner in national history and culture. The brand-name “Banco do Brasil” is one of the most recognised and valued by Brazilians, who recognise in the institution such attributes as solidity, reliability, credibility, security and modernity. Due to its very competitive activities in the markets in which it operates, Banco do Brasil is a profitable company, aligned with social values. BB’s vocation as an instrument of public policies has a focus on the sustainable development of the country and community interests, this being an important differential of the Bank. A differential which can be summarized as Sustainable Regional Development. Through the adoption

of economically viable, environmentally correct and socially just practices, the business strategy of Sustainable Regional Development seeks to perfect local economies, generating jobs and guaranteeing incomes in a sustainable, inclusive and participative manner. In 2010, the year in which the Bank commemorated 202 years of existence, Banco do Brasil remained as the largest financial institution in Latin America, with R$811.2 billion in assets. In addition to this, it has maintained its leadership in various segments of the market, and strengthened its support in the development of the country, as well as consolidating its high standards of Corporate Governance. In order to ensure its leadership position in a country of continental proportions, Banco do Brasil operates in all the sectors of the financial market – from banking, cards, asset management, to insurance, pensions and saving bonds, as well

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as an extensive portfolio of products and services, seeking to align these increasingly with the precepts of socio-environmental responsibility. With a nationwide coverage and a presence in 3,550 Brazilian municipalities through its service network, BB has the largest branch network in Brazil, and intends to set up a branch in every town in Brazil by 2015. In addition to this, once again BB ended the year with the largest park of automated cash machines in Latin America, with 45,000 terminals of its own. Based in Brasília (DF), Banco do Brasil has a physical presence in 23 countries, and through a network of 1,039 representative banks, it covers 140 countries in all, being the Brazilian bank with the largest service network of its own outside Brazil. The activities of the Bank in other countries are supported by three key factors: (i) the existence of Brazilian communities in other countries; (ii) the internationalization of national companies, and (iii)

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the expansion of Brazil’s commercial relationships with the rest of the world. BB adopts technologies and processes which keep it at the forefront of the financial market. To this end it invests continuously in the training of its 109,000 employees, helping them to develop a professional career based on satisfaction and growth, preparing them to provide a flexible and quality service to BB’s customers, who number more than 54.4 million. As a conglomerate, Banco do Brasil has 19 subsidiaries, 6 sponsored entities, as well as a stake in 10 companies in strategic businesses for the Company. BB also has stakes in 10 affiliated companies through its investment bank, BB-BI. BANCO DO BRASIL OVERSEAS In the last few years, Brazilian companies have intensified the drive to internationalize their activities, building companies and forming partnerships in other countries and regions. This move has been requiring similar behaviour from the financial industry. The model focused on financing and the stimulation of foreign trade is tending to evolve into a more far reaching and complementary phase, which requires national banks to internationalise in order to meet the specific need for banking services in the region where the companies are located.

The brand name “Banco do Brasil” is one of the most recognised and valued by Brazilians, who recognise in the institution such attributes as solidity, reliability, credibility, security and modernity.

By the same token, services for individuals, increasingly present in other countries, whether through tourism travel for work, require global financial institutions. This new reality of the market has led Banco do Brasil to initiate a number of actions and projects with the objective of taking advantage of the opportunities identified and maintaining its role as the largest protagonist of international business, among Brazil’s financial institutions. In this way, Banco do Brasil’s international strategy is focused on increasing the reach of its network abroad, to cater to the wave of internationalization by Brazilian companies, private individuals and the increase in import and export flows. With a focus on these trends, and supported by analysis of opportunities carried out by specialist consultancy companies, the development of Banco do Brasil’s internationalization strategy in 2010 adopted the following regional policies: United States Based on studies drawn up by a specialist consultancy, Banco do Brasil revised its operational strategy in the United States, based on prioritising inorganic growth (acquisition of local banks), with the possibility of organic expansion (establishment

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of branches) in areas with a concentration of target audience over the medium and long-term. For this reason, Banco do Brasil continues to be interested in the acquisition of financial institutions in the market, with a focus on small-sized banks established in regions with a high concentration of Brazilian residents. BB’s strategy for the North American market proposes to cater to all the needs, through its products and financial services, of the more than 1.5 million Brazilians resident in that country . Based on this strategy, the Bank has redesigned its operational model, seeking to concentrate its activities in specific branches to improve productivity and reduce costs. Under the new model, BB’s service in the US is organised as follows: • BB Miami began to serve the banking and retail segment; • BB New York started to concentrate on the wholesale segment, with the branch being restructured to better serve this type of client; and • BB USA Servicing Center, in Orlando, will concentrate its activities on the back-office operations of the branches in the United States, including the wholly-owned subsidiaries of Banco do Brasil Securities LLC and BB Money Transfers. This new model was possible, based on decisions by the North American government during the year: • In April 2010 Banco do Brasil received authorization from the US Federal Reserve to acquire financial institutions in the US, and expand its operations in the local capital markets. As a Financial Holding Company (FHC) Banco do Brasil is authorised to open or relocate branches, operate with residents in the United States, acquire banking institutions and request authorization to expand its scope of operation in the United States; • In July 2010 Banco do Brasil in Miami received authorization to transform its branch licence, which was only authorised to operate with nonresidents, into a full branch, which also authorises transactions with US residents. In addition to this, seeking to implement specialization in its units, as a way of optimising its service, BB Miami absorbed the retail client base from BB New York, which is now dedicated to clients in the corporate segment; and • In October 26, 2010, Banco do Brasil Securities, LLC received authorization to open a branch in Miami. ▪ In December 16, 2011 , Federal Reserve Board

Banking & Finance

(FED) approved Banco do Brasil to acquire the entire share capital and voting of Eurobank, North American financial institution. Europe Banco do Brasil is continuing with its organizational restructuring in Europe, with the aim of improving its operational, administrative and financial efficiency. With this remodelling of BB’s operations in the old continent, and the redistribution and centralisation of its activities, the Bank intends to generate new business. BB Europa Servicing Center, the second international unit for administrative services, entered into service in July 2010, in Lisbon Portugal, with the objective of centralising and rationalising the back-office services for the units located in Europe. South America In April 2010 BB acquired shareholder control of Banco Patagonia in Argentina, which constitutes a milestone in our internationalization process. This was the first step taken in a new model of operating in markets with potential. The operation has the objective of expanding partnerships with Brazilian and Argentinian companies, and achieve the diversification of products and services, seeking to build on the potential of providing services to clients, the expansion of its loan portfolio, to operate along the value chain in the corporate segment, established in Argentina. Banco Patagonia has 732,000 clients, of which 12,000 are corporate, with 154 branches located principally in the provinces of Buenos Aires and Rio Negro. Banco Patagonia is a solid institution, having a strong relationship with local companies,

particularly in the management of company payrolls, as well as operating in the retail banking segment. BB contributes its experience in serving major Brazilian corporate groups. This acquisition allows the expertise of each institution to be brought together, with an initial focus on Brazilian corporate groups that have activities on Argentinean soil and the potential to cover their entire value chain, including suppliers, clients and local employees. In South America, other priority markets in the process of international expansion are: Chile, Peru, Colombia, Uruguay and Paraguay.

RESTRUCTURING OF THE INSURANCE SEGMENT The Brazilian market for insurance, supplementary pensions and saving bonds has been growing at a fast rate, and the forecast for the future is that this expansion will continue. The ratio between annual insurance premiums collected and GDP in developed countries is around 10% , while this ratio in Brazil, with an insurance premium volume of R$122.4 billion collected, is a new 3.4% of GDP, revealing the significant potential for growth in this sector. According to forecasts by CNSeg (National Insurance Confederation), the Brazilian insurance markets should grow by 12% in 2011, rising to R$137.4 billion in premium revenue, this expansion being based on the expectation of access to the insurance sector by socio-economic classes C and D – segments in which Banco do Brasil is well-positioned – as well as expansion in the area of popular insurance, including micro-insurance. Also part of the growth projects is the formation of a technical chamber for the production chain in the supplementary health segment, which

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will analyse the sustainability of the sector and the use of retirement plans for the payment of health expenses. Other points worthy of note, that for CNSeg are essential for the strengthening of the sector in 2011, are: • Regulation of the shielding of pension plans, and the creation of new Sustainability Platform products; • Economic viability for the providing of insurance for old cars and permission for the use of used parts in the event of accidents; • Expansion of guarantee insurance and reinsurance, especially for the carrying out of works under the PAC (accelerated growth program), the 2014 World Cup and the 2016 Olympic Games; and • The creation of a Regulatory Insurance Agency, which would encompass the three bodies which currently govern the insurance and pension sector in the Country (Susep, ANS and Previc) and also integrate the scenario for 2011. As a result of this situation, Banco do Brasil has continued with the process of restructuring its insurance division, based on the following premises: (i) Companies in the insurance area will be under private-sector control, with BB Seguros holding the largest possible equity stake in these companies; (ii) Partners of BB Seguros cannot be competitors; and (iii) Insurance products will be exclusive to BB’s distribution network.

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Another premise in the restructuring of the insurance area is the drive for operational efficiency, so as to provide better results for the companies in this segment, and as a consequence for BB. The evolution in this process will provide the Bank with a better dynamic in the way that it operates, in addition to maximising the generation of earnings in the businesses of the Insurance Conglomerate and obtaining better synergy gains in operations with its partners. ALTERATIONS IN THE SHAREHOLDER COMPOSITION OF THE INSURANCE COMPANIES Mapfre partnership Considering the directives presented, BB, through its wholly-owned subsidiary BB Seguros, announced in May 2010 a partnership with Grupo Mapfre for the formation of a strategic alliance in the segments of individuals, P&C and auto insurance, for a period of 20 years. The Mapfre Group is the largest insurance group in Spain, and has a presence in 43 countries, particularly Latin America, where it occupies first position in property insurance. It has of its own branches, more than 10,000 active brokers, 18 territorial departments and 15 million clients throughout the world. So as to equalise the intended shareholders partnership in the two holding companies which will be set up, BB Seguros plans to pay out an amount equivalent to R$295 million. Shareholding participation in IRB-Brasil Re Banco do Brasil has made a proposal to the Federal Union, through the Finance Ministry, to begin non-binding discussions for the acquisition of a shareholding stake in IRB-Brasil, duly observing the regulations and norms covering

such an operation. IRB-Brasil is the largest reinsurance group in Latin America, with assets of R$10.4 billion and premiums of R$2.9 billion. The Federal Union holds 100% of the ordinary shares, and 50% of the total capital of the company. This operation aims to complement the activities of BB, because reinsurance is a way of passing on the insurance risk from an insurance company that has a contract higher than its financial capacity. It is a common practice for the mitigation of risk and preservation of the stability of insurance companies. Strategic Alliance with Grupo Icatu In January 2010 a non-binding Memorandum of Understanding was signed between BB and Grupo Icatu, with the objective of creating a strategic alliance for the development and sale of capitalization products in the Brazilian market, which proposes to integrate the businesses of these institutions, in such a way that there is no competition between the partners. In addition to this, it is envisaged that there will be a distribution channel of Banco do Brasil which will sell these capitalization products on an exclusive basis for a 20 years period.

Renewal of Partnership with the Principal Financial Group In April BB Seguros and Principal Financial Group renewed their strategic partnership, to work on the development and sale of private pension products in Brazil. As a result of this agreement, Principal acquired an equity stake of 4% in the total paidup capital of Brasilprev, held by Sebrae (Serviço Brasileiro de Apoio a Micro e Pequenas Empresas). In addition to this, the exclusivity of Brasilprev was maintained for the sale of private pension plans

through BB’s existing distribution channels up to October 2032. The counterparty to this is that BB Seguros increased its stake from 50% to 74.995% in the total paid-up capital of Brasilprev. With this partnership BB hopes to solidify an association between BB Seguros, a wholly-owned subsidiary of Banco do Brasil, which has the largest number of service outlets in the Country and Principal, which has vast experience in international market, serving 18.9 million clients through offices in Asia, Australia, Europe, Latin America as well as the United States. Odontoprev The strategy of forming alliances with other institutions has enabled Banco do Brasil to fulfill a long-standing demand of its employees. Announced in August 2010, the partnership between BB and OdontoPrev, the operator of dental care plans associated with Bradesco, will permit the sale of plans through the branches of Banco do Brasil. In addition to this, dental plans had been made available to approximately 260,000 beneficiaries, among BB’s employees and their dependents since November 2010. OdontoPrev is the leader among companies in the dental care segment, having been in existence for 23 years, covering more than 4.4 million people through the various business lines in which it operates, with a vast network of approximately 25,000 authorised agents throughout Brazil. Sale of Brasilsaúde In July 2010 BB Seguros formalised the sale of all its shares held by BB Seguros (49.92% of the total capital) in Brasilsaúde to Sulamérica Seguro Saúde, for a total value of R$29.2 million. STRATEGIC ACQUISITIONS AND PARTNERSHIPS In 2010 Banco do Brasil finalised the integration process with Banco Nossa Caixa which resulted

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in some positive advances in BB’s businesses, particularly in São Paulo. Also, in this year, the strategic partnership was consolidated with Banco Votorantim. Below we show the main results of these two processes. Strategic partnership: Banco Votorantim The acquisition of a 50% stake in Banco Votorantim (BV), consolidated in 2010, a strategic step forward for Banco do Brasil the credit market, with emphasis on the vehicle financing segment, which is passing through a period of accelerating growth in Brazil. The partnership resulted in a growth in the volume of personal loans last year of 23.2%, with particularly strong growth in the vehicle financing segment, which saw an increase of 32.1% compared to 2009. In addition to this, this partnership allowed Banco do Brasil, among other aspects and synergies: • To access alternative distribution channels, such as concessionaires partners and stores of BV Financeira; • To use the successful model in the promotion of sales on a nationwide basis in the vehicle financing market; • To deal with the payroll of approximately 7,000 employees, among who included around 5,000 employees of BV Financeira; and • To acquire payroll loan and vehicle financing portfolios as a consequence of the operational agreement. The transaction resulted in Banco do Brasil ending up with 50% of the total capital, and approximately 50% of the voting capital of Banco Votorantim and required an improvement in the policies and norms of BV, as well as its risk management. The new Corporate Governance structure of BV, as set out in the terms of the Shareholders Agreement at the beginning of the partnership in September 44

2009, was completely implemented in 2010 and has a regulatory function, with equal status of the governing bodies among the partners, such as the Board of Directors, Board of Auditors, Audit Committee and Advisory Committees of the Board of Directors. Every year the President and Vice-President of the Board of Directors and the Board of Auditors of the company are rotated between members nominated by BB and members nominated by Votorantim Finanças, no casting vote being attributed to any member of the Board of Directors. The strategies of the institutions are independent, acting in complementary fashion in particular segments, although risks and results are shared by the conglomerate’s shareholders. Banco Nossa Caixa The incorporation of Banco Nossa Caixa produced some important results for the businesses of Banco do Brasil, expanding its share of the country’s most important market. The acquisition intensified the relationship with the government of São Paulo and the Judicial Power in that state. As part of this acquisition was the purchase of the payroll of civil servants of the municipal authority in the state capital, BB assumed a leadership position in business with the public sector in the state of São Paulo, adding a base of 12 million clients. Among the business and synergies resulting from this incorporation move, of particular note were the following: • The contracting of loans to private individuals from branches of the BNC already represented 56.2% of the volumes paid out in the state during the second half of 2010; • 50% of the consortium quotas sold in São Paulo was carried out through the branches of BNC; • The total contribution margin of individual clients increased by 208%, between the months of March CFI.co | Capital Finance International

and August 2010 while the contribution margin per individual client was up 92% over the same period; • Reduction of 20% in total expenses in 2010, compared to 2009; • Reduction of 98% in the amount spent on electronic fraud in 2010 through the network of BNC, compared to 2009. This gain was achieved principally by the introduction of a chip in the bank’s credit cards; • of 127.9% in company credit limits and 9.1% in limits for individuals. The negotiations for the acquisition of this São Paulo bank began in 2008. In March 2009 the transaction was approved by Central Bank and consolidated in the first half of 2010, ending with the total integration of the branch network in June. The operation included changes to the business environment of the branches, the replacement of ATM channels and the unification of systems, products and services. 952 premises, of which 566 were branches, were switched over to the BB brand, with the result that the Bank also assumed the leadership position in terms of number of service outlets in the state. Considering the information technology standpoint – which is always one of the most critical aspects in a process such as this – the implementation of the project by the Bank was a benchmark case in the market, demonstrating notable capacity both from a technical perspective as well as the managing of an extremely complex project. The period for incorporation period (approximately 9 months) surprised observers, as did the quality of the process, which had a minimal impact for clients. Another critical aspect present in similar operations is the integration of the employees from the company absorbed. In this case, 14,000 people were integrated into BB, coming from another corporate culture, representing a major challenge to be overcome in record time, ensuring an

Autumn 2012 Issue

Banking & Finance

Buenos Aires appropriate balance and respect for the difference in cultures. PARTNERSHIPS IN PAYMENT MEANS SEGMENT Partnership of BB, Bradesco and CEF – ELO Cards In 2010 Banco do Brasil formalized a strategic partnership with Banco Bradesco and Caixa Econômica Federal in the card segment for the creation of a payment means chain, which comprise the issue of credit, debit, prepaid and private label cards, the payment collection network and a brand name, all referred to as Project Elo. The project involved the creation of the Elo Group, to consist of a financial institution, which would be the promoter of sales, processor and administrator of the Elo brand, a payment collection company (Cielo), CBSS and manager of the self-service terminals, with the aim of: (a) Creating a company of shareholdings (Elo Participações), in which would be consolidated the combined businesses related to electronic means; (b) The launching of a Brazilian brand for credit, debit and prepaid cards, to be called Elo, which would be managed by a specific company (Elo Serviços), controlled by Elo Participações; and (c) Integration of Companhia Brasileira de Soluções e Serviços – CBSS, directly or indirectly, into Elo Participações. Project Elo, implemented in the first few months of 2011, should bring benefits which include: (a) Gains in market share in the national card market, with the expectation of reaching 15% of sales within five years; (b) An increase in customer base size, with the prospecting of new consumers; (c) Improvement in competitiveness with the entry of a new brand name into the national card market, providing gains in synergy and economy of

scale for Banco do Brasil. Being completely Brazilian, the ELO card, in contrast to other card brands, will not require the payment of royalties for the use of international brand names. With the launch of this brand name, BB expects to capture 15% of the card market within five years. With this, the Bank’s operation in this sector will be consolidated, already having a leadership position in the payment collection market through Cielo, in a partnership signed with Bradesco 14 years ago (under the name Visanet) which today has 49% of the national card market. Currently, company clients of BB affiliated to Cielo can receive sales from credit and debit cards of the following brand names: Visa, Mastercard, Amex, Diners, Visa Vale and Aura – the Elo will complement this range. In addition to this the receivables from the sales can be collected ahead of time through Advanced Credit to Storeholders (ACL) and Card Receivables to be Realised (RCR) or they can be used as a guarantee for loan operations.

SHARING OF TERMINALS BETWEEN BB, BRADESCO AND SANTANDER Banco do Brasil, Bradesco and Santander on February 11th, signed a memorandum of understanding for the consolidation of their respective external ATM machine terminals (ATM machines installed outside the branches), such as those located at airports, fuel service stations, supermarkets, shopping centers, pharmacies and bus terminals. With this, the banks intend to provide greater convenience and comfort for their clients and increase operational efficiency with a reduction in expenses. The first phase of this project, with the application of a pilot plan, was authorised by the Brazilian anti-trust authority, Cade, in March 2011. If this sharing arrangement comes to fruition, the clients of these three banks will be able to access around 11,000 ATM terminals spread across the country. i

PARTNERSHIP WITH CIELO AND OI Cielo Banco do Brasil through its subsidiary, BB Banco de Investimentos S.A. (BB-BI), acquired shares held by Santander Espanha in Cielo S.A. (5.11% of the paid-up capital) and Companhia Brasileira de Soluções e Serviços – CBSS (4.65% of the paid-up capital). As a result of these transactions, BB has strengthened its participation in the capital of the companies which operate in the sector. Oi In 2010 Banco do Brasil signed a partnership agreement with the telephone operating company Oi for the expansion of a solution known as Oi Paggo. This involves two services: mobile payment for Ourocard clients and the sale of a co-branded credit card to Oi’s client base.

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Banking & Finance

> Flavio Peppe, Ernst & Young

Fruitful Relationships: Clearing and Settlement in Brazil

By Flavio Peppe

As Brazil’s economy has grown, so have its financial markets. The volume of equities traded on the main market, BM&F BOVESPA, has increased fivefold over the past five years, and the Exchange’s derivatives platform was the world’s sixth-largest in terms of contracts traded in 2010. In these circumstances, it is no surprise that traditional and alternative investment managers based in the US, Europe and Asia are joining the tide of banks, trading firms and infrastructure providers flocking to the Brazilian markets. Nonetheless, potential new entrants to the Brazilian financial markets should be aware that some of its unique features. The country is renowned for its range of regulatory and legal requirements, although some of these protectionist features have helped to insulate Brazil from the worst effects of the global financial crisis. As a result, foreign firms often choose to form partner ships with established local players as the best way to achieve compliance and have a presence in this emerging market. This is the second paper in our series to focus on the particular opportunities and challenges that face global asset managers entering the Brazilian market. Where the first paper examined the overall investment climate, this paper sets out the key features and structures of Brazil’s unique clearing and settlement framework. It also identifies some other key considerations that foreign investors need to be aware of before investing or setting up operations in the world’s seventh-largest economy. THE RAPID GROWTH OF BRAZIL’S ECONOMY AND FINANCIAL MARKETS ARE ATTRACTING A WAVE OF FOREIGN ENTRANTS Foreigners visiting Brazil sometimes acquire a taste for soft drinks made from guarana beans, a natural stimulant, which are hugely popular. In the same way, international investors looking to spice up their returns are developing an increasing appetite for exposure to Brazil’s rapidly growing economy. National output expanded by 6.9% in 2010, and the Brazilian Government predicts annual growth to continue at an average rate of 4.9% between 2011 and 2015. Brazil has an expanding middle class, growing

consumer demand, booming commodity exports and a vast program of public and private sector investment. As Brazil’s economy has grown so has its financial markets. The volume of equities traded on the main market, BM&F BOVESPA, has increased five-fold over the past five years, and the exchange’s derivatives platform was the world’s sixth-largest in terms of contracts traded in 2010. In these circumstances, it is no surprise that traditional and alternative investment managers based in the US, Europe and Asia are joining the tide of banks, trading firms and infrastructure providers flocking to the Brazilian markets.

“The volume of equities traded on the main market [...] has increased five-fold over the past five years…” Nonetheless, potential new entrants to the Brazilian financial markets should be aware that some of its features are as unique as those of the famous guarana bean. The country is renowned for its range of regulatory and legal requirements, although some of these protectionist features have helped to insulate Brazil from the worst effects of the global financial crisis. As a result, foreign firms often choose to form partnerships with established local players as the best way to achieve compliance and have a presence in this emerging market. FOREIGN INVESTORS SHOULD BE AWARE OF BRAZIL’S UNIQUE NATIONAL PAYMENTS STRUCTURE, DEVELOPED IN RESPONSE TO SPECIFIC HISTORICAL FACTORS In this paper we place particular emphasis on an area that foreign entrants to Brazil’s financial markets are unlikely to be familiar with

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– the country’s unique clearing and settlement arrangements. Fund transfers, payment mechanisms and post-trade clearing and settlement are not typically a primary consideration when entering a new market. They are often described as “financial plumbing,” but in the words of one former US banking regulator, “they are more like the central nervous system.” The global financial volatility of recent years has only increased awareness of how essential it is for different elements of the financial system to work together; this is an area that firms looking to operate in Brazil cannot afford to ignore. Many of the unique features of Brazil’s current financial architecture have their origin in the 1990s, when Brazil was going through a period of very high inflation. As a result, regulatory attention was focused on reducing the length of settlement cycles. During the following decade, attention shifted toward reducing settlement risk and potential contagion arising from institutional failure. Settlement risk or “Herstatt risk” – named for a German bank that failed in 1974 – is the risk that a financial institution may fail to complete both legs of a transaction, leaving its counterparty exposed to a sudden loss. A number of legal and structural reforms were made in response to these concerns, including the Brazilian Central Bank (Banco Central do Brasil or BCB) being given the power to nominate certain clearing and settlement systems as systemically important. Systemically important platforms are required to settle transactions in central bank funds, on a delivery versus payment (DVP) basis. In practice, bond, equity, foreign exchange and derivatives platforms – including the majority of over-the-counter (OTC) trading systems – are all designated as being systemically important. Structurally, the BCB established a realtime gross settlement system, known as the Reserves

Autumn 2012 Issue

Banking & Finance

Transfer System (Sistema de Transferência de Reservas or STR), to settle transactions using accounts held at the central bank itself. Payment messages are sent to STR via the National Financial System Network (Rede do Sistema Financeiro Nacional or RSFN). In addition, the BCB advised the National Congress on The Payment Systems Law of 2001, which took several further steps to reduce settlement risk. These steps included permitting multilateral netting by clearing houses and safeguarding assets posted as collateral from judicial seizure and the reach of bankruptcy law. THE BRAZILIAN CENTRAL BANK SITS AT THE CENTER OF A COMPLEX BUT HIGHLY EFFICIENT NETWORK OF CLEARING AND SETTLEMENT SYSTEMS As a result of these reforms, Brazil’s national payment system today is characterized by the extensive use of straight-through processing. All large value and other systemically important fund transfers are settled in same-day funds, and typically do so within a few minutes of being initiated. Interbank fund transfers are settled irrevocably on a real-time basis. The architecture utilized to make this to happen is centered on STR. This forms the hub of Brazil’s payment systems and functions in conjunction with a variety of other clearing and settlement platforms, connected via the RSFN. All systemically important interbank transfers are settled directly through STR. Some other settlements take place via SITRAF – a privately operated fund transfer system that effectively shares a platform with STR. Two other clearinghouses also provide interbank clearing and netting: SILOC, for deferred transfers, and COMPE for checks. In both cases, settlement is made through STR. The efficiency of this structure means that transfers between Brazilian retail and commercial bank accounts are now among the fastest in the world. Most retail banking payments are settled on the same day they are initiated, and electronic transfers from checking accounts are typically completed in less than one minute. In the financial markets, most transactions settle either on the day a trade is made, or one day later (T+1). Federal government bond transactions are cleared and settled through two systems. The most important is SELIC, which handles OTC transactions on a real-time gross settlement basis and is operated by the BCB itself. Deals transacted on the stock exchange (BM&F BOVESPA) are cleared and netted off by its own Debt Securities Clearinghouse and settled jointly with the STR. The Debt Securities Clearinghouse is one of four multilateral netting systems owned and operated by BM&F BOVESPA. The others are the FX Clearinghouse, for transactions involving the US dollar and Brazilian real; the Derivatives Clearinghouse, for swaps and futures; and the Equity and Corporate Bond Clearinghouse (former CBLC), which mainly handles equities. Each uses the RSFN to arrange settlement in

conjunction with STR. Corporate bonds and derivatives traded off the main exchange are cleared and settled through CETIP, a publicly owned organization focused on OTC activity. FOREIGN ENTRANTS TO BRAZIL’S FINANCIAL MARKETS ARE SUBJECT TO SOME SPECIFIC TAX AND REGULATORY REQUIREMENTS As well as the unique features of Brazil’s clearing and settlement systems, foreign individuals and companies entering Brazilian financial markets should be aware of several other factors that apply only to overseas players. Resolution 2,689 of the National Monetary Council requires all foreign investors to nominate both a legal and a fiscal representative within Brazil. A legal representative is required to respond to any civil claim that may arise against the foreign investor, and a fiscal representative to liaise with the Brazilian Internal Revenue Service. In practice, a single financial institution can often act as a foreign investor’s legal and fiscal representative, and take responsibility for the investor’s regulatory reporting to the BCB or the Brazilian Securities & Exchange Commission (Comissão de Valores Mobiliários or CVM). Foreign investors are also required to hire a local custodian, and firms wishing to trade on an exchange need to establish a local office or enter into partnership with a local institution. Any organization establishing a mutual fund in Brazil should also be aware of the requirement for daily net asset value reporting to the CVM, for disclosure on their website.

“The real has gained significantly against the US dollar over the past two years…” Lastly, and most importantly, foreign currency investments in Brazil are liable to a financial transactions tax (Imposto sobre Operações Financeiras or IOF). Unlike a withholding tax applied to outflows, the IOF is levied on capital inflows to the Brazilian financial markets. Apart from revenue generation, the main aim of the IOF is to limit the effect of short-term capital flows on the value of the Brazilian real. The real has gained significantly against the US dollar over the past two years, reflecting a hawkish interest rate policy and the effect of growing commodity prices. In October 2010, the IOF levy on foreign currency conversions for investment in bonds, derivatives and many other financial instruments was raised to 6%, with a lower rate of 2% applied to equities. This has not prevented international investors from allocating funds to Brazilian assets, but it has certainly encouraged them to look more carefully at their Brazilian strategies and operating structures. It also illustrated how important it is for foreign entrants to plan an optimal route through the complexities of Brazil’s laws, taxes and regulations.

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WE EXPECT FOREIGN PLAYERS TO PLAY AN INCREASING ROLE IN THE EVOLUTION OF BRAZIL’S FINANCIAL MARKETS We have summarized some of the most important features of the Brazilian payments system that foreign investors should be aware of, along with some other key regulatory and tax-related requirements. As already mentioned, these complexities – and their associated costs – are often seen as having partially insulated Brazil’s financial markets from global trends. This has helped to limit the impact of the global financial crisis on the Brazilian economy, but it has also tended to hold back the pace of market development. Nonetheless, Brazilian financial markets are evolving. Asset classes such as real estate funds, private equity funds, alternative investments and ETFs are gaining increasing traction, even if they are at an earlier stage of development than in many other emerging markets. Similarly, the vertical integration that is still a notable feature of Brazil’s financial markets is the subject of growing discussion. At a time when regulators in the US, Europe and elsewhere are looking to break up vertical silos, BM&F BOVESPA is rare in providing the trading platform, posttrade processing, clearinghouse and depositary services for a large proportion of national securities transactions. In response, Brazilian asset manager Claritas has recently signed an agreement with BATS Global Markets, an alternative trading venue, to explore the creation of a new Brazilian trading platform with its own clearing and depositary services. At the same time, BM&F BOVESPA, unusually for a leading national stock exchange, is taking steps to attract more high frequency traders – a group widely seen as crucial to the success of alternative trading platforms. It is currently developing a new multi-asset platform in conjunction with the CME of the US. In a separate development, US futures exchange ICE has acquired a 12% stake in CETIP. It therefore seems certain that the structure and features of the Brazilian investment market will continue to evolve, albeit under the watchful eye of the BCB, CVM and the National Monetary Council. Like the guarana tree, which protects its caffeine-packed fruit with bitter leaves, foreign investors may find some features of Brazil’s settlement systems a challenge. However, in our view this is likely to be outweighed by their appreciation of the resulting benefits. Over time, foreign entrants also have the potential to play a growing role in the evolution of Brazil’s financial markets. i Flavio Peppe is a Partner of Ernst & Young Brazil

Banking & Finance

> Africa’s Sovereign Wealth Funds:

National Fortune Building By CFI

While the US and Europe drown in debt, Africa is suddenly awash with sovereign wealth funds.

he world has truly turned on its head. While America and Europe struggle to pay their bills, a handful of resource-rich African countries are able to save. Fifteen years ago the notion that any more than the odd African government would have a sovereign wealth fund (SWF) was inconceivable. Such funds, which had the firepower to bail out Wall Street, are hardly synonymous with Africa, a continent better known for aid and poverty than any financial largesse. Yet in a stark reflection of how wealth has migrated from developed economies south as well as east, oil producers Nigeria and Ghana are laying the foundations for sovereign funds; indeed, Nigeria is in the process of hiring a team of executives with the help of consultancy KPMG. These are just two in a raft of African governments with a newfound ability to save, buoyed by a combination of debt relief five years ago and the prolonged commodity boom. As in Latin America, where sovereign funds have sprouted over the past year in unlikely quarters such as Peru, Bolivia and Colombia, in Africa there are now about 15 sovereign funds, with five more in the offing. Advisors from Norway, the UAE and Singapore criss-cross the continent offering expertise. Some countries have been nurturing national nest

Countries have been nurturing national nest eggs for a while. eggs for a while. Algeria’s oil-fed fund is worth around $56bn (€42bn), Libya’s has $60bn which will now go to fund reconstruction after the end of Gaddafi’s 42-year rule, and Botswana’s Pula Fund (saved from diamond revenues) is worth $7bn. Oil producer Angola – which now tellingly owns the equivalent of around 4% of the listed companies of Portugal, its former colonial master, including banks, telecoms and energy companies – is planning a fund. Uganda, where the oil won’t flow for several years yet, and even tiny, landlocked Rwanda, without a drop of oil but hoping to earn foreign currency from exporting methane gas from Lake Kivu, plan to get in on the act. Other

governments, from Gabon to Equatorial Guinea, Morocco and South Africa, have stockpiled huge reserves and could follow the trend. All want to invest the billions of dollars their central banks have stashed away for the long term, seeking to better manage their national wealth, counter commodity cycles and guard against inflation. Optimistic forecasts estimate Nigeria’s wealth fund could top $250bn one day. That’s small beer compared with the $627bn Abu Dhabi Investment Authority, Norway’s Government Pension Fund (accrued from North Sea riches and which holds about 2% of all European equities) or China’s $408bn Investment Corporation, which manages the massive foreign-exchange reserves garnered from export-led growth. But in today’s straitened times the prospect of new African funds swelling the number of these sought-after, long-term investors, that are free of the liabilities that limit pension funds and other institutions, is a thrilling prospect. “African governments have rapidly accumulated reserves and are attempting to manage them for the long term for future generations. A shift in money and investment is clearly happening,” says Patrick Thomson, global head of JP Morgan’s $65bn sovereign business. He predicts that combined sovereign funds and central-bank reserves will hit $20trn by 2020 thanks to contributions from new and fast-growing funds just like Africa’s. Nigeria and Ghana’s new funds won’t have much initially. Nigeria needs to invest in infrastructure and here the plan is that money is funnelled through an Infrastructure Fund within the broader sovereign wealth fund. “They won’t put more than $10bn-$15bn dollars away over the next five years because of the infrastructure deficit,” predicts Lagos-based expert Bismarck Rewane. Nor will Ghana squirrel away much at first. Although new oilfields are due onstream, the sector is still small. Savings won’t be significant until production hits 250,000 barrels per day, not forecast until 2013. And Ghana is planning to save only a small proportion of its oil earnings anyway. A law passed last March allows the government to use 70% of oil revenues to fund its budget, only saving 30% in

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heritage and stabilisation funds. Conventional thinking would have Africa’s savings invested in liquid, safe fixed-income and equity markets in developed countries. But in these changed times, new wealth funds say they are observing where the big guns’ funds are investing, which means they may not be piling into Western economies just yet. As the European and US debt crisis drags on and growth in developed markets grinds to a halt, sovereign funds are beginning to diversify. The idea of government money being squandered on loss-making investments in US banks excited public opinion in China. Managers of Norway’s wealth fund have said they plan to reduce exposure to European assets over time in favour of broader investment in emerging markets. Research from consultancy Monitor Group shows that the Asia-Pacific region attracted the largest chunk of sovereign wealth fund direct investments in 2010 at $25.2bn – nearly half of the total. “Returns on many traditional asset classes are currently depressed and seem likely to remain so, particularly developed-market equities and government bonds,” says Monitor. “In this vein, SWFs have turned their eyes toward emerging markets.” Nigeria’s eagle-eyed central bank governorLamidoSanusi recently decided to put 10% of the country’s $33bn foreign-exchange reserves into renminbi, saying there was “less appetite” for holding dollars. There will also be pressure to invest closer to home. “Buying shares in Marks & Spencer would prompt the difficult question back in Africa of why on earth aren’t these guys buying a chunk of my company,” says Ayo Salami at London-based

SWF face pressure to invest closer to home. asset manager Duet Group. Africa’s funds will also be prevailed upon to buy local-government bonds to help finance domestic deficits; the hope is that new sovereign funds will encourage Africa’s own asset-management industry too.

Autumn 2012 Issue

Banking & Finance

Opportunities to manage the money may also be used as a carrot to draw more of the big investment banks to Africa. In the long term, Africa’s wealth funds could also want to pick assets that are

SWF have turned their eyes toward emerging markets. more directly strategic and beneficial to Africa. Ways to invest externally for the continent without stoking inflation could include things such as satellites, which would transform the cost of telecommunications. In this way Africa’s future sovereign funds could become major players in development finance, transforming into sovereign development funds involved in national strategies for growth. Investment abroad will also be limited by Africa’s enduring need to stabilise. During the financial crisis even the strongest economies drew

on their sovereign funds to shore up rocky times back home. It’s not just the idea of using capital in poor countries to subsidise capital in rich counties that goes down badly. In some quarters the very idea of saving per se, in a continent where poverty is widespread and infrastructure frequently dire, isn’t that popular either. Sovereign wealth funds in poor but resourcerich countries may be lauded by the World Bank as buffer mechanisms against boom and bust, and by bankers who fly in seeking lucrative mandates, but the average African politician doesn’t go a bundle on the idea. The argument goes that if you don’t have enough schools or hospitals, why save billions in oil revenues in an offshore fund for the future? “The problem of addiction is to resolve the addiction rather than to lock the cocaine away. The preferable outcome is that they become an efficient member of society,” says Rewane. Recent revelations around the Libyan Investment Authority, which scored a two-out-of-10 rating on the SWF Institute’s Linaburg-Maduell Transparency Index, can be used to argue the case for spending rather than saving, says Sebastian Spio-Garbrah, founder of DaMina Advisors, a New York-based political-risk consultancy. He argues that the fund’s poor returns go to show that developing African countries would be wiser to spend their money at home. “Gaddafi would have been better off taking this money out and buying a car for every Libyan.” And there is little thanks for investing abroad too, says Spio-Garbrah. “Libya’s fund was invested across Europe but they ganged up to kill him.” Libya’s sovereign wealth fund was found languishing with almost half the portfolio in cash, as well as low-yielding European and African investments including Italian bank UniCredit, Juventus Football Club and LAP Green Network, a loss-making African telecoms company. Nigeria’s powerful state governors, who manage swollen oil-fed budgets (some the size of small countries), are also arguing that it can’t afford to save just yet. Because of the lack of a clear legal basis on revenue distribution between federal, state and local governments, they have blocked the passage of the SWF bill, which still hasn’t been passed into law. In the latest twist they’ve applied to the Supreme Court to block a $1bn transfer from the Excess Crude Account (ECA) into the sovereign fund, arguing that they can’t afford to get less oil revenue when they are having to finance a new minimum wage and just before the government plans to remove subsidies on fuel. “It will pass. There will be a trade-off somewhere,” says Rewane.

the Congo in 2006. In a salutary example, rather than saving or investing the tax revenue on recent oil transactions, the government used the money to fund Russian fighter jets to defend Uganda’s border. The central bank was obliged to fund the controversial $720m purchase ahead of the anticipated tax revenues coming in and Mutebile says he has only been paid back half the money so far. Elsewhere, the World Bank helped Chad set up a fund, but instead of saving money for education and health, the government used it to buy arms. In Nigeria, where institutions are much more robust than Uganda, saving oil revenue is still a slippery business. At its height Nigeria’s ECA, set up in 2003, in which the government saves any revenue above a benchmark price set each year in the budget, reached about $40bn. It’s valued at around $6bn today after being raided to fund the election. The episode also went to show how political change thwarts even the best-laid plans to save. In 2003 finance ministerNgoziOkonjo-Iweala turned Nigeria’s budget around, but her removal from the post – although she’s back in office now – saw the savings slip away. Nigeria’s other problem is that oil revenue snakes its way through the state-owned Nigerian National Petroleum Corporation before it ends up in central bank coffers. As a result, a fair bit is siphoned off en route. “The NNPC has been known to under-report its oil revenues,” says KayodeAkindele, a partner at Lagos advisory firm 46 Parallels. Like the ECA, the NNPC is also vulnerable around election time. “Money can be used without ringing alarm bells. It is seen as a cash cow,” he says. SWFs have a reputation for being opaque; more so in autocratic regimes. Only a handful of African countries willingly divulge their books. It makes gauging the extent of savings and the number of funds difficult but, as the continent finds itself in a better place financially than ever before, more countries are starting to save. A decade ago any discussion on sovereign wealth would have focused on OECD countries. Now the world’s wealth has tipped in Africa’s favour. It puts paid to that old adage that Africans kill the cow but the West steals the milk. i

And despite enthusiasm for the wealth fund concept, saving will be tough for some governments. Uganda’s central bank governor Emmanuel Tumusiime-Mutebile admits managing the revenue will be “a challenge” and that his country needs to “strengthen its institutions” ahead of pumping the oil that was discovered along its border with the Democratic Republic of

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Banking & Finance

> Cover Story:

Zenith Bank: A Winner in Nigeria Zenith Bank was selected for CFI’s cover story because of its major success in our 2012 Banking Awards programme and given its outstanding contribution to the industry in Africa – but mainly because Zenith is a future leader in international banking. In our view Zenith is a name to watch. WORTHY WINNER The Bank was named Best Commercial Bank in Africa this year in view of its sterling work at home over the past 22 years and given the excellent progress already made in distant markets within Africa and far further afield 2012: THE YEAR SO FAR Results for the first six months of 2012 show an improvement over the same reporting period last year with gross earnings of N 151 billion (up 23 per cent). Profit after tax rose to N 42.4 billion (up 32 per cent) while earnings per share stood at N 1.35 versus N 1.01 for the period ending June 30th 2011.

Praise is due then to Zenith Bank’s management team which is headed by Godwin Emefiele, the Group Managing Director and CEO, a pioneering staff member who has been a board member for more than a decade. He took over from the charismatic founding CEO, Jim Ovia, in August 2010. The bank’s exceptional performance stems from its experienced leadership, professionalism and the vision of management and staff. BUILDING VALUE According to Emefiele, the Bank’s main focus is that of building value for customers and unlocking the real value of their businesses. As he points out in Zenith’s most recent Annual Report, ‘ Our

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performance and success hinges principally on satisfying customers better than the competition’. Mr Emefiele reports that Zenith is on a solid growth trajectory and that is most certainly the case: the Bank seems well positioned for the future. The CEO has spoken of an obligation to build a stronger and more durable bank for the benefit of future generations: ‘We shall persistently leverage our heritage of excellent people, sound business model and experienced management team to create pioneering solutions that surpass our stakeholders’ expectations. The operating results of the bank, since it went

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Banking & Finance

Good commercial banks are a cornerstone of any economy and we are delighted after much deliberation to announce Zenith Bank as the Best Commercial Bank Africa. CFI.co was looking to identify a bank that works to the benefit of all stakeholders. To our mind, good banking is about finding and maintaining the right balance between all the stakeholders’

public in 2004, tell of impressive performance by all relevant measurements. Total assets grew from $1.25bn in 2004 to $14.19bn in Q3 2011, representing a growth of 1,039 per cent. Within the same period, total deposits increased by 1,079 per cent from $845m to $9.97bn, as at September 2011.

STRONG GROWTH Zenith Bank has built a brand as a reputable, international financial institution – recognised for innovation, superior customer service and performance while creating premium value for all stakeholders. Today, the bank is known for its innovation, solid financial performance, stable and dedicated management, highly-skilled personnel, cutting edge ICT, strategic distribution channels and asset quality. The key strategies used over the past 12 months to drive the robust growth were as follows: • Delivery of superior service to all customers;

interests. Under Jim Ovin’s leadership, Zenith created strong foundations with a broad shareholder base, high levels of capitalization and very strong corporate governance. Godwin Emefiele and his team have continued to build on these foundations. It is the Bank’s commitment to all of its stakeholders that shines through, enabling it to provide the

• Development of deeper and broader relationship with clients and a striving to understand their individual and industry characteristics with a view to formulating specific solutions for each segment of the customer base; • Optimal expansion of the bank’s operations by adding new distribution channels and entering into new markets with strong identified opportunities;

• Maintenance of the Bank’s position as a leading service provider in Nigeria, while expanding its operations internationally in West Africa and the financial capitals of the world; • Concentration on efforts to be a leading service provider in Nigeria by continuing to build on longstanding relationships, capabilities and the strength of the Zenith brand and reputation; • Enhancement of the Bank’s processes and systems to deliver new capabilities, improve operational efficiencies and achieve economies of scale.

highest level of services. There has been substantial investment in staff development creating a team that we feel will continue to work to the very highest standards and bring ever increasing standards of banking to clients and results to investors, while through the Bank’s CSR policy, Zenith Bank ensures it is also playing its part in society as whole.”

MOST RECENT FULL YEAR RESULTS Sir Steve Omajafor, chairman of Zenith, termed 2011 as ‘another challenging year for operators in the banking industry. Never-the-less Zenith was able to exploit opportunities in the market which translated according to Omajafor into a ‘Cheery performance that further attests to the durability and resilience of the brand. These results are once

again, an eloquent testimony to the sound financial health of the Bank and the Group.’ The year 2011 witnessed improved stability in the Nigerian banking sector and this was largely due to the impressive growth in the economy brought about by the successful economic and structural reforms initiated by government. Real GDP grew by 7.4 per cent in Q3, 2011 (a marginal reduction over the same period in the previous year due to a decrease in the oil sector). Agriculture, wholesale and retail trading, telecoms, manufacturing plus the finance and insurance sectors brought about significant non-oil growth. Inflation was a challenge

“Ten years ago, I asked how many of the children had email addresses. The response: not even one. I told them that they must go to the internet cafes, work with computers, mobile phones and PDAs. They should tell their parents to forget taking a holiday and instead buy them a computer. Within three years, more than half of the children had email addresses.” Jim Ovia, Member of The Order of the Federal Republic of Nigeria and the founder of Zenith Bank. Mr Ovia has a passion for IT and is a champion of the ‘Youth ICT Revolution’ in Nigeria.

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Banking & Finance

Zenith Bank, London

in 2011 and despite the best efforts of the Central Bank, the rate reduced only marginally from 10.5 per cent in November to 10.3 per cent at year end. CAPITAL MANAGEMENT ASSURANCE The strategy for assessing and managing the impact of Zenith Bank’s plans on present and future regulatory capital forms an integral part of the bank’s strategic plan. Specifically, it considers how the present and future capital requirements will be managed and met against projected capital requirements based on its own assessment and against the regulatory capital requirements, taking account of the bank’s business strategy and value creation to all its stakeholders. The capital adequacy of the bank is reviewed regularly to meet regulatory requirements in order

to adopt and implement the decisions necessary to maintain the capital at a level that ensures the realisation of the business plan with a certain safety margin. The Central Bank of Nigeria (CBN) requires each bank to maintain a certain ratio of total regulatory capital to the risk-weighted asset at or above the minimum of 10 per cent. Zenith Bank Plc has consistently met and surpassed this requirement. Most of the bank’s capital is Tier 1 (Core Capital), which consists essentially of share capital, retained earnings and reserves. The group’s capital plan is linked to its business expansion strategy which anticipates the need for growth and expansion in its branch network and IT infrastructure. The capital plan sufficiently meets regulatory requirements as well as provides

adequate cover for the group’s risk profile. Its capital adequacy remains strong and the capacity to generate and retain reserves continues to grow. ROBUST LIQUIDITY METHODS Zenith Bank’s liquidity profile remains very strong (being a consistent net placer of funds in the interbank market) and its risk management practices give assurance that this profile will be maintained. The bank has a sound and robust liquidity risk management framework that ensures it maintains sufficient liquidity, including a cushion of unencumbered, high-quality liquid assets at all times. Zenith Bank’s compliance with liquidity and funding requirements includes the following processes: projecting cash flows and considering the level of liquid assets necessary in relation to

“Zenith Bank’s strong capital adequacy ratio (two and one half times the allowed minimum) means we have the sixth largest bank capitalisation in the continent of Africa.” - Goodwin Emefiele

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Banking & Finance

Goodwin Emefiele, Group Managing Director and CEO

“The increase in shareholder funds from $125,000 in 1990 to $2.3 billion today means that Zenith is the biggest bank in Nigeria, West Africa and number six in Africa by this measurement. Twenty two years ago we had one shop but by 2012 Zenith could boast 500 well run branches and business offices. The IPO in 2004 was a brilliant indicator of confidence in the brand with a subscription

of 500 per cent. Since then we have opened offices in the United Kingdom, Ghana, Sierra Leone and Gambia as well as representative offices in South Africa and China. Their performances have been good. I promise that we are going to service customers everywhere very well and grow this franchise not only in Nigeria but also far outside these shores.”

Zenith Bank, Nigeria

“Liquidity is even more important than profitability. Indeed the latter follows on from the former. The 2009 stress test was a walk in the park for Zenith. At this time the emphasis at Zenith is on enterprise risk management to ensure our NPL ratio continues to be the lowest in Nigeria. “ Goodwin Emefiele

needs; monitoring balance sheet liquidity ratios against internal and regulatory requirements; maintaining a diverse range of funding sources with adequate back-up facilities; managing the concentration and profile of debt maturities; monitoring depositor concentration in order to avoid undue reliance on large individual depositors; and ensuring a satisfactory overall funding mix, while maintaining liquidity and funding contingency plans. In 2009, the Central Bank of Nigeria (CBN) conducted a special audit to ascertain the stability of the banking sector in the country. Zenith Bank was one of the 14 banks that passed the audit. The result of the audit led to the quasi-nationalisation of 10 banks representing about 50 per cent of system assets.

RATINGS AND CORPORATE GOVERNANCE Zenith Bank has consistently recorded good ratings from both the international (Fitch Ratings, Standard & Poor’s) and local (Agusto & Co.) rating agencies. The ratings on Zenith Bank Plc are supported by its leading market position in all key performance indices. Zenith Bank has consistently put in place a robust system of corporate governance, bearing in mind the key elements of honesty, trust, integrity, openness and accountability as well as commitment to the organisation’s goals. To uphold strong corporate governance and transparency, the bank adopts a robust public disclosure policy. This is to forestall incidences of abuse, such as insider trading.

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All financial information, as well as exceptional and extraordinary events capable of influencing the public decision concerning the bank, are approved for dissemination by the board and then related through authorised means to the public at the same time. The release of such information is done speedily and as often as stipulated by the regulatory bodies. MOST BANKING SERVICES ARE AVAILABLE AT ZENITH Zenith operates across most banking service areas in both the public and private sectors. Emphasis is placed on corporate and investment banking, commercial and consumer banking, personal and private banking, trade services and foreign exchange, as well as treasury and cash management. Other non-banking financial services are offered mainly through the subsidiaries. Zenith has substantial market share in the manufacturing, construction, general trade and commerce and logistics sectors. The Bank’s customer base is largely made up of large corporate entities – many of which are the subsidiaries of successful multinational corporations. i

Banking & Finance

> Sergio Caveggia, Tax Partner, Ernst & Young Argentina: M&A in Emerging Countries – Tax Risks and Opportunities

THE IMPORTANCE OF TAXES IN M&A PROCESSES Companies are focusing more and more on the tax aspects of M&A. This focus is partly because tax authorities are scrutinizing transactions more closely than ever before. But this increase concentration is also due to the drive to ensure that deals deliver the value they promise, as company boards examine transactions in more detail. This is particularly important in emerging markets, where even companies with years of experience doing deals in these regions of the world face unfamiliar legal and regulatory challenges, of which, tax is one of the biggest. Uncertainty is one of the main characteristics of emerging countries, and it should be managed by familiarizing with the local environment, not just the local tax law, practice and procedure but also the reasoning behind it. A global M&A tax survey report recently prepared by Ernst & Young shows that companies continue to seek value from transactions in a wider range of tax areas than ever before. Accordingly, mentioned survey also concludes that more than half of the tax directors questioned said that when planning a transaction, they reviewed

the tax effectiveness not just of matters requiring immediate attention to get the deal done, but also of other aspects of their company´s operations that could be affected by the transaction – areas such as tax-effective supply chain planning, intangible assets, indirect taxes. Also, the M&A tax survey report shows that fiftyseven percent (57%) of tax directors surveyed said that their companies place more importance on tax issues as part of the deal processes compared to three (3) years ago. Half of these said their companies placed significantly more importance on tax – a figure that has nearly doubled since 2010. There has also been a material increase in the percentage of tax directors who say that tax is a primary component of transaction value for their companies. Some of the causes that increased the importance of the tax analysis in M&A processes are the following: • Increasing focus on tax efficiency to reduce the cost of deals or improve the return from deals; • Increasing complexity of tax legislation affecting deals;

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• Increasing scrutiny of deals by the board of directors; • Increasing scrutiny of deals by tax authorities; • Increasing scrutiny of deals by shareholders DEALING WITH TAXES IN EMERGING COUNTRIES More and more capital is flowing into emerging markets through M&A. Such investments offer companies opportunities to expand into new markets and to make their supply chains more efficient. Yet risks remain, particularly around tax. Many multinational companies had done a deal in at least one of the BRIC countries (Brazil, Russia, India and China) during the past three years. Outside the BRIC countries, the M&A survey report, identified evolving M&A interest in a number of other emerging countries or regions, including Indonesia and Southeast Asia, South Africa, Nigeria, Argentina, Chile, Colombia and Peru. Emerging markets may be a focus of corporate M&A, but even companies with years of experience doing deals in these regions of the world face unfamiliar conditions, particularly legal and regulatory ones. Unsurprisingly, a main

Autumn 2012 Issue

Banking & Finance

Buenos Aires, Argentina challenge is tax. Principal challenges when entering a transaction in emerging countries are the following: • Uncertainty of how tax legislation and practice will be applied to the particular transaction steps; • Risks that the tax system or tax incentives will change, affecting projected tax costs; • Currency and tax issues in relation to repatriating income flows; • Risk of inheriting pre-transaction tax liabilities; • Retrospective changes to tax legislation or its interpretation; • Limited case law and the unpredictability and duration of the litigation process. Consequently, an awareness of the potential tax risks in emerging markets is essential. But investors also need a thorough understanding of the tax environment in the particular market where they are investing. There is no substitute for local expertise in navigating the tax uncertainties that can erode the value of a deal. THE IMPORTANCE OF ADOPTING PROPER TAX PLANNING – THE TAX IMPACT OF ACQUISITIONS AND INVESTORS “EXIT STRATEGY” Apart from the tax risks related to a potential investment in emerging markets, the investor and specially investor’s tax advisors should assess all aspects to draw up a proper tax planning related to the structure to be adopted when acquiring an investment or exiting it. Aspects like the decision to carry out the

acquisition through a share deal or an asset deal shall influence not only the clauses to be negotiated so as to limit successor´s responsibilities of the tax contingencies that the buyer might eventually bear but also the tax costs of the acquisition, the tax impact in the future distribution of dividends, the generation of intangible assets which may not be deducted due to legal restrictions, and the matters associated with the foreign exchange market and foreign trade for the incoming and outgoing foreign currency, among others. The exit strategy is a also fundamental aspect to evaluate right from the very moment of planning the structure of the acquisition. Thus, the investor should weigh whether by adopting a structure of purchase that implies, for example, a tax saving in the purchase or a limitation on the tax contingencies that the buyer will bear, the tax impact derived from the sale will eventually be significantly larger than the advantages or benefits obtained when purchased. In conclusion, the matters mentioned above disclose the recent growing importance of tax matters as an essential risk factor to consider by the investor planning to acquire businesses in emerging markets. Besides, tax issues become relevant as part of the strategic planning tools that the investor should take into account when acquiring, running or eventually exiting a business. i

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Sergio Caveggia is a Tax Partner currently in charge of the Transaction Tax Area in Argentina. He joined the tax division of Ernst & Young in 1994, and has over 18 years experience in dealing with tax-related matters. He has served numerous clients in a variety of industries. He has developed strong expertise in international taxation and mergers and acquisitions matters, structures for inbound and outbound investments, buy side, sell side and restructuring services within the Transaction Tax area. Moreover, he has been involved in practically all Buy-side and Sell-Side due diligence analysis in our firm in the last 10 years. He is a Certified Public Accountant, a graduate from University of Belgrano in Argentina, from where he also obtained his Tax Specialist’s Degree. He is also a member of the Professional Council of Economic Sciences of Buenos Aires and the Argentine Fiscal Association.

>THE

EDITOR’S HEROES

he publishing world is awash with lists and rankings of the wealthy and powerful and I often feel drawn to the latest offerings from Forbes. But I wanted to bring you something a little different. The ten chosen are good examples of individuals that help shape a better world for us all. They are not CFI.co’s Top Ten but I believe they are people with whom we should become much better acquainted. To my mind each name below is helping to improve the world in significant but quite different ways. I wanted to recognise their achievements in this first issue by

calling them CFI.co’s Emerging Market Heroes. I hope you find my choices interesting (as you would expect there was much debate at CFI.co about who should be included). I am not going to justify these decisions but would hope the heroic ten speak eloquently for themselves. If there are any Heroes you think should be considered for inclusion in the next issue – or indeed have any comments about those included here – I would welcome your feedback at editor@cfi.co

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Autumn 2012 Issue

The Editor’s Heroes

>DILMA ROUSSEFF Brazilian President

“You have one hour to solve this problem.”

Brazil’s President Dilma Rousseff calling on ministers to help the country’s farmers who were suffering from the effects of bad weather. She extended the deadline, but there was no way they would be allowed to fail. One of the three, agriculture minister Mendes Ribeiro, describes the president as a very precise and direct leader. There is no denying that the main challenges facing the Brazilian economy include the achievement of sustainable growth and the struggle for a fair distribution of its rewards throughout society. The country is fortunate in having as its president Dilma Rousseff, a highly principled leader who may well prove to have the necessary qualities to build on the success of her predecessor. Ms Rosseff, 62 years, was not so well known when former president Luiz Inacio Lula da Silva made clear his view that Brazil should have her

as its first female president. He realised that under her leadership – as during his beforethere would be full understanding that Brazil’s challenges start at home and that the country must mobilise its considerable potential for the benefit of all. President Rouseff has indicated that her presidency represents continuity for the country and a strong role for the state. We expect her to be a resolute leader. Life has been a struggle for the new president who has only recently recovered from lymphatic

cancer. As a young woman she opposed the military dictatorship and was jailed for three years. A career civil servant, she was chosen by Lula partly because she had not been tainted by the corruption scandals surrounding some of the other likely candidates. Once a left wing revolutionary, she is now tooting the horn for private enterprise and rightly so. It has been a long journey and a necessary one for her and her people. The struggle continues.

> MONCEF MARZOUKI Tunisian President

“The democratisation of Tunisia, Egypt and other countries has allowed a number of extremists free riders into the political system. But it has also definitively refuted the myth that democracy and Islam are incompatible.”

In 2011, popular protests in Tunisia rid the country of Zine al-Abidine Ben Ali and towards year end Moucef Marzouki was installed as president of his country. These events provided clear inspiration for the Arab Spring. Mr Marzouki had been a powerful focus of opposition to former president Ben Ali and, perhaps unsurprisingly, found himself in a jail cell soon after making an election challenge. The Islamic Ennahda party became the dominant force in Tunisia after the election last year and President Marzouki is seen as bringing balance to the political system. The election of Marzouki occurred as a result of a power-sharing agreement between Ennahda and two smaller secular parties.

Mr. Marzouki has pointed out that the Arab revolutions remain fundamentally about social justice and democracy – not about religion or establishing Shariah law. He has also said that extremists advocating violence are a very small minority in Tunisia and are extremely unpopular among the religious as well as the secular. He believes that the strength and importance of extremists groups have been exaggerated by the media: ‘But that image is a distorted fantasy; it does not represent any sociological or political reality. Arguing that the groups who have recently staged violent demonstrations represent the entire Arab population is as absurd as claiming that white

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supremacist groups represent the American people or that the Norwegian right-wing mass murderer Anders Behring Breivik is representative of Europeans.’ What matters most to his people, according to their president, is ‘building new democratic institutions; creating jobs and halting the exodus of Tunisian boat people seeking a better life in Europe.’ The President has brought great hope to the hearts of his people and is working hard to stabilise the institutions in his country. He has refused to accept the view that Muslims cannot be allowed a democratic voice and truly free enterprise.

The Editor’s Heroes

> AUNG SAN SUU KYI Chair for the National League for Democracy, Burma

“I could not as my father’s daughter remain indifferent to all that was going on.” Suu Kyi, daughter of a Burmese independence hero, has never been indifferent to the goings on in Burma. She is one of the most potent symbols of peaceful resistance to an oppressive regime. Chair for the National league for Democracy, Burma, she became one of the world’s best known

prisoners after years in jail and house arrest. Suu Kyi became involved in the struggle to replace the military junta 25 years ago. The Buddhist faith brought a sense of inner freedom during her captivity and Suu Kyi has said that the concept of ‘Loving Kindness’ should

govern Burma’s transition to democracy. This lady favours reconciliation rather than revenge. There is great hope in the country and far further afield that Suu Kyi will lead a democratic Burma after the elections planned for 2015.

> ÁLVARO URIBE Former President, Colombia “I will protect all Colombians regardless of whether the attacks come from guerrillas or paramilitaries. No one can feel the owner of the country and no one can feel excluded from the right of property. The basic dream of many Colombians is to have a secure nation, without exclusions, with equity, and without hatred. In the name of justice there cannot be subjection and in the name of peace there cannot be impunity.” During his eight year presidency, Alvaro Uribe tackled the criminal gangs, armies and random violence that held sway over large areas of his country. His government was virtually facing civil war against well organised forces. He brought renewed confidence to Colombia and hopes for a brighter future. Mr Uribe’s efforts promise greater safety and prosperity for his people. Uribe was convinced that his government had

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to show sufficient military strength – as well as a willingness to compromise – to bring the guerrillas to the negotiating table. His plan paid off. During his presidency, Uribe made it clear that Colombia’s key priorities for a prosperous society were to challenge terrorism and drug trafficking. He understood that the rule of law is required for the economy in his country to flourish. And he did something about it.

Autumn 2012 Issue

The Editor’s Heroes

> VIRGINIA M. ROMETTY IBM, CEO, USA “...And I actually think strategic belief could end up being more important than strategic planning in this day and age – how you keep the long view in your mind. Clients often say to me, “What’s your strategy?” And I say, “Ask me what I believe first, that’s a way more enduring answer.” This idea of a strategic belief is saying that if you can agree amongst the firm about the future there are some really big arcs of change. For us, one of these is this era of cognitive computing which is about to start. And one of the biggest things all of us as have learned over this year is to keep reinventing. Don’t take for granted where you’re at, but keep a longterm view is that thought.”

CFI.co believes that Rometty, CEO of IBM, has been instrumental in developing services at the Company that will open up markets and help world economies converge. We must include her as one of our heroes because her project addresses concerns that are so very important to us.

New markets such as cloud computing and geographic markets is of critical importance too. And business analytics software are driving the growth Virginia Rometty understands this very well. objectives of IBM but at the same time are offering the necessary support to the global village. It is not only the new technologies that support economic growth – the identification of new

> DR. NGOZI OKONJO-IWEALA Minister of Finance, Nigeria “....That’s what this administration is focusing on:

Job creation and inclusive growth.” Harvard educated Dr. Okonjo-Iweala, a recent candidate for presidency of the World Bank, is one of the world’s most respected economists. She must be congratulated on ensuring Nigeria’s first sovereign debt rating. This achievement brought significant foreign investment to Nigeria. Dr. Okonjo-Iweala is a tough operator who is keen on tackling corruption. She is the right CFI.co | Capital Finance International

person to see that the benefits from Nigeria’s oil revenues are distributed equitably throughout the nation. Nigeria is experiencing strong economic growth but the lack of a truly effective distribution of wealth is massively restrictive. Income inequality is a severe hindrance to sustainable growth. This is one of the major challenges she faces.

The Editor’s Heroes

> DR. NAWAL EL SAADAWI Author, Egypt

“Now I had learnt that honour required large sums of money to protect it, but that large sums of money could not be obtained without losing one’s honour. This was an infernal circle whirling round and round, dragging me up and down with it.” Like so many of our other heroes, Dr Saadawi has seen the inside of a prison cell because of her views. She was incarcerated in 1981 after helping to publish the feminist magazine Confrontation. The opinions expressed conflicted with those of the late President Anwar Sadat, her views were considered dangerous and Dr Saadawi was not released until shortly after the President’s death. Her books have been banned in Egypt and she has been exiled more than once for her calls for equality and the recognition of women’s rights. A qualified medical practitioner, Dr Saadawi

was fired from her position as Egypt’s Director General for Public Health after her book ‘Woman and Sex’ appeared in 1972. The Egyptian branch of her ‘Arab Women’s Solidarity association’ was declared illegal in 1991. Because of the power of her writing and the discomfort caused to those with closed minds, she has found her name on death lists, been forced to flee the country and there have been calls for her to lose her Egyptian nationality. Dr. Saadawi’s work has been published in more than 30 languages and she has been hailed as

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‘One of the Greatest Minds of the 20th Century’. Her example shows clearly that if the voices and talents of women are ignored the capacity and output of a country is reduced by more than half. The value of the body of work produced by Dr. Saadawi means that she is an inspiration to people not only in the Middle East but in all communities of the world. We have much to learn from her including an understanding of the connection between oppressive cultural practices and some physical and psychological problems experienced by women.

Autumn 2012 Issue

The Editor’s Heroes

> USAIN BOLT Olympic Champion, Jamaica

“It’s what I came here to do. I’m now a legend. I’m also the greatest athlete to live. I’ve got nothing left to prove.”

He has nothing left to prove? Perhaps so, but we identify in Bolt a hunger for continuous improvement. He wants to go on winning and beating his own records. We feel sure that the world will be hearing much more from Usain Bolt during the coming years. Does he have a future

humanitarian or political role to play? Our hope is that the charismatic Bolt will continue to be an inspiration for people all over the world. He is a towering figure on the sporting scene and surely the greatest athlete of his generation. Running an incredibly fast 100 metres is not a CFI.co | Capital Finance International

trivial feat but requires long preparation and superb execution on the day. Sport is important and brings people together. Bolt is bringing masses of people together in his own very special way.

The Editor’s Heroes

> DR. ROSS JACKSON Chairman, Gaia, Canada/Denmark “Therefore, I will go on record again with pretty much the same statement that I made over ten years ago. The current global financial system is systemically unstable and flawed and continues to be an accident waiting to happen.” Few would deny that parts of the capitalist system – in particular its banking and financial services – are in need of urgent attention. We should also be alert to the effects of our continuously increasing demands on the world’s limited natural resources. Once again – although we are optimistic – these are concerns that are relevant to the CFI. co agenda and so we strongly applaud this hero. Ross Jackson and his wife Hildur (under the Gaia movement) are pioneers of green energy and eco-villages – some of which are to be found in the emerging markets. Dr Jackson, whose achievements in business – including hedge fund management – are considerable, offers in-depth solutions to our current problems and rejects the option of maintaining the status quo. His book Occupy World Street deserves a wide readership. He has an extraordinarily powerful intellect and favours a holistic perspective. We recommend our readers to consider for themselves the proposals Jackson makes for the rehabilitation of those flawed systems of trade and finance that threaten economic and social progress and cause damage to the environment to the detriment of future generations.

www.occupyworldstreet.org

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Autumn 2012 Issue

The Editor’s Heroes

> MALALA YOUSAFZAI The Malala Education Foundation, Pakistan “I was scared enough to see the pictures of bodies hanging in Swat but the decision to ban girls from going to school was choking me and I decided to stand against the forces of backwardness.”

On Wednesday 10th October this year, surgeons in Pakistan removed a Taliban bullet from the head of our youngest hero – fourteen year old Malala Yousafzai. She was attacked in this way because of her brave response to the atrocities of the Tehreek Taliban Pakistan (TTP) in the otherwise peaceful Swat Valley, known as the Switzerland of Pakistan. The Taliban had imposed their will with monstrous force against all men and women who didn’t conform completely to their outrageous world view. People considered obstacles to this backwardness were slaughtered, women were banned from going out shopping and more than 400 schools were closed down. Malala pointed out in her blog: ‘Some people

are afraid of ghosts; some people are afraid of spiders. In Swat we are afraid of humans. But not humans like us – these were barbarians.’ The diaries of Malala Yousafzai are as important to us as those of Anne Frank. They describe everything that happened during the Taliban occupation when girls had to hide books under their shawls and ran the risk of having acid thrown in their faces. Once the Taliban had been driven from Swat, her campaign gathered momentum and became more and more ambitious. Campaigning for peace and education, Malala won a host of national and international awards including Pakistan’s highest commendation for civilians. And she went back to school saying, ‘I will carry on my work for the girls

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and I will speak out for their rights.’ This was too much for the barbarian who boarded her school bus, identified Malala, shot her in the head and neck and injured another girl. The other Taliban barbarians have threatened a further attack should she survive. Her father has said that nothing would stop either of them from continuing their work. ‘The Taliban must not think for a moment that they have won.’ At CFI.co we believe that Malala is going to be the winner. She has brought together people of all faiths who are determined to defy the barbarian agenda and replace it with freedom, education, peace and prosperity for all. We pray not only for her full recovery but for the continuation of her important work into adulthood.

Small and Medium Size Enterprises

> Enterprise Europe Network:

Helping SMEs Realise their Potential Small businesses looking to succeed in today’s market need to trade across borders, invest in research and development and access finance and funding. A unique business support network set up by the European Commission and operating in 50 countries helps them to do just that.

he Enterprise Europe Network, made up of close to 600 local business and innovation organisations, is the world’s largest business support network. It connects European small- and medium-sized enterprises (SMEs) to cross-border business and technology partners and offers valuable information and advice on how to access finance and apply for EU-funded programmes and protect intellectual property.

With branches around the globe acting as a onestop shop, the Enterprise Europe Network helps companies to identify their potential, needs and relevant EU funding and finance opportunities. Active in the European and 23 countries in the Americas, Asia, Africa and Middle East, the Network offers comprehensive advice and assistance to businesses and entrepreneurs free of charge, helping them make the most of the opportunities in Europe and beyond.

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After four years in operation, more than three million SMEs have already profited from the Network’s support. IMPROVING ACCESS TO FINANCE FOR SMEs Accessing finance is a key concern for small businesses. They often struggle to convince financial institutions to invest in them or lend to them. The EU has established tools specifically targeted at SMEs, providing guarantees, loans and

Autumn 2012 Issue

Small and Medium Size Enterprises

CASE STUDY: Uncorking new possibilities Brought together by the Enterprise Europe Network, a Spanish SME has teamed up with

equity to financial intermediaries who can then lend to small businesses or make available equity finance. The tools have been specifically developed to cover areas of the market where access to finance is difficult and to target companies’ start-up, expansion and business transfer phases. So far, more than 160 000 European small businesses have benefited from loans backed by the European Commission’s financial instruments. On average, each SME that gets a guaranteed loan creates 1.2 jobs. Other EU initiatives also facilitate access to loans and equity finance for SMEs, such as the PROGRESS Microfinance programme, specifically designed to respond to the needs of the European microfinance sector, and the initiative JEREMIE, which makes use of the European Structural

German researchers in an EU-funded project to prevent contamination in wine corks. A common fault in wine, ‘cork taint’ affects as much as 5% of the bottled wine in Europe, resulting in annual losses of EUR700 million. To combat the problem, a team at the Institute of Plasma Research in Stuttgart, Germany, is leading a project called Neatcork. The goal is to treat the corks in an atmospheric pressure air plasma process before sealing the bottles, eliminating any risk of cork taint. For help assembling a research consortium the Institute turned to the Enterprise Europe Network branch SteinbeisEuropa-Zentrum, who invited the institute to meet with a group of companies brought to

Funds for SME finance. All these instruments are not directly available to SMEs but are implemented by the European Investment Fund (EIF), which acts on behalf of the European Commission and works with selected financial institutions at national and regional level, such as banks and venture capital funds. To find out more about the financial instruments and how to get in touch with them, start by contacting your local branch of the Enterprise Europe Network. Its experts will help identify the sources of finance that best suit your business and offer tailor-made advice. ACCESSING EU PROJECTS AND FUNDING European programmes offer funding opportunities in many sectors, such as research and innovation, environment, energy and transport. Companies

the Stuttgart region by the Network branch in Barcelona, ACC1Ó. One of them was the Catalonian Research and Innovation Centre (CRIC), a private research and innovation centre based in Barcelona. In fact, a local company with whom the centre has close ties, Maquinaria Moderna, an SME specialised in machinery for wine bottling, was looking for ways to avoid this spoilage. The Neatcork project came to light soon after the company mission. The project has received EUR1.01 million in funding under the EU’s research programme FP7 and it expects to develop a technology that can potentially benefit thousands of European wine producers.

can apply directly for these thematic programmes, on condition that they present sustainable, valueadded and transnational projects. The EU’s support comes in the form of subsidies which only cover part of the costs of a project, known as co-funding. The major funding initiative is the Seventh Framework Programme for Research and Technological Development (2007-2013) or FP7 for short. The indicative budget for the SME is around 1.3 billion. The European Enterprise Network helps SMEs apply for FP7 funding, which can be a complex task. Network experts can help find international project partners, formulating their project ideas and increasing their proposal-writing and project management skills to prepare winning applications. So far, the Network has helped more

CASE STUDY: Guided tours for the digital age Thanks to the Enterprise Europe Network and Icelandic technical know-how, two former radio journalists from Germany are selling their multimedia city tours to iPhone users. Through their Trier-based SME called Audiobits, Markus and Ute SchneiderLudwig produce audio books, podcasts and self-guided audio tours. For help building the business the husband and wife turned to the Enterprise Europe Network, based at the IHW/HWK Europa- und Innovationscentre. Using the Network’s powerful business matchmaking database, Network expert

Thomas Weinand came across an intriguing company, Locatify, a client of Reykjavikbased Network expert Kristín Halldórsdóttir at Innovation Centre Iceland. The smartphone technology start-up was seeking content providers in the niche virtual tour guide field. The companies agreed to cooperate, inspiring the Ludwigs to create a multimedia iPhone tour of Trier. The 30-minute tour of Germany’s oldest city, complete with maps and images, is led by fictional wine merchant Claudius Publicus and Medieval-era nun Sister Brunhildus.

Oldest city in Germany – Trier

CFI.co | Capital Finance International

Small and Medium Size Enterprises

CASE STUDY:

The sweet smell of success for a Swedish firm Dalecarlia Chocolates’ star product is a chocolate praline in the shape of the Dalecarlian horse, Sweden’s national symbol. With exports to more than 30 countries worldwide, the company wanted to bring the taste of Sweden to an even larger audience and break into one of the most attractive foreign markets, China. The company contacted the Enterprise Europe Network based in the Teknikdalen Foundation in

Borlänge for help. As one of nearly 600 partner organisations across Europe and beyond, the Borlänge hub was able to quickly contact its Chinese counterpart in the city of Wuhanand the University of Dalarna. Together they looked for the right partner to distribute and promote the Dalecarlia brand. The Swedish company is now opening a sales office in China.

Dalecarlian Horse

than 1 500 SMEs to apply for EU research funding. The Network also sees public procurement as a prime market opportunity for creative concepts, products and services. Members hold events to bring together buyers and sellers, and introduce companies to authorities who are actively seeking innovative products. PROMOTING CROSS-BORDER COOPERATION The European Enterprise Network encourages SMEs to do business across borders through partnerships and technology transfer agreements. In three years, 4 300 cross-border cooperation agreements were concluded through the Network with a total impact on sales growth estimated at € 450 million. Participating firms created 2 400 new jobs. The partner organisations have access to two powerful databases: one for business partnerships and one for technology transfer. Company profiles and offers are inserted into the databases and

made available to the whole Network. Local offices use the databases to search for the right match for their clients and then help them to link up. The databases are among the world’s largest, and contain more than 23 000 profiles. In addition, the Network organises brokerage events to bring companies together. Experts also provide advice on European regulations and intellectual property law. SEIZING GLOBAL OPPORTUNITIES A recent study carried out by the European Commission showed that trading abroad is of major importance for European SMEs, and the European economy, given that internationally active firms report employment growth of 7% compared with only 2% for companies that have not internationalised. However, SMEs face particular obstacles to tapping the global market, not least when it comes to access to market information, locating possible

The Enterprise Europe Network was set up by the European Commission’s Enterprise & Industry Directorate-General and is managed by the Executive Agency for Competitiveness and Innovation. To find the Network near you, visit ec.europa.eu/enterprise-europe-network

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customers and finding the right partners. In addition to helping European companies to make the most of their opportunities in the single market, the Enterprise Europe Network opens doors to markets beyond EU borders. With branches in 21 countries outside the EU – in Europe, the Middle East, Asia and the Americas – the Network is well-placed to help European enterprises establish themselves in foreign markets. Network experts also help SMEs facing complex issues such as compliance with foreign laws, for example mandatory rules of contract law, customs rules, technical regulations and standards, managing technology transfer and protecting intellectual or industrial property rights. i

> Africa’s New Metropolises:

Cities Built to Thrive By CFI

Supported by a wall of money and faced with an urban population explosion, Africans are designing the metropolises of the future.

t can take three stressful hours to jostle, bumper to bumper, from Lagos’s airport in Ikeja to a hotel in the centre of town. Angola’s capital Luanda, where a room weighs in at $400 a night, sits alongside Tokyo as the most expensive city in the world. Travel to any African city and diversity and excitement aside, unpredictable

infrastructure, poor services and planning and sprawling slums eventually blight the journey. As investors turn their gaze on Africa, its cities will be a determining factor in attracting investment. And the pressure is on to mould them for the future as rural populations arrive en masse. Few will see as rapid an expansion as

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Ouagadougou, the capital of Burkina Faso, which the United Nations agency UN Habitat predicts will grow by 81% in the next 10 years to 3.4 million in 2020; or Lagos, which will soon overtake Cairo as Africa’s biggest city. With no time to waste, few resources to spare and tough environmental challenges, African cities have to come up with

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and Latin America and coming to Nairobi, Lagos and Cape Town. “People rely on private vehicles because public transport isn’t predictable, but we believe IT can help public transport work better,” says Tony Mwai, IBM’s country general manager for East Africa. Transport inefficiencies in Nairobi cost an estimated $517,000 (€417,000) a day in lost productivity, fuel consumption and pollution. New city infrastructure such as BRT systems, fibre-optic cables and modern technology mean African cities harbour an advantage despite the challenges. Developed countries’ cities struggle to maintain dated and crumbling infrastructure and have to take out the old before they can usher in the new – indeed, New York spent millions pulling out old copper wiring before it could lay modern cables. “Africa has a once-in-a-generation opportunity,” argues ZemedenehNegatu, East African managing partner for Ernst & Young, who talks about a “wall of money” coming Africa’s way and most recently advised drinks group Diageo on its $225m purchase of Ethiopian state-owned brewer Meta Abo. “Because it is the least urbanised continent on Earth, Africa has a blank sheet of paper when it comes to building its cities. Africa can learn lessons in how not to urbanise and get it right.” It’s a central theme at UN Habitat in Nairobi, which argues cities in developed economies grew at a time when oil was cheap and cars ubiquitous, but that this model is out of date today. “Copying the European and American car-dependent urban models isn’t the desirable direction or a feasible, long-term option,” argues Dr Joan Clos, its executive director. “Re-imagining urbanism is the key term here, whereby we have to draw attention to different urban options for environmentally sound and better-organised cities in Africa.”

ways to nurture inward investment and build capacity for the future. This is prompting some startling innovation.

“We believe that cities will unlock the future of Africa.” Arnold Meyer, Head of Renaissance Capital’s real-estate arm

Technology is helping traffic-choked cities to get moving. For example, IBM ramped up its presence on the continent to service a client, India’s BhartiAirtel, when it bought telecom operations in 17 African countries a few years ago. Now, through its Smarter Cities initiative, IBM is advising authorities in Accra, Nairobi and Johannesburg on how to tackle congestion. Mobile data is being used to build traffic databases to better predict bottlenecks, site relief roads and forewarn hauliers carting their wares into city centres of traffic levels. Sensors and CCTV will help enforce rules and capture data for the bus rapid transit (BRT) systems some cities are introducing. Bereft of funds to build underground networks, these dedicated bus lanes – with subway-like stations where passengers pay for tickets before they board – are a green, affordable solution to congestion, proven in China

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Gordon Pirie, deputy director of the African Centre for Cities at the University of Cape Town, thinks local efforts are key to making Africa’s cities environmentally and socially sustainable. He says modernisers are too quick to duplicate cities in developed economies and that the solution to Africa’s urban development and better service delivery lies in indigenous, small-scale initiatives. He highlights society and community-based schemes like Cape Town’s Violence Prevention through Urban Upgrading initiative. This group has come up with ways to reduce violence and crime in the township of Khayelitsha by changing the design of neighbourhoods, improving the lighting and landscaping. In another initiative, Kenyan entrepreneur and architect David Kuria has built a business around the provision of public toilet and shower facilities. Staff man and clean the units, which are sited amid the hustle and bustle of newspaper stands, shoeshine stalls or moneytransfer booths in what he calls a “toilet mall”. The idea is to try to change social norms and encourage more people to use public toilets, he says.

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Infrastructure developments can be bogged down by corruption, bureaucracy and land-rights issues. So far Nairobi has 34 pay-per-use eco Ikotoilets across poor communities, with more in the offing. In fact, most of the small-scale, local innovations that Pirie believes will change Africa’s cities are environmental. Cape Town plans to derive 10% of its power from renewables by 2020. Its bid to cut emissions includes schemes such as installing 300,000 solar water heaters over the next four years. In Lagos the government has introduced a waste-to-wealth programme that converts about 10% of the city’s waste to other uses. Around 40 tonnes of paper, plastic and nylon are recycled daily and the state government hopes to triple this to 35% by 2015. Accra in Ghana was praised for its robust environmental policies in the African Green City Index, a research project backed by German conglomerate Siemens, ploughing into Africa and winning contracts through its Infrastructure and Cities division. The research, which aims to give governments an insight into pressing environmental challenges, found that local assemblies work successfully

Eko Atlantic hailed as ‘Africa’s Hong Kong’ will be a masterpiece of urban planning with wide boulevards, tree-lined avenues and views over the marina waterfront. with the national government to implement green policies and that Accra has introduced environmental monitoring that gauges air quality and sanitation, unprecedented in Africa. Some 74% of the city’s power supply is derived from hydropower and ambitious projects such as One Airport Square have set a high bar for all new and aspiring green developments. The building, which houses business and retail units, consumes 40% less energy than comparable buildings, recycles rainwater and has concrete overhangs to provide shade. Residents in Accra’s informal settlements are also more likely to have land tenure, meaning they have better access to services and are more likely to upgrade facilities themselves. In another trend, new cities and satellite towns are springing up. Soon it’ll be hard to believe that Tatu City, being hewn out of a 1,000 hectare site 15km north of Nairobi, was ever a lush coffee plantation. The developers behind Kenya’s first purpose-built city believe it will reflect the zeitgeist of a modern,

urban nation – the kind of place where people have their own front door, car parking, electricity and easy access to schools, work and shopping. Construction has begun on phase one with basic infrastructure going in to serve a commercial and business hub. A residential area will follow, housing 62,000 people along with hospitals, police stations and green parks; developers are now trying to persuade Kenya’s Stock Exchange to move here. “We believe that cities will unlock the future of Africa” – Arnold Meyer, Head of Renaissance Capital’s real-estate arm “We believe that cities will unlock the future of Africa,” says Arnold Meyer, head of the Russian banking group Renaissance Capital’s real-estate arm, backers of the project but with sights set continent-wide. The bank has bought up land around major cities including Luanda, Accra and Harare in Zimbabwe and is currently working on a master plan for a new city outside Lubumbashi in the DRC. It also has a stake in Roma Park, a 104-hectare site in the Lusaka suburbs, Zambia’s first mixed-use complex that will combine residential, industrial and retail developments when it opens. “We will put in the infrastructure, lay the foundations, and then let cities grow naturally,” says Meyer. But building new cities isn’t straightforward in a continent where infrastructure developments can be bogged down by corruption, bureaucracy and land-rights issues. “It’s not in the nature of local people in Africa to sell their land,” says Peter Welborn, head of residential and commercial property at estate agent Knight Frank’s Africa division. It’s a challenge Lagos has navigated by building a city based on land reclaimed from the sea. A new island called Eko Atlantic is already being hailed as ‘Africa’s Hong Kong’. This four-squaremile business and residential development will accommodate 250,000 commuters a day and have 250,000 homes, plus office space, marinas, giant malls, trams, its own power station and skyscrapers. “It will be a masterpiece of urban planning with its wide boulevards, tree-lined avenues and views over the marina waterfront,” gushes the company behind its development, South Energyx Nigeria. A so-called Great Wall of Lagos will protect the city from the pounding Atlantic and give more shelter to Lagos, which has retreated 1km since the 60s because of coastal erosion. The theory goes that more cities will reduce the primacy of giant capitals and spread prosperity and wealth around nations. “Concentrating almost all national human, economic and other resources in a geographically concentrated area is one of Africa’s key problems,” says Clos. “It generates huge cities that become dysfunctional because of pollution, congestion and crowding.” New

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cities will also encourage the relocation of large organisations. The rejuvenation of Nigeria’s oil city Port Harcourt, for example, should lure back big oil and gas groups that relocated their staff to Lagos during the militancy. Nigeria LNG has already announced plans to move its HQ to purpose-built offices and once the big oil companies go back, support services will follow. There is no need for all government ministries to be located in a country’s capital city, argues Clos, who is speaking at the World Urban Forum in Naples. “Why not put fisheries ministries near the coast?” he asks. But not all new cities have gone down a storm – indeed, satellite towns excite fierce debate. Critics say they lure high-income groups, with house prices out of reach of the masses. It’s argued that they foster property bubbles and pockets of exclusion – or, alternatively, will become the ghettos of tomorrow, put up fast and cut off from their environment. Nova Cidade de Kilamba outside Luanda is a case in point. This mixed residential development – with its 750 eight-storey apartment buildings, schools and more than 100 retail units – has sprung up in the past three years and stands empty. Built by the state-owned China International Trust and Investment Corporation for an estimated $3.5bn,

The best and unique aspects of Africa’s existing cities are the thriving SME cultures. most of the apartments are still uninhabited because the majority of Angolans can’t afford them. Nor, critics say, will new cities ever capture the best and most unique aspects of Africa’s existing cities, like thriving SME cultures. New cities won’t have the backyard jumble of tiny shops where entrepreneurs congregate and share ideas on pavements. These informal business incubators spin out entrepreneurs who have honed a makeshift inventiveness in electronics, telephone banking, energy-saving devices and the arts. Alternative solutions to housing could be more low-cost homes within a city’s own confines. In Addis Ababa, Ethiopia, Jemo Condominium Site in the suburbs of Lideta and Gulelle houses 10,000 condos, with another 100,000 in the pipeline for low-income families. Satellite towns may not be the solution but they are a sign of progress nonetheless. “Every journey starts with the first step and the renewed African attention to urban planning and management of its cities is a major breakthrough,” says Clos. “It shows that Africa’s general perception of the importance of cities and the human habitat of the future is changing.” By better organising cities and developing mixed-use land, city dwellers don’t have to travel so far between home and work and

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cities function more efficiently. UN Habitat estimates a city’s poorest inhabitants spend up to 30% of their income on transport getting to work. Africa’s cities are doing more to improve their revenue collection too. Initiatives are focused on building a culture of payment but also developing new ways to generate revenue and collection. IT is being used by city authorities to make government services more transparent and improve the tax take. “IT systems take the human element out of it,” says IBM’s Mwai. In Lagos tax revenues have increased from $3.7m a month in 1999 to nearly $92m. Governor Babatunde Fashola says tax rates have not increased but enforcement has. In a groundbreaking scheme at Tatu City, the developers have wrested control of essential services off Kenyan utility companies and in the first project of its kind the city’s own, privately run council will collect taxes and provide services. In this way the Tatu council will act as a retailer of electricity and water, buying in services in bulk and selling them on in what Meyer heralds as the “future for African cities”. He adds: “Governments should put in place the regulator framework and let the work be done by private institutions.” Despite the tough business climate, foreign investors flock to Africa’s cities by the day. Burberry has just opened its first boutique in Johannesburg; Gucci and Prada are in Casablanca. In Dar es Salaam, Honda has teamed up with a Tanzanian company and is preparing to build a plant to sell cars locally. South African supermarket chain Massmart, now majority owned by US giant Walmart, is expanding into Nairobi. Ghanaian company Gadco, the largest commercial rice farmer in the country, is planning an assault on Accra. It’s developing an integrated value chain encompassing farms, processing plants and distribution networks to feed the city, and others, in a process its founder, Nigerian entrepreneur ToksAbimbola, calls “turning African agriculture on its head to point at Africa, not the West”. As investors pile in, now is the chance for cities such as Lagos, Nairobi and Johannesburg to realise their ambitions and become truly world cities. Efforts to overhaul infrastructure, transport, housing and planning have a new urgency. i

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Small and Medium Size Enterprises

> Mona Vyas: “The Entrepreneur” – A Sense of Balance rom the moment of conception to the surrender of the last breath, entrepreneurs have to fight innumerable battles: political, cultural, economical, sociological, psychological, metaphysical, geopolitical, hereditary and biological.

per cent in comparison to 2011. Asia has reported an outstanding economic growth of 7.9 per cent for this same period[3]. A reason for this expansion? Perhaps a greater sense of balance has been achieved by entrepreneurs.

The world today reflects a complex, unpredictable and incalculable playground. Are there underlining factors surfacing and steering the success and failure rates of enterprises?

“I believe the journey in 2012 is into the more personal aspects of entrepreneurship…”

Predictably, the headlines are covered with business closures throughout the globe. The UK has a very high failure rate for start-up businesses. It is reported two-thirds of entrepreneurs fail. In 2011, 23,600 businesses collapsed. This is expected to hit 25,600 in 2012 and 25,800 in 2013[1]. These are startling figures that cannot be ignored. How many jobs are lost? How many families are effected? How many health problems arise and literally how many lives are lost? One of the great failures is a poor fit between the entrepreneur and their venture. But we must question “poor fit” at which level? The entrepreneur and “the markets” or the entrepreneur and “the mind”? Another reported fact is that 69% of VAT-registered businesses cease to trade within ten years of registering for VAT[2]. This figure does not take into account the failure rates amongst the majority of start-up businesses, which undoubtedly is higher, some predicting almost 80%. Naturally, this means our societies are accepting these great failure rates. So how does an entrepreneur achieve success when faced with growing, interconnected markets with so many varieties of inner and outer conflicts? Can a balance between competing interests truly be achieved? The world of global commerce is fast-paced and set within a polarised world; the right wing and the left wing; the republicans and the democrats; the rich and the poor. It is fragmented yet intertwined at best, the coalition government an example. The world of commerce has no global governance, no global regulations and indeed, the absence of a global model that is aligned throughout economies. It is evident that opposites are in conflict, and the “modern entrepreneur” is placed facing a fractured world. The entrepreneur is competing for victory in every encounter of the fast changing global world. Despite the downturn, the global economy has expanded, albeit at a slower pace than in 2010. This year the U.S economy has grown by 1.8 per cent, and the GDP of the troubled eurozone rose by 1.6 72

Mona Vyas

So what is an entrepreneur? An entrepreneur is an enterprising individual who builds capital through risk and/or initiative, contributing significantly to its economy, and thus the global economy. Entrepreneurship is unquestionably the back bone of each community, economy, country and continent. SME’s in the UK account for 99 per cent of all enterprises, employing 13.8 million people and have an estimated annual turnover of £1.5 billion[4]. In a recent study[5] between 2002 and 2010, 85% of all net new jobs were created by SME’s. Yet, alarmingly, it has been reported that there was a 20.3% increase in businesses failing in Quarter 3 2011 compared to the same period in 2010 and a 7.8% increase in failures for Quarter 3 2011 compared to Quarter 2 2011[6]. These are astonishing figures. This sector can no longer be overlooked and is screaming for aid. But why do they fail? The most common reasons are inadequate understanding of the business and insufficient capital to sustain the venture. Even though these are the two most obvious contributors cited, entrepreneurs face two conflicting yet interlinked sensory battles on their path to success prior to these. I believe the journey in 2012 is into the more personal aspects of entrepreneurship and a new dimension on solving difficult problems and conquering challenging times. The inward battle – the physiological, the sociological, the determination, the culture, the mythology, the natural creativity, and one’s integrity, morals, ethics, and disciplines; and The outward battle – the systems, the government, the bureaucracies, the geopolitical constraints, the turbulent markets, the challenges and obstacles beyond one’s control and predictions. Within these battles are underlining principles that surface and form a great part of the journey to an entrepreneur’s success. It is these underlying (and CFI.co | Capital Finance International

often overlooked) principles that determine the success or failure of a venture, and indeed, the entrepreneur; in advance of the common factors being brought in to play. This article serves to highlight the importance of the underlying principles. In conjunction rests the notions of conflicting but intertwined inward and outward battles. A successful enterprise can only be achieved by accepting that neither the inward nor outward battles will be sustainable without the other. In essence, it requires a conscious “sense of balance.”

Underlying principles: AN INTROSPECTION OF “THE SELF” At the core of all enterprises lies evident the “seed planted”. An introspection of your own strengths, weaknesses, cultural assets and indeed, your life’s purpose; how can one connect to the world of entrepreneurship? Fundamentally, it is an examination of the inward battle. It’s an examination of one’s attributes, discipline, ethics, morals, determination, and creativity, and aligning that to the venture itself. It is the relationship of how these core tenets will enhance the venture, and the examination of how they will interplay with outer influences; how they will affect the market place, how the business will be a reflection of the entrepreneur’s core being. Unless there is a perfect alignment between the founder of the enterprise and the venture itself, there will be a high chance of failure. This exercise is vital prior to putting any business plans into action. VISION & MISSION The vision will be the greatest personal resource of an entrepreneur. A visual that is perfect and reflects a compelling cause of the future outcome will lay a strong foundation. The mission is the drive to achieve the vision. It can be condensed to a statement that defines the enterprise at the most basic level that drives your vision forward, serves as a reminder of your vision and guides the actions of the enterprise. THE GAME PLAN Great thinking precedes great achievements. Intelligent strategic planning will usually result in a fortunate future. Planning for the future requires longterm thinking; setting priorities and concentrating until they are accomplished. It is being aware of the obvious such as securing capital, the premises, the employees, the business plans, to the unobvious of identifying, and forming relationships with, key players who impact and add value to the venture, as well as setting quarterly targets, monthly milestones, weekly agendas and daily disciplines.

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It is here where an entrepreneur will sometimes collide with the outward battle, but minimising risk is taking a step closer to achieving success. What is the end goal? How will you get there? There is a fine line between the altruism and the enlightened venture’s self-interest that ensures long-term profitability. Profits must be kept in their appropriate framework. The late Peter Drucker, the management expert, said it so well: “There is nothing so useless as doing efficiently that which should not be done at all.” Be clear on your activities. It is the power of focus, for clarity precedes success. CULTURAL AWARENESS Deal first or relationships first? Informal relationships or formal relationships? Decisions, decisions… It is imperative to appreciate patterns of cross-cultural business behaviour across the globe. Cross-cultural influences cannot be escaped in an increasingly globalised economy. Cultural differences impact everything from communication, attire, organisational culture to project management. Entrepreneurs who take cultural differences into account and practically prepare strategies for global liaisons will stand a higher chance of success than those that are ignorant. This interplays with an earlier tenet of introspecting oneself; realising the value of one’s own culture, which is interlinked within the global business culture. The venture will only enhance to the degree the entrepreneur is willing to learn and develop. In today’s globalised world, culturally educating oneself is a prerequisite to success. Understanding selfdevelopment is a lifelong learning process can only elevate an entrepreneur’s success. PHILOSOPHY Many say philosophy is for fools. But much of the history of the 20th century is more or less the product of a small number of philosophical ideas and the philosophers who created them: Marxism ruled

the lives of more than a 100 million people; Fascism destroyed the lives of millions of people and caused a World War; both Marxism and Fascism were opposed by men in the name of Liberalism, Democracy, Catholicism, Protestantism, or Science, each of which are themselves either specific philosophies or derived from more comprehensive philosophical systems. Whilst Marx and Nietzsche were regarded as unsuccessful, it can be argued that their ideas and values created and destroyed civilisations. The lives people lead and the choices they make are the result of the philosophies they hold, whether they are conscious or unconscious of this fact. Human beings orient their lives around their perceived realities, what they believe is the prism through which they explain their experiences and relationships with others and the basis upon which their moral code is formed and developed. Similarly, the entrepreneur’s philosophy is one of the leading causes affecting the success of the enterprise. Fundamentally, philosophy deals with the logical side of life’s information and thinking habits. What we know determines our philosophy, how we feel about what we know determines our attitude toward market conditions. It is the “business philosophy” that will determine the direction of the venture and steer forward the enterprise. Never before have enterprise creation, economic risk, political barriers, regulatory framework and geopolitical aspects been more closely intertwined. Entrepreneurs must accept the conflicting inward and outward battles. Entrepreneurs must consciously capitalise on their strengths and weaknesses learnt from the sensory plains of inward and outward introspections. Failure can no longer be accepted; perseverance must be the course for steering the enterprise. Through a sense of balance and alignment, entrepreneurs must renew their own determination to conquer the venture’s mission and enhance global economies. i CFI.co | Capital Finance International

ABOUT THE AUTHOR Mona Vyas CEO of Global Portfolio Partners Ltd (UK) Mona has worked on a number of large scale real-estate projects in Europe, Africa, the Middle East, Asia and Central America. Throughout her career, the business activities of Mona have been wide and varied with focus on three principal business sectors; business analysis, turnkey solutions and valued engineered solutions for integrated resort schemes. Cultural nuances may be important too, and understanding them can be a vital ingredient in developing successful projects. She speaks four languages fluently in addition to English, and is comfortable operating all over the world. With 25 years of experience in international business development, Mona has developed a refreshing and innovative approach. She has sound business acumen, and possesses a highlydeveloped sense of personal integrity, combined with an altruistic nature. She sees no conflict between these attributes and gaining commercial success – indeed quite the opposite. She believes that it is only with these attributes that she, and her clients, can achieve the full extent of success they strive for. [1] A report by BDO LLP -Industry watch survey [2] FinancialPreneur.com [3] Knight Frank Global Wealth Report 2012 [4] Department for Business Innovation and Skills November 2011 [5] Presented by the European Commission [6] Equifax Quarter 3 Business Failures Report 2011

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> International Finance Corporation (IFC):

Banking On Women – Changing the Face of the Global Economy

omen entrepreneurs are changing the face of the global economy, helping to sustain job creation and economic growth. While investors are increasingly looking to the BRICs and beyond for growth opportunities, the fact is that women represent the largest emerging market. It is estimated that women-owned entities represent over 30 percent of registered businesses worldwide. According to the Harvard Business Review, women control about $20 trillion in global consumer spending and it is projected to reach $28 trillion by 2014. However, all too often women, including women entrepreneurs who already face societal and cultural barriers also find it more difficult than men to gain access to finance. The International Finance Corporation (IFC), part of the World Bank group focused on private sector development as a means of lifting people out of poverty, is seeking to increase access to finance for women entrepreneurs. We

do this by leveraging our extensive global network of more than 850 financial intermediaries and by working with corporations that share our objective to strengthen and broaden outreach to women. IFC has set itself ambitious targets and in FY 13 IFC has committed to support projects that will provide access to financial services to $22.74 million micro or individual clients, at least 50% being women, and to 750,000 small and medium sized businesses (SMEs), at least 25% being women-owned. Financial inclusion and access to finance for women including women micro entrepreneurs has positive impact. Last year, IFC was able to extend about $33 million microloans around the world through its client network. The challenge is to increase access to finance for women entrepreneurs who operate entities that are larger than micro enterprises. For example Millar Landy Quiroga, a woman entrepreneur who runs a micro business in the Colombian Capital Bogota, who is a client

A female entrepreneur in Nigeria

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of BancaMia, is grateful for the micro loans she received to improve business at her family run lumber yard. As she says “Thank God we have done so well, that’s what the loans have helped us with” and she has plans for the future, “I would like to create more jobs, hire people, [and] make it a bigger company.” While Microfinance has an important role to play, it is only one part of the solution. The challenge is how to improve access to larger formal sources of credit for women. However, there are many barriers. Unfavorable business and regulatory environments are among the barriers that impede women entrepreneurs from accessing finance. The fact that many emerging markets financial institutions do not tailor financial products and services to women entrepreneurs represents a missed opportunity and constrains private sector development. IFC’s Banking on Women program is working towards realizing the objective of increasing access

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to finance for women entrepreneurs. It is playing a catalyzing role to help partners and financial institutions worldwide to profitably and sustainably serve businesses owned and run by women, focusing on regions and countries that have strong enabling ecosystems for SMEs as well as large numbers of women entrepreneurs. IFC is targeting global, regional and local financial institutions with an SME lending track record as partners, as well as the value chains of local, regional and global corporations that share the objective to strengthen and broaden outreach to women entrepreneurs. IFC uses its investment capital to help financial institutions profitably expand their portfolios and to help women entrepreneurs access finance and strengthen their businesses. We are also exploring non-traditional models for increasing reach to women entrepreneurs through community banks, cooperatives, chambers of commerce and business associations. During the fiscal year that ended June 30 2012, IFC invested in six projects around the world. Three investments in Eastern Europe for a total of $50 million for lending to Women-Owned SMEs, in Garanti Romania, Abank in Turkey, and Fibabank in Turkey. The program has also made two investments in Asia, with $75 million to BII Indonesia, 30 percent of which is for Women-Owned SMEs and a further $25 million in loans to OCB, Vietnam, with a 30 percent carve out to Women-Owned SMEs. The program is already started to show signs of success where it was launched in Eastern Europe. In Turkey, many women own or run smaller businesses, but only 15 percent of women have access to formal finance. IFC and its clients are trying to change that. In FY12, IFC partnered with FMO, the development bank of the Netherlands, to provide a $40 million loan to a bank to increase finance to small and medium enterprises owned by women entrepreneurs. More than half of the loan has been on-lent to women entrepreneurs so far. In the Bayram Pasa district of Istanbul, Dilek Seyitoglu oversees the operations of Star Plastic, a small but successful manufacturer employing 25

people and exporting its plastic products to over 10 countries. “We had been working with Abank for two years,” said Seyitoglu. “Then our bank suggested this financing for women entrepreneurs and we successfully applied for it. Thanks to the Abank loan we bought our facility and, thanks to this, we can look at the future with confidence.” Seyitoglu believes such loans will play an important role in supporting women, including women entrepreneurs. “Men are dominant and active in business life in Turkey, so supporting women with these women entrepreneurship loans from Abank and IFC is very important in helping women become more present.” Then in July 2012, IFC provided long term client Bank of Georgia with a $25 million loan to support the Bank in reaching out to female entrepreneurs, who face more challenges accessing credit than their male counterparts. Through the bank’s network of 164 branches, the program is expected to help SMEs both inside and outside of the capital Tbilisi. Bank of Georgia’s interest in the program was piqued after they worked with IFC on a womenowned SME survey, which found that such businesses comprised noticeable proportion of the Bank’s SME lending. However, focus on providing access to finance to women by the Georgian finance sector still represents a largely untapped market opportunity. With the Bank of Georgia already a dominant player in the SME space, it has now rolled out innovative products targeting the underserved but high potential women entrepreneur market. Additionally, Banking on Women, is not just about social and economic development, it makes good business sense. Take the example of the Australian market leader Westpac, who believe the ‘female economy’ is worth investing in. Westpac has found that focusing on the women segment has been a powerful tool for strengthening their balance sheet. Westpac’s value proposition for the women segment combines strategy focused on marketing, branding, financial educa-

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tion, and face-to-face and social medium networking as well as volume targets supported by continuous research. Westpac has also found that whilst women clients are more risk-adverse and need more information to make decisions, they are better depositors. They remain loyal to institutions that treat them respectfully and are strong brand advocates. The benefits of increasing reach to women clients can be measured by revenue increase and balance sheet growth for banks, and improved incomes for women and their families, and increased economic development and growth for countries. Gender equality is smart economics, as more women participate in the workforce, the more a country’s per capita income increases. IFC also offers advisory services to financial institutions to deepen their ability to reach women-owned businesses through: strategic planning, market positioning/segmentation, product repositioning and staff training. The management and business skills of women entrepreneurs need strengthening. IFC is working with women entrepreneurs providing customized training in business planning and management, financial literacy etc. IFC also facilitates networking and mentoring sessions for market expansion and business growth. We have even launched a Banking on Women LinkedIn group to help connect women entrepreneurs and client banks. With our network of clients around the world IFC has the platform and expertise to effect positive change for access to financial services for millions of women in emerging markets and it is a development imperative we can deliver on. A robust pipeline of new investments is under development and IFC is working on establishing new partnerships around the world with financial institutions, corporations, chambers of commerce and business associations to achieve ambitious goals of increasing access to finance for women including women entrepreneurs. i

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> European Investment Fund (EIF):

Loans for Microbusinesses Across Europe

fter completing his 26-month military service, Andronikos (23) set up his own car wash business on his parent’s land. The land in Episkopi had been unused for a few years and even though he had thought of opening a carwash before, he did not have the means to buy the equipment needed. He went to the Co-operative Credit Society Kouriou to ask for a micro-loan of EUR 20 000 and weeks later was able to buy a brand new vehicle lift to get the business off the ground and is now washing around 60 cars per week. He currently employs two people and with plans to start washing larger vehicles including tourist buses, tractors and trucks, he will start looking for a new employee to handle the new vehicle lift in the next few months.

entrepreneurs like Andronikos from accessing finance.

“Microfinance has traditionally been a tool for fighting poverty in developing countries.”

Progress Microfinance was set up in November 2010 with EUR 203 million of funding from the European Commission and the European Investment Bank. Targeting all EU-27 Member States, Progress Microfinance helps to increase access to finance for people who have lost or are at risk of losing their job or have difficulties entering or re-entering the labour market. Examples of potential micro-entrepreneurs targeted by Progress Microfinance include female entrepreneurs, young entrepreneurs, entrepreneurs belonging to a minority group, entrepreneurs with a disability and sole traders. The European Investment Fund (EIF) acts as Management Company for the EU Microfinance Platform – European Progress Microfinance Fund, the main vehicle through which Progress Microfinance is implemented. Progress Microfinance does not provide direct financing to micro-entrepreneurs or individuals but loans of less than EUR 25,000 are provided by selected intermediaries participating in the facility.

across the European Union who had business ideas but didn’t have the cash to turn these ideas into a reality. The funding issue is not just a problem for micro-borrowers but also for microfinance providers. According to a European Microfinance Network (EMN) study, ‘the most pressing problem for the microfinance providers is the lack of access to long-term funding’. Progress Microfinance, an EU initiative launched in 2010 helps to bring a solution to this pressing problem. By working with Microfinance Intermediaries to provide support for microbusinesses, Progress Microfinance has helped to remove barriers previously preventing

Eligible intermediaries under Progress Microfinance are any public and private institutions across the EU-27 Member States that provide micro-credits and/or guarantees on micro-credits to individuals or micro-enterprises established in the EU Member States. These could include financial institutions, microfinance institutions, guarantee institutions and other institutions authorised to provide microfinance loans/guarantees. The selection of intermediaries involves looking at their financial standing and capacity, operational capabilities, non-bank status and strategic planning to reach

Andronikos is one of many micro-entrepreneurs

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financial sustainability. Microfinance has traditionally been a tool for fighting poverty in developing countries. However there is a real need for microfinance resources also in the EU and Progress Microfinance aims to meet those needs. A recent EIF working paper on microfinance in Europe provided a comprehensive analysis of the market, concluding that the microfinance market is still immature and fragmented. At the same time it also highlighted its growing importance as a market segment with a potential to help to reduce unemployment while fostering financial and social inclusion. Microfinance fits hand in glove with the EU 2020 objective of targeting social inclusion. The example of Andronikos in Cyprus shows how young entrepreneurs with visions but without finance can eventually become economically selfsufficient through targeted microfinance support. Having sufficient finance to make a business work creates jobs, creates futures and creates important structures within an inclusive society. Less than two years after the launch of Progress Microfinance, 20 microfinance intermediaries have entered into funding or guarantee agreements with EIF which over the next 2-3 years are expected to generate more than EUR 180 million in new microcredits in15 countries across the European Union. The selection of intermediaries will continue until 2016 with a target to generate EUR 500 million of new micro-credits across EU-27 by 2019. Banco di Credito Cooperativo Mediocrati (BCCM) is the 20th and most recent transaction signed under Progress Microfinance since its inception in 2010. To date, commitments of close to EUR

Autumn 2012 Issue

Small and Medium Size Enterprises

What is “micro“? Microfinance is the provision of basic financial services to poor (lowincome) people (who traditionally lack access to banking and related services) (CGAP Definition, Consultative Group to Assist the Poor). Microcredit is defined by the European Commission as a loan or lease under EUR 25,000 to support the development of self-employment and micro-enterprises. It has a double impact: an economic impact as it allows the creation of income generating activities and a social impact

as it contributes to the financial inclusion and therefore to the social inclusion of individuals. A microenterprise is any enterprise with fewer than 10 employees and a turnover below EUR 2m (as defined in the Commission Recommendation 2003/361/EC of 6 May 2003, as amended).

Source: EIF

EIF Took Kit for SMEs: The EIF focuses on the whole range of micro to medium-sized enterprises,

Overall situation of European micro-firms compared to other enterprise size classes: When looking

starting from the pre-seed, seed-, and start-up-phase (technology transfer, business angel

at the business climate of micro-enterprises, the EU Craft and SME barometer shows that micro-

financing, microfinance, early stage VC) to the growth and development segment (formal VC

enterprises on balance estimated their overall situation substantially less favourable than small or

funds, mezzanine funds, portfolio guarantees/credit enhancement).

medium sized firms in the second half of 2011.

Source: European Small Business Finance Outlook, May 2012 (EIF)

Source: European Small Business Finance Outlook, May 2012 (EIF) – UEAPME Study Unit (2012)

“… commitments of close to EUR 80 million under Progress Microfinance have been signed for microfinance providers across the EU …” 80 million under Progress Microfinance have been signed for microfinance providers across the EU including in Belgium, Bulgaria, Cyprus, France, Greece, Lithuania, Poland, Portugal, Romania, Spain and The Netherlands. Financial support under Progress is often complemented by other forms of microfinance support. Through JASMINE technical assistance funding, MFIs can improve visibility and quality of services and products offered. The EIF signed a EUR 3 million senior loan agreement with ‘Mikrofond’ aiming at supporting micro-enterprises in Bulgaria and with ‘microStart’, Belgium, a microcredit pilot programme based in the Brussels

neighbourhoods most affected by unemployment. These two microfinance institutions both benefited from Progress Microfinance funding instruments and from JASMINE technical assistance. In addition to Progress, EIF provides Technical Assistance to selected microfinance institutions and micro-credit providers active in the European Union to increase the quality of their internal processes. JASMINE Technical Assistance services consist of an institutional assessment or a rating exercise performed by Microfinanza Rating or Planet Rating and Capacity building in the form of tailor-made trainings to the staff and management of the selected MFI. Trainings are delivered by experts from the Microfinance Centre, a network based in Poland and active in Asia, Africa and Europe on the other hand. The trainings focus on the weaknesses observed during the assessment / rating reports.

Regional Policy and it is free of charge to the beneficiary institutions. Currently 25 non-bank micro-credit providers were selected to receive an assessment, a rating and up to twelve days of advisory support per year under JASMINE. The JASMINE Initiative acts as a doorstep to potential funding at a second stage under EIFmanaged microfinance mandates, helping non-bank microfinance institutions to scale up their operations and maximise the impact of microfinance products on micro-enterprises development and unemployment reduction within the European Union. Good examples of these synergies are Permicro in Italy, the first EIF direct equity investment into a non-bank MFI, and Qredits in The Netherlands which both signed a guarantee agreement and loan deal with the EIF. i

The Technical Assistance is financed by the European Commission, Directorate General for

EIF’s central mission is to supportEurope’s small and medium-sized businesses (SMEs) by helping them to access finance. EIF designs and develops venture capital and guarantees instruments which specifically target this market segment. In this role, EIF fosters EU objectives in support of innovation, research and development, entrepreneurship, growth, and employment. The EIF total net commitments to private equity funds amounted to over EUR 6bn at end 2011. With investments in over 370 funds, the EIF is a leading player in European venture due to the scale and the scope of its investments, especially in high-tech and early-stage segments. The EIF guarantees loan portfolio totalled over EUR 4.4bn in close to 220 operations at end 2011, positioning it as a major European SME guarantees actor and a leading micro-finance guarantor. CFI.co | Capital Finance International

Small and Medium Size Enterprises

> Brazil Venture Capital:

Fresh Fuel For Tech Triangle Take Off By CFI

Entrepreneurs are finally getting access to the capital to boost Brazil’s tech sector.

ilicon Valley’s presence is now being felt in Brazil. Despite a fast-growing, tech-hungry population and top-rate programmers and engineers, a year or two ago it was nearly impossible to get access to venture capital or angel investment. Indeed, it was very difficult to get any kind of growth capital at all, and the outlook for entrepreneurs and start-ups, unless they were already cash- rich, was bleak. But this is changing quickly. At the end of 2010, investors from Europe, California and the rest of the US began to show interest in investing in a few tech firms, some of which were new, and some of which had been going it alone financially for some time. Now, just months later, many venture capitalists are setting up local offices, hiring Brazilians and working to adapt as quickly as possible to the local environment.

“There´s so much room to grow… The $15bn Brazilian e-commerce market is growing by 35% a year” Angelina Clarke, ex- McKinsey consultant in Sao Paolo

It’s not hard to see why. The now-famous Brazilian economic boom is powered largely by a huge, newly empowered consumer base, whose 200 million members are gobbling up digital products and especially fond of online social interaction. “Internet penetration is growing, broadband

“The first investors were truly angels” penetration is growing very fast, and e-commerce is growing at a rate of 20%- 40% a year,” says Marcelo Sales, one of the entrepreneurs who founded Movile, the mobile phone app success story, and recently left an administrative role to become an angel investor. “Five years ago it was pretty hard to have access to money at all. There were a few angels, but they really were angels – sent from God. It was very difficult to have access to capital in Brazil.” Though Brazil has been growing steadily for years now, cultural and macroeconomic factors have worked against the small-time entrepreneur. Brazil has some of the highest interest rates in the world – a relic from the age of hyperinflation – a riskaverse population and extremely underdeveloped

The São Paulo See Metropolitan Cathedral

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local corporate debt capital markets. A smart programmer who gave up a secure job at a big company to go it alone was considered extremely brave, if not a little foolish. “There´s so much room to grow… The $15bn Brazilian e-commerce market is growing by 35% a year” – Angelina Clarke, ex- McKinsey consultant in Sao Paolo

Autumn 2012 Issue

Small and Medium Size Enterprises

THE TECH TRIANGLE Brazil’s up-and-coming digital playground, the “Brazilian Silicon Valley”, is an area akin to California’s crescent of technology. Almost all cross-border start-up activity has its locus within the triangle extending from the financial capital, São Paulo, to Campinas (a small city in the same state which is a player because of its university’s excellent computer-science

But as the rich countries plunged into deep economic crisis in 2008, and Brazil plugged along relatively unscathed, a flood of international interest, not to mention capital, has descended on the country, opening up previously undreamedof opportunities. When Silicon Valley – broadly defined – woke up to the opportunities here, they found themselves scrambling to cover all available ground. “The market opportunity is even more attractive than the US, because there´s so much room to grow,” says Angelina Clarke, an American who recently left her position as consultant at McKinsey in São Paulo to make her way in Brazil’s growing entrepreneurial scene. ”The $15bn Brazilian e-commerce market in 2010 was bigger than the $12bn Australian market and the $7bn Indian market, [is growing by 35% a year], and if you look around, very few companies are moving fast enough to truly take advantage of it.” There has been a flurry of activity, though. Movile recently acquired two companies in deals to the tune of $12m-$20m; a Groupon spin-off, PeixeUrbano, attracted a lot of attention and the competition of Groupon’s actual local subsidiary, ClubeUrbano; BuscaPé, a shopping comparison site, is gathering steam; and credit-check software developer Crivo is changing the way Brazilians use banks. Some of the deals are secret, but a number of well-known VCs are arriving and ready to put down money. The catalyst for much of this interest was Brazil’s successful bid for the Olympics, to be held in Rio de Janeiro in 2016, and plans to host the World Cup in 2014, says Bedy Yang, who founded Brazil Innovators, a Silicon Valley-Brazil entrepreneurial development network. “But apart from the Olympics and the World Cup, there’s a lot of well-placed optimism around the economy itself,” she says. “The middle class is growing, 30 million people have moved from real poverty to the middle class. And Brazilians are very active in social media. They’re early adapters, for sure.” This is more than just healthy optimism. Brazilians demonstrably love social media. They have one of the highest Twitter usage rates in the world. There are more mobile phone accounts than people, and these are increasingly attached to smartphones. And the population has been migrating quickly to

programme) and Rio de Janeiro. While this is quite a bit bigger than the equivalent in California, it is still a very small fraction of Brazil. There is better technology infrastructure here than the rest of the country, but not the heavyduty stuff of the southern San Francisco Bay. Campinas, because of its size, is most likely to develop an identity uniquely tied to technology,

Facebook from Orkut, the Google-run favourite of yesteryear.

but shouldn’t ever feel a need to break off from the financial behemoth just to the southeast. Most deals will end up being signed in the offices of São Paulo, probably with alumni of Campinas punching above their weight on the tech side, and some of the flashier businesses close to the beaches of Rio.

1999-2000 there were a few start-ups in Brazil, some of which still exist today. The founders of

The Jockey Club, Campinas “If you take the average number of hours that Brazilians spend on social networks, it’s far above the international average, and I don’t know why,” says Sales. “Maybe it’s the social culture. But there is a huge growth of digital goods and everything is coming together to make a good combination.”

The opportunities offered by Brazil outweigh the headaches. The Brazilian entrepreneurial scene has shadowed the upheavals in California. There was a small bit of activity at the beginning of the turn of the century, but the bursting of that bubble left things deflated for almost a decade. “As we know, Silicon Valley has its own cycles and bubbles,” Yang says. “In

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BuscaPé came from universities at that time and said, ‘Hey, we want to create technology and be entrepreneurs,’ but from 2001 to the end of 2010, there was very little movement. The Brazilian economy was doing pretty well, and if you went to a good school, you just took a good job at a tech company or a bank.” Despite the better financial prospects for start-ups, there is still not a strong tradition of entrepreneurship, and failure is often looked down upon. Meanwhile the economic boom is pulling bright young graduates in the opposite direction, as there is a shortage of qualified employees across various sectors, especially in technology and engineering. A bright student is likely to be offered a good, stable job, with high pay (São Paulo currently has the highest executive remuneration in the world), and good prospects for advancement. Why throw that aside for something that might go up in flames?

Small and Medium Size Enterprises

“In Brazil, we tend to take the view that everything is going to go tits up eventually, so if someone tells us in advance that there is a chance it will, we’re positive it has no hope,” says 29-year-old worker Luisa, who was recently approached by international investors with a sizeable headhunting fee to recruit some of her colleagues to a new enterprise with a huge potential upside. She was able to offer them double what they were currently making, but came back empty-handed.

core of intellectual elites” who “understand the concepts prevalent in Silicon Valley well, and have a great respect for Silicon Valley and the US at large. Brazilians love to socialise in business, which can make the process more personal and exciting than in the US. “I continue to be fascinated with Brazil and push through because I believe in the longterm potential this market has to offer,” he adds “and many of the more difficult aspects are likely to show improvements as this market matures.”

“Everyone was either quite content with where they are now, or extremely wary of a couple of gringos with too much money and not enough reassuring guarantees,” she says. “They tended to assume [the investors] would throw this failed project on their CV and take off back to Europe.” This initially left the investors flabbergasted, but they are now trying to establish local roots and partnerships. “One thing that I think is really important is that for the first time, the already existing generation of entrepreneurs, that understand digital markets and digital companies, are now becoming angels and investors,” says Sales, noting they have the experience to create a second generation. “ In the US you have a lot of examples like that, but in Brazil, this is just the beginning. The founders of MercadoLibre [South America’s answer to eBay, with roots in Argentina] and BuscaPé are becoming investors, and I myself am now an angel.”

Arun Mathew at Silicon Valley’s Accel Partners, one of the bigger names to be establishing a presence in Brazil, expects to see quick developments on the cultural front. “The entrepreneurial scene is still nascent,” he says. “It’s very early in the life cycle of the career entrepreneur. People are moving to that world. The computer- science programmes at USP and Campinas [two universities in the state of São Paulo] are some of the best in the world. But at the moment a lot of the graduates are going to large corporations.” Small, innovative firms are especially well- placed to turn revenue in Brazil compared with other emerging markets, he adds, because of the high penetration of credit cards, making online transactions easier. “In Brazil there are opportunities for all types of start-ups, from financial services to consumer internet, and including adaptations of a lot of consumer businesses based here in the US. It’s not just foreigners but Brazilians adapting successful US models.”

Daniel Turini, founder of Crivo – which rode out the last decade with no outside funding – says he has seen the approach of foreign investors change radically since his company was one of the first approached last year. “Not only are they much more interested, many have bought companies or opened offices here and have hired some of the brightest Brazilians to help them understand our business culture and laws,” he says. “They know a lot more than they did just a few months ago.” Another surprise for foreigners has been the complexity of tax codes, bureaucracy and business laws. In a culture where most things are relaxed on a personal level, new arrivals are taken aback to find how seriously one must take an arcane set of codes. It’s often impossible to navigate them without experienced local talent.

“There are two types of start-up activity going on at the moment,” notes Brazil Innovators’ Yang. “There are big investors who like to create local copycats of businesses that were successful elsewhere. AirBnB [a US website that connects budget travellers to people with a bed to rent out] is one example. Take that, and target it to 200 million people in Brazil. “We believe that is just the low-hanging fruit. There is another, deeper space to create really new products here,” she adds. “There’s a lot more capital than there was before – we just need entrepreneurs to show that they will face the risk.” i

“I have been warned on countless occasions of the complexities of doing business in Brazil,” says Ofer Baharav, a Silicon Valley emerging-markets entrepreneur and CEO of start-up VideoVivo. He rattles off a list of the areas he was cautioned about, including major bureaucratic ineﬃciencies, a complex tax system, cultural misunderstandings, a style of doing business that differs markedly from the US’s, an aversion to risk, lack of understanding of the early-stage investment cycle and the absence of a viable investment ecosystem. “Sadly,” he says, “these premonitions have been proven to be right on the mark across the board.” He thinks the opportunities offered by Brazil outweigh the headaches, however, and cites “a

Rio de Janeiro

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State Bank of Mauritius Group (SBM) is a leading financial services group in Mauritius with presence also in India and Madagascar. Set up in 1973 and listed on the Stock Exchange of Mauritius since 1995, SBM is owned by some 16,500 domestic and international shareholders. It provides all services of a universal bank within a diversified business model. The lines of business include: Personal Banking, SME Banking, Corporate Banking, Cross Border Banking and Financial Institutions. Innovation, f lexibility, accessibility and reliability are the key attributes that have contributed to the Group’s reputation and trustworthiness.

SBM aims to pursue its strategy of diversifying its income streams. The Group aims at significantly expanding its India business taking into consideration the excellent prospects that this market offers and building on the experience and expertise garnered in Mauritius. SBM, which currently operates two branches in Madagascar, also aims at further penetrating Africa, building on the close links of the continent with Mauritius. SBM is currently embarked on a major upgrade of its technology infrastructure that is intended to extensively improve customer service and operational efficiency.

STATE BANK OF MAURITIUS LTD SBM Tower, 1 Queen Elizabeth II Avenue, Port Louis, Republic of Mauritius T: (230) 202 1111 – F: (230) 202 1234 – Swift: STCBMUMU – E: sbm@sbmgroup.mu – www.sbmgroup.mu

Sustainability

> DESERTEC:

Clean Power From the Deserts By Michael Düren

Solar power from deserts can contribute significantly to a future renewable energy system. The technically accessible solar potential in deserts exceeds the global energy demand by a factor of 20.

n the DESERTEC concept, a smart super grid based on HVDC technology interconnects wind, solar and other renewable energy sources with distant consumers on a scale of several thousand kilometres. The large grid averages out the natural fluctuations of renewable energy sources to a large extend. A large-scale production of solar energy in desert countries has important socio-economic implications. The interconnection of continents by large power grids introduces new economical interdependencies, which can help to reduce the North-South gradient of economic wealth. ABUNDANT SOLAR POWER For 200,000 years, mankind had a sustainable energy system, based on biomass, wind, sun and water for cooking, heating, mobility and mechanical work. 250 years ago, during the period of industrialization, fossil fuels became available at large scale, and today, they cover 85% of the worldenergy system. The abundant solar power that is available in the deserts of the world can play a key role for a future renewable energy supply. The “clean power from deserts” or “DESERTEC” concept is an inherently international, transcontinental approach, where the central technical starting point is a super grid that distributes electric power over distances of thousands of kilometres and averages out fluctuations of the renewable sources as well as of the energy consumption. The challenge to replace coal, oil and gas also in the non-electricity sector is often forgotten in the public discussion about local renewable energy systems. MISSION IMPOSSIBLE – THE INCREASING WORLD POWER DEMAND Today, the world power consumption is approximately 15,000GW, averaged over day and night and over the whole year. The world is facing an increasing world population and an increasing energy demand per capita, what may lead to an

expected global power demand of approximately 24,000 GW in 2050. Figure 1 illustrates how the primary power divides into fossil, nuclear and renewable energies. Taking the climate goals serious, the fossil contribution has to be reduced by at least 50% in the coming decades to have an significant effect on the accumulated CO2 at all. This means that capacities of 15,000 GW of primary power have to be newly installed without exploiting the remaining fossil resources. For illustration, one should keep in mind that 1 GW corresponds to the electrical power of one nuclear power plant. To build and run 15,000 additional nuclear power plants (fission or fusion) in the next 40 years (i.e. 1 new reactors per day) is simply impossible from the point of view of the qualified manpower that is

Figure 1

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needed to do so. THE FUTURE IS ELECTRIC If fossil fuels are drastically reduced in future, they will have to be replaced by other energy carriers. Options are synthetic fuels (liquid, or gaseous like hydrogen), or electricity. Electric power is a prime choice, as the transport and distribution of electric power is very efficient and simple and the demand of electric power by the consumer is increasing. THE SOLAR POTENTIAL IN DESERTS The total solar irradiation in the deserts of the world is immense. Using current technology of thermal concentrated solar power plants (CSP), the technically accessible power exceeds the world energy

Sustainability

consumption by a factor of 20. Figure 2 shows a map of those desert areas that are well suited for standard CSP technology. Overlaid is a satellite photo of the earth at night. The yellow lights indicate areas where there is a high consumption of electricity at night. It illustrates the concentration of

Autumn 2012 Issue

electrical power consumptions in the USA, Europe and Japan and also the lack of electrical power in the populated areas of Africa and South America. SOLAR POWER PLANTS IN DESERTS There are two competing technologies (PV –

photovoltaic and CSP – concentrated solar power plants) available for converting solar radiation into electricity. The CSP systems consist of a mirror system that follows the position of the sun, an absorber that converts the solar radiation into heat and a steam engine with generator that converts

Figure 2: The red colour indicates desert areas that are well suited for solar power plants due to large direct solar irradiation. Overlaid is a satellite image of the earth at night. The yellow lights indicate the areas with concentrated electricity consumption (Source: DESERTEC)

THE PARABOLIC TROUGH There are several technological realizations for CSP. The most mature one uses a parabolic trough that follows the position of the sun by a one-axis rotation. It focuses the solar radiation in one dimension onto an absorber pipe.

Figure 3

The absorber pipe has the purpose to absorb light and to convert it into heat. The absorber pipe is usually made from special, double walled glass with a vacuum in between (like a thermos jug), to minimize heat dissipation. The inner part of the absorber pipe has a special coating which absorbs light but has a small radiant emittance in the infrared to minimize losses by heat radiation. The absorber pipe has to resist large heat loads and steep temperature gradients, e.g. when a cloud is passing. The thermal power is transported to the steam engine by a liquid. Standard technology uses a heat transfer oil at temperatures up to

400°C. Newer power plants directly evaporate water at high pressure and reach temperatures above 500°C. Here the technological challenges are the phase transition and the high pressure of the vapour. Some plants have parts of their mirror fields at different temperatures to optimize temperature and heat emission at the same time.

for a location in Spain and shorter in sites of higher solar irradiation as e.g. in North Africa.

The steam engine with a generator converts thermal energy into mechanical and electrical power. According to the laws of thermodynamics, its efficiency depends on the temperature difference between the incoming steam and the outgoing water. To optimize the efficiency, most steam turbines use water-cooling. For desert use air condensers are needed that have a closedcircuit water-cooling system, leading to a loss of about 10% of efficiency compared to water-cooled systems. An alternative to air-cooling is cooling with seawater.

THE POWER TOWER While the parabolic trough and Fresnel systems focus the sunlight in one dimension, power towers focus in two dimensions and can therefore reach higher temperatures and higher Carnot efficiencies. Higher temperatures also mean a more efficient heat storage. The technology of power towers is very promising for the future, but currently there is little commercial experience, as only very few power stations are in operation (see Figure 4). One big advantage of the power tower compared to the parabolic trough is that the power tower can be built in a hilly area whereas the parabolic trough needs a flat surface. The heat carriers that have been investigated are steam, liquid sodium, and others. The research tower in Jülich/Germany uses ambient air that is aspirated through the absorber.

Parabolic trough systems are a proved, mature technology (see Figure 3). Commercial systems have been operational in the desert for over 25 years in a reliable way. Prominent examples are the SEGS plants in the Mojave Desert in California, USA. CSP power plants use components that can, to a large extent, be produced in desert countries themselves. The materials used are mainly glass, steal, concrete and copper and those are sufficiently available on the world market, also for large-scale production. The energy repayment period of a parabolic trough system is 5–6 months

Figure 4

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Sustainability

CSP offers a largely unexplored field to synthesize gaseous and liquid fuels using catalytic reactions at high temperatures. A prominent example is the generation of alcohol using synthesis gas that is generated in a solar tower from CO2 and water. THERMAL STORAGE USING MOLTEN SALT Solar thermal power stations use heat as intermediate energy medium and allow for a cost effective storage of energy at large scale. First commercial systems are operated that combine a parabolic trough power plant with a large-scale storage capacity using molten salt as storage medium. During the day the molten salt from the “cold” container is pumped into the “hot” container using a heat exchanger that transfers the thermal energy from the thermo oil coming from the solar mirror field to the molten salt. After sunset the salt is pumped back to the original container through a heat exchanger that gives the energy to the steam system. This way the steam turbine can continue to operate during night. In the commercial systems in Spain the size of the heat storage is optimized to deliver electricity during the evening peak hours.

The investment of the heat storage system pays off for two reasons: it allows an electricity production on demand when the electricity price is highest and it allows to operate the steam turbine at full load for a longer time every day without having to cut the solar peak power during midday.

Another reason for building hybrid power stations is to minimize initial investments. Starting from an existing modern combined cycle gas turbine, the fossil fuel can be replaced by solar energy stepby-step by adding a solar field that delivers part of the exergy.

HYBRID POWER STATIONS As CSP power stations use conventional steam turbines, one can combine solar power and fossil power in the same power plant without doubling the investments for the power block. Even though CSP stations with heat storage can deliver power day and night, there may be reasons to operate a CSP station with fossil fuels, e.g. to bridge a bad weather period.

SEAWATER DESALINATION IN DESERT COUNTRIES For many desert countries the future fresh water supply is an even more serious issue than the energy supply. Today, many desert countries exploit fossil water reservoirs for drinking water and for agriculture. The fossil water sources are limited and the demand for water is increasing due to the population rise. The problem may be intensified in future by reduced rainfalls due to climate changes, especially in many regions of Africa. Seawater desalination can mitigate the problem. As seawater desalination is inherently energy intensive, it is important to integrate seawater desalination into an overall energy concept. An elegant way to combine electricity production and seawater desalination is to use the waste heat of CSP stations for desalination.

The fossil water sources are limited and the demand for water is increasing due to the population rise.

Figure 5

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Sustainability

Autumn 2012 Issue

THE LEARNING CURVE AND THE INTERNALIZATION OF EXTERNAL COSTS The change of our global energy system requires huge investments. Conventional power plants, like e.g. gas turbines, need a comparably small initial investment, and a large proportion of the electricity costs comes from the costs of the fossil fuel. Renewable energy systems have small running costs and the major part of the electricity costs are investment costs, i.e. manpower and material during construction and the interest of the investor. In addition, there is a learning curve to pay in the coming years, as the required technologies are partially still in the precommercial development phase and not yet in mass production. All that makes the switch from an exploiting energy system to a renewable energy system economically difficult, and political regulations or incentives are needed so that renewable energies can compete with the old technologies on a free market. Possible political tools are feed-in tariffs, carbon certificate trading or energy taxes. A first and overdue measure is the cancellation of governmental subsidies for the mining or use of fossil fuels. A more difficult

WIND POWER IN DESERTS AND OFF-SHORE In many desert countries there are trade winds that allow for an efficient and reliable production of wind power. Modern wind power stations are a highly cost efficient way to produce renewable energies. Due to the fluctuating nature of wind, wind power has to be integrated into a large grid to average out fluctuations and it has to be combined with other sources of renewable energy in a common concept. Naturally, wind energy is not limited to deserts. There is a large unused energy potential offshore that is waiting to be harvested. Wind power increases with the third power of the wind speed, and therefore offshore wind power is significantly larger than on-shore wind power. What the desert is for solar energy, the sea is for wind energy. THE IDEAL SOLAR THERMAL POWER STATION To summarize, the ideal solar thermal power station in the desert focuses the light by a large concentration factor, reaches highest temperatures, stores the heat using a large volume of cheap storage material, and uses the stored heat to produce electricity on demand.The waste heat is used for seawater desalination and as process heat for industrial processes. POWER TO THE PEOPLE – THE SUPER GRID The electric power produced in deserts has to fulfil first the growing power demand of the local population in the desert country. The large potential will exceed the local demand by far and can be used to export electrical power to the neighbouring countries. By the use of a super grid that spans

step is the internalization of the external costs. Examples for external costs of fossil fuels are the long-term costs of global warming, the costs of air pollution to the health of the population and the costs of oil pollution by accidents during drilling and transport of the oil. Examples for external costs of nuclear industry are the long term costs of nuclear accidents, the costs for keeping nuclear radioactive waste repositories safe over centuries and the costs to prevent the proliferation of nuclear weapons. A first political measure to bring the old and the renewable energy industries to an equal footing would be to force energy companies to re-insure those risks. A full risk assessment and insurance against costs of possible terroristic attacks in nuclear industry would certainly make nuclear power economically unattractive. The same will be true for oil and coal companies if the impact of global warming is internalized.

feed-in tariffs, wind, CSP and PV power stations will be economically competitive in many areas of the world in the coming decades, due to the rising costs of fossil fuels and due to the cost reduction by mass production of components for renewable energy power stations. This fact makes investments in new fossil or nuclear power stations uncertain already today, as a power station that is constructed today will not be competitive during its whole life span any more. In addition, future investments in fossil and nuclear industry will face an increasing risk of penalties (taxes, re-insurance, environmental conditions, etc.) due to the decreasing acceptance in the public opinion. Therefore, feed-in-tariffs and other political measures are not needed to make the energy revolution happen, but they are urgently needed to make the energy revolution happen in time, i.e. before humanity runs into serious problems of energy shortage and climate change.

It can be predicted that even without internalizing external costs and without special

continents, all kind of distant, renewable energy sources can be interconnected among each other and with the consumers. HVDC TECHNOLOGY The super grid became feasible by recent progress in the technology of high voltage direct currents (HVDC) which is needed for long distance transmission and allows for point to point connections with small power losses. AVERAGING OUT FLUCTUATIONS Sun and wind are fluctuating energy sources. The sun has a daily and a yearly cycle, and due to clouds and weather conditions there is a stochastic behaviour in addition to the predictable oscillations. For wind energy the stochastic fluctuations dominate the cyclic variations. The fluctuations are spatially correlated, and the correlations decrease with distance. By interconnecting a large number of fluctuating energy sources, part of the fluctuations are averaged out.

Demand Control – Smart grids do not only adjust the production to the consumption, but in addition they adjust the power consumption to the availability of power.

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ENERGY SECURITY Energy has to be available 24h per day, every day in the year. Our current fossil energy system based on coal, oil and gas uses storage capacities to ensure permanent availability. In the electricity sector, today’s base load power stations fired by coal and nuclear energy are supplemented by gas and oil power stations to account for peak hours of electricity demand. If in future a major fraction of the electrical power comes from sun and wind, the fluctuations and the daily and yearly cycles of these renewable energy sources have to be taken into account for a secure energy supply. The main ingredients for a stable, renewable energy supply based on energy from deserts are: • A large-scale smart super grid • CSP thermal storage • Overcapacities and a “fine-tuning” of the selection of various power sources • Large scale water pump storage • Power to gas production • Back-up power stations ENVIRONMENTAL ISSUES Numerous large-scale solar power stations, wind parks, overhead lines, and large pump storage stations certainly have an impact on the environment that has to be carefully studied. Nevertheless, all conceivable impacts of this renewable energy concept are put into perspective compared to the impact of global warming, air pollution, oil pollution, nuclear accidents, or coal and uranium mining and radioactive waste repositories.

The apparent (relative) cost advantages of fossil and nuclear energies are deceptive and caused by not internalising external costs. THE SPECIAL SITUATION OF MENA AND EUROPE In MENA (Middle East and North Africa) the population and the need for electricity are growing rapidly. There is little industry in North Africa, a high unemployment rate and a lack of prospects for the young generation. The idea of DESERTEC is to construct solar and wind power stations in MENA. The excess of energy that is not needed in the country itself can be exported to Europe. That creates an economical interdependence between MENA and Europe and is a basis for a stronger future collaboration. It is a classical win-win situation. Europe has the knowledge how to build the power plants and the HVDC grid. It also has the money to pay for the learning curve. MENA has the optimum sites for solar energy power stations and the manpower to construct them. Europe can profit from a cost-effective clean solar power generation, from a political stabilization of North Africa due to the economic growth, and from a new business market in its vicinity.

The rising problem of migration and extremism can be mitigated by a close collaboration of Europe and Africa. Africa has the advantage of getting sustainable energy, fresh water from seawater desalination, new possibilities for industrial growth and a large number of new jobs and perspectives for the future of the young population. The power connection of the continents can bring the continents closer together in an economical and may be even in a cultural way. Representatives from North-Africa have expressed that they do NOT want turnkey power stations made by European companies any more, but that they want to gain the know-how themselves how to build solar power stations and have local value added. The DESERTEC foundation supports this concept and has set up an academic and a university network where institutes from most of the North African countries are represented. A large number of (local) engineers is required, so that the goal to build a large amount of power stations in the coming decades can happen sufficiently fast. DESERTEC READY TO GO Clean power from deserts is ready to go. It has an overwhelming potential for a sustainable world energy supply. Basic concepts and technologies are available to be implemented. Nevertheless, the way to an almost 100% renewable, carbon free energy supply still requires huge efforts of technical R&D, and more important, significant changes in the political and socioeconomic boundary conditions. Looking at today’s economical and political decisions, it seems that many people either ignore or underestimate the range of the required changes of the world energy system. i

About the Author Michael Düren studied Physics at the RWTH in Aachen, Germany and obtained his PhD in 1987 in the field of particle physics. After being a postdoc at the Max-PlanckInstitute for Nuclear Physics in Heidelberg,he habiltated at the University ErlangenNürnberg, was interim professor at the University Bayreuth and, since 2001, he is full professor for experimental physics at the JLU Giessen. Since 1988, he is member of the Energy Working Group at the German Physics Society. In 2006, he was co-founder of the interdisciplinary SEPA working group (Solar Energy Partnership Africa-Europe) at the Univ. Giessen and in 2008 co-founder of the DESERTEC foundation. Since July 2011, he is coordinator of the DESERTEC Academic Network.

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The DESERTEC Foundation is a global civil society initiative aiming to shape a sustainable future. It was established on 20 January 2009 as a non-profit foundation that grew out of a network of scientists, politicians and economists from around the Mediterranean, who together developed the DESERTEC Concept. Founding members of DESERTEC Foundation are the German Association of the Club of Rome, members of the international network as well as committed private individuals.

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> NEPAD: Boosting Africa’s Most Valuable Renewable Natural Assets – Fish

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ierra Leone’s fisheries sector, valued at 735 million US dollars, has received a boost from the Partnership for African Fisheries Programme (PAF), through 1,4 million US dollars disbursed by its West Africa Pilot Project (WAPP). This intervention will provide direct and indirect employment for over one hundred people, hoping to strengthen the livelihood of about five hundred people in Sierra Leone. The Partnership for Africa’s Fisheries (PAF), managed by the New Partnership for Africa’s Development, NEPAD Agency, has been working to empower the fisheries sector by facilitating access to financial institutions, particularly to those most vulnerable to fishing such as small-scale and grassroots fishers. It also promotes responsible fisheries management, sustainability in Africa’s fisheries and supports reforms in governance and trade. The fisheries sector of Africa has the potential to contribute about six percent of the continents annual economic growth; however, it has not enough resources to deal with this challenge because of over exploitation, illegal fishing, inadequate management, lack of economic constraints and the threat of climate change, according to recent estimates. Experts warn that Africa may be losing the potential to harvest between 2 to 5 billion US Dollars of economic returns every year due to mismanagement. Also, illegal fishing in SubSaharan waters is costing about 1 billion US dollars every year.

In order to deal with these challenges, PAF established and oversees continental working groups in key policy areas such as Good Governance; Illegal, Unreported and Unregulated Fishing; Fisheries Investment; Fisheries Trade and Access to markets; and Aquaculture. The working groups are composed of African and non-African experts in fisheries and aquaculture. They draw on experience in fishing communities, industry, government and educational institution. PAF was established in 2009 as a collaboration between the NEPAD Agency and the UK’s Department for the Environment, Food and Rural Affairs (DEFRA) and builds on earlier fisheries reforms in Africa such as the Abuja Declaration on Sustainable Fisheries and Aquaculture in Africa. It hosted the 2010 hosted first Conference of African Ministers of Fisheries and Aquaculture (CAMFA) in Banjul, The Gambia. This African Union-led conference was the first of its kind and facilitated information sharing and promoted dialogue on the role and importance of the fisheries sector. CAMFA was established as a policy organ of the African Union (AU) to provide high-level guidance for continent-wide reforms. In January 2011, the 16th Summit of the AU endorsed the establishment of CAMFA. Through CAMFA all AU member states have committed to develop and implement a Comprehensive African Fisheries Reform Strategy by 2013. This was a milestone for the fisheries sector since fish is one of the leading export commodities for Africa, with an annual export value of nearly 4.8

billion and 614 million US dollars for intra-African trade. It also makes a valuable contribution to food and nutrition security on the continent feeding 200 million Africans yearly. In many parts of Africa, fish is considered as the only protein food and represents the sole source of essential elements and fats to many vulnerable rural African consumers, especially women and children. However, Africa is still unable to meet its own fish consumption needs due to inadequate infrastructure, lack of financial resources, technologies and mismanagement and therefore has to import fish products. Hence, fisheries is also integral part of the agenda of NEPAD’s Comprehensive Africa Agriculture Development Programme (CAADP) aimed at increasing food supply and reducing hunger through national budgetary allocation. So far, 30 African countries have signed the CAADP Compact to commit at least 10 per cent of their national budgets to agriculture. PAF supports these efforts and is being incorporated into their national CAADP food security investment plans, one of the key drivers to raise agricultural productivity on the continent to at least 6 percent annually. In essence, PAF is about increasing, sustaining and protecting Africa’s most valuable renewable natural assets – fish – and to stimulate growth across the continent. This means strengthening Africa’s capacity to consider, determine and implement responsive reforms in fisheries governance and trade. i

About NEPAD The New Partnership for Africa’s Development (NEPAD) is a flagship socio-economic programme of the African Union (AU). NEPAD’s four primary objectives are to eradicate poverty, promote sustainable growth and development, integrate Africa in the world economy and accelerate the empowerment of women. The NEPAD Agency is a technical body of the AU that advocates for NEPAD, facilitates and coordinates development of NEPAD continent-wide programmes and projects, mobilises resources and engages the global community, regional economic communities and member states in the implementation of these programmes and projects. The NEPAD Agency replaced the NEPAD Secretariat which had coordinated the implementation of NEPAD programmes and projects since 2001. The strategic direction of the NEPAD Agency is premised on six themes: Agriculture and Food Security, Climate Change and Natural Resource Management, Regional Integration and Infrastructure, Human Development, Economic and Corporate Governance as well as Cross-Cutting Issues including Gender, ICT and Capacity Development. 90

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> Emmanuel Nnadozie, UN Economic Commission for Africa: What We Know About Domestic Resource Mobilization in Africa major challenge facing African countries is how to mobilize adequate, stable and predictable domestic resources to finance priority programmes and projects of the New Partnership for Africa’s Development (NEPAD), the development framework designed by African leaders in 2001. For example, it is estimated that Africa’s infrastructure financing needs is as much as $93 billion per year with a gap of about $31 billion per year. There are also significant financing gaps in other priority areas such as health, education, and science, technology and innovation.

“Closing Africa’s financing gap requires strengthening domestic resource mobilization and developing innovative approaches to mobilize development finance.” This problem has been aggravated by the impact of global economic crisis and the eurozone debt crisis as it has negatively affected financial inflows into Africa. From the work done so far by the Economic Commission for Africa (ECA) and the NEPAD Planning and Coordinating Agency, we know a number of things about domestic resource mobilization in Africa:

1. AFRICAN COUNTRIES GENERALLY HAVE LOW SAVINGS RATIOS RELATIVE TO OTHER COMPARABLE REGIONS. The average ratio of domestic savings to GDP in Africa over the period 2005-2010 was about 22 percent compared to about 45 percent in East Asia and the Pacific and 30 percent for middle income countries (Table 1 column 2). Within Africa, (outside of North Africa), savings ratio is particularly very low indicating that if African governments want to close the existing gap between domestic savings and investment requirements, they have to do more to strengthen domestic resource mobilization. 2. THE AVERAGE TAX RATIOS IN AFRICA TODAY IS COMPARABLE TO THAT IN HIGH INCOME COUNTRIES AND IS ACTUALLY HIGHER THAN IN THE AVERAGE MIDDLE INCOME DEVELOPING ECONOMY. Over the period 2005-2010, tax ratio in Africa (tax revenue as a percentage of GDP) was 20 percent compared to 15 percent for high income countries, 13 percent for middle income countries, and 11 percent for East Asia and the Pacific (Table 1 column 3). In other words, African countries on average have tax ratios higher than what is observed in other regions. However, tax ratios in the western countries of the European Union are much higher than the African average. Furthermore, Africa’s high average tax ratio masks the reality in several countries in the region where the tax ratios are below 10 percent (Central African Republic, Republic of Congo, Ethiopia, Liberia, Nigeria, Sudan etc). The relatively high tax ratio observed in Africa suggests that for African countries to increase tax revenue

they should not rely on increasing the tax rate. Rather they should focus on expanding the tax base, improving tax administration, and tapping relatively underutilized sources of taxation such as property and environmental taxes. 3. AFRICAN COUNTRIES ON AVERAGE RELY ON INTERNATIONAL TRADE TAXES MUCH MORE THAN MIDDLE INCOME COUNTRIES AND DEVELOPING COUNTRIES IN EAST ASIA AND LATIN AMERICA. African countries depend on international trade taxes more than any other region. Over the period 2005-2010, taxes on international trade represented about 21 percent of total tax revenue in Africa compared to about 7 percent for East Asia and the Pacific and about 8 percent for middle income countries and also Latin America and the Caribbean (Table 1 Column 6). They also rely relatively less on taxes on income and profits (Table 1 column 5). Overall the ratio of “indirect” to direct taxes is significantly higher in Africa than in middle income and other developing countries. The continental average masks a sharp difference between North Africa and the rest of the continent, the latter having higher incidence of international trade taxes and relying more on consumption taxes. 4. TAX RATIOS ARE STRONGLY RELATED TO THE STRUCTURE OF THE ECONOMY AND QUALITY OF GOVERNANCE. There is a very strong negative association between the tax ratio and the share of agriculture in GDP; in other words, the higher the share of agriculture in the GDP, the lower the tax ratio. The correlation coefficient between these two variables is (-0.61).

Gross domestic savings (% of GDP)

Tax revenue (% of GDP)

Tax on goods and services (% of taxes)

Tax on income and profits (% of taxes)

Tax on trade (% of taxes)

Other taxes (% of taxes)

Africa

21.87

20.34

42.19

31.95

21.05

4.80

Sub-Saharan Africa

16.22

17.64

43.07

25.57

27.37

3.98

North Africa

30.67

26.26

42.26

44.64

7.84

5.26

East Asia & Pacific

44.52

10.67

41.98

40.21

7.15

10.66

Latin America & Caribbean

22.50

13.05

44.21

38.26

7.62

9.91

High income

19.47

15.34

45.85

45.62

0.65

7.88

Middle income

30.27

13.56

50.70

30.77

7.77

10.75

Low income

10.07

11.09

Table 1: Domestic Savings and Taxes in Africa Compared with other Regions (2005-2010 average) Source: Based on computations by Economic Commission for Africa.

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Autumn 2012 Issue

This might reflect the tendency for agricultural activity to occur within the informal sector. A larger share of manufacturing and services, instead, tends to be associated with greater tax revenues to GDP ratio. Interestingly, while there is a strong correlation between gross domestic savings and oil exports, there is virtually no evidence of correlation between tax rates and the proportion of fuel exports in total country exports. Turning to the quality of governance, there is indication that a better government might effectively be more likely to mobilize larger volumes of resources via taxation. Quality of governance is viewed in terms of government effectiveness, control of corruption, rule of law, regulatory quality, political stability and absence of violence, and voice and accountability to citizens. 5. ILLICIT FINANCIAL OUTFLOWS CONSTITUTE A MAJOR OBSTACLE FOR MOBILIZING DOMESTIC RESOURCES FOR DEVELOPMENT IN AFRICA A key issue that requires urgent attention by African countries is illicit financial outflows from the continent. The trend has been increasing over time and especially in the last decade, with an annual average illicit financial flow of US$ 50 billion between 2000 and 2008. Illicit financial resources are drained out of Africa through various channels, including trade mis-invoicing, transfer pricing, investment related transactions, and bank transfers. Multinational companies (MNCs) are the most significant perpetrators and they have a variety of techniques at their disposal to protect their profits from taxation

by employing complex, country-specific strategies. The most popular of these is ‘transfer pricing,’ which is the manipulation of prices of cross-border transactions between related affiliates. The motives and mechanisms are generally similar to those utilized in trade mis-invoicing. Other forms of illicit commercial activities include tax avoidance and tax evasion. These activities basically shift money beyond the reach and appropriate use of domestic authorities. As much as 60 percent of global illicit financial flows originate from commercial transactions through multinational companies. In conclusion, African countries have made some progress in mobilizing domestic revenue over the past decade. Nevertheless, there are still significant gaps between domestic revenue and investment requirements, indicating that more needs to be done to boost domestic revenue, address illicit financial flows and also exploit other sources of financing. There is improvement in tax collection in the continent, leading to revenue increases. Yet, tax administrators face enormous challenges. The right policies must be put in place for more effective, efficient and fair taxation through deepening the tax base, removing tax preferences, dealing with the use of transfer pricing techniques of multinational firms, taxing extractive industries more fairly and more transparently and addressing capacity constraints of tax administrators. i

ABOUT THE AUTHOR Professor Emmanuel Nnadozie is the Director of the Economic Development and NEPAD Division at the United Nations Economic Commission for Africa (ECA). He was formerly Senior Economist and Chief responsible for the UN Coordination Unit for AU/NEPAD Support at ECA and Focal Point for the African Peer Review Mechanism at ECA. Before joining ECA in June 2004 he was Professor of Economics at Truman State University (1989-2004), Visiting Professor at the University of North Carolina (1996-97), and Research Fellow at the University of Oxford, England (1994). Prof. Nnadozie was also formerly Chief Planning Officer at the World Bank’s Agricultural Development Program in northern Nigeria. His scholarly works have appeared in both academic and non-academic journals all over the world, most notably African Economic Development, Academic Press/Elsevier, 2003. An award-winning educator, Professor Nnadozie was recognized as The Most Outstanding Black Missourian of the Year in 2003. He served as President of the African Finance and Economics Association of North America (1999-2001), and Editor, Journal of African Finance and Economic Development [currently Journal of African Development] (1998-2002).

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Inter-American Bar Association (IABA):

E-Sustainability – Law and Technology Working for the Environment

The Thomas Jefferson Memorial, Washington, D.C. n June 2012, the United Nations Conference on Sustainable Development, also known as Rio+20, gathered 188 Heads of States and delegations in Brazil to discuss the progression of global environmental protection and, above all, the future prospects for the environment and its relationship with society. Apart from the criticism over the results obtained in the meeting, two points stand out, and they deserve special attention in this article: (i) the impressive number of Heads of States and delegations who attended the meeting in Rio de Janeiro to discuss environmental preser-

vation in the midst of global economic crisis and (ii) the fact that, for the first time, the discussion broached, with the due attention, the relationship between environmental protection and the use of technology in our “Information Society.” [1] Focusing on this second matter, the Inter-American Bar Association, through its Committee on Telecommunications Law, Science and Technology, was invited by the UN, along with the Brazilian Chamber of Electronic Commerce (www.camarae.net), to organize an “On-Site Event” that dealt CFI.co | Capital Finance International

with the subject of e-sustainability and how the State, Business and Civil Society in general could contribute to environmental conservation in light of the use of everyday technology that now is present in our “online” life in the Information Society. And so it was done. The seminar on “e-Sustainability: Law and Technology in the Service of Environmental Protection” was an exciting success. With the participation of national and international associations, representatives of Brazilian government and multinational companies, the discussions regarding the subject have shown how important the role

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of the digital world in preserving the environment actually is. Issues of how to organize the next steps towards an online presence in this new Sustainable Information Society were also raised. This article aims to simply and briefly, bring up these major steps free of technical language. We will define the roles of the most important players that are involved in this issue (Item 1) and will also talk about the creation of metrics that would help in the calculation of the benefits achieved and that can also be an incentive to the adoption of measures and creation of public and private policies (Item 2). I – WHO DOES WHAT? THE ROLE OF THE INDIVIDUAL IN THE NEW SUSTAINABLE INFORMATION SOCIETY The participation of Heads of States in Rio+20 and all the repercussion that the subject of environmental protection has generated in the recent years show how outdated the concept of environmental degradation by Brazilian Professor Eduardo Viola [2] as being a “disease of the rich” really is. The concept of sustainable development, despite the triviality of its use, is already known or at least understood by most people. However, it is always necessary to define each one’s roles and what can and should be done to put the debate into action and, also, the share of responsibility for using natural resources each one of us is responsible for. The definition of roles, in this regard, seems to be fundamental for the adoption of practices of effective policies for environmental protection, including the virtual environment. 1.1 – THE ROLE OF STATE IN THE DEVELOPMENT OF EGOVERNMENT The definition of simple, effective and efficient public policies, focused on the sustainable development should, as a starting point for any analysis, relate to the controls and incentives that should be transferred to society, with regard to defining the principles of its own activity in management of public affairs. In this sense, it is essential that the effective search for sustainability in the Information Society goes through the assumption, by the States, of a model of governance that takes advantage of the available technological resources. The reduction in paper production, with the adoption of electronic and online models for the rendering of services to citizens should be a prerogative of every State, in the adoption of what we call e-Government.

“The most important question is how to transform the corporations from antagonists of environmental protection to partners in the friendly environmental protection.”

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In this sense, as the headquarters of Rio+20 and also the headquarters of the e-Sustainability Seminar, Brazil has been fulfilling its role in the struggle for dematerialization of its administrative and bureaucratic processes. Assuming an ambitious model of e-governance, Brazil has adopted in recent years, a structured planning for the adoption of digital tools and also on-line structuring of its functions and services, placing them at the disposal of all citizens, in virtual environments, avoiding, with this policy, unnecessary travels, overloading of the public transportation system, expenses with such materials and generation of waste, in a way to prevent the emission of carbon into the atmosphere. Income tax declarations are annually sent to the Brazilian Internal Revenue Service via internet, consultations in public systems, registries, court proceedings and even the public consultation of bills can be freely accessed on95

Sustainability

line by any Brazilian citizen. From the creation of a certification system based on digital identities, more than 5 billion electronic invoices were issued in Brazil in 2011. Also following the National Broadband Plan, Brazil already has more than 70 million people connected to the internet and with access to all e-Citizen services offered by the State. Similar numbers and examples are increasing in the Brazilian government, generating general economy of procedures, materials, and most importantly, natural resources. But none of these advances would be possible if there wasn’t a conjunction of the following four factors, which are essential commitments for the creation of any structure of e-Government: (i) political commitment to transformation of the State and the breaking of bureaucratic resistance paradigms ; (ii) adoption of well-structured planning based on effective policies to the adoption of digital tools of government; (iii) strengthening of the role of state institutions focused on technology and the creation of a connected society; and, especially (iv) the creation of regulatory frameworks allowing the practice all points listed above. 1.2 – THE ROLE OF CORPORATIONS AND VOLUNTARY COMMITMENTS When the UN launched the Global Compact (www.unglobalcompact.org), a free initiative designed for the adoption of corporate social responsibility practices, some leaders of major corporations in the world declared that after centuries of responsibilities assigned to the States, it was time to let the leadership of the relevant issues of our global society to corporations. Apart from the matters that may arise from the possible interpretations of this positioning, the importance of the role of corporations when it comes to environmental protection is undeniable, especially if considered the model for economic growth currently adopted. The corporations are responsible for a huge part of the use of natural resources and activities that are or might be potentially harmful to the environment are originated in their production channels. The most important question is how to transform the corporations from antagonists of environmental protection to partners in the friendly environmental protection. The answer may lie in volunteerism or in the concept of “faire ensemble”, fairly used by French jurists. Current experiments on environment preservation policies show how obsolete public policies based on command and control [3] are enforced (if at all) at a minimum and, instead, how the environmental protection instruments can be reinstated (through green taxation or green markets for carbon credits, for example). The central idea supported here is that the participation of corporations could achieve higher levels and with more commitment if the direct benefits of adopting environmentally sustainable practices could be felt. The role of corporations, before the prism of volunteerism, could be expanded beyond obligations related to the pure, hard core of their activities and their impacts on the environment to encompass other peripheral fields of its operations that could also represent envi-

ronmental gains, such as consumer awareness office supplies, paper, energy, computers, travel of executives, etc [4]. It is precisely in this point that technology can help the Information Society to do their part and help in the environmental protection. But how to engage the companies throughout the world without the threat of a strong State sword over their heads? The answer may lie below. II – GENERATION OF METRICS AND ENVIRONMENTAL MARKETING FOR THE MEASUREMENT OF ENVIRONMENTAL BENEFIT The growing ecological awareness of citizens nowadays is the greatest ally that sustainable development has in the world. It is expected that the environment is protected and initiatives for this purpose are recognized, validated and preferred by the market in general. Hundreds of studies and analysis point the fact that consumers tend to prefer companies that have their brands and philosophies aimed at environmental responsibility. Regarding the adoption of everyday technologies for the protection of environmental resources, the problem is the lack of simple and objective metrics that can serve as a reference for states or corporations. The lack of such metrics makes it impossible for states and corporations to understand the results that small actions could have, both from the standpoint of costs and impacts on the environment and, on the other hand, and even more important, prevent the market and consumers in general to understand and value the importance of such actions. Due to the inexistence of any recognized standard to demonstrate how the environment is benefited by company policies and initiatives that could be easily applied, such as digital execution of agreements or using video conference resources more often (instead of a proper meeting, for example, to which it would be necessary to print papers, move people, generate pollution, maybe overload public and private transportation, etc.), simple and meaningful actions are not being taken. Likewise, the lack of such metrics, innovative public policies also cease the creation of the environmental preservation cycle to e-Sustainability or the Sustainability of Information Society ceases its growth. Such studies along with the creation of metrics that allow simple calculation of the positive impacts of the adoption of online services to replace traditional media services performed via “physical” could allow the adoption of several behavioral actions by individuals and corporations or even encouraged by coherent and cohesive public policies. This is not rocket science, just commitment, study and calculation. Inspired by the winds blown in Rio+20 and based on cooperation agreements that were signed in the course of e-Sustainability Seminar: Technology and Law in the Service of Environmental Protection, two significant actions are being taken by the associations that organized the event.

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On one hand, the Inter-American Bar Association started acting on the assembly of a Digital Rights Inter-American Observatory, with the purpose to create a reseau of lawyers for all the Americas that could contribute to the development of standards and rules that can encourage and enable the adoption of sustainability practices for the Information Society. Secondly, in cooperation with ITI – National

Institute of Information Technology (www.iti.gov.br), the Brazilian Chamber of Electronic Commerce started works and studies for the preparation of the first national model for e-metrics sustainability, which, when duly published, will allow with precision, the quantification of the environmental benefit of all technological measures for the preservation of environmental resources and environmental protection in Brazil. This innovative initiative will, once fi-

nalized, be an example for all Latin American countries from the Digital Rights Inter-American Observatory. These are really interesting times to be lived and even more interesting when we have the opportunity to contribute to the development of our society through actions that really count. Each one of us can contribute to our ability. i

ABOUT THE AUTHORS Leonardo A. F. Palhares

Caio Iadocico de Faria Lima

Brazilian Lawyer, partner at corporate law firm Almeida Advogados, President of the Committee XVI: Telecommunications, Science And Technology Law of the Inter-American Bar Association and Vice President of Strategy at the Brazilian Chamber of Electronic Commerce.

Brazilian Lawyer, associate at corporate law firm Almeida Advogados, member of the Inter-American Bar Association and Joint Coordinator of the Legal Committee of the Brazilian Chamber of Electronic Commerce.

The United Nations Conference on Sustainable Development (UNCSD), also known as Rio 2012, Rio+20, or “Earth Summit 2012” was the third international conference on sustainable development aimed at reconciling the economic and environmental goals of the global community. Hosted by Brazil in Rio de Janeiro from 13 to 22 June 2012, Rio+20 was a 20-year follow-up to the 1992 Earth Summit / United Nations Conference on Environment and Development (UNCED) held in the same city, and the 10th anniversary of the 2002 World Summit on Sustainable Development (WSSD) in Johannesburg.

Founded on May 16, l940 by a group of distinguished lawyers and jurists representing forty-four professional organizations and seventeen nations of the western hemisphere, the Inter-American Bar Association (“IABA”) represents a permanent forum for the exchange of professional views and information for lawyers to promote the Rule of Law and protect the democratic institutions in the Americas. Approximately every 12 months, the IABA holds an international conference in one of the countries of the Americas during which time special seminars on legal topics are presented and IABA Committees and Sections meet. The IABA also offers regional seminars, has an active Young Lawyers Section, and participates in international conferences and meetings sponsored by other international and national legal organizations.

[1]AsdefinedbyFritzMachlup:“InformationSocietyisaterm–alsocalledKnowledgeSocietyorNewEconomy–thatemergedattheendofthetwentiethcentury,originatedinthetermglobalization.Thiskindof societyisinprocessofformationandexpansion.Thisnewmodelofsocialorganizationisbasedonamodeofsocialandeconomicdevelopmentwhereinformationplaysakeyroleintheproductionofwealthand contributingtothewelfareandqualityofcitizens’life.FortheadvancementofthissocietyisnecessaryforthepossibilityforeveryonetoaccesstheInformationandcommunication,thatarepresentinourdailylife and that provide essential tools for personal communications, work and leisure.” [2] E. VIOLA, A evolução das políticas ambientais no Brasil (1971-1991), Dilemas Socioambientais e Desenvolvimento Sustentável. Campinas: Unicamp, 1992. [3]CommandandControlisthewayweusuallyidentifypublicpoliciesthatassigntheroletothestatetocreatestandardstobefollowed(command)andcommittooverseetheirproperdischarge(control),assigning punishments to those who do not obey. [4]MicrosoftrecentlypublishedanarticleinBrazil(http://www.camara-e.net/2012/04/18/verdes-sim-com-muito-orgulho/)ontheireffortstominimizeby30%theenvironmentalimpactsoftheirofficeactivitiesin the environment, getting the tools from power management of your servers in a reduction of consumption of over 22 million kWhs of electricity.

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> Corporate Social Responsibility (CSR):

Creating Shared Value and Sustainable Compassion By CFI

CSR should not be viewed as a cost exercise, but without shame as a profit exercise. Turning profits by creating positive change for society – rather than just paying charity out of gains – is proving to be plain good business. wenty years ago the term ‘sustainable development’ was a buzzphrase at Rio’s Earth Summit, bringing the notion of corporate social responsibly (CSR) into focus. And while it is safe to say that the initial battle-cry to political action has largely dwindled to a whimper, it also seems as though CSR – the stirrings of which can arguably be traced back to the example set by big-hearted industrial philanthropists such as John D Rockefeller – has been decidedly shorn of its buzzy lustre and the media fanfare of even just a few years ago.

Or has it? Certainly, there have been cutbacks. Giving USA Foundation revealed that charitable 98

donations by US companies fell by 8% in inflation-adjusted terms in 2008, the year of the economic crash. The following year, a survey of UK businesses by auditors KPMG and charity Business in the Community found that a third of companies had scaled back their CSR budgets. “In 2007, you couldn’t open a newspaper without seeing articles about climate change or the need for sustainability – barely a week went by without a large company proclaiming its sustainability strategy and environmental credentials. That has noticeably subsided. And understandably,” says Lindsey Parnell, EMEA president and CEO for Interface, a carpet manufacturing business CFI.co | Capital Finance International

famous for its high-profile resource-hogging volte face and the subsequent evangelising on the subject by its late founder, Ray Anderson. Widely seen as operating ahead of the curve in the industrial arena, the company’s reduction in waste alone – defined by Interface as “anything that does not provide value to the customer” – has resulted in savings of around $430m (EUR350m) since 1994 and has more than funded the entire sustainability drive. “Most countries are at best in the doldrums and at worst in the recession,” adds Parnell. “Companies are in the trenches, in survival mode – they’ve cut costs, they’ve cut costs and they’ve cut costs. Many

Sustainability

“A perfect storm of communicatory pressure is forcefully blossoming, prompting companies to buck up their ideas and shift away from straightforward shareholder sycophancy.” have to look to the short term to ensure survival.” Yet despite some inevitable downsizing of ambitions, the appetite of the world’s blue-chip bastions to keep CSR on the agenda appears to be remarkably robust. If anything, the determination to proclaim intent and trigger a do-gooding arms race to benefit the triple bottom line of people, planet and profit is getting stronger. According to another recent study by KPMG, corporate responsibility reporting hit an all-time high in 2011, with 95% of the Global Fortune 250 putting themselves up for scrutiny, up from 80% in 2008. The research, which analysed 3,400 companies worldwide in 15 industry sectors, also found that the majority (69%) of the top 100 publicly traded companies in the 34 countries surveyed produce sustainability reports. Walmart is widely seen as a gargantuan figurehead for the discipline’s serious application; once the epitome of faceless corporate avarice, it has since 2005 been producing profound ripple effects throughout the business ecosystem by setting a goal of being totally supplied with renewable energy, having zero waste and selling products that sustain both people and the environment. In 2010, the ante was upped again with a goal to eliminate 20 million tonnes of greenhouse-gas emissions from its supply chain by the end of 2015 – the equivalent of one-and-a-half times its estimated global carbon footprint growth over those five years. Big shots making big claims, shooting for big targets and in some cases making relatively big impacts may be old news perhaps, but if media types are increasingly fatigued by CSR narratives, then consumers and stakeholders – empowered in particular by social media and unprecedentedly unfazed by corporate machinations – are decidedly not. Susan McPherson, a CSR expert currently serving as senior vice president at Fenton – a company boasting some 30 years’ experience of working with businesses on issue-led campaigns – believes that a perfect storm of communicatory pressure is forcefully blossoming, prompting companies to buck up their ideas and shift away from straightforward shareholder sycophancy. Enterprise collaboration software platforms such as Yammer – essentially an internal Facebookstyle mechanism – are stoking debate internally,

Autumn 2012 Issue

she says, while the world outside, contextualised and inspired by the radical mediums of WikiLeaks and the Occupy movement, can orchestrate hitherto unthinkable levels of volubility through interconnected social media. “A few years ago, it was the CEO and the executives who had the voice. You didn’t give a junior staffer the microphone,” McPherson explains. “On the outside, the only way you could interact was write a letter to the customer-service department or go via the website and upload a comment. And the only person that would see it would be you and the corporation. All of that has completely changed.” Twitter has particular heft in this respect, with Amazon’s perceived slight against lesbian, gay, bi and transgendered literature standing out as a recent example: within hours of #amazonfail trending, the company was forced to awkwardly address the issue. McDonald’s was also left smarting when an online campaign to promote the nutritional merits of its ingredients backfired, as animal-rights activists and discerning diners whipped up a McFail frenzy. Increasingly, actual and potential consumers are developing a hankering for products and services conceived well within the CSR straight and narrow. Investigating the trend, an extensive

CSR has growing influence as the millennial generation’s job-hunters simply do not want to work for companies that aren’t doing good! Weber Shandwick and KRC Research survey spanning four countries (China, Brazil, the US and the UK) found that 70% of respondents shy away from a product if they don’t like the parent company. Similarly, 67% check product labels to find the parent company, and 56% would think twice about buying a product if they couldn’t find information about the corporation behind it. In the US, one out of six consumers will stop buying a product altogether if they discover that they don’t like the parent company. Another reason for businesses to ignore CSR trends at their peril, says McPherson, is the discipline’s growing influence on the millennial generation’s job-hunting activities. “They simply do not want to work for companies that aren’t doing good,” she ventures. Indeed, a PricewaterhouseCoopers study recently found that 88% of millennials said they will choose employers who have CSR values that reflect their own and that 86% would consider leaving an employer if its CSR values no longer matched their expectations. “Brands are talking to each other in a way they simply weren’t 10 years ago, and they are staffing up on CSR,” says Cara Chacon, director of social CFI.co | Capital Finance International

and environmental responsibility at outdoor apparel giant Patagonia, which is well known for its deep-seated sustainability credo. “They are seeing it as just as important as quality and profit, as an added value component. It is sort of like an insurance policy for your brand, your supply chain and your workers, and an empathy and awareness to customer needs.” But if CSR’s philosophical fundamentals are becoming ever more intertwined with corporate strategy, what does the discipline actually look like in practice in 2012? Multi-tentacled and conceptually malleable, CSR has a long history of meaning different things to different people and businesses. Pinning it down has never been harder. “[It is] unfortunate that ‘corporate social responsibility’ stuck as the label to describe the interaction of business with environmental, social and ethical issues,” says Stephen Jordan, executive director of the US Chamber of Commerce’s Business Civic Leadership Center. “Basically, CSR became shorthand for dealing with the interdisciplinary skill sets of navigating business and social, environmental and ethical interests. Properly speaking, the whole field should be considered ‘socio-economic management’. Practitioners deal with very different problem sets and offer very different value propositions, and they should be respected for their particular technical skill sets.” Jordan believes that the traditional CSR umbrella is split into four segments: applied philanthropy (“how can my company contribute to addressing social, community or environmental causes that are too big for any single organisation to handle?”); CSR operations (“how should companies address the externalities caused by their businesses?”); stakeholder relationship management (“building up trust and social capital so that the external environment aids and abets the competitive position of the company”); and social innovation (“the business leaders who are trying to develop business products and services that address specific social and environmental concerns – the synthesis of the profit motive with social and environmental benefit”). The latter two, in particular, are becoming increasingly attractive to business leaders, resulting in recent years in the emergence of a new term: ‘creating shared value’ (CSV), a business philosophy entirely rooted in the idea that the competitiveness of a company and the health of the communities around it are mutually dependent. Brought to worldwide prominence by Michael E Porter, a leading authority on competitive strategy and head of the Institute for Strategy and Competitiveness at Harvard Business School, CSV is an explicit recognition and, in turn, capitalisation on these dynamic connections. “The reason it resonates is that value is created,” says Justin Bakule, a director at FSG, a non-profit 99

Sustainability

“CSR is just as important as quality and profit, as an added value component – like an insurance policy for your brand, your supply chain and your workers, and an empathy and awareness to customer needs.” Cara Chacon, Director of Social and Environmental Responsibility for Patagonia

social impact consultancy that works closely with Porter on CSV issues. “Those initiatives that are most successful are the ones that are most closely related to the core objectives of the business. “ Broadly speaking, CSV is achieved through reconceiving products and markets, redefining productivity in the value chain and enabling local cluster development (i.e. infrastructural concerns related to transport, supplies, talent acquisition and legislative issues).

how much does it all cost?’ That’s the problem,” he explains. “That’s where they are going wrong. You can’t see it as a cost exercise – you’ve got to see it as a profit exercise and not be ashamed of that. “There is some sort of discomfort linking profit to sustainability. We need to be as profitable as the next company – maybe even more so to justify what we do. We’ve had our share of critics, but this isn’t marketing gloss or superficiality. You’ve got to change the way you do everything.”

Examples include General Electric’s (GE) extraordinary ‘ecomagination’ programme, which was directly driven by a societal and governmental need for more efficient products and produced off the back of more than 100 interviews with NGOs, activists and government officials. Starting in 2005, GE has achieved sales worth $18bn from the programme, which is predicted to grow at twice the rate of the company’s revenues in the next five years.

For Wayne Visser, founder and director of the research company Kaleidoscope Futures, the think-tank CSR International and the agency Sustainability Market, we have reached a moment in time where CSR as most casual observers known it has become moribund, and the playing field has been aggressively furrowed by innovative, mutually beneficial collaboration. While he acknowledges that CSR has had a positive impact on both communities and the environment, he says its success should be judged within the context of the total impact of business on society and the planet. From this perspective, he says, it has failed on virtually every measure of social, ecological and ethical performance.

“The toughest problems in the world cannot be solved by any one sector or entity and for those things to happen it requires collaboration – it requires mutual trust and benefit,” says Bob Corcoran, GE’s head of citizenship. “We just think it is good business. The appearance of caring or charitable works is not enough. Sustainability is not enough. “Good business is the recognition of all stakeholders and the optimisation of value creation. It results in customer retention, employee retention, in increased understanding of the environment – customer environments, markets and the world you operate in” – Bob Corcoran, GE’s Head of Citizenship “Good business is the recognition of all stakeholders and the optimisation of value creation. It results in customer retention, employee retention, in increased understanding of the environment – customer environments, markets and the world you operate in. It makes you better able to solve those problems without being part of the problem. It is about the fundamental nature of good business and the impact it has in multiple areas.”

“To quote Warren Buffett, it is only when the tide goes out that you know who has been swimming naked,” says Visser. “During the recession we’ve seen a number of companies who have been practising a fairly superficial and narrow version of CSR finding themselves exposed as they cut back. In developed countries, a very limited perspective on CSR is starting to die out – the belief it is only about charity and philanthropy. “CSR 1.0 is dying. It needs to,” he concedes. “But it will be replaced by CSR 2.0, which is more transformative – more about how you change the business to create positive change for society, rather than simply acting with your money once you’ve made it.” i

Over at Interface, Parnell is in full agreement. “CEOs come up to me and say, ‘OK, that’s great, but

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Feels proud of having been the ﬁnancial structuring agent of

ÒTheÊGreatÊMuseumÊofÊTheÊMayanÊWorldÓ at Merida, Yucatan. The ﬁrst museum in Latin America built under the

PUBLICÊPRIVATEÊPARTNERSHIPÊ(PPP/PPS)Êmodel This project was granted the "Partnership Award 2012" as “The Best Pathﬁnder Project in the World”; which is given in London by the prestigious British publication Partnerships Bulletin.

Financing provided jointly with:

Sustainability

> IBGC – Brazilian Institute of Corporate Governance: Progress in Corporate Governance – Brazil is Also Onboard By Heloisa B. Bedicks

n a hindsight, we can identify several milestones in the evolution of capital markets, as well as national and international organizations that underpin such evolution. As part of an ongoing process, crises in corporate and financial systems and dynamics have been followed by improvements in regulatory and self-regulatory frameworks, driven either by changes in the legal system or voluntary adoptions of Corporate Governance practices encouraged by codes. In the mid-90s, the Cadbury Report was published in the UK as the first so-called Corporate Governance code, detailing a great number of recommendations focusing on corporate checks and balances that would subsequently influence similar publications around the world. This initiative came in response to shareholder dissatisfaction with the way in which the companies they invested in were being managed at that time. Meanwhile, the adoption of corporate governance best practices in Brazil has accelerated as the country returned to international markets and initiated its privatization process and opened the domestic market. During this period, the Brazilian Institute of Corporate Governance – known by its Brazilian acronym, the IBGC – was created in 1995 to encourage businesses to adopt transparent, responsible and equitable practices.

“… the adoption of corporate governance best practices in Brazil has accelerated …” Following a global trend and inspired by the German Neuer Markt model, the Brazilian stock exchange created the Novo Mercado in 2000, offering higher Corporate Governance standards for companies voluntarily willing to be listed on such level. The expression “corporate governance” was defined in the Code of Best Corporate Governance Practices, published by the IBGC in 1999, as a “system whereby organizations are run, overseen and incentivized. It involves relationships between the shareholders, the Board of Directors, the Officers and oversight bodies”. The reform of the Corporation Act, allied with IBGC’s Code and a growing interest for corporate

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governance by institutional investors boosted the Brazilian capital market The Novo Mercado, which companies opt to join voluntarily, also encouraged Brazilian companies to adopt best practices and was inaugurated by CCR’s IPO and Sabesp’s migration from a lower level. A few years later, when Natura also went public on the Novo Mercado, this opened a new door to other companies to access the Brazilian capital market. While Brazil was creating and strengthening its corporate governance structures, the US worked quickly to pass the Sarbanes-Oxley Act (SOx) after a number of accounting related corporate scandals, setting out much stronger rules on risk management, internal controls and management liability. Subsequently, a number of major European companies saw themselves facing corporate governance problems which culminated in several countries adopting stronger rules, with greater disclosure and a “comply or explain” based policy, on which companies must indicate whether they have adopted specific corporate governance practices or explain any lack of compliance with the rules. A similar debate began in Brazil as attempts were made to improve corporate disclosure practices. As an example, the rules issued by the Brazilian Securities and Exchange Commission (CVM) can be cited, including rules 480 and 481, both published at the end of 2009. Rule 481 empowered shareholders and made it easier for them to attend company meetings and exercise their voting rights. Under rule 480, companies were required to disclose the average, maximum and minimum compensation for directors and officer of listed companies as well as their compensation policies. This was a very controversial issue on a market which was not used to reporting management compensation. This information must be disclosed by companies on the reference form, a very important tool used to increase transparency and accountability. In a constantly changing environment increasingly connected to the rest of the world, Brazil has seen a significant increase in the number of companies issuing only voting-shares and the first companies with dispersed capital started to appear. As shareholder control has become more dispersed among companies listed on the Brazilian market, CFI.co | Capital Finance International

there have been changes to corporate governance systems. Processes change so quickly that there is not always sufficient time to disseminate and implement corporate governance practices and, as a result, management political power can be excessively strong while the corporate governance practices that could provide equilibrium to the system are not consolidated.

“… Brazil has seen a significant increase in the number of companies issuing only voting-shares …” In such cases, the role and performance of the board of directors are increasingly important to counterbalance management and ensure that corporate decisions are taken in the best interest of the company’s interests. Previously considered little more than an addendum, the Board of Directors has become a major player in strategic decisions and supports implementation of best practices separating management from ownership. A stronger board represents greater corporate transparency and champions the principles of corporate responsibility, accountability and fairness, with corporate governance as a channel of value creation. Companies with a greater focus on best corporate governance practices tend to be more competitive, as they find it easier to raise funds in the market and survive for longer. Although there are exceptions, we now find there is greater balance between the agents of corporate governance: shareholders, the Board of Directors, management and stakeholders. The evolution observed signals and is influenced by board maturity, as boards take on a wider range of responsibilities. The board is charged with safeguarding the company’s objectives and governance system. Among other recommendations detailed in the IBGC Code, board members must act independently, have time available to fulfill their responsibilities and a strategic vision, as well as congregate gender and backgrounds diversity. The debate on the importance of individual board member attributes in Brazil has evolved into a discussion of board efficiency. Board members

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Autumn 2012 Issue

have become more aware that everybody should follow recommended best practices because board decisions are taken on a collegiate basis and responsibilities are shared. Board member independence is often held to be a key factor for propagating good governance throughout an organization’s structure. In an environment where and officers hold more and more responsibilities, four organizations – the Association of Capital Market Investors (Amec), the Association of Financial Capital Market Organizations (Anbima), the BM&FBovespa and the IBGC, supported by the CVM – launched the Brazilian version of theTakeover Panel (CAF in Portuguese). Inspired by the UK’s Takeover Panel model, this self-regulated body seeks to “ensure equitable treatment for shareholders of publicly traded Brazilian companies during tender offers and corporate restructuring operations”. From October, the CAF will be providing opinions and

issuing rulings, when asked to do so, and is likely to improve market’s predictability and fairness, as explained by then CVM chairwoman, Maria Helena Santana, during the International Corporate Governance Network (ICGN) conference in Rio de Janeiro.

ABOUT IBGC Founded on November 27, 1995, the Brazilian Institute of Corporate Governance – IBGC is a domestic and international non-profit institution which seeks excellence in Corporate Governance in a very wide variety of organizations. As a reference center, the Institute organizes courses, surveys, talks, forums and an annual congress, in addition to other Corporate Governance activities. In line with its practice, IBGC was honored in an annual award sponsored by the International Corporate Governance Network (ICGN) on the category Excellence in Corporate Governance. Currently, it is also considered Centre of Excellence in Corporate Governance in Latin America, Caribbean and Lusophone Africa, a title conferred by the Global Forum on Corporate Governance (GCGF). Internationally, is hosting, up to this year, the Global Reporting Initiative (GRI) activities in Brazil, a global network that seeks to promote good practices adoption in organizations. This way, The Institute contributes to sustainable performance and influences the agents of society towards more transparency, fairness and responsibility.

ABOUT THE AUTHOR Heloisa B. Bedicks is the managing director of the Brazilian Institute of Corporate Governance – IBGC, the leading corporate governance organization in South America. She is also president of the IGCLA (Latin American Corporate Governance Institutes), a networking of 11 Latin American countries Institutes and she is governor of the Board of International Corporate Governance Network (ICGN). Mrs Bedicks is an IBGC Certified Director, a member of the board of directors of Mapfre Garantias e Creditos SA. She also serves as a member of the advisory board of Anbima (the Brazilian Financial Capital Markets Association) and the advisory board of the Guia Exame de Sustentabilidade (Exame is the leading business magazine in Brazil). She holds a MBA from Universidade Presbiteriana Mackenzie, a degree in Economics from Unicamp, in Accounting from PUC Campinas and a post graduate degree in Finance from Universidade Salesianas. She has attended corporate governance and directors programs in the Yale University, University of Chicago and Stanford University.

During her four years’ term, which ended in July, Maria Helena took steps to advance and improve Brazilian capitals market regulation. This initiative has resulted in more complex corporate governance issues faced by some companies: conflicts between minority shareholders, management of companies with dispersed ownership, related-party transactions and longterm versus short-term outlooks. The CVM will be responsible for ongoing enforcement efforts to ensure that companies provide higher-quality information on their filings; it will also have to take a strong stand

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in related-party transactions, during potential conflicts of interest and when supervising and punishing transgressions or even crimes, such as insider trading. We must continue to drive the debate on best corporate governance practices and their benefits, particularly when we realize that the advances we have achieved so far are concentrated mainly in the South and Southeast regions of Brazil. Engagement of corporate governance agents is a continuous and gradual process which tends to have a greater effect in the long term, as time is required to show the benefits of the adoption of best practices, such as the increase in companies’ value, and the easier access to funds. The IBGC believes that the challenges we face can be overcome and that the best way forward for any company is to adopt the principles and best practices of Corporate Governance. i

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> Turkey Energy Hub:

Power Play in the Pipeline By CFI

With huge new regional discoveries of gas reserves, Turkey eyes an opportunity to become a key player in the energy sector.

tanding on the boardwalk at Beirut’s expensively enlarged new marina, looking to the west, all seems peaceful in the Mediterranean. In mid-August there are still families in the restaurants overlooking the bay, children are still pestering parents for ice creams and moored yachts gently bob and gleam. There is no such feeling of tranquillity in Lebanon’s neighbour to the north, Syria, where the horrors of what is a civil war in all but name continue to unfold. Or in those to the south, where the lack of progress on creating a Palestinian state has raised international concern about a possible new outbreak of violence involving Israel, the West Bank and Gaza. The irony is that all three countries – Lebanon, Israel and the Occupied Palestinian Territories (as they are known in official diplomatic parlance), along with Cyprus and Greece, are on the verge of a significant turnaround in their economic fortunes,

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thanks to the discovery of huge deposits of natural gas lying just off their coastlines. Although they may not make their citizens as rich as the Arabs of Dubai, Doha or Abu Dhabi, they could go a long way to raise standards of living and give a vital boost to government coffers. And that’s not counting the US, European and regional banks, corporations and investors that stand to benefit from the tens of billions of dollars that will be spent in the next few years on exploiting the reserves and building new projects for the pipelines, refineries, export terminals, storage facilities and power plants that will be needed both offshore and onshore. There’s only one problem: Turkey, where prime minister RecepErdogan’s hopes to make his country the primary energy hub in the region are not only succeeding, but rapidly strengthening its strategic role there. That’s making Ankara even more determined to support its allies in

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Turkish Cyprus and to stand up to the Israeli government of Benjamin Netanyahu, which has refused to apologise for the military action it took in boarding the Gaza flotilla ship Mavi Marmara in international waters in 2010, leaving nine Turkish citizens dead. Tel Aviv’s wooing of the ruling Greek Cypriot government since then – which, as it happens, holds the rotating presidency of the EU in Brussels until the end of December – combined with indications that Israel is forming close military ties with Nicosia, has done nothing to help the situation, at least as far as the heir to the Ottoman Empire is concerned. After all, Turkey, under Erdogan, regards the eastern Med as its own backyard. Turkey’s hopes to assume a new global energy role took a giant leap forward in June when Azerbaijan’s president, IlhamAliyev, travelled to Istanbul to sign a $7bn agreement with Erdogan to build TANAP,

Autumn 2012 Issue

a trans-Anatolian pipeline connecting the vast Shah Deniz gas field off the coast of Baku in the Caspian Sea to Bulgaria via Turkey. Stretching 2,400 miles (3,850km), the link will transport 16 billion cubic metres (bcm) of gas a year at a cost that is expected to be far cheaper for importers than shipments of liquefied natural gas (LNG), coal or shale gas, never mind alternative fuels such as solar and wind. Construction is due to begin at the end of next year, with completion set for 2018. “Today’s signing is the most important step in completing the legal framework for this project,” Erdogan told reporters. “This project won’t just deepen ties between our countries, it will create an organic tie between Azerbaijan and Europe via Turkey.” In addition, he noted that it would help Europe to diversify the sources of its own gas imports and reduce its heavy dependence on Russian supplies.

Blue Mosque, Istanbul

“We have ambitious plans for growth and consider Turkey to be an attractive market offering a range of investment opportunities in oil, gas and utilities sectors” Carl Sheldon, CEO, TAQA (Abu Dhabi’s state energy company)

TANAP’s shareholders – BOTAS, the Turkish state-owned pipeline and gas company, and TPAO, the Turkish Petroleum Corporation, along with Azerbaijan’s state oil company, SOCAR – seem confident of growing European demand. In July, less than a month after agreeing on TANAP, they announced plans to expand the line to 30bcm a year by 2026 and possibly double that, depending on the availability of Caspian gas. “Additionally, gas from the other side of the Caspian could be directed to the TANAP pipe, transiting via Azerbaijan,” Erdogan hinted at the signing ceremony in June. He was referring to negotiations being held by the European Commission with Kazakhstan and Turkmenistan, which also have massive reserves of natural gas, about building a subsea link, the Trans-Caspian Pipeline (TCP), to connect the eastern shores of the Caspian with Baku. The TCP could shift another huge amount, 30bcm of gas a year, onward to Turkey and to Europe’s high-value markets, thereby reducing the two Central Asian countries’ reliance on importers in Russia and Russian infrastructure and ensuring a diversity of supplies for the EU. Uzbekistan, and possibly even Iran, might join later, say industry analysts. Supplies from Kurdistan in Iraq are another possibility. Turkey’s energy minister, TanerYildiz, told a conference in its capital Erbil in May that “Turkey should be considered as the regional Kurdish government’s gateway to the West.” While it’s not clear how these exports would connect with the TANAP pipeline, there’s little doubt that Turkey will play a vital role in hydrocarbon exports from Iraq, a country that ranks fifth among the world’s oil producers and has 10% of its gas reserves. Such prospects help to explain why there’s a scramble to persuade SOCAR to share its 80% stake in TANAP with ‘minority partners’. Oil giants such as Britain’s BP and Norway’s Statoil, which together are in the forefront of developing the Shah Deniz field, along with Total of France and

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energy groups OMV of Austria, MOL of Hungary and RWE of Germany, as well as Gaz de France, are likely bidders, according to reports. BOTAS and TPAO also want to raise their combined share in TANAP from 20% to 50%. Crucially, the agreement between Erdogan and Aliyev will allow Turkey to access six million cubic metres of gas for its own domestic use or for export. This makes Turkey far more than simply a transit corridor and provides the basis for a massive expansion of its own oil and gas infrastructure, as well as its fuel-hungry industries. Ironically, the country has virtually no oil or gas of its own, yet the fact that it managed to come second, after China, in GDP growth last year is a sign of what it could do with more and cheaper energy. SOCAR announced shortly after the Istanbul meeting that it would invest $17bn in Turkey over the next eight years. New refineries, petrochemical complexes, terminals, storage facilities, utilities and industrial zones are being planned. In late May the chairman of Abu Dhabi’s state energy company, TAQA, Hamad al-Hurr alSuwaidi, together with Turkey’s minister of finance, Mehmet Simsek, and energy minister Yildiz, confirmed that they have set up a joint committee to foster investment in Turkey’s oil, gas and utilities sectors. “We have ambitious plans for growth and consider Turkey to be an attractive market offering a range of investment opportunities,” TAQA’s CEO, Carl Sheldon, told reporters in Ankara. Last December, Turkey became a key conduit for the transport of a whopping 63bcm a year of Russian gas to Europe, not least from the vast Shtokman field in the Arctic, when it agreed to let the Kremlin’s South Stream pipeline network, due for completion in 2015, pass through the Black Sea. The game-changing project, which involves Russia’s Gazprom, Italy’s Eni, Electricité de France, Germany’s Wintershall, Serbia’s Srbijagas, GeoplinPlinovodi of Slovenia, Hungary’s MOL, the Hungarian Development Bank and Bulgaria’s Bulgargaz, as well as BOTAS, will have two branches: one carrying gas to Austria’s continental gas hub and storage centre at Baumgarten via Bulgaria, Serbia and Hungary, and another from Varna in Bulgaria to Greece and Italy. Additional links may tie in Slovenia, Bosnia, Croatia and Macedonia. Meanwhile, the prospect of a further expansion of the existing 692km South Caucasus Pipeline (SCP) that has linked Baku with Erzerum in Turkey’s eastern Anatolian province, via Georgia, since 2006 has taken on a new importance given the discovery in July of other gas reserves along Azerbaijan’s Caspian shores, as well as what many in the industry feel will be a significant rise in demand in Europe, particularly central and southeastern Europe, in the next two decades. Natural gas transported by pipeline, the experts assert, is not only far more friendly to the environment than oil, coal or shale gas, but

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also much cheaper than LNG shipments from countries such as Qatar and Nigeria. In addition, given the long-term contracts involved, natural gas transported by pipeline ensures a much larger degree of energy security, as well as the promise of substantial, long-term investments in muchneeded infrastructure by governments and the private sector.

to another proposed European venture, the TransAdriatic Pipeline (TAP), which would terminate in Italy after passing through Greece and Albania. TAP’s shareholders include Statoil of Norway, EGL of Switzerland and E.ON Ruhrgas of Germany.

that the area in question – the deepwater Levant Basin – has at least 1,000bcm of gas reserves, and possibly much more, including oil as well as gas: enough, at minimum, to fill TANAP for 60 years.

There are many hotspots in the region, geopolitically speaking, which make life difficult for energy and pipeline projects to go ahead at a speed that project development and SCP is a key existing gas commercial realities dictate. The transportation infrastructure to east Med disputes involving Turkey, “Funding for ‘Nabucco West’ that would ship gas supplies destined for Israel, Cyprus and Lebanon will not connect TANAP’s terminus in Bulgaria with European markets. The capacity be resolved soon. of the pipeline is 8.8bcm of gas a Baumgarten has already been promised by the Speaking to the Anatolian media year, and this could be expanded March, Turkish energy minister European Investment Bank and the European in to 20bcm if it can be connected to Yildiz said: “All the feasibility Bank for Reconstruction and Development.” Turkmen and Kazakh producers studies conducted are now pointing through the planned Trans-Caspian to Turkey [as the most suitable Pipeline. However, there is a need transportation route for exports from for a significant upgrade and expansion of SCP the Caspian, which would be the main supplier of the eastern Mediterranean].” He was referring and of the Turkish pipeline system if they are to gas for both TANAP and TAP, it is regarded as a to industry studies that show that pipelines laid serve the European markets. serious competitor to Nabucco West, especially through Turkey’s territorial waters, or on its shores, since Shah Deniz’s lead operator, BP, is also said could help Israel, Cyprus and Lebanon, as well as Turkey’s would-be partners in Europe are weighing to be interested in taking a stake in the line. Costing Gaza, sell their gas to Asian consumers, not just up their options. TANAP effectively put paid to €1.5bn, TAP is initially planned to have a capacity European ones. He added: “If we did not have the European Commission’s grandiose project, of 10bcm, which may be doubled later. the Mavi Marmara issue with Israel, there could Nabucco, first mooted in 2002, which had already have been many joint projects between us. The lost some of its shareholders’ confidence because Given the European Commission’s intense concern transportation of natural gas [from the eastern of escalating costs – estimated by the Hungarian about energy security and its eagerness to reduce Med] would be at the top of the list. That would government this year to be at least $30bn – and the EU’s heavy reliance on Russian supplies – have been only right to do. Yet that natural gas a lack of confirmed supplies. Named after the which currently account for about 40% of its gas pipeline is not worthy of the nine lives we lost.” opera by Giuseppe Verdi, the Nabucco proposal imports (more than Norway’s 30% and Algeria’s called for a 2,400km gas pipeline to connect gas 15%), some industry experts say it is possible that So much for a quick resolution of Turkey’s fields in Azerbaijan and Turkmenistan with the both European links could be built. But much will problems with its Mediterranean neighbours. Add Baumgarten hub in Austria via the Caucasus, depend on whether demand in Europe rises as a couple of other thorny issues to the brew – the Turkey and central Europe. Its initial capacity was expected over the coming decades and whether fact that no agreement has been reached after set at 16bcm, rising in stages to 31bcm. European importers will turn to other suppliers decades of negotiations on solving the disputed in the Middle East and North Africa, as well as issue of the Turkish Republic of Northern Cyprus Instead, some of Nabucco’s original shareholders, Russia, or to other fuels. and its relations with the Greek Cypriot government which included MOL, RWE, OMV, Bulgargaz in the south, plus Ankara’s firm refusal to deal and Romania’s Transgaz, as well as BOTAS, are With so many diplomats, politicians and corporate with the internationally recognised Greek Cypriot planning to build a much smaller ‘Nabucco West’ executives flying into Istanbul and Ankara from government; and you have a heady mixture that that would connect TANAP’s terminus in Bulgaria London, Brussels, Paris, Vienna, Budapest, could well end up unresolved – as have so many with Baumgarten. It is expected to cost less than Moscow, Baku, Kurdistan and Abu Dhabi in recent other regional issues. i half the original proposal, depending on whether months, the casual observer could be forgiven for it has the full capacity to transport the 10bcm a thinking that Turkey is already an energy hub, year that TANAP plans to send to Europe, or rather than having to wait till the end of the decade less. Funding has already been promised by the as Erdogan has suggested. But that will depend European Investment Bank and the European on other diplomats, politicians and corporate Bank for Reconstruction and Development. executives from Tel Aviv and Nicosia, as well as Beirut and Damascus, being willing to make the While Turkey favours Nabucco West, some trip as well. There’s little prospect of that happening industry sources say that the link could lose out right now, nor in the medium term, despite the fact 106

Given that Statoil also holds more than 25% of the consortium operating the Shah Deniz field in

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ANNOUNCING

AWARDS 2012 AUTUMN HIGHLIGHTS In this and future issues of CFI.co we will be identifying individuals and organisations that readers and our judging panel consider worthy of special recognition. We hope you find our short profiles of winners and the reasons given for their awards interesting as well as informative. All the winners announced below were initially nominated by CFI.co audiences and

then shortlisted for further consideration by the panel. Our research team gathered additional information to help reach a final decision. In many cases, senior members of nominee management teams provided the judges with a personal view of what sets their companies and institutions apart from the competition. As world economies converge we are coming across many inspirational individuals

and organisations from developing as well as developed markets â&#x20AC;&#x201C; and everyone can learn something from them. If you have been particularly impressed by an individual or organisationâ&#x20AC;&#x2122;s performance please visit our award pages at www.cfi.co and nominate.

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> ZENITH BANK IS NAMED BEST COMMERCIAL BANK IN AFRICA

Zenith was picked out for our cover story this issue and described by the judging panel as a future leader in international banking because of its excellent record at home and highly promising regional and international expansion programme. There is strong leadership at the Bank and CEO Godwin Emefield reports a solid growth trajectory. This outstanding bank was founded by Jim Ovia, a key player on the Nigerian business scene.

> JONES DAY: WORTHY LABOUR & EMPLOYMENT SECTOR LEGAL AWARDS WINNER IN THE UNITED STATES

The judging panel agree the firm’s claim that it shows a ‘relentless focus on client service’. Traditional courtesy and a high level of client care at Jones Day are apparent at all times and help the firm deliver great results. Jones Day has undertaken significant work in 2012 on behalf of U.S. Steel, Abbott Laboratories and Verizon.

> J. P. MORGAN IS THE BEST PRIVATE BANK IN THE UNITED STATES

Excerpts from the judges’ summary: “JP Morgan’s 160 years of experience has produced an outstanding private bank in the United States that is also a top performer in all other regions of the world. The plans announced two years ago for the expansion of business outside the United States have been fruitful. The judges welcomed recently appointed CEO John Duffy of JP Morgan US and his early published remarks on wealth management.

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> STATE BANK OF MAURITIUS IS NAMED BEST BANK IN THE COUNTRY This bank has been a continuous and most effective innovator – providing customers with a broad range of accessible, secure and reliable services across the country (with small farmers as well as large International corporations counted among its clients). According to the CFI.co judging panel, “The State Bank of Mauritius clearly demonstrates that it understands the needs of all of its stakeholders and has achieved sustainable growth over nearly 40 years. The Bank always has a keen eye on what customers need and by prudently investing in staff, infrastructure and technology, has achieved a series of firsts for the Banking sector in Mauritius. It is the level of innovation the Bank shows that has really set it apart

from its competition. The Bank ensures that its services are easily accessible and secure whether online or through its extensive branch network. With the Bank set to further develop its international business over the next few years, the judging panel have no doubt that it will become a very important regional player.” This commitment to service and innovation has paid off handsomely as is demonstrated in the Bank’s latest financial results. With profits up over 30% and a growing international presence, SBM looks set to use the skills it has developed in securing 25% of the highly competitive domestic market to bring further and significant international growth.

> LUKOIL RUSSIA: OBVIOUS CHOICE AS CORPORATE LEADER 2012 According the judging panel, LUKOIL, Russia is a model of transparency and good governance and an obvious choice as a Corporate Leader in Europe. LUKOIL generates a mass of favourable statistics. It ranks as the 40th largest company in the world by sales and sits five places higher on the list in terms of profitability. The Company (with a current market capitalisation of close to $50 billion) is responsible for around 17 per cent of Russia’s oil production and refining activity. LUKOIL delivered $38.4 billion to the Russian government in tax for the year 2011. CSR activities focus

on education, support to orphans and the funding of museums. The judges commented favourably on the LUKOIL Pension Fund, pointing out that the Company matches employee contributions in all countries in which it is represented. This was one of the first nongovernment pension funds in Russia and it is properly audited and very well run. The CFI panel congratulates LUKOIL as an example of a very large oil and gas company that truly promises benefits to all stakeholders – and delivers handsomely.

> EMIRATES: CORPORATE LEADERSHIP FROM THE AIR

The airline is now the largest employer in the UAE and shows a high level of concern for the welfare of its 62,000 workers – many of whom are far away from their homes. The Emirates fleet is young and eco-efficient and the airline has done much to support the Dubai Desert Conservation Reserve and eco-tourism projects in the UAE and Australia. The judging panel felt that Emirates take their CSR responsibilities very seriously and are making good progress.

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> BANCO INTERACCIONES: SUPPORTING THE PUBLIC SECTOR IN MEXICO

The role that Banco Interacciones plays in the Mexican economy should not be underestimated. The Bank is a key player in financing the public sector and by maintaining a clearly defined strategy has produced excellent results for all stakeholders. Banco Interacciones is an excellent example of how a streamlined and focused bank can produce outstanding results and contribute to the development of a domestic market. The judges commented that, “Good banks are a cornerstone of any economy and we are delighted after much deliberation to announce Banco Interacciones as the Best Investment Bank Mexico 2012 and Best Government Banking, Mexico 2012. It was the Bank’s ability to react quickly and professionally that separated it from the competition. Banco Interacciones has been a substantive factor in helping create sustainable growth within the Mexican market. It is the Bank’s focus and commitment that shines through, enabling it to provide the highest level of service.”

> GOLDMAN SACHS: BEST INVESTMENT BANK USA

Despite significantly reduced revenues in 2011, the judging panel was overall highly supportive of Goldman’s recent investment banking activities and termed the Bank’s corporate social responsibility programmes as ‘inspirational’. The panel commented favourably on risk management at Goldman Sachs as well as referring to their ‘sterling work in M&A advisory and strong revenue generation through equities trading.’

> CHINA MERCHANTS BANK AS BEST PRIVATE BANK CHINA 2012

CMB is the preferred private banker to many of China’s ultra-high net worth individuals. The Bank largely confines its activities to the domestic market which it clearly understands well and where it is very well received – with a strong and strategically well-placed branch and office network. The country is justifiably proud of CMB with recognition coming from Peking University (over six consecutive years) as a ‘Most Respected Chinese Enterprise’.

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> STEEL GIANT IS ANOTHER CORPORATE LEADER

Arcelor Mittal is a global leader in steel and mining. The panel pointed to the philanthropy as well as the extraordinary business acumen of chairman and CEO Lakshmi Mittal who founded the Mittal Steel Company in 1976 (Arcelor is its successor). Education, health and community development are at the heart of the company’s CSR concerns. The judges praised the Arcelor Mittal Foundation which works for the sustainable development of local communities. Bem Bank in Brazil is a microcredit facility supported by AM and serves 3000 people. The panel also congratulated this Corporate Leadership Award winner on its Gender Diversity Steering Group, its success in encouraging employees to take up voluntary work in communities and the redevelopment aid provided by the Company following the earthquake in Haiti.

> ABERDEEN ASSET MANAGEMENT: BEST ASSET MANAGER AWARD, UK

Based in Scotland, Aberdeen Asset Management PLC was managing assets in excess of $280 billion in June 2012. As a global investment management group it manages assets for both institutional and retail clients from offices around the world. Under Martin Gilbert’s leadership the approach to leveraging local decision making within the framework of the group has produced excellent long term sustainable value for clients.

> BEST INVESTMENT BANK, SAUDI ARABIA – NCB CAPITAL

The judges applauded NCB’s 2011 M&A deal ($500 million) consolidating six construction companies. This was the largest M&A deal in the region from Saudi Arabia’s biggest asset manager ($11.75 billion). This was the first subsidiary of a Saudi Bank to be licenced by the Capital Market Authority for Investment Management and Asset Management in Saudi Arabia.

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> BURGAN TAKES THE PRIZE FOR PRIVATE BANKING IN KUWAIT For a private bank, its most important asset is trust. To develop that trust it has to show the highest level of integrity, while truly understanding and responding to client needs. When a bank is trusted in this way the level of referrals will increase. Burgan Bank’s strong growth over recent years clearly demonstrates the high levels of trust clients have placed in the Bank. The judging panel found that, “Burgan Bank’s commitment to quality shone through in its Private

Banking services. The Bank is committed to maintaining the highest standards in all its activities, provides a broad range of products and has excellent services. What sets the Bank apart from others in the region is its level of innovation and the effort put into staff development. It is apparent that Burgan has built up high levels of trust with its clients as a result. The Bank’s recent financial results clearly confirm that we are not alone in having full confidence in its ability to look after clients.”

> LONDON STOCK EXCHANGE WINS 2012 AWARD IN EUROPE

London is the home of the largest stock exchange in Europe and ranks fourth globally. There are around 3000 listed companies from 60 countries around the world and the panel noted that London is particularly strong in emerging markets ET.

> MORGAN STANLEY: BEST COMMERCIAL BANK USA

Morgan Stanley’s inevitable move into commercial banking after the 2008 crisis was well thought out and has been a great success. The Bank is a concerned employer who year by year is ranked highly on lists of best places to work. The panel applauds Morgan Stanley’s efforts to support – among other groups – working mothers, African Americans and Hispanics.

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> UNE EPM TELECOMUNICACIONES S.A. IS NAMED BEST MOBILE TELECOMS PROVIDER, COLOMBIA

World leading Telecoms businesses are critical to a country’s sustainable development. Colombia is fortunate in having a pioneering telecoms provider in the form of UNE. This provider is innovative, dependable and understands the need to properly engage with all stakeholders. As Colombia continues to grow and develop economically, we are sure that UNE under CEO Marc Eichmann’s leadership will play an important role to ensure the growth is sustainable.

> WELL IN THE LEAD FOR 2012: CREDIT SUISSE PRIME BROKERAGE

The outstanding performance of Credit Suisse in Prime Brokerage during 2011 saw client assets increased by over 25 per cent. The judging panel agreed that Credit Suisse is the front runner in European brokerage at this time.

> AWARD WINNER OPTIMA ENERGIA, MEXICO: ENERGY SAVING SOLUTIONS WITHOUT UP-FRONT COSTS The CFI.co judging panel was unanimous in declaring Optima Energia winner of its 2012 award for ‘Best Sustainable Energy Technology, Mexico’. Its president, Enrique Gomez-Junco, a Wharton Business Transformation Award winner and CNN Entrepreneur of the Year (2006) is to be congratulated on having established an energy savings company that offers clients total financing of projects. Optima is the only company in Mexico to provide a complete package of this kind and the results have been outstanding. Customer confidence levels are high at all stages of the process with strong levels of satisfaction upon project delivery. A Finance Corporation loan was its first direct investment in an energy services company in the region. The Optima business model provides compelling reasons for the granting of this loan. The Company has demonstrated

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a highly innovative approach to the reduction of greenhouse gas emissions while allowing for impressive savings. Gomez-Junco has shown that providing sustainable energy solutions makes good business sense all round. Optima is a company to watch and its president expects to be announcing major advances before the year is out. Optima has been very active in the hotel sector providing the required financial investment and cutting energy and water costs by an average of forty per cent. All project expenses and upgrades are paid for out of the eventual savings and clients escape all up-front costs. Mexican municipalities have also expressed appreciation of Optima’s services and the mayor of Linares reports savings as a result of a lighting modernisation programme. Acapulco – Guerrero’s project will bring sustainability to

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the town and the people of Cadereyta Jimenez will have safer homes from better street lighting that delivers cost reductions and significant ecological benefits.

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> TRUST MERCHANT BANK IN THE DRC WINS MULTIPLE AWARDS These Trust Merchant Bank wins recognise the Bank’s major contributions to sustainable growth and the excellence of its banking services as well as the more promising outlook for the Congo. In the words of the panel, “The Democratic Republic of the Congo is emerging from decades of unrest and finally looks set to take advantage of its huge economic potential. Sustainable economic growth is vital to the nation’s continued development. This can only happen if there are banks that truly understand the needs of business in general and SMEs in particular. The DRC is fortunate in having a bank that is working to the very highest

standards and understands the banking requirements of the DRC. Trust Merchant Bank (TMB) has clearly demonstrated this quality through their highly professional approach which is having real impact. TMB Staff are at the core of the Bank’s success and there has been on-going investment in human resources at all levels.” The judges felt that TMB was performing well in relation to its domestic banking competition and providing SME’s with the resources they need. CFI.co are delighted to award TMB as the Best Commercial and Retail Bank in the DRC and for providing an outstanding contribution to SME development in Africa.

> THREE PRINCIPLES AND STRONG CORPORATE LEADERSHIP AT MITSUBISHI

Mitsubishi Corporation – the multinational conglomerate – refers to itself more humbly as a ‘community of independent companies’. The independents are tied together by their wholehearted acceptance of the ‘Three Principles’, namely corporate social responsibility; integrity and fairness; and global understanding through business. The Mitsubishi Foundation was established in 1969 to mark the centenary of the organisation and all those independents are successors to a shipping company founded in Japan in 1870. The judging panel recognised the significant efforts of Mitsubishi in helping Japan recover from the 2011 Earthquake after a 10 billion yen donation to the cause. The judges describe Mitsubishi as an outstanding example of corporate leadership in Asia.

> CORNING IS OUR CORPORATE LEADER FOR 2012 Throughout Corning’s 160 year history, research and development have been at the very core of the business. Under Wendell P Weeks’ leadership Corning has continued this tradition and is still at the cutting edge of developing new and better products. Corning is a perfect example of how a manufacturing company can grow sustainably through creating an environment that constantly encourages innovation. Probably best known in recent times for Gorilla Glass, this is just one of long list of innovations that have kept Corning in business when many others have dropped by the wayside.

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> PACIFIC RUBIALES WINS CSR AWARD

CFI.co recognises Pacific Rubiales as the Oil & Gas Company with the Best Corporate Social Responsibility policy. The Company’s attention to conditions in the work place and concern for sustainability issues is quite outstanding. Alejandro Jimenez, CSR Manager at Pacific Rubiales, commented: “This award is an excellent message for our markets and stakeholders because it shows that we are a company that grows and is committed to the sustainable development of the areas in which we operate – and we also have a forefront CSR policy in accordance with world standards”.

> MICHAEL S DELL NAMED CORPORATE LEADER FOR NORTH AMERICA

Since Michael Dell returned to the company he founded he has managed to reposition it into a PC manufacturing colossus. Through careful repositioning and acquisitions Dell’s reliance on PC manufacture is over, with 50% of profits coming from the non-PC side of the business. Michael’s leadership and vision appears to have protected the long term interests of Dell’s stakeholders.

> CHILDREN’S RIGHTS CONCERNS OF AWARD WINNER NORGES

Norway’s Central Bank has decided on children’s rights and child labour as a strategic area for corporate concern. In 2009, Magdalena Kettis, head of Social & Corporate Governance at the Bank produced a paper: ‘Children’s Rights – A Concern For Investors. Each year Norges make an assessment of their holdings for compliance with their stated criteria for proper conduct. The panel applauded the systematic and determined approach of Norges in helping reduce the incidence of abuse of children in the workplace.

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> INCREASING DEMAND FOR SHARI’AH COMPLIANT BANKING AT GULF AFRICAN BANK Gulf African Bank (GAB) wins the 2012 award for Best Islamic Bank in Kenya. The award underscores the achievements at the bank since 2008 when it was first granted a full commercial banking license as a dedicated Islamic Bank. The rapid growth over the past four years is testament not only to the demand for Shari’ah compliant products in Kenya but also reflects the innovative approach of GAB, the continual improvements there and the habit of putting the needs of the client first. The judges expect to see GAB continue to grow rapidly as one of the leading banks in the region.

> ITAU PRIVATE BANK IS NAMED BEST PRIVATE BANK BRAZIL 2012

Without question a major force for private banking in Latin America, Itau also boasts a very strong international network which the judging panel considers to a have ‘a good and secure future’. Investor relations are well thought out and very effective. This winner also scores high in terms of sustainability and is a responsible and generous corporate citizen.

> CHINA CONSTRUCTION BANK NAMED BEST COMMERCIAL BANK CHINA

CCB delivers strong online, telephone and mobile banking. Corporate governance at the organisation is good – with an understanding that this is the key to improved international competitiveness and more efficient modern banking. The judges consider the Bank’s corporate social responsibility as exemplary given its material support to a great number of good causes and its stated aim of helping whenever possible to improve lives.

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> WIPRO: INNOVATIVE SINCE 1945 We applaud the ‘WIPRO Way’ which calls for good timing, predictability, reliability and cost-cutting at this IT giant from Bangalore. WIPRO started out as a vegetable oil manufacturer in 1945 and has been headed by Azim Premji since the late 1960s. Chairman Premji was described by Business Week as India’s Tech King (which according to the CFI.co judges is just about right). The judges declared WIPRO a Corporate Leader in Asia because of the organisation’s history of innovation and strong CSR policies – which focus to a large extent on the quality of school education.

> HANA BANK WINS BEST PRIVATE BANK KOREA 2012

Hana, one of the biggest and best run banks in Korea is a subsidiary of Hana Financial Group. In 2011, HFG entered into what the judging panel termed as a ‘very promising alliance’ with Indonesia’s largest private bank. The judging panel also commented on the Bank’s rather humble presentation of its strong credentials as well as ‘an obvious and continuous concern to enhance the client banking experience’.

> BERENBERG BANK: BEST PRIVATE BANK IN GERMANY

Brenberg is one of Europe’s oldest financial institutions and brings a sense of duty to relationships with clients. If you are looking for a private bank that fully understands the need to be open, transparent and accurate you will find that Brenberg’s long heritage and accumulated knowledge can be put to good use.

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> HONG KONG EXCHANGE WINS ASIA AWARD

HK Ex, listed in Hong Kong in 2000 is one of the world’s largest operators and the judging panel commented on the strength of recent developments. The panel spoke too of the strong investor relations programmes at HK Ex and noted that the operator had received the ‘Caring Company’ award from the Hong Kong Council of Social Services for seven consecutive years up to 2011/12.

> AWARD WINNER SHOWS THERE IS ALWAYS MORE THAN ONE WAY TO SOLVE A PROBLEM Acumen Fund has changed the way support is given to the provision of critical services in the developing regions. The flexible long-term investments of patient capital are helping change the world fight against poverty. Jacqueline Novogratz’s drive stands out as an example to all involved in investment. Through identifying entrepreneurs with solutions and providing not only investment but management support and maybe most critically preparing the new businesses for further investment, Acumen’s investment model is producing real results and proving that the correct kind of finance can be better than charity. We are pleased to recognise Jacqueline and Acumen as Corporate Leaders.

> GO DOT CO Simple, meaningful URLs facilitate commerce and help drive innovation. GO.CO (.CO Internet SAS) is ensuring that the next generation of businesses have strong urls and this achievement certainly deserves recognition. The most useful innovations are often the simplest and by providing an easy way for existing and new companies to move away from the overcrowded DOT COM space, GO.CO are encouraging growth right across the globe. The judging panel particularly liked the way GO.CO prevent their domains from being parked so that the “gold rush” is a thing of the past. The panel felt that this sensible decision will prove to be one of the major driving forces behind the rapid international uptake of GO.CO domains.

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> Barry Tong, Grant Thornton Hong Kong Limited: China: M&A Due Diligence Pitfalls

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o acquire a business is a journey and in the words of Lao Tzu, “…a journey of a thousand miles begins with a single step.” One of the first steps that increases the chance of a successful merger or acquisition is thorough financial and tax due diligence. Investment decisions, mergers, acquisitions and joint ventures, if successful can propel a business to new heights, but if unsuccessful, can lead to ruin. When purchasing a business the greatest danger may lie below the surface. Due diligence gives you an understanding of the business and identifies the issues you need to know to make an informed decision and to get the valuation right.

At times we are asked, “Why is due diligence necessary?” Buyers may believe that as they have the seller’s audited financial statements, met with

“Audits typically have a greater focus on the balance sheet than the income statement; they do not address the quality of earnings, business issues and trends, market share, customer or supplier concentrations, management, systems, or infrastructure.”

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the seller’s management, who have confirmed their investment thesis and also visited the seller’s facilities and seen their equipment, that formal due diligence is unnecessary. But an audit is not enough. Audits typically have a greater focus on the balance sheet than the income statement; they do not address the quality of earnings, business issues and trends, market share, customer or supplier concentrations, management, systems, or infrastructure. The standards can be quite different for due diligence as well. If the buyer is paying a multiple of earnings, adjustments to earnings and normalised revenue and expense items can have a material impact on purchase price. Effective due diligence assesses the seller’s quality of earnings and determines the relative contribution of the various value drivers. It can corroborate the buyer’s investment thesis or provide the data required to support an adjustment to the valuation. Beyond this, due diligence assesses the seller’s personnel and systems, identifies issues to be addressed in the purchase agreement and gives the buyer a head-start on post-acquisition integration issues. During due diligence various adjustments are made to earnings and adjusted earnings are often used as a proxy for cash flow. Cash flow, in turn, is often used to substantiate the valuation. Although the primary objective of due diligence is not valuation, due diligence establishes normalised earnings which is the “raw material” of valuations. Given the importance of adjusted earnings, it merits looking at some of the most common adjustments to earnings.

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Barry Tong, Partner, Advisory MANAGEMENT PROPOSED ADJUSTMENTS – If management’s proposed adjustments are not well documented or do not make sense, the buyer has no obligation to accept all or any portion of them. A ‘bridge’” can illustrate the magnitude and direction of the key factors that cause a change between two periods. These graphic pictures can be worth more than a thousand words in your understanding of what caused the difference in earnings or cash flow. MANAGEMENT‘S ACCOUNTING JUDGMENTS – Management’s judgments impact earning. The judgments made about the adequacy of the bad debt reserve, warranties, inventory reserves, accruals, or allocations of expenses in carveout situations can all have a significant impact on earnings and hence your conclusions about cash flow.

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ACCOUNTING POLICIES, PROCEDURES AND PRACTICES – Revenue recognition, cutoffs, nonrecurring items, one-time expenses (layoffs and discontinued operations), cash verses accrual accounting methods can, intentionally or unintentionally, mislead a buyer’s conclusions regarding operating cash flow. Any changes in accounting policies, procedures or practices during the periods being analysed can distort your conclusions, e.g. extending the useful life of depreciable assets between year one and two can improve earnings without any underlying economic impact. FORECASTS AND RUN RATES – Discontinuities between historical results and forecast assumptions that are unsupported or a recent significant change in run rate or the run rate assumptions require special attention and possibly due diligence adjustments. We find it useful to focus on backlog as a key short-term predictor of future revenues. The importance of backlog increases if run rates are being proposed as the basis of forecasts. Let’s turn our attention to some specific risks that we commonly see in our due diligence work in China and some approaches for mitigating these risks. MINORITY-INTEREST AND JOINT VENTURE INVESTMENTS – Acquiring a minority interest in a business or entering into a joint venture are common ways to invest. In these cases, the scope of your due diligence should include background checks on the owners and managers. Spend time to get to know your partners over several meeting, both business and personal. The relationship with and trust in your business partner is vital to the success of your investment. MULTIPLE SETS OF BOOKS – It is common for Chinese private companies to have multiple sets of books and it is essential to understand why there are multiple sets and the differences between them. Frequently the “tax books” will understand income in order to reduce the tax liability, which may result in a potentially large contingent liability for a buyer. REVENUE RECOGNITION AND CASH RECONCILIATIONS – We recommend reconciling cash deposits (from bank statements) to revenue. Although not perfect, it is an approach to corroborate revenue and develop and understanding of how and when key customers pay. OWNERS’ COMPENSATION AND PERSONAL EXPENSES – These are probably the most common due diligence adjustment to earnings for smaller private companies. The owner’s post-close compensation arrangement must be understood and documented.

the owners or managers may be on the company’s payroll, customers may include related or affiliated companies, and key suppliers may be related or affiliated by common ownership. The due diligence process needs to identify these relationships and determine if there is contractual employment, sales, or purchase agreements that will survive closing. TRANSFER PRICING – The seller may have sales or purchases that do not appear to be economically justified, but may be because related or affiliated companies are involved. Sometimes affiliated companies are used to move money into other jurisdictions. The ownership of Chinese companies is not always transparent and may be quite complex. Transfer pricing policies need to be understood and documented so they can be supported from a tax standpoint.

Clearly, the process of acquiring a business is a journey with many risks, but in the words of another philosopher, “…any journey well begun is half finished.”

CONTINGENCIES – Adjustments here often arise from off-balance sheet obligations and can be significant surprise to a buyer. Contingencies can refer to a number of different off-balance sheet liabilities, such as leases, litigation, or third-party guarantees. Thorough due diligence is required to identify and quantify these risks. How the transaction is structured is also critical to who owns these liabilities post-close. MANAGEMENT – Due diligence unveils the capabilities of the existing management team and what needs to be done if this needs to be upgraded. Is the business essentially honest? Is its administration competent? Are any problems with the financial information fixable? Will the buyer be able to engineer a higher standard of financial reporting in the target company? Management is always a key fixture in Chinese company and attention to detail needs to be placed upon it. Analysing the contents of the financial due diligence also gives the buyer an opportunity to examine cultural compatibility, as well as the level of competence that the buyer has to work with. PROFESSIONAL ADVICE – These are just some of many financial due diligence issues that need to be addressed – they may vary depending upon each specific case. A good professional adviser will be able to discuss all issues with you, assess what needs to be checked through, and allocate dedicated on the ground staff to look into and report back. Advisers who subcontract such work are not ideal, as they may not be able to manage the process directly, owing to a chance of an increased margin of error. Proven track record and sufficient resources in China should be taken into consideration. Clearly, the process of acquiring a business is a journey with many risks, but in the words of another philosopher, “…any journey well begun is half finished.” i

RELATED-PARTY TRANSACTIONS – Are family members employees of the business? Do family members control businesses that are key customers or suppliers to the seller? Relatives of

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Grant Thornton Hong Kong Limited is a member firm of GrantThornton InternationalinHongKongwhichisanintegratedpartofGrantThorntonChina, offeringafullrangeofassurance,taxandadvisoryservicestoprivatelyheld businesses and listed companies of all sizes.

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Legal

Edward Bibko, Baker & KcKenzie:

Kazakhstani International and Domestic Securities Offerings May be Substantially Affected by Recent Legal Amendments

The Ascension Cathederal in Almaty, Kazakhstan With its large natural resources and relatively transparent legal regime, Kazakhstan has long been a destination for international companies. In addition, its domestic companies have been attracting international capital for years. Within the CIS, the country has been one of the most active in terms of cross-border listings, particularly those involving the listing of a Kazakhstani business in London through a newly formed topco in a tax-neutral jurisdiction such as the Isle of Man. However, recent changes in law may significantly impact future cross-border listings from Kazakhstan. On 28 December 2011, Kazakhstan adopted amendments to its Securities Market Law. The express purpose of these were to streamline the legal framework for the offering and placement of securities and provide stronger investor protection. However, these amendments included, among other things, significantly increased penalties for conducting an international securities 124

offering without a domestic listing and a sizeable domestic tranche. They also appear to provide a basis for enforcement against companies who used a popular, but noncompliance issuance structure. Most of the amendments came into effect on 1 February 2012, including those relating to international and domestic capital markets transactions. The main features of the amendments are described below. BACKGROUND For several years Kazakhstani companies looking to "place securities in a foreign state" have been required under Article 22-1 of the Kazakhstani Administrative Code to obtain the consent of the National Bank of Kazakhstan and to also list the securities on a Kazakhstani stock exchange. For purposes of this requirement, a Kazakhstani company is one which is managed from Kazakhstan or has at least two-thirds of its assets within Kazakhstan. In addition, the prevailing view is that the â&#x20AC;&#x153;placement of securiCFI.co | Capital Finance International

ties in a foreign stateâ&#x20AC;? covers placing securities by way of listing and placing on a foreign stock exchange. Article 22-1 also required, for equity securities, that at least 20% of the securities be offered through a Kazakhstani securities market. Although these obligations existed, it was never clear how they could be enforced against a foreign topco issuing securities under its home jurisdiction, outside of Kazakhstan. Under law, the financial regulator could seek cancellation of the state registration of securities issued in breach of applicable regulations. However, this enforcement mechanism was of no use where the topco's securities were issued under the foreign law and not registered in Kazakhstan. The only other available sanction was a provision under the Administrative Code which authorised modest fines against issuers breaching requirements relating to the issuance and placement of securities. As a result Kazakhstani businesses often ignored the provisions of Article 22-1 in

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listing shares abroad. Explicit Listing Requirement; Substantially increased administrative liability. The amendments introduced a new requirement providing that securities issued by Kazakhstani companies may be listed and remain so on a foreign stock exchange provided that there is consent from the NBK and the relevant securities are also listed, and remain listed, on a Kazakhstani stock exchange. This in effect makes explicit the prior interpretation that these requirements would apply to foreign listings as these would constitute "foreign placings" under the old wording. The recent amendments also sought to address noncompliance by significantly increasing the applicable administrative penalties. Now, the placement of securities made in breach of the applicable legislative requirements is punishable by a fine of up to 50% of all of the proceeds of such placement. Authority to levy this fine rests with the National Bank of Kazakhstan. The amendments also seemingly clarify that compliance is measured at initial issuance and so long as the foreign listed securities remain listed abroad. This suggests that the National Bank of Kazakhstan (NBK) could enforce penalties against companies that had issued securities prior to the amendments without complying with the local listing and offering requirements. 20% LOCAL OFFERING REQUIREMENT EXTENDED TO BONDS The Amendments extended the local offering requirement, previously applicable to share offerings and offerings of derivative instruments such as global depositary receipts (GDRs), to bond offerings. Now, under Article 22-1 of the Securities Market Law, an issuer an issuer placing bonds outside of Kazakhstan must offer at least 20% of the bonds through the local securities market in addition to obtaining the permission of the financial regulator for the foreign offering. Although it is not absolutely clear, based on the 2012 NBK Rules (discussed below), it is likely that the above requirements would apply to a foreign special purpose vehicle issuing bonds which is (a) at least 50% owned by a Kazakhstani company, or (b) which benefits from a guarantee provided by a Kazakhstani company. 2012 NBK RULES On 24 February 2012, the National Bank of Kazakhstan (NBK) issued new rules specifying procedures for giving consent for issuance and placement of securities outside of Kazakhstan. The new Rules establish certain additional requirements which the issuer must meet before being legally able to obtain the Financial Regulator's consent for issuance and/or placement of securities in a foreign state. The additional requirements include that the: issuer must not have defaulted on its previously issued debt securities; debt securities previously issued by the issuer and currently in public circulation have not been de-listed; and the leverage ratio of the issuer must not exceed 2:1. These requirements existed previously for bonds issued under Kazakhstan law, but did not apply to foreign-law-governed securities.

“… recent changes in law may significantly impact future cross-border listings from Kazakhstan.” Edward Bibko

With respect to shares and derivatives representing shares, the new Rules introduced a new requirement that these securities may be issued in a foreign state only if the issuance will not trigger an event of default and acceleration of debt securities previously issued by the issuer. In particular, equity securities may not be issued in a foreign state if: the issuer has outstanding debt securities; the prospectus of the relevant debt securities contains a change of control restriction that would be triggered by such issuance; or the new securities will result in breach of this restriction and acceleration of debt securities. DOMESTIC BOND ISSUANCES The Securities Market Amendments make a number of changes concerning domestic securities issuances. For example, they impose new obligations on issuers of bonds regarding preservation and disposal of assets. Now an issuer of domestic bonds is obligated by law: not to dispose of assets with a value more than 25% of its total assets; not

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Astana, Kazakhstan to be in default with respect to more than 10% of its assets; not to change its legal form; and to redeem the bonds when delisted. Under the amendments the issuer is obliged to engage a "representative agent of bondholders" when it issues domestic that are in public circulation. The Amendments also exempt holders of domestic bonds from the requirement to pay a state duty in a legal action in connection with the issuer's default on bonds. Prior to this change, the state duty was 3% of the value of the claim.

regulations. To be recognised as Qualified Investors these entities need to meet certain criteria showing they are sophisticated in dealing with financial instruments. Accompanying this change, certain securities and financial instruments are designated for purchase only by Qualified Investors, these include: securities and other financial instruments of foreign issuers issued under foreign law and not admitted to trading on the Kazakhstani stock exchange; and derivative securities and instruments not admitted to trading on the Kazakhstani stock and commodity exchanges.

QUALIFIED INVESTORS Finally, the amendments introduced the concept of "Qualified Investors" which are defined to include Kazakhstani and international financial organisations and other entities recognised as such by Kazakhstani brokers and dealers in relation to the National Bank of Kazakhstan's

CONCLUSION The changes created by the Securities Market Amendments clarify longstanding rules relating to foreign listings and provide real teeth for their enforcement. In the past issuers have often ignored the requirement to make a local

ABOUT THE AUTHOR Edward Bibko is a partner in Baker & McKenzie’s International Capital Markets Group based in London. He joined Baker & McKenzie’s London office in February 2001. Prior to joining Baker & McKenzie, Edward practiced in New York and Chicago law firms and worked as a financial analyst for

IBM. Edward is ranked as a leading capital markets practitioner in Chambers Global 2009 and currently serves as a member of the Firm’s International Capital Markets Group. Mr Bibko specialises in international equity and debt capital markets transactions. He received a doctorate from Syracuse University.

ABOUT BAKER & McKENZIE Baker & McKenzie is the world’s leading law firm, with 3,750 lawyers who “speak” 75 languages in 71 offices worldwide. The company had $2.27 billion in revenue in 2011.

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offering and listing because of the additional burden and cost to the transaction or for other practical reasons. It remains to be seen whether having to strictly comply with these requirements will dampen enthusiasm for cross-border listings involving Kazakhstani companies. In addition, it is unknown whether the NKB will impose penalties for past non-compliance or otherwise force Kazakhstani companies with a foreign listing to list their shares locally as well. i

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> SaĂşl RenĂŠ Medina, Tax and Legal Advisory, Ernst & Young: Current Tax and Business Topics in Venezuela

PARAFISCAL CONTRIBUTION TRENDS IN VENEZUELA In recent years, Venezuela has experienced an increase in indirect taxation, by means of the creation of several parafiscal contributions aimed at securing resources and support from the private sector for the development of certain areas of public interest, such as prevention of drug use, promotion of research activities on science and technology, or the promotion of sports, among others. For the purposes of this article, we will refer to the reforms made in 2010 to contributions for the prevention of drug use and for science and technology research, and the recent enactment in 2011 of the Master Law on Sports that provides for a contribution in this area. During 2010, the Master Law against the Illicit Traffic and Consumption of Psychotropic and Narcotic Substances was reformed into the new Master on Law on Drugs, with main modifications thereto relating to the taxable basis of the parafiscal contribution set forth in such Law, as well as the

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term for filing the respective contribution. This contribution is aimed at the obtaining of resources for the development of programs and projects for drug consumption prevention. The taxable basis was increased from net book income to operating income for the period, keeping the same 1% rate. Likewise, the term for return filing was modified from 15 business days after closing of the financial period to 60 continuous days following the period closing. Also, in 2010, the Master Law on Science, Technology and Innovation was reformed, focusing on modifications to the mechanisms for compliance with parafiscal contributions set forth therein, but keeping the same rates as those established in the former Law, ranging between 0.5% and 2% of gross income of the year preceding that in which the return must be filed, even though the activities subject to application of such rates were also modified. The 2005 Law provided that for purposes of

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complying with such contribution, the taxpayers (companies that have obtained gross income over 100,000 tax units -equivalent to Bs.F. 9,000,000 / USD 2,093 023, at the official exchange rate of Bs.F.4.3 to USD1) â&#x20AC;&#x201C; may i) make contributions to public or private entities that have registered projects for the development of science and technology with the competent administrative authority; or ii) implement projects within the company with the same objective, representing the acquisition of new technology or knowledge transfer to company personnel. The 2010 reform unified the enforcement mechanisms, with main emphasis on the payment of contributions to entities attached to the competent administrative authority on science and technology, in charge of implementing development projects in such areas. In 2011, the Master Law on Sports, Physical Activities and Physical Education was enacted, following the trend of creating parafiscal contribu-

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Parque Cristal Building, Caracas, Venezuela

tions to meet specific needs of general or social interest. This Law provides for payment of a contribution to the National Fund for Development of Sports, Physical Activities and Physical Education, equivalent to 1% of net book income when it exceeds 20,000 tax units (equivalent to Bs.F.1,800,000 / USD 418,604, at the official exchange rate of Bs.F. 4.3 to USD1). This contribution is an obligation to be fulfilled by companies or other public and private organizations engaged in for-profit economic activities in Venezuela, with the term for declaring this contribution being 120 continuous days from the financial period closing. The Law provides for the following compliance mechanisms: i) payments made to the National Fund for Development of Sports, Physical Activities and Physical Education; or ii) execution of the company’s own projects for development of physical activities and good practices; or iii) sponsorship of sporting activities under the guidelines set forth by the National Sports Institute. For own projects and sponsorship, only 50% of the obligation corresponding to this contribution will be considered. Within the general terms of these parafiscal contributions, each operates under a specific scheme, since the taxable bases, tax rates and compliance mechanisms differ from each other, thus requiring their proper evaluation to ensure full compliance therewith, regarding investments to be made in Venezuela.

BUSINESS TOPICS IN VENEZUELA – LAW OF COST AND FAIR PRICES One of the main aspects to be considered in Venezuela nowadays is the entry into force in 2011 of the Law of Costs and Fair Prices, which is aimed at the State supervision of costs and prices of certain goods and services through the Office of the Superintendent of Costs and Prices (SUNDECOP in Spanish.) From a practical point of view, the implementation of this Law has implied that manufacturers, distributors and marketers of the products specified by the SUNDECOP have been required to provide information on their cost structures, in order to determine the maximum retail price for sale thereof both at wholesale and retail levels. During the fourth quarter of 2011 and the first quarter of 2012, information on the food sector and personal hygiene products was required, these being the first groups on which such legislation was applied, with the next groups being drugs and automotive parts, as it has been recently announced by the authorities of SUNDECOP. As in the case of parafiscal contributions, appropriate support from expert advisors in the area is recommended, in order to evaluate the information to be submitted to SUNDECOP within the framework of the Law of Costs and Fair Prices, so to determine any possible optimization of the current cost structure of the companies. i

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Saúl René Medina is a Senior Manager of the Tax and Legal Advisory Division of Ernst & Young in Venezuela. Saul holds a degree in Law from Universidad Católica Andrés Bello (1997), and with post-graduate studies in Tax Law at Universidad Central de Venezuela. Likewise, he has participated in corporate restructuring processes (mergers and incorporation of new companies), including the analysis of the respective tax aspects and their effects on foreign investments. Saul has wide experience in the advisory to taxpayers for the recovery of excess tax resulting from VAT withholdings. He holds expertise in tax litigations, both at administrative and judicial level.

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> LEX Africa:

The Changing Face of Power in Africa By Greg Knot

No longer the “dark continent”, Africa is shedding light on investors’ quests for new sources of energy. Recent oil and gas finds, coupled with renewable energy progress and power project successes, have switched attention from the problems of the past to the promise of the present. While oil and gas are still being discovered in a and African Development Bank. environmental and other regulatory obligations, few other parts of the world, including the Eastern The Chad-Cameroon pipeline project turned both during construction and operation. Mediterranean, Northern Europe and Gulf of Mexico, sour when the President of Chad elected to spend Among other things, the project company it is the finds in Africa that are arguably fuelling the the funders’ money for other purposes, including committed to providing alternative water most investor excitement. arms purchases. The Lesotho electricity generation supplied for villagers whose access to the river To quote Paolo Scaroni of European energy plan was clouded by corruption, which culminated would be restricted as a result of the project. It giant, ENI, as reported in the New York Times of in the conviction and imprisonment of the project’s also undertook to plant indigenous vegetation 10 April 2012, “Africa will be the backbone of our chief executive. on islands and riverbanks around the Bujagali production and growth in the next 10 years”. Other big energy projects have suffered a reservoir, to monitor fish stocks and restock if His words have been echoed by other major more mundane fate. They typically took so long necessary, to provide alternative facilities for white players in the international energy industry, to reach closure, both financially and in respect water rafting enterprises, and to minimise the hailing natural gas finds off the northern coast of of construction, that they limped along for years effect of construction through traffic management Mozambique and Tanzania as the most significant without any particular results being delivered until and environmental management programmes. gas discoveries in a decade. With Nigeria being the finally petering out altogether. Another important facet of the project has been fifth largest producer of liquified natural gas (LNG) Change is certainly in the air. Recently, several an extensive public consultation and disclosure in the world and Nigeria, Equatorial Guinea and major African energy projects have reached programme to increase community awareness and Angola being significant sources of oil, the stage closure without the faintest taint of corruption or provide opportunities for community involvement. is set for Africa to play an increasingly On its website, BEL notes that because of important role in meeting the world’s the severe shortage of electricity in Uganda, energy needs. electricity consumers regularly experience According to media reports, recent “… the stage is set for Africa to play an rotating blackouts of between 12 and 24 gas finds in Mozambique (including by a day. It also notes that the Bujagali increasingly important role in meeting hours ENI of Italy and Anardarko of the USA) Hydropower project, while going a long the world’s energy needs.” rival the entire reserves of Kuwait, and way towards alleviating Uganda’s energy expectations are rising that there is much poverty, will not cause greenhouse gas more to come since this part of the world emissions, in contrast to most electricity Gret Knot has been virtually untapped. generated in Uganda (much of it by diesel Adding to the buzz about Africa and oil generators). incompetence. In fact, they have been hailed are new oil fields in Ghana and Uganda, natural Talking of minimising greenhouse gases, another as clear proof that the continent has turned the gas fields off Namibia, and exploration being major power project that is setting the pace for the corner and that the 21st century will prove to be undertaken in East African countries such as transformation of the African energy landscape – the age of the “African Lions”. Kenya and Tanzania, previously overlooked in and investors’ perceptions of it – is South Africa’s One such project is the Bujagali Hydropower favour of oil-rich West Africa. Renewable Energy Independent Power Producers Project in Uganda, a 250-megawatt power These headline-making events are not the Programme (REIPP). generating facility built on the Victoria Nile River. only reason for investors’ high hopes for Africa as This project is surely one of the most rigorously the new energy frontier. Other developments that RENEWABLE ENERGY SET TO BECOME REALITY reviewed, carefully planned and painstakingly are sparking optimism are the continent’s recent Through the REIPP, the South African Department executed projects in the energy sector in Africa. successes in achieving power project closure, of Energy aims to procure a total of 3 725 It was initiated in 2006 when the project along with regulatory reform in the energy sector Megawatts of energy from renewable sources sponsor, Bujagali Energy Limited (BEL), was and the progress being made in renewable energy. such as wind, solar, biomass, biogas and landfill chosen as the preferred bidder in an international gas, among others. The programme consists of competitive bidding process, run by the POWER DEALS SIGNED AND SEALED five bidding phases or ‘windows’, the first two of government of Uganda with support from the In the past, Africa earned an unfortunate which have already passed (in November 2011 World Bank. Completion and commissioning is reputation as a continent with a poor track record and March 2012 respectively). expected in the second half of 2012. for achieving closure in infrastructure projects in The Department has drawn widespread various sectors, including energy. praise for its capable handling of an extremely STAKEHOLDER MANAGEMENT AND GOOD GOVERN Two of the largest failed power projects were complex bidding process. So far, the REIPP ANCE EMPHASISED the World Bank-funded oil pipeline from Chad programme has been immaculately executed, One of the requirements BEL had to meet was the and Cameroon to the Atlantic Ocean, at a cost with industry watchers noting the comprehensive filing of a social and environmental assessment, of US$4.2 billion, and the electricity generation bid specifications, inclusive consultation process the aim being to ensure the hydropower project component of the Lesotho Highlands water and disciplined approach to deadlines, as well would deliver maximum benefits (including to project, involving about US$3.5 billion in funding as the integrity of the process of selecting local communitiewws) while complying with strict from the World Bank, European Investment Bank preferred bidders. 130

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…the 21st century will prove to be the age of the “African Lions”

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Administrative efficiency has gone hand in hand with high-level political support, and this has not been lost on investors, advisors and other players, who have flocked to take part in the programme. South Africans are eager to see the REIPP go into action to generate independently produced renewable energy. Business and consumers alike will welcome the prospect of competition to the national utility, not to mention the likelihood of greater security in their energy supply. In many ways, South Africa’s REIPP is a flagship project not just for the country but all of Africa – and one that the investor community is watching closely. Other African countries are also developing renewable energy programs for example the largest wind farm in Africa is planned at Lake Turkana in Kenya, a GBP533 million project with a capacity of 300MW. Wind power is also being developed in South Africa, Ethiopia, Tanzania, Egypt and Morocco. The huge hydroelectric potential of the Democratic Republic of the Congo remains undeveloped.

The Parliamentary Portfolio Committee on Energy has already held two public hearings on the ISMO Bill, which has been well received by a cross-section of energy industry stakeholders, including business, trade unions, academia and interest groups such as the Heavy Energy U sers Group. The latest round of public hearings, held in May 2012, attracted as many as 148 submissions. Some of the key issues that stakeholders raised in their submissions are the need for independent transmission lines to minimise connection risk, bulk electricity supply and network tariffs, and transparency in the allocation of megawatts between Eskom and independent power producers. The Department of Energy has said it will consider the proposals submitted about ISMO when developing the policy guidelines and regulations that will pave the way for the creation of ISMO, which will no doubt further enhance the attractiveness of the sector to investors.

AFRICA-FRIENDLY INVESTMENT Africa’s energy landscape is changing rapidly, in POLITICAL WILL IS PARAMOUNT more ways than one. New gas and oil discoveries in Government should always be the champion in countries outside the traditional resources footprint setting the regulatory framework for private sector participation in the energy sector and it seems in North and West Africa have fuelled a flurry of that this is a lesson Africa is taking to heart. As activity among energy investors from Europe, China and India. For the most part, Africa is welcoming with Uganda’s hydropower project, the REIPP in South Africa has enjoyed top-level political support the intense interest being shown in its power resources, the development of which is critical from its inception. If South Africa is to succeed for economic in introducing growth and the independent eradication of p o w e r “… procure power from the poverty. production – and in so doing independent power producers so as to There is set a precedent widespread level the playing field …” for other African understanding countries – it that investors will be critical to not only need to continue setting know the rules the tone from the top. by which they will be playing but also that these Up to now, South Africa’s energy sector has rules will be fairly and transparently applied. Africa been dominated by a state-owned monopoly is responding by introducing regulatory reforms, which, understandably, will be reluctant to lose its such as in South Africa where independent power grip on the market. Investors, on the other hand, producers are set to enter the market imminently. will need the assurance that fair competition will The continent is also showing itself capable of prevail and that new entrants will be protected managing major power projects efficiently and from potential market abuse. They will also want transparently, sending positive signals to citizens clarity on how they will be expected to interact with and investors that Africa has the power to deliver the incumbent. on its promise. The need for sound legal advice In this regard, the South African government when investing in Africa was the reason for the is not only making the right noises but following up formation in 1993 of Lex Africa, Africa’s first and with appropriate action by preparing to establish largest legal network with members in 27 African the Independent System and Market Operator countries. Pieter Steyn, Chairman of Lex Africa and (ISMO). Briefly, ISMO’s role will be to procure director of its South African member, Werksmans power from the independent power producers so Attorneys, notes that Africa is now a recognised as to level the playing field and eliminate conflict of emerging market not just for natural resources interest between the buyer and seller of electricity. but increasingly for consumer goods and services According to the ISMO Bill issued by the Minister such as telecommunications and banking. With of Energy, ISMO will be a separate juristic person an ever increasing population, the need for energy with a nine-member board of directors, whose security is becoming an important issue for African chairperson will be appointed by the Minister. It governments and provides enormous scope for appears that ISMO, like Eskom (the South African effective public-private partnerships. i state owned energy monopoly), will be regulated by the National Energy Regulator of South Africa (Nersa).

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Author: Greg Nott, director at Werksmans Attorneys, is the Head of the Africa practice area at the firm. He specialises in corporate governance, cross border transactions, arbitration and public/private partnerships, as well as contractual, statutory and regulatory issues in the power, mining and telecommunication sectors. In 2010 Greg was awarded Lawyer of the Year (Legal Business UK) and has been recognised in Chambers and Legal 500 Publications

With its extensive network of leading legal firms spanning 27 African countries, Lex Africa affords the international business community access to an established pool of skilled and reputable lawyers, all of whom strive to facilitate trade and investment in the continent through best legal practice. Established in 1993 Lex Africa’s management office is situated at Werksmans Attorneys in Johannesburg. For more information on member firms and to view the 2012 Guiwde to Doing Business in Africa please visit www.lexafrica.com.

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Panama: a Tax-Friendly Environment for Foreign Investors By Luis E. Ocando Bustamante

The economic boom of Panama[1] has been accompanied by changes in its tax system, making Panama more attractive for foreign investors, especially for multinational companies that focus on regional or global context. Over the last years, Panama has introduced changes in its domestic taxes as well as in the international taxation field. These changes have allowed Panama to consolidate its position as a main financial and international services center in the region. The economy of the country is based mainly on the services sector. Panama has become a centre for international services not only for its geographical position but also for economic characteristics, like the use of the US dollar as its currency, and certain tax benefits. In order to promote the use of the country as platform of services by multinational corporations, the legislation counts with special regimes. For instance, the Law 41 of 2007 created a special regime for the establishment of multinational companies that operate in Panama providing those services included in the Law 41[2] to its head office or related companies. The regime also applies for a head office of a multinational company. Benefits include exemptions on corporate tax income, VAT, special rules for labor, custom and migratory matters, among others. The Law N°41 of 2004 is another attractive regime which provides tax benefits for companies operating in “Panama Pacific Special Economic Area” (former Howard Air Base). The regime applies as long as the companies are dedicated to specific services activities, such as maritime services, offshore services, call centers, information technologies, among others mentioned in the Law. The benefits include exemptions for income tax, dividend tax, import duties, VAT, capital gain tax, among others. The special regimes mentioned above are only examples of the number of laws that provide in-

centives in the country. Panamanian law include tax incentives for a wide range of activities, such as tourism, call center, free trade zone (known as Colon zone), telecommunication, and agriculture. As for the general income tax regime, after a 2010 tax reform, changes introduced in the domestic legislation made the country more competitive, reducing the corporate income tax rate from 30% to 25%, which is below the regional average rate. As in the case of many countries in the region, Panama does not count with integration rules applicable for dividends, however as a general rule, dividends are subject to a withholding reduced rate of 10%, which may be further reduced up to 0% under some tax treaties. The territorial system, that has characterized Panama since its first form of income tax, has not been subject of severe modifications. Therefore, Panama continues to be one of the few countries in the world where taxes are imposed only on income generated within the country. On the other hand, Panama has been moved toward the international taxation landscape, introducing new concepts and increasing its tax treaty network. At the moment, seven double tax treaties are already in effect. Those are treaties with Mexico, Spain, Barbados, the Netherlands, Luxembourg, Singapore, and Qatar. Tax Treaties with France, South Korea and Portugal will be in effect on January 1st, 2013. Furthermore, Panama has signed tax treaties with Italy and Ireland which are not yet in force. Negotiations have been finished with Belgium, Czech Republic, Bahrain, Israel, Belgium, and United Arab Emirates, but the treaties have not yet been signed. In this context, Panama is the only country in Latin American with the most extensive treaty network, compared with other economies of the same size. Companies may take advantage of it to avoid double taxation or obtain reduced treaty rates. After a process led by the Government, in July of CFI.co | Capital Finance International

2011 Panama was removed from the “grey list” of the OECD. The decision to begin a process for the exclusion of Panama from this list was part of a national strategy to promote Panama´s international services. Currently, Panama is working to maintaining this new status through the signing of more tax treaties and the amendment of its domestic law. In summary, perspective for investment is more than hopeful. According to the Government, the growth prospects are reinforced by a comprehensive five-year plan that focuses on logistics, tourism, agriculture, and financial services as the key sectors. Besides, off-shoring services, maritime services, private health services and Regional Headquarter of Multinational are considered sectors with a future potential. i [1]AccordingtoInternationalMonetaryFundestimations,Panama had7.505%growthin2010,7.404%in2011,withaprojectionof 7.238%growthfor2012,6.563%for2013,5.832%for2014,and 5.3764% for 2015. [2]Forexample,directionoroperationsmanagement;logistics and/orstorageofcomponents;technicalassistancetoitsbusiness group;financialManagementandtreasuryservices;accounting ofbusinessgroup;consulting,marketingandadvertising,among others.

Luis E. Ocando Bustamante is an International Tax Partner of Ernst & Young, Panama, Central America, and Dominican Republic

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NAMIBIA’S CHANGING TAX LANDSCAPE – FROM SIMPLE TO COMPLEX By Cameron Kotzé

he collection of revenue for the Namibian fiscus has been under scrutiny for some time. Questions have been posed as to whether Namibia should change from a territorial (source) based tax system to a residency based system to increase the potential base from which revenue can be collected.

A study was done more than 10 years ago to advise the Namibian government on changes to the existing tax laws. This study concluded that the Namibian tax base should be broadened but stopped short of recommending that the basis of the income tax system should change from territorial to residence. Many of the recommendations made by the advisors have been implemented albeit that it has taken quite a long time get the proposals enacted into law. One of the recommendations of the study was to simplify the legislation so that every Namibian taxpayer understood the need to contribute tax to the State and how the amount that should be contributed is calculated. Amendments made to the existing legislation have fallen far short of this goal. In fact, some amendments that have been made

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to the Income Tax Act lack clarity and require careful analysis by experienced tax law experts. Given the technical capability of the current staff of Inland Revenue, the application of some provisions that have been introduced into law is questionable. The officials at the Inland Revenue office have displayed a pragmatic approach for many years in the past. This was mainly attributable to the shortage of skilled trained tax professionals in the country. Namibia’s taxpayer population has never actively pursued complex tax schemes to engineer a low effective tax rate and, coupled with the pragmatic approach of the officials at Inland Revenue, this resulted in a very cordial relationship between the tax collector and taxpayer. This relationship has been affected in recent times due to the collapse of the administrative capacity of Inland Revenue as well the draconian penalty system for non-compliance. Late payments of tax attract interest at a rate of 20% per year (calculated daily and compounded monthly at one stage) but the overpayment of tax attract no interest at all and still attracts no interest. In addition to this, the late payment of tax in some cases also attracts a penalty of up to 100% of the tax payable. Taxpayers have been confronted with

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these penalties even in cases where no malice was intended. It is clear that Inland Revenue is (correctly) seeking to tax income that that has escaped the tax net before. For example, a few years ago a withholding tax on interest earned from local banks and collective investment funds was introduced. Apart from a change in the law to subject the interest component of a distribution by a collective investment fund to tax, other interest income was always subject to tax but most individuals failed to disclose the interest income in their tax returns albeit that the banks submitted interest earning declarations to Inland Revenue. Stakeholders however were not consulted sufficiently prior to the introduction of the tax and those affected by the new tax sought plans to avoid it. This resulted in Inland Revenue having to refine the rules to ensure they collected the expected tax. A withholding tax on services rendered by nonresidents to residents has also been introduced recently, and applies irrespective of where the services are rendered. Thus, the source based principle has been extended to catch services rendered

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outside Namibia, on the basis that the Namibian taxpayer can claim a deduction for the amount paid to a non-resident. Services rendered within Namibia have always been subject to tax but previously escaped the tax net due non-disclosure by service providers and poor policing mechanisms employed by the Inland Revenue Directorate. Unfortunately the withholding tax on services legislation has been very poorly drafted and has created a lot of uncertainty amongst many taxpayers. The income contributed by the mining industry to the fiscus is also questioned by the Government. Comparative studies have shown that the contribution of the Namibian mining industry in the form of v taxes and levies are amongst the highest in the world. Some of recent proposals made by the Ministry of Finance would have had a devastating impact on the industry and were withdrawn after robust consultations. A levy on the export of raw minerals is still under investigation and will be introduced in the future. A transfer tax on the transfer of shares in property owning companies has recently been proposed. This proposal will ensure that the effective transfer of ownership of all properties (residential and commercial) will become subject to transfer tax. The draft legislation is very complex and will probably result in taxpayers seeking various avenues to reduce the tax payable. A further example of broadening the tax base is the environmental taxes that will be introduced soon. The basis of the tax is that the polluter (consumer) will pay the tax on goods used which are considered to be harmful to the environment. Other recent amendments to broaden the tax base include ring fencing of income from loss making trade and gains on the disposal of mineral rights. The taxing of gains on the disposal of mineral rights is the first move towards taxing capital gains in Namibia. The study conducted to advise on the changes to the tax laws of Namibia recommended that a capital gains tax should be considered. This will clearly broaden the current tax base and generate extra income for the fiscus but there are concerns that the introduction of such a tax may not generate sufficient net revenue after taking into account the cost of collection.

Cameron Kotzé, Partner, Ernst & Young Namibia

Formal cross border thin capitalisation rules will be introduced in the foreseeable future. This is very necessary as there is uncertainty about Inland Revenue’s formal position on how to calculate a taxpayer’s capital base for purposes of determining whether the thin capitalisation proCFI.co | Capital Finance International

visions of the Income Tax Act are triggered. The thin capitalisation provisions became effective in 2005 but the Inland Revenue Directorate has not focussed on this aspect of the law when assessing taxpayers. There could be a significant opportunity for Revenue to collect extra tax once these guidelines become effective. Tax incentives are also under consideration. Inland Revenue holds the view that the current incentives contained in the Income Tax Act have not encouraged significant investment in attracting new investment in the manufacturing industry in particular. Although this may be true, the question must be asked whether the process that has been followed by Inland Revenue in recognising the incentives has been executed efficiently and equitably. The perception is that Inland Revenue Directorate made it as difficult as possible for an investor to obtain manufacturing status. The officials involved in the evaluation process lacked the skill to make an informed decision on the nature of taxpayer’s activity and had no clear guidelines to follow when applications were considered. No plausible reasons for turning down applications were provided to applicants. Given this background it is no wonder that investors have not queued up to invest in Namibia – the environment is just too uncertain and it is not worth taking the risk. It is very likely that the export processing regime currently in place will also be phased out. The impact of phasing out is under investigation and affected investors will have to be consulted before a final decision is taken. The benefit from having export processing zone status has also not attracted a significant amount of investors to Namibia – mainly due to the compliance burden that the investor has to take on, and limitations where the final product is exported to South Africa. The possibility of an autonomous Revenue Authority is also under investigation. The lessons learned by other countries in Africa which have opted for autonomous revenue authorities are compelling, in that revenue collection had increased substantially after creation of such a body. The culture of compliance by taxpayers had increased dramatically and the tax base had broadened naturally. What was once a stable and uncomplicated tax environment will be changing and become complex. This will require a significant lift in the skills level of the staff at the revenue authority. I believe that Namibia has the capacity to answer to this call and such a change will be good for Namibia’s citizens and those wanting to do business in the country. i 135

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> World Bank Group’s PREM:

Harnessing Trade Opportunities for Growth and Development

he pace of global trade integration over well below 10 percent, and in many countries a Two years later, this investment drove chemical the past two decades has been extraorsignificant share of trade is duty-free. Advances in products to the third-highest spot on Macedonia’s dinary. Trade has been a key driver of transport (such as containerized shipping) and inexport list, lessening the country’s reliance on metglobal growth, convergence, and poverty formation and communications technologies have als and textiles. Or take Nicaragua, where a comreduction. During 1983–2010, global trade grew greatly reduced the cost of shipping goods and of bination of low labor costs and an improved secutwice as fast as gross domestic product (GDP). managing complex production networks. Together rity situation contributed to a dramatic expansion Developing countries in particular have benthese developments led to two major changes in of investment in free zones, attracting producers efited—on average annual exports from low- and the structure of global trade: (a) the vertical and of electronic wires and medical devices. Between middle-income countries have expanded some spatial fragmentation of manufacturing into highly 2006 and 2008, “ignition wiring sets for vehicles” 14 percent every year since 1990. The share of integrated “global production networks”; and (b) became the country’s fourth biggest export. manufactured products in total exports of low- and the rise of services trade. middle-income countries inThese examples demonstrate creased from just 15 percent the powerful impact the new In a world of footloose, global value-chain oriented in 1970 to roughly 60 percent global trade and investment today, a level approaching the environment can have on investment, a key objective is therefore to create share in high-income countries small economies. Global value greater linkages between the export-oriented foreign chains have made exporting (72 percent). While the world economy has been hit hard by manufactures much easier investors and the domestic economy. the 2008 financial crisis and than in the past because firms its aftermath, it is important to can specialize in specific segDr. Otaviano Canuto recognize the progress made ments of a supply chain for in recent decades to leverage a product. But if the benefits trade opportunities for creating employment and of global value chains are accentuated for small reducing poverty. The open global trading system and the rise of gloeconomies, so too are the risks. The 2008 trade bal “fragmentation of production” (supply chains) shock demonstrated that complementary poliThe rapid and sustained expansion in trade was make it much easier for countries to exploit trade cies to manage the short term effects of volatility enabled by a process of economic reforms aimed opportunities. Examples abound. Take Macedonia, are critical. From a longer-term perspective, host at removing barriers to trade, a multilateral trading where in 2009 an EU-based chemical manufaccountries for investments which are limited to system that reduced uncertainty for traders, and turer opened a plant in a recently-established spea small part of a supply chain are vulnerable to technological advances that reduced trade and cial economic zone. The plant began production any small change in the economic formula that communications costs. Average tariffs today are of emissions-control systems used in automobiles. brought the investment in the first place. Strategies

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that are focused simply on attracting investment may therefore have serious limitations in terms of sustaining economic growth and reducing poverty. The investments offer jobs – often a large number of them – but if a country offers little more than cheap labor, it might not retain “footloose” investors and weaken its longer-term prospects for economic development. In a world of footloose, global value-chain oriented investment, a key objective is therefore to create greater linkages between the export-oriented foreign investors and the domestic economy. This can happen through three broad channels: 1) vertical linkages – expanding the reliance on domestic suppliers of goods and services and sales of products to domestic firms; 2) horizontal linkages – including collaboration between foreign investors and domestic institutions such as universities; and 3) movement of skilled workers in and out of foreign firms. FACILITATING VERTICAL SUPPLY CHAIN LINKAGES Embedding foreign investors into the local economy depends crucially on establishing links in the domestic supply chain, both forward and, most

importantly, backward to local suppliers. Such links also facilitate the spillover of technology and knowledge from foreign investors to local firms and workers. Developing competitive local suppliers requires a strong, competitive local industry base. The characteristics of the business environment, notably the degree of home grown competition pressure, and the degree of exposure to foreign competitors in the domestic market and external markets, are important. In the fragmented globalvalue-chain environment, governments can boost their positions by establishing clear rules and enforcement mechanisms to reduce the risks (and thus the costs) of contracting and by providing incentives for foreign investors to use local sources for production inputs. So-called FDI-SME linkage programs have been established in a wide variety of industries and country contexts. In most cases, they focus on a small set of large foreign investors, who contribute time and resources to supporting the technical upgrading of local SMEs, with the aim of identifying potential supply partners. One of the most successful in Latin America was Costa Rica’s Supplier Development Program (part of the Provee Program), which facilitated SME linkages in high technology sectors, following the influx of high technology FDI linked to the investment by Intel. This program, and others like it, show the potential of establishing sustainable supply chain partnerships even in small, developing countries. But they also highlight the importance of an aggressive, and resource-intensive effort on the part of government (typically through an investment promotion or SME agency) to support these initiatives. STRENGTHENING THE ABSORPTIVE CAPACITY OF LOCAL FIRMS Whether local firms can benefit from the knowledge and technology of foreign investors is critically dependent on their absorptive capacity. Among the most important policies here are those focused on the local learning and innovation environment infrastructure, including investments in education, interactions between institutions of higher learning (e.g. training centers) and the private sector, and technological research institutes. Policies should also target the elimination of barriers to firm growth. Improving access to finance is one key ele-

ment of enhancing local firms’ capacities to absorb FDI spillovers. Improved financing terms are often components of linkages programs, for example offering suppliers faster payment terms or leveraging the low credit risk of the large foreign investors to facilitate access or better terms for local suppliers. For example, the NAFIN factoring program in Mexico transfers the credit risk of the small suppliers to highly creditworthy buyers and enables the bank to offer factoring without recourse or any collateral from SMEs. BUILDING COMPETITIVE DOMESTIC EXPORTERS While large, foreign investors tend to account for the majority of exports, over the long term, sustainability of export flows will depend on the emergence of competitive domestic exporters. Indeed, the ability of local firms to survive the rigors of foreign markets is, in effect, proof that the domestic sector has come of age. A focus on SME competitiveness implies a need for export promotion agencies to move much further upstream in the value chain and target resources to improve the productivity of firms that are seen to have high “export potential”. CONCLUSION Developing countries have benefited enormously from the dramatic changes in the global trade and investment environment brought about by the development of global value chains. For small economies in particular, value chain oriented investment has brought with it export industries on a wholesale basis. To take advantage of the dynamic potential of FDI and lower the vulnerability to the footloose nature of value chain investments, export activities need to go beyond being an enclave. Leveraging the potential of value chain oriented export strategies requires building competitive domestic firms and establishing effective linkages between foreign investors and the domestic economy. These are essentially two sides of the same coin. Building up domestic supply side capacity is a long term and difficult challenge, but if done effectively within the context of global supply chains, it will leverage FDI as a platform for the development of a sustainable national export sector, on the backs of competitive, globally integrated, local firms. i

By OTAVIANO CANUTO Otaviano Canuto is Vice President and Head of the Poverty Reduction and Economic Management (PREM) Network, a division of more than 700 economists and public sector specialists working on economic policy advice, technical assistance, and lending for reducing poverty in the World Bank’s client countries. He took up his position in May 2009, after serving as the Vice President for Countries at the Inter-American Development Bank since June 2007. Dr. Canuto provides strategic leadership and direction on economic policy formulation in the area of growth and poverty, debt, trade, gender, and public sector management and governance. He is involved in managing the Bank’s overall interactions with key partner institutions including the IMF and others. He has lectured and written widely on economic growth, financial crisis management, and regional development, with recent work on financial crisis and economic growth in Latin America. He speaks Portuguese, English, French and Spanish.

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> Michael Lalor, Ernst & Young

Attractiveness for FDI: The African Growth Story By Michael Lalor

Ernst & Young’s Africa Attractiveness Survey provides evidence of the growing interest in the African continent as an investment destination and place to do business. Africa has many elements of a compelling investment proposition – natural resources, rapid economic and population growth, maturing political systems, and a rapidly improving environment in which to do business.

In a global context in which rapid growth markets are dominating capital flows and investor attention, a diverse group of African economies, including the likes of Nigeria, Ghana, Angola, Ethiopia, Tanzania, Mozambique, and Zambia, are among the fastest growing in the world, with growth of 7%+ over a sustained period.

seeking higher returns, the African growth story should therefore stand out. While most developed economies continue to struggle, Africa clearly offers an exciting opportunity for investment and growth, and an alternative to the ultra-competitive Asian and other rapid growth markets.

At the same time, many of the companies that have pursued a longer term Africa growth strategy are generating excellent returns from their investments. In fact, empirical analysis reveals that ROI from investments in Africa have consistently been among the highest (if not the highest) in the world since the 1990s.

It is little surprise therefore that investor interest in Africa has been on the increase. Our Africa Attractiveness research shows that foreign direct investment (FDI) projects in Africa have grown at a compound rate of almost 20% between 2007 and 2011. The trend continued last year with the number of projects up close to the peak of 2008, and a year-on-year growth rate of 27%. Equally importantly, Africa’s global share

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of FDI increased substantially, up to 5.5% of all new FDI projects globally from 4.5% in 2010. For us, this certainly reflects both resilience and the growing attractiveness of Africa as an investment destination. THE CHANGING CHARACTER OF FDI INTO AFRICA It is important to note that, although we measure FDI by both capital amounts invested and number of projects, we tend to emphasise numbers of projects. This is because such a large proportion of capital flowing into Africa still goes into the capital intensive resource sectors (primarily Oil & Gas); this is not necessarily the best quality investment in terms of sustainable growth and job creation, and tends to distort the overall picture of FDI flows. Clearly, natural resources will remain a key focus for FDI. Oil & gas is a key focus, not only the well established producers in North and West Africa (including Ghana now), but also East Africa, all the way from the gas fields in Mozambique up to the rift basins in Kenya and Ethiopia. Similarly the mining sector will also remain very important. There is no doubt, however, that the ongoing growth of a ‘consumer class’ in Africa, with increasing access to communication and information technology, is attracting ever increasing attention from consumer-orientated companies. As a result, the composition of FDI is rapidly diversifying, with financial services, for example accounting for the highest proportion of FDI projects into Africa, and FDI into other sectors, such as consumer products, retail, telecommunications, and automotive, growing substantially. In our Africa Attractiveness research this year, we have dug a bit deeper into the activities and sectors into which FDI has been going over the period from 2003-2011, and made some interesting initial observations in terms of the increasing diversification of investments: 1. Over 50% of the projects that have been

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from a project perspective, then a richer, more nuanced picture begins to emerge.

invested into in Africa over that period have been in service-related activities (excluding manufacturing, infrastructure, agriculture and extraction). 2. Almost 70% of the capital invested into Africa (and nearly 40% of new FDI projects) over that period has gone into manufacturing-type and infrastructure-related activities (and not extractive activities, as many people may assume). 3. Manufacturing activity alone accounts for 40% of all new FDI-related jobs in Africa since 2003. 4. Of the investment into manufacturing (which has constituted almost 25% of all FDI projects, 30% of all capital into Africa), a large proportion of the capital has gone into natural resource sectors (primarily Oil & Gas and Mining).

In terms of project numbers, South Africa is top for whichever period one measures over the past decade. This largely reflects the diversified structure of the South African economy, which is today primarily services- rather than resource-based. As a result a large proportion of FDI into South Africa is going into sectors such as IT, telecommunications, automotive, and financial services (which tend to be less capital intensive than resources). Although mining does remain an important sector in South Africa, even here, a large proportion of investment is going into manufacturing rather than pure extractive activity. The North African countries still perform relatively well when measured on a project basis (although the numbers dipped in Egypt, Libya and Tunisia last year because of the political situation), with large investments into construction and real estate projects particularly noteworthy. There is, however, a diverse group of â&#x20AC;&#x2DC;emergingâ&#x20AC;&#x2122; African economies that are becoming increasingly attractive destination markets for FDI, including the likes of Ghana, Zambia and Mozambique. However, the rising star is arguably the three largest markets of the East African Community

DESTINATION MARKETS FOR FDI Depending on whether one measures FDI by capital investment or projects, the perspective on which are the attractive markets for FDI can look quite different. Most analyses tend to look at capital flows, and, as a result the oil rich countries such as Nigeria, Angola, more recently Ghana, and the North African states tend to dominate the list (with South Africa, because of its relative size and development, the only exception to this rule). However, if one looks at FDI

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(EAC), namely, Kenya, Tanzania and Uganda. We expect broad-based economic growth in this region over the next decade, with recent oil & gas discoveries acting as a growth accelerator. Important too is the structure of EAC, which is making good progress toward the creation of a market of close to 150 million people, a combined GDP approaching US$100b, and an economic growth rate in excess of 6% over the past decade. These key numbers would put the EAC in the same sort of category as Bangladesh and Vietnam, both listed among Goldman Sachs’ so-called “Next 11” (those countries, after the BRIC economies, with the highest potential of becoming the world’s largest economies in the 21st century). THE PROSPECTS FOR FDI INTO AFRICA We have no doubt that the prospects for FDI into Africa are very positive. The African growth story is a compelling one. In the current global economic context, it would be difficult to find an alternative investment destination that offers 10-15 years of sustained economic growth off a platform of ongoing political and socioeconomic reform and progress, a diverse group of economies among the fastest growing in the world, and profitability levels and rates of return that are among the highest in the world. Although a perception gap does remain among many investors that have not yet ventured into Africa – lingering concerns about factors such as political risk, corruption, the challenges of doing business – those already doing business on the continent understand that many African countries actually benchmark well against their emerging market peers, that the risks can be managed, and that the rewards on offer make 140

it one of the most attractive investment destinations in the world today. THE FDI OUTLOOK FOR SOUTH AFRICA • South Africa (SA) is Africa’s largest economy; it has a sizable domestic market with growing levels of disposable income, a comparatively well-educated labour force, and an institutional environment that conducive towards business. • SA’s substantial resource endowment has meant that South Africa has been a popular destination for FDI for a number of decades. This trend has continued over the period 200311, although FDI capital inflows have been lower than those going into oil rich countries like Nigeria and Angola. • This trend partly reflects SA’s own wealth and capital investing capacity, but also the changing and increasingly diversified nature of the SA economy, with the service sectors now contributing more than 65% to GDP. • This diversification is reflected in the makeup of FDI flows, much of which is now directed towards (generally less capital intensive) manufacturing and services. As a result, SA is the leading FDI destination in Africa in terms of project numbers. • FDI inflows to South Africa are forecast to average about $10b pa over the next five years, with approximately 125,000 new jobs created as a result. THE FDI OUTLOOK FOR TANZANIA • Tanzania is forecast to be one of the fastest growing economies in the world over the next five years, has a relatively well educated labour force, and is politically stable. As a result it is attracting increasing investor attention. CFI.co | Capital Finance International

• Over the period 2003-2011, Tanzania has attracted $13.2b of FDI, with the bulk going into resources (Tanzania has fairly sizable gold reserves), but with communications and alternative/renewable energy also attracting substantial FDI. • FDI inflows to Tanzania over the next five years are forecast to average about $2.2b pa, with approximately 28,000 new jobs created as a result. i

Michael Lalor is a partner in Ernst & Young’s Europe, Middle East, India and Africa practice and is responsible for the firm’s Africa Busiess Centre.

12–14 November 2012 Perth Convention and Exhibition Centre Perth, Australia

One city. One event. All resources. The Australian Securities Exchange (ASX) is proud to present ARC 2012, an event which will be the ‘ﬁrst of its kind’ resources event in the Asia Paciﬁc region. The event will promote the Australian resources value proposition to an international audience through education, information and networking.

ARC: Bringing international investors to Australia Keynote speakers include: The Hon.Colin Barnett MLA The Premier of Western Australia

The Hon. Martin Ferguson, AM Minister for Resources, Energy and Tourism

David Peever RIO Tinto, Managing Director Australia

Murray Bailey Yancoal, Managing Director

David Gonski AC Future Fund, Chairman

Karl Simich Sandﬁre Resources, Managing Director

Ken Brinsden Atlas Iron, Managing Director

Andrew Wood WorleyParsons, Group Managing Director – Finance/CFO Lance Hockridge QR National, MD and CEO

Michael Carey Shell, Director Brian Cox Professor of Particle Physics

Jimmy Wilson BHP Billiton, President, Iron Ore

Michael Young BC Iron Limited, Managing Director

Brad Lingo Drillsearch, Managing Director Dan Lougher Western Areas, Managing Director

Michael Deegan Infrastructure Australia, Infrastructure Coordinator

FOUNDATION PARTNER:

Brian Smith Chevron, General Manager Operations

EVENT PARTNERS:

GOLD SPONSORS:

SILVER SPONSOR:

BRONZE SPONSORS:

Investments

MALAYSIA – YOUR PROFIT CENTRE IN ASIA Malaysia is strategically located at the crossroads of East-West trade. The country consists of thirteen states and three Federal Territories, with a total landmass of 329,845 square kilometers (127,354 sq mi). The capital city is Kuala Lumpur, while Putrajaya is the seat of the federal government. Malaysia borders Thailand, Indonesia, Singapore and Brunei. Malaysia has unveiled an ambitious plan through the Economic Transformation Programme (ETP) to propel the country towards becoming a high income and developed country by 2020. The Malaysian Government has also unveiled the 10th Malaysia Plan 2011 – 2015 and the 12 National Key Economic Areas (NKEAs) under the ETP.

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The ETP has identified 131 Entry Point Projects (EPP) worth US$ 444 billion to be implemented over the next 10 years and expected to generate some 3.3 million jobs. In this regard, the government recognizes that international companies and foreign direct investments assume a vital role in realizing the government’s vision. To date, a total of 110 EPP projects have been announced by the Government with investments amounting to US$56.8 billion. These projects are projected to contribute some US$41.1 billion in gross national income and create over 313,741 new jobs by 2020. Amongst the NKEAs prioritized are oil and gas and energy sector, electrical and electronics, ICT, education and tourism. To move the country forward, the government

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has embarked on a drive to shift Malaysia from a current upper middle income country of around US$9,700 per capita income to US$15,000 by 2020. For this to happen, the economy must grow at 6 percent per annum over the next 10 years. Based on the latest figure by UNCTAD’s World Investment Report 2012, Malaysia’s foreign direct investment (FDI) inflows in 2011 jumped 31.5% to US$11.97 billion (RM37.83) from 2010, making the country the top five preferred investment destinations in Asia. Malaysia is also the third most popular destination for FDI in Asean after Singapore and Indonesia. Based on UNCTAD’s new FDI Contribution Index, Malaysia was among the few economies that

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had exceeded the organisation’s expectations, noting that the country is in a solid position to implement its new set of “next-generation” investment policies. The FDI Contribution Index ranks the countries surveyed based on the significance of FDI and foreign affiliates to their economies in terms of value added, employment, wages, tax receipts, exports, research and development expenditures and capital formation.

most markets in the region. A.T Kearney Global Services Location Index has ranked Malaysia as the 3rd most attractive location for outsourcing destinations for nine consecutive years since the inception of the index in 2003. Malaysia’ location in the centre of the ASEAN region provides easy and convenient access to the other markets in the region. Investors can use Malaysia as a launch pad into ASEAN, the economic powerhouse of more than 600 million people while

16th to 14th ahead of countries such as Australia (15th), Britain (18th), South Korea (22nd), China (23rd), Japan (27th) and France (29th). This positive ranking will continue to support the country’s investment promotion drive. The report assesses a country based on four competitiveness factors: Economic Performance, Government Efficiency, Business Efficiency and Infrastructure. Among the four competitiveness factors, Malaysia registered commendable improvements in the Business Efficiency factor, from 14th last year to 6th position and Government Efficiency to 13th from 17th in 2011.

The Malaysian Government is also in“Malaysia’s foreign direct investment creasingly liberalizing its services sector as this will be a key driver for growth. ServBased on the A.T. Kearney’s latest 2012 (FDI) inflows in 2011 jumped 31.5% to ices industries where Malaysia is emergForeign Direct Investment (FDI) ConfiUS$11.97 billion from 2010″ ing as a strong leader include, regional dence Index, Malaysia climbed to 10th establishments, tourism, medical travel, spot in ranking from the previous 21st Gross Domestic Product growth expected to averIslamic finance, R&D activities, education, logistic position. The country’ favorable position in these age six per cent, annually. If ASEAN were a single and professional business services, can be avenue reputable rankings reflects investors’ confidence country, it would be worth US$2 trillion, and rank for enhancing bilateral investment further. in the government’s various initiatives to transform as the ninth largest economy in the world and third the country into a high-income economy by 2020. largest in Asia. For a country with a population of 28 million peoMalaysia has adopted a more selective and tarple, Malaysia today is one of the world’s top locaMalaysia, being a progressive Islamic country, is geted approach in attracting investment. The tions for offshore manufacturing and service-based also gaining reputation as a global leader in the areGovernment recognises the need to develop the operations with the presence of more than 8,000 as of halal products and Islamic finance. Malaysia’s high technology sectors as part of its strategy to foreign manufacturing companies. Over the years, halal certification has gained international recognisustain the momentum of economic growth and to many of these companies have expanded and dition which also meets stringent international health improve the competitiveness and resilience of the versified their operations, reflecting their continued and safety standards. Malaysian economy. confidence in the country’s potentials and prospects as an investment destination. Malaysia’s conducive and vibrant business enviAgainst this backdrop, the Malaysian Investment ronment was acknowledged in several internationDevelopment Authority (MIDA) is adopting a more There are many factors that have enabled Malayal rankings. The World Bank ranked Malaysia 18th focused and targeted approach in attracting quality sia to attract quality investments over the years. in the Ease of Doing Business Report for 2012. investments. MIDA will continue to intensify its efAmong others, include its continued political staThis ranking is up 5 notches from 2011 ranking. forts in identifying and attracting investments in the bility, a diversified economy, developed infrastruchigh value-added industries, high technology and ture, liberal and transparent business policies, Malaysia also ranked the 14th most competitive knowledge intensive industries. strong supporting industries and a strong financial economy in the world for 2012 by the Institute for services sector. Management Development (IMD) Switzerland in The Malaysian Investment Development Authority the latest World Competitiveness Yearbook (WCY) (MIDA) will assume an important role in ensuring The country has a multi-ethnic and multilingual 2012 survey. Malaysia moved up two spots from that there is a significant leap in investment activiworkforce that can effectively communicate with

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ties in all sectors of the economy led by a more dynamic private sector to achieve the targets set under the 10th Malaysia Plan (10 MP) and Economic Transformation Programme (ETP).

“Malaysia today is one of the world’stoplocationsforoffshore manufacturingandservice-based operations”

In this regard, MIDA have chosen a new logo that is vibrant and modern, reflecting MIDA’s key roles and core competencies. The bold, block letters of the new MIDA corporate logo represent the integrity and professionalism of the organization. The grey lettering suggests neutrality and reliability, enhanced by an eye-catching, strong red motif that resembles an arrow moving forward. As a one-stop centre for investment, MIDA assist companies that wish to operate in Malaysia to obtain manufacturing licenses, investment incentives and work permits for expatriates. It also provide post-licensing assistance, e.g. providing exemption from import duties on raw materials and machinery used in manufacturing, and assisting investors to obtain approvals and facilities from state governments and local authorities to implement their projects. MIDA has also been empowered by the Government with the necessary authority to negotiate directly with investors for targeted projects and provide the necessary support, including special incentives. With this development, MIDA will be able to make decisions expeditiously on approval of projects and incentives in the manufacturing and selected services sectors. In order to sustain Malaysia’s competitiveness, the government will continue to implement new policies and fine-tune existing measures to facilitate the conduct of business and to assist the private sector to access new markets. i

About MIDA Malaysian Investment Development Authority (MIDA) is the principal Malaysian Government agency responsible for the promotion and coordination of the manufacturing and services sectors in Malaysia. MIDA assists companies in the implementation and operation of their projects. Please visit www.mida.gov.my for more information.

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> Q&A with AzPromo:

Foreign Direct Investment (FDI) in Azerbaijan WHAT WOULD BE THE KEY SECTORS YOUR COUNTRY WISH TO FOCUS ON DEVELOPING? ARE YOU PLANNING TO ATTRACT INTERNATIONAL INWARDS INVESTMENT TO THESE SECTORS? Azerbaijan is a country with wide range of investment opportunities and is undoubtedly one of the most attractive destinations for foreign direct investments (FDI) in the region. There are good opportunities for the development in the following sectors: Agriculture and food processing. Agriculture is one of the most important sectors of the economy in Azerbaijan. Today, the agricultural

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sector employs over 39% of the active labour force of the country. The fertile lands, abundance of water and climatic diversity create favourable conditions for a strong agricultural sector. Meanwhile, the food-processing sector constitutes an important component of the national economy and accounts for around 14% of national manufacturing output. Furthermore, Azerbaijan trades intensively in agricultural and food products. Existence of 9 climatic zones out of 11 in the world creates favourable conditions for the development of agriculture in Azerbaijan. Possessing great potential for development, the widest range of investment incentives and

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high economic profitability, the agriculture and food-processing sectors remain among the most attractive for investment in the economy of Azerbaijan. Different financial and non-financial schemes, such as exemption of farmers from taxes (except land tax), state subsidies, discounts and other privileges have been developed in order to promote further development of business in the sector. Alternative and Renewable Energy. Alternative and renewable energy sector is quite new (except for hydro-energy which is one of the traditional energy sources) promising area of the

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economy. According to estimations, Azerbaijan has a great potential to raise effectiveness of use of the energy resources of the country by involving the following renewable energy sources: • Hydropower (by using the energy of small rivers); • Wind (average annual wind speed in Absheron peninsula is 5.8 – 8.0 m/sec and number of wind gusting days per annum is up to almost 245-280 days); • Solar (Azerbaijan has got 2500 hrs – 2800 hrs of sunshine period with 250 sunny days per annum); • Thermal waters (with over 400 million cubic meter/day of between 35-100o C total resources of the thermal waters); • Biomass (with annual waste emission plays around of 2.0 mln. tons). Construction. The construction sector is also a huge growth area, as one can witness Baku and regions of Azerbaijan look like a huge construction yard. Major redevelopments are underway to give the country a facelift, and much of the infrastructure is being built from the scratch. Many foreign companies are also fighting for a piece of that pie. Thus, inflow of investments is welcome in Azerbaijan for starting up a construction projects only by forming joint venture with local entities.

Flame Towers, Baku

Forty hotel construction projects were ongoing in 2011, six of which were five-star hotels built in Baku city.

Vodafone. More than half of the population is registered as internet users. Online payments, registrations, taxation, and other e-services are being widely introduced and the sector is developing. Along with all these Azerbaijan still seems covenant area to invest and benefit. Petrochemical industry. Throughout the 20th century chemical industry has been vibrant and growing due to oil production. Numbers of petrochemical and chemical facilities were built during soviet era along with city of Sumgait that produced most of the chemicals of the country. After the soviets collapsed many facilities were incapable to run. But, by the end of 2011 a new decree was signed by the president to give rebirth to this field by establishing a brand new and modern Sumgait Chemicals Production Site. It is 37 km away from Baku city and resides nearby the Caspian Sea that makes cargo transport a lot easier and suitable for future trade of goods and offshore carriages. This site will consist of plenty chemical plants that will be open to both local and foreign investors. A number of tax and customs incentives as well as concessional loans are considered to be granted in the Park. The investment potential of these sectors is broadly presented in all promotional activities of AZPROMO.

Tourism. Tourism is another important sector. We are learning from the experiences of many countries’ well-known tourist destinations, such as our close neighbor Turkey. The year of 2011 was designated as the “Year of Tourism” in Azerbaijan. 40 hotel construction projects were ongoing in 2011, six of which were five-star hotels built in Baku city. It is no wonder that world-famous hotel chains are entering the market. All of six new hotels in Baku are the leaders in the global hotel industry (Hilton, Jumeirah, Kempinski, Four Seasons, Marriott, and Fairmont). Of course, we do not only aim at luxury tourism, as most of tourists prefer budgetary spending. Therefore, we dare to attract many more international middle-class and budget hotels companies to heavily invest in this particular field.

ARE THERE PARTICULAR GEOGRAPHICAL AREAS AND CITIES YOU PARTICULARLY WISH TO DEVELOP? To achieve diverse and rapid development, the Azerbaijani government executes extensive programmes, one of which is the State Program on socio-economic development of regions (2009-2013) This program aims to develop all regions and cities of the country and contains widespread renovation, development and construction of interconnected roadways, bridges, highways, utilities, schools, hospitals, olympic sports centers, industrial buildings and many other diverse infrastructures to enable expansion of the business throughout the country.

One of the ongoing biggest projects – construction of large-scale summer and winter tourism complex in Shahdag Mountain – is in the implementation phase. Construction of this complex stimulates development of the winter sports in the country.

As a proof, the city of Sumgait – as it once carried out a title of chemicals capital of the Soviets – is set to be chemical and industrial superpower of Azerbaijan nowadays. Sumgait Technological and Chemicals Manufacturing Park is currently being established to vitalize country’s industrial strength and regain its title as an industrial city.

Telecom/ICT. Telecommunications sector is developing and attracting investments as well. Soon Azerbaijan will launch its first satellite. Minister of Communications and Information Technologies made a forecast that during the years of 20202025 the revenues from this sector will reach significant sum. There are five major cellular phone carriers in Azerbaijan, two of which are world’s telecom giants like TeliaSonera and

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Government also pursues strategies to restore the economic activities in the areas traditionally known for specific products manufacturing.

One of the ongoing audacious urban development works is “Baku White City” project that will be one of the largest modern projects in the world, built entirely on ecologically reclaimed industrial zone. As a lead consultant, the world-renowned global multidisciplinary engineering and architectural design firm Atkins (UK) performed master planning and detailed planning activities for the project. Along with specialists from Azerbaijan,

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Fosters and Partners (UK), established by legendary architect Norman Foster and American architectural bureau F+A Architects, were also involved. Baku White City will encompass 244 ha, making it largest development in Caucasus region – 11 times the size of Iceri Shahar (The Old Town) in Baku and more than Monaco inhabitating up to 50 000 residents. When completed BWC will be able to provide 48 000 workplaces, 20 000 residential and commercial units and 40 000 parking spaces. Currently this project is looking for principle investors in all aspects to be financed. Currently a number of projects are being implemented in the regions of Azerbaijan. Among them are such projects as construction of Aluminum plant in Ganja, construction of Cement Factory in Gazakh region. The establishment of Ganja Industrial Park that will boost development of industrial areas is also on stake. This is important both from regional development perspectives and for opening of new work places. After Baku, construction boom now spread to other big cities of Azerbaijan. Besides that, government pays special attention to reconstruction of infrastructure in the regions of Azerbaijan. Since acquiring independence in 1991, tremendous efforts were made to develop the infrastructure area and this resulted in Azerbaijan’s lead in infrastructure of the region. Many mega infrastructural projects are underway. One such project is the Baku-Tbilisi-Kars railroad, which is also called ‘Iron Silkway”. After completion of this project in 2012 Azerbaijan will turn into logistic hub by restoring ancient trade routes which will connect Asia to Europe. We have also managed to establish air connections to major European and Asian cities, and Azerbaijan has never been so well connected. Despite relatively small territory of the country, we have six international airports; latest

opened in November 2011 in Gabala. The biggest one is in Baku. The new 53,000m2 terminal of Heydar Aliyev International Airport designed by world-known “Arup” company, with capacity of 3 million passengers a year will promote Baku and Azerbaijan to the wider world. The Baku International Sea Port which will be the largest on the Caspian is also under construction. Being located on the territory of 400 hectares the Port will capacitate 21 mln tons of goods per year or 150 000 containers. It is needless to mention that most of the above infrastructural projects will enable to increase the capacities for moving of persons and goods to and from Azerbaijan and will make Azerbaijan the logistic hub of the region. One of the ongoing biggest projects – construction of large-scale summer and winter tourism complex in Shahdag Mountain – is in the implementation phase. Construction of this complex stimulates development of the winter sports in the country. Another ambitious project is construction of “Khazar Islands” which will cover 2 000 hectares and is being developed 23 km away from capital city. Numerous residential buildings, office spaces, educational and medical facilities, business centers and other amenities will be constructed in the city. Leading companies experienced in the construction of cities from UAE, UK, The Netherlands and other countries are engaged in the project. WHAT ARE YOUR PLANS TO DEVELOP YOUR FINANCIAL SECTOR, INCLUDING IN BANKING, YOUR STOCK BROKERAGES AND THE DOMESTIC STOCK EXCHANGE MARKET? Financial sector in Azerbaijan has gained its sustainability and market cap during last 10 years by leaping numbers of newly opened commercial banks, insurance companies and financial entities of multi-purpose loans etc. Currently, up to 44 banks, 19 insurance companies and 38 money-

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lending equity funds are operating in Azerbaijan serving millions of customers. Some of them have international operations in the cities of Tbilisi, Moscow, London, Paris, Frankfurt-Mein, St. Petersburg and New York. As a result of widespread privatization after gaining independence, the financial sector has also passed through all procedures and state-owned banks’ shares were bid and sold to investors. In the beginning of 2011, total assets of all local commercial banks exceeded $13.6 bln and kept their rating not below BBB- (according to Fitch and S&P indices). One of the Russian major banks, Bank VTB, established its office in Baku in 2009 and expanded business to substantial extent with millions of dollars portfolio. Hence, audit & financial consulting firms are also doing a successful business in Azerbaijan. Worldwide-spread and recognized as “Big Four”the audit, tax & legal giants – Deloitte, KPMG, PriceWaterHouse Coopers and Ernst & Young are among these promising companies which run in Azerbaijan as well. They, along with local audit companies, offer diverse services including overall financial analysis, corporate taxation issues of enterprises based on IFRS standards. Despite major financial downgrade & economic recession, Azerbaijani banks kept their credibility while maintaining their stable portfolio and revenue growth (total profit from banking activity in 2003: $25 mln; in 2010 increased more than 10 times: $300 mln.) These indicators demonstrate the reliable business climate of financial & banking field in Azerbaijan. Azerbaijan has stakes and is actively engaged with the European Bank for Reconstruction and Development, Asian Development Bank, World Bank, Islamic Development Bank, Black Sea Trade & Development Bank, etc. all of which have

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running projects portfolios in the country. There are also representative offices of some leading foreign banks in Azerbaijan, such as KfW, Societe Generale, etc. that are actively involved in financing of local companies and mainly infrastructural projects.

resources and a favourable location on the crossroads of Eurasia with the best infrastructure in the region, make our country very attractive investment destination. But all abovementioned certainties are only a glimpse into the advantages of our country.

As for the domestic stock exchange market, in 2000 Baku Stock Exchange (BSE) was constituted with an aim to create an organized stock market in the country. The trading partners include banks, capital management organizations, financial funds, holdings and industrial companies. BSE carries out trading and settlement (clearing) operations for corporate securities. Trading, depository and clearing operations on primary and secondary markets of public securities (T-bills of Ministry of Finance and Notes of the Central Bank) are carried out solely at BSE. At present, BSE has 19 shareholders including Istanbul Stock Exchange among them.

Azerbaijan has many attractive sides which are really appreciated by the foreign decision makers, but still strongly require publicizing on the international level. From this point of view, one of the major objectives of AZPROMO is promotion of our country as the favourable investment destination by organizing international business events along with matchmaking between local and foreign entrepreneurs, making specific country presentations and publishing brochures on priority investment sectors. Undoubtedly, business forums, investment seminars, road shows and one-to-one business meetings are essential tools for presentation of country’s investment opportunities and specific business projects initiated by local companies directly to the foreign potential investors.

HOW DO YOU WISH TO PROMOTE INTERNATIONAL INVESTMENTS INTO YOUR DOMESTIC COMPANIES? The fact that, Azerbaijan has been receiving the largest amount of foreign investments in the region proves the existence of firm and favourable investment climate in our country. Since 1995, almost 120 billion USD was invested into Azerbaijani economy of which more than a half was made by foreign businesses. The striking results in investment attraction are achieved through the implementation of quite serious economic and legal reforms, liberal economic policy and a policy of ‘open doors’ for foreign investors. Along with favourable legal regime that provides foreign businesses with certain necessary guarantees, there are a number of other key positive factors behind our success in attracting foreign investments. Political stability and sustainable economic development over the last 15 years, reformist business environment, liberal trade regime as well as the presence of abundant

Moreover, in order to increase awareness of foreign investors in the projects to be implemented in Azerbaijan and increase efficiency in finding foreign business partners the “Investment Projects Catalogue” based on local businesses’ proposals has been prepared by our organization which is being continuously updated. To promote the sectors with competitive advantage, AZPROMO publishes brochures and catalogues highlighting the sector potential and business opportunities. All these measures create great scope for expansion of cooperation between local and foreign entrepreneurs and stimulate implementation of joint investment projects in Azerbaijan.

ARE YOU PLANNING TO PROMOTE PPP (PRIVATE PUBLIC PARTNERSHIPS)?

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PPP model of cooperation between public and private sector is something new for Azerbaijan. AZPROMO itself being a kind of PPP established by Government closely works with representatives of both private and public institutions. Currently all PPP relations are governed by Civil Code, law on public procurement and other related legislation. Today a number of projects offered by public authorities with participation of foreign companies are currently being implemented. Such projects are mainly implemented in infrastructure and include building of and reconstruction of roads, bridges, passages, etc. As an example of PPP project which is currently being implemented in Azerbaijan, I can specify construction of Waste-to-Energy Plant which is a “turn-key” contract and being carried out with the principle of “Design Build Operate”. So the designing, building and operating are entirely being held by “CNIM” S.A. The designing, construction and 20 year operation of the future Waste-toEnergy plant with 500,000 tons of MSW per year is considered in 20 ha area designated in Balakhany settlement. The amount of electricity obtained as a result of burning of waste will be equal to 231,5 million kWh/year. The other PPP projects are implemented by Azerbaijan Investment Company (AIC) together with foreign partners. The main objective of the AIC is to implement fixed-term equity investments in the private sector and to assist FDI in the nonoil sector of Azerbaijan. One of the biggest PPP projects of AIC is the construction of the modern shipyard and ship repair facility on Caspian Sea which is being implemented together with State Oil Company of the Republic of Azerbaijan (SOCAR) and Keppel Offshore and Marine (Singapore). In order to further promote PPP projects we plan

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Presidential Palace, Baku to include information on projects offered by state authorities to our Catalogue of Investment Projects to keep foreign companies informed.

give broad information on type of permit required, process of obtaining it, granting authority, state fee and other related information.

imposed on specified products and equipments which are imported for the purpose of using in agricultural and food production.

HOW ARE YOU LOOKING TO CUT RED TAPE FOR INDUSTRY AND COMMERCE? Well, one of the priorities of the Government is to support development of local business. In order to simplify procedures for doing business, lessen bureaucracy and reduce number of documents, different reforms on registration of legal entities, registering property, customs, payment of taxes and other sphere have been implemented during last years.

From our side, as a part of policy advocacy role of AZPROMO we regularly analyze current legislation and prepare our proposals on improvement of both investment and export related legislation.

Taking into consideration wide opportunities existing domestically, the government of Azerbaijan successfully implements import substitution objectives.. The production is not only focused on meeting the domestic demand but also export oriented.

These reforms have been observed by international community. Thus, World Bank 2009 report named Azerbaijan top reformer improving its position from 97th place to 33rd out of 181 economies. Azerbaijan improved in seven of 10 indicators, catapulting 64 places in the rankings, the biggest jump ever recorded by the World Bank. One of the brilliant examples of the reforms was the introduction of “one-stop-shop” system for registration of legal entities, effective from January 2008. This system was designed explicitly to reduce the red tape, costs and paperwork associated with the process of business registration. After this, the number of procedures and number of days to establish a company was reduced to five and three respectively. Very recently the system was further developed and “online” registration of the company now is a reality. Besides this, the “E-Government” project is currently under implementation. The aim of the project is to increase the introduction level of ICT in state agencies and using modern ICT to render services to citizens. Implementation of this project will enable to increase the quality of services rendering to population, reduce the time and costs. Azerbaijan is pursuing its goals to ease business conditions and establishing favorable environment for starting business. A new information portal on permits and licenses www.icazeler.gov.az will be launched on March, 16th. . The web-site will

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HOW DOES YOUR GOVERNMENT PLAN TO MAKE IT EASIER FOR SMALL AND MEDIUM SIZE TO GROW THEIR BUSINESSES? Considering that small and medium size enterprises are one of the major determinant factors for sustainable economic growth, Azerbaijani government implements significant reforms and provides incentives in order to stimulate SME’s development and increase its share in the whole economy. Simplified tax system and concessional credits for starting and improving business are striking examples of supporting policy pursued by the government to SMEs. In order to ease tax burden for small and medium size businesses the country introduced simplified tax regime, whereby legal entities with total revenue not exceeding 150,000 AZN (approximately 190,000 USD) for the previous 12 months period are charged at the rate of 4% in the capital city of Baku and 2% in other regions of Azerbaijan of the gross revenue. In that case, such enterprises are exempt from VAT, profit and property taxes. The National Fund for Entrepreneurship Support was established by the government with its primary mission to support the development of SME in Azerbaijan by providing concessional credits of 6-7% annual percentage rate to entrepreneurs in all regions of Azerbaijan (the loan portfolio was approximately 578 million USD as for the 01 August 2011). Moreover, there are a number of state subsidies for agricultural growers on purchase of seeds, fertilizers, fuel and for covering other costs. In order to support companies in agricultural sector Azerbaijan abolished all taxes, except for land tax. Along with that, no customs duties and VAT are

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HOW DO YOU PLAN TO MAINTAIN GOING FORWARD THE IMPRESSIVE STRONG ECONOMIC GROWTH YOU HAVE EXPERIENCED OVER THE PAST IN LIGHT OF THE GLOBAL SLOWDOWN? Azerbaijan’s economy has become one of the fastest growing in the world. In 2006 and 2007, Azerbaijan topped the world GDP real growth rate table accounting for 34.5% and 25% respectively. Even in the period of global financial turmoil Azerbaijan managed to keep the high pace of development. Today, share of Azerbaijani economy in the region of South Caucasus accounts for over 73% which shows the economic potential of the country. Of course, rich oil and gas reserves play important role in the development of Azerbaijani economy and provide great prospects for the country. But it is known that economic development in only one direction might be the reason for negative results in future, considering that oil price trends in international market are unpredictable. Therefore, with embarking on the course of development in the beginning of 21st century, the diversification of economy and the development of non-oil sectors became key strategic goal for our government. Today, a large amount of funds are allocated both by public and private sectors in our economy for the purpose to promote the development of non-oil related industries such as agriculture, food processing, tourism, alternative energy, ICT, chemical industry and so on. Just as an example, almost 16 billion USD were invested in the non-oil fields of national economy in 2011, which makes over 78% of total investments. As a result of well-

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considered policy of Azerbaijani government, in 2011, non-oil GDP growth accounted for 9.4% and this is not the limit of our potential at all. All necessary measures serve one single purpose which is transformation of the country from singlesector economic growth into a diversified and stable economy. WHAT ROLE WILL THE “GREEN AND CLEAN” TECHNOLOGY AND THE RENEWABLE ENERGY SECTOR PLAY IN YOUR COUNTRY IN THE FUTURE? Alternative energy is set to be a future emerging sector, especially after the announcement of 2010 as a year of ecology. Many projects were launched over the course of that year by a State Agency for Alternative and Renewable Energy Sources within the Ministry of Industry and Energy established in 2009.

5 MW hybrid Experimental Polygon and Training Center in Gobustan which covers solar, biogas, wind and thermal energy sources. Caspian coast is also a perfect source for wind energy, and pilot projects are being developed with participation of foreign investors. The number of wind farms will be increased, tariffs are being restructurized by the Government and I am sure the subsidies will be provided, as showcased in many European countries. The declaring 2010 the Year of Ecology gave a start to the implementation of numerous environmental projects. More than that, in December 2011 the President signed a decree on drafting of State Strategy on usage of alternative and renewable energy sources for the years of 2012-2020, which considers implementation of measures to further stimulate the development of sector.

Solar energy will be promising business in the coming years, as Azerbaijan begins its own solar panels production. The first in Azerbaijan solar production plant with capacity of 30 MW or 120 000 units per year has already started its activity. Another project is launching of the first in the world

Besides that, in order to improve ecological situation in Baku and surrounding areas “Tamiz Shahar” JSC was established to carry out the works through placement and disposal of the solid household wastes in accordance with the modern standards.

“Tamiz Shahar” JSC was entrusted with the function of management, placement and disposal of household wastes in accordance with modern standards, carrying out this process in an organized manner, as well as improvement of environmental situation of the city and development of this field based on the principles of market economy. i

Azerbaijan Export and Investment Promotion Foundation (AZPROMO) being the single organization in Azerbaijan that serves as a “one-stopshop” for international investors has good knowledge of investment opportunities and market features of the country and provides newcomers to the Azerbaijani market with all kinds of support and information. Foreign investors enjoy AZPROMO advices relevant to doing business in Azerbaijan. AZPROMO was established in 2003 with the purpose of attracting foreign investment in Azerbaijan. In 2005, AZPROMO’S activities expanded to include the promotion of Azerbaijani exports overseas and the brand “Made in Azerbaijan”. The main aim of AZPROMO is to increase non-oil FDI inflow in Azerbaijan as well as to stimulate strengthening and expansion of the country’s non-oil export capacities. Our main task is working with foreign investors who wish to start business activities in Azerbaijan. AZPROMO provides a range of support services for interested foreign businesses free of charge, including consultancy and logistic services. AZPROMO also works closely with Azerbaijani entrepreneurs, helping them to discover new markets and find partners overseas. Our core function is to build bridges between the private and public sectors of the economy. AZPROMO has representative offices in Georgia, and also in Austria, we are an active member of the World Association of Investment Promotion Agencies (WAIPA), and are on the board of directors of WAIPA covering the South Caucuses and Central Asia. AZPROMO also serves as a mediator in handling concerns of investors helping to address them and advising the Government of Azerbaijan on improving the business climate. Aftercare services for existing foreign investors who are interested to retain investment, expand it and re-invest are also provided by AZPROMO.

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> MIGA (World Bank):

During the Storm – Shift from North to South FDI By Manabu Nose and Moritz Zander

t MIGA (the Multilateral Investment Guarantee Agency) we see the principal near-term risks for emerging market foreign direct investment (FDI) on the supply-side of financing. Despite a rise of emerging market risk perceptions, demand for project financing continues to be strong. In the medium-run, intra-emerging market financing will increasingly replace funding from developed markets.

and exploration successes in mineral and petroleum sectors. Accordingly, investment opportunities in the emerging world, well beyond East Asia and Latin America, remain aplenty. Take sub-Saharan Africa. It is estimated that the continent needs over $90 billion dollars per year over the next decade to meet infrastructure needs: speak multi-million dollar investments in road and rail networks, power, water and sanitation projects, many of which will be solicited through public-private partnerships. In addition, the expansion of access to submarine fibers will create new opportunities in broadband and telecommunication service providers in still underserved markets.

based—could contract further as European banks see dollar-funding cost remain high. Data presented in the IMF’s recent Global Financial Stability Report suggests that the bank deleveraging process in the EU will weigh particularly heavy on project finance and longerterm bank syndication. Across all emerging markets, bank lending in specialty lines such as project finance and structured credit fell sharply in the second half of 2011. Similarly, while overall capital flows into emerging markets appear to have held up in 2011, syndicated bank lending to developing countries from EU banks has dropped sharply since last fall.

2011 was a tumultuous year for emerging market investors. First, there were the upheavals in the Middle East and North Africa region, widely known as the ‘Arab Spring.’ Waves of popular unrest led to regime change in Tunisia, Egypt and later Yemen. On the face of it, we see the principal peril to Libya and Syria got tipped into open civil conflict. emerging-market FDI flows on the supply-side of This is unfortunate because funding for projects Sub-Saharan Africa, while scoring some successes financing. For, critically, 2011 was a tumultuous in a number of developing countries is badly in democratic transitions, also signaled uncertainty year in advanced economies also. As concerns needed. For investors the prospect of permanently with elections, a number of which were surrounded over sovereign debt sustainability, credit quality higher real growth sustained by improving buffers by violence, most notably in Cote d’Ivoire. Rising and market pressures in the European financial and more resilience remain. In preliminary food and oil prices led to popular data it appears that FDI flows into unrest in a number of regions. developing countries, albeit less And more recently, investors were volatile than portfolio flows, slowed “Real growth in Sub-Saharan Africa (5.3%), scared by military coups in places considerably since the summer was robust, helped by booming commodity as diverse as Maldives and Mali, of 2011. But if emerging-market Papua New Guinea and Guineagreenfield investment flows have not prices and exploration successes in mineral Bissau. contracted further it is also because and petroleum sectors.” a growing share of those flows—what Yet, this resurgence of political risk the World Bank calls “South-South” in emerging markets contrasts with last year’s system intensified, bank lending in the euro area investment flows—is now originating in emerging economic performance. Despite the slowing slowed markedly in the latter half of the year. economies. growth momentum in North America and the euro Facing the prospect of stricter capitalization rules zone, developing countries’ aggregate growth, thus and pressure from regulators to improve buffers, Over the last two decades, emerging economies’ far, has proven impressively resilient. Not only did many EU-based banks accelerated their efforts to share of total outward FDI flows multiplied from developing countries contribute much of global deleverage. 5% in 1990 to almost 30% in 2010. With slowing growth in 2011, but many countries managed to growth momentum in North America and the euro strengthen buffers against shocks through the oftThe magnitude by which deleveraging in the zone haunted by crises, there is every reason to cited channels of trade and portfolio flows. Global European banking sector may detrimentally impact believe that this trend will continue. In MIGA foreign exchange reserves in emerging markets greenfield investment into emerging markets we have observed this shift both from our client rose to over US$6 trillion by the end of 2011. And remains hard to predict. However, what we do base directly, as well as in our annual surveys of fiscal space in many places remains comforting, know does not make us optimistic. Particularly global investors. albeit less so than in 2008. If EU-based global in the euro zone, financing for projects and large corporates continued to post impressive earnings bank syndication may become harder to come by Aside from strong balance sheets and a robust growth in 2011, it is because an increasing share in the longer run. Faced with higher dollar-funding appetite to expand into yet untapped markets, of their revenues came from emerging markets. costs and rules that require banks to match longwhat drives South-South investments? The term loans with funding from sources with similar fastest growing and lion’s share has come from Moreover, the above-average growth has not been maturities, these business lines, in which European Asia, notably China. Historically, much of it has confined to the traditional high-performers. Real banks previously had a particularly strong position, been resource-seeking FDI: extractive industries growth in Sub-Saharan Africa (5.3%), for example, will become less lucrative. Even in the petroleum enterprises in resource-abundant Middle East, was robust, helped by booming commodity prices sector, oil-secured lending—which is mainly dollarCentral Asia, sub-Saharan Africa, and South

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America. More recently, however, the sector composition is diversifying. Manufacturing firms, including from the metal, electronics, and chemicals industries, have joined the pack, benefitting from lower unit labor costs. Second, strong cash flows from the revenue of booming commodity prices have boosted cross-border merger and acquisition activity in the energy industry, originating in traditional oil-exporter countries around the Gulf region, Russia and the Commonwealth of Independent States (CIS). Prominent recent examples include the joint-venture between CNPC (China) and Russia’s Rosneft, or the participation of ONGC Videsh (India) in the development of the Sakhalin I oil and gas exploration project, also in Russia. Notably, outward FDI in the Arab states is mainly undertaken by state-owned enterprises such as Dubai World, the Qatar Investment Authority, and SABIC. Finally, in Africa, the level of outward FDI is still limited, but intraregional investment (along with trade) is picking up fast. South African investors in particular are leading the way with respect to foreign investment into neighboring countries. Indeed, the potential for intra-Africa investment volume to further grow is large, as a recent UNCTAD report suggests, since South investors may be better positioned to develop business and manage risk in places that other foreign investors still perceive as impenetrable and excessively volatile.

Research on the origins and drivers of South-South FDI is still limited, but explaining capital outflows from developing countries (where the marginal return to capital is higher) might be related to the ‘Lucas puzzle’ in international investment flows debated since 1990s. Access to resources is surely important, but it applies to only a limited number of countries such as China and some of the CIS. A competing hypothesis, more consistent with intraregional FDI in Africa, is risk appetite. South investors may simply be more comfortable with investing in developing countries, as they have a comparative advantage at operating in similar political, economic, and institutional environments as they encounter in their home markets. Related to the notion of familiarity (or Lucas’ information asymmetry) is a different conception of risk. For South investors, institutional quality may be less of a barrier to enter a new market, particularly if the tail risks of political events can be mitigated through insurance. Surely, the sooner Europe’s banking sector will get fixed, the less the impact will be felt by developing countries. Nonetheless, over the medium term, the shift from North to South as the principal origin of emerging-market FDI flows will likely accelerate. For South-based investors with the right animal spirits and strong balance sheets may be better placed to capitalize on emerging-market momentum. i

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[1] Manabu Nose and Moritz Zander are economists in MIGA’s economics and policy group. MIGA is a member of the World Bank Group. [2] IMF Global Financial Stability Report, April 2012, Chapter 2 (p.44) [3] UNCTAD World Investment Report 2011, Chapter II

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> Claire Meyer, European Development Finance Institutions: Africa and Energy Access Financing Impact

nergy is arguably one of the major challenges the world faces today. For those living in extreme poverty, the lack of access to modern energy services dramatically affects health, limits opportunities and widens the gap between the Haves and Have-Nots. In Africa, the lack of affordable and reliable energy impedes economies to develop by shortening business operating hours, making business production uncertain and discouraging investment. The poorest people pay a high price in health, labor, time and cash for the energy they use. Access to energy and affordable energy in Africa is a necessary precondition to achieve development goals that extend far beyond the energy sector: it provides the basis for the development of modern forms of healthcare, education, transport, production and communication. Energy is back on the agenda of governments, international organizations and the development scene in Africa. 2012 was declared International Year of Sustainable Energy for All by the United Nations. The UN Secretary-General Ban Ki-moon launched the “Sustainable Energy 4 All” (SE4All) initiative, urging all stakeholders to take concrete action toward three critical objectives: (1) ensuring universal access to modern energy services; (2) doubling the share of renewable energy in the global energy mix and (3) doubling the global rate of improvement in energy efficiency. The global target date for achieving the SE4All targets is 2030 but this will not become a reality without massive increases in the quantity and quality of energy services. Africa is the continent with the highest priority on energy development: in 2012 nearly half of the countries in Africa face energy crisis. Even though the African continent is well endowed with renewable energy resources (hydropower and geothermal especially), most remain untapped. However, changes in precipitation can result in loss or variability in hydro-electricity potential, variations in runoff and impacts on biomass production. Therefore, access to energy in Africa also includes developing conventional energy such as gas and diesel, to provide for instance stability to grids, because of the changing climate conditions of Africa and dwelling resources. There is no (or less) renewable power to provide when there is no (or less) water, sun or wind.

“Energy is back on the agenda of governments, international organizations and the development scene in Africa. “

in 2011, €EUR 689 million have been invested in 61 projects in Africa. To benefit from additional financial leverage and risk sharing, EDFI has also created two joint financing initiatives with the European Investment Bank (EIB): European Financing Partners (EFP) especially designed for Africa, the Caribbean and Pacific countries and the Interact Climate Change Facility (ICCF), which also includes the Agence Française de Développement and is especially designed for projects focused on clean energy or energy efficiency. EFP and ICCF’s unique decision model is effective, efficient

Africa is a key priority for many of the 15 European bilateral development finance institutions (EDFIs):

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and serves as the foremost example of the strong partnerships, which European institutional investors are increasingly forging, in order to play a leading role in sustainable private sector development in Africa and in the energy sector. For every project, the EDFIs have upheld the highest standards on environmental and social issues, and in corporate governance in Africa. Why invest in joint instruments when bilateral development finance institutions can do it individually? Firstly, EFP and ICCF financing supplements the total financing raised, which enables EDFIs to invest in larger projects. This is important because many energy infrastructure projects require economies of scale to be bankable and because long term funding is scarce, especially in Africa, where the country risks are often considered too high for commercial banks to provide funding. Secondly, EFP and ICCF financing enables broader participation by a range of DFIs with minimal additional costs and without the requirement for their significant dedication of administrative resources, as the execution and subsequent monitoring of the project is undertaken by one of the EDFIs on behalf of the group of DFIs. EFP and ICCF enhance very much the efficiency of the transaction.

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WHAT ARE THE IMPACTS FOR ENERGY INVESTMENTS IN AFRICA? On the African continent, according to ARE (Alliance for Rural Electrification), the overall amount of people without access to electricity has reached 589 million in 2008. The number of people that have no access to electricity has increased by 9 million people annually[1]. Access to sustainable sources of reliable and affordable energy has a profound impact on multiple aspects of human development; it relates not only to physical infrastructure (e.g. electricity grids), but also to energy affordability, reliability and commercial viability. Most firms are less concerned with the price of power than with the quality and reliability of supply. So, how to invest and in which country? EDFI and its joint financing

instruments EFP and ICCF focus on energy investments with the highest impact potential in target countries with binding constraints. Two example countries with these characteristics are Kenya and Zambia. Energy supply in Kenya is a constraint on growth: Kenya has required emergency power generation every year since at least 2005. A 2009 World Bank study suggests significantly improving electricity generation capacity could increase Kenya’s annual GDP growth rate by 1.7 percentage points. In contrast to Kenya, Zambia is not yet supply constrained, though it still has a growing need for investment. In particular, the country has tremendous potential to grow its energy production, especially hydro, with the aim

of exporting power to other countries. Zambia is rich in lakes and rivers, and has a potential hydro capacity of 6,000 MW[2]. In 2012, EDFI contracted Dalberg Global Development Advisors to undertake an independent evaluation of three energy projects in sub-Saharan Africa financed by EFP: Copperbelt Energy Corporation in Zambia (CEC), Olkaria III in Kenya; and Rabai Power in Kenya[3]. The consultants analysed the impact of the projects and the role of EFP: while not always the only option, EDFIs provided finance on terms unavailable from commercial lenders, and sometimes key advisory support as described for the three energy projects evaluated:

Example of Energy Projects Financed in Africa by EDFI Olkaria III (Kenya): First geothermal independent power producer (IPP). Expansion of the capacity to 48 MW from 13MW. Olkaria III is the only IPP geothermal plant in Kenya and possibly the most efficient plant of any kind in the country. Since the expansion of the plant, Olkaria III has always averaged over 96% availability, and has been dispatched at an average of 92%.

Rabai Power (Kenya): Thermal independent power producer (IPP). The plant became operational just as the country was experiencing nationwide power rationing due to poor hydrology. Rabai is the most efficient thermal plant in Kenya, but is not currently operating at full capacity because of transmission line bottleneck.

Copperbelt Energy – CEC (Zambia): Transmission Company CEC transmits power to all the mines in Zambia’s Copperbelt region. Mines consume about 60% of Zambia’s power. The acquisition finance was complemented by a guarantee on a capital expenditure loan for upgrades to CEC’s network and expansion of its operations. This expansion has included the exploration of new business activities such as power generation.

Why Did the European Finance Partners Invest? - Commercial lenders did not understand geothermal IPP generation - Delays meant that financing came after project construction

- EDFIs were willing to take on the risk of lending in a time of high political risk in the country – could have collapsed without their support - DFIs as equity partners helped improve overall credibility of the project

- EDFIs were preferable to other investors because of loan durations required, and equity participation which enabled the borrower to get continued advice

The Catalytic Role of EFP: Other Inputs From DFI Financing - EDFIs took lead in structuring own finance offering

- EDFIs expedited dealings with the government speeding up the development process - EDFIs assisted borrower in achieving high environmental and social standards

Development Effects

The electricity generated by the Kenya IPP projects reduced the supply shortage and now generates national cost savings of USD 20 million and USD 59 million in 2011 for Rabai and Olkaria III respectively. Kenya IPP environment has been cited as the most advanced subSaharan African country, having progressed farther on energy reform programs than most other countries on the continent. The three projects assessed, illustrate the potential multiplied impact of energy infrastructure investments, especially in constrained environments. For the Kenya IPP projects, new electricity generation should help support hundreds of thousands of jobs additional to the

number of jobs created in the plant. Furthermore the projects will lead to national cost savings in the tens or even hundreds of millions of dollars. For example, Olkaria III has allowed economic benefits from lower costs and higher reliability: the plant added 3.5% in national capacity;

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- EDFIs have a good reputation in the country, and ensure that the borrower is viewed favorably by the government - The borrower considers the EDFIs higher SHE requirements to be useful

Linked to the acquisition was CEC’s subsequent listing on the Lusaka Stock Exchange.

is currently supplying 6% of Kenya’s energy consumption; and helped reduce load shedding in the country while keeping the environmental impacts especially small. In Zambia, CEC’s transmission infrastructure was already in place, but its maintenance and expansion is important

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The European Development Finance Institutions (EDFI) and its joint financing initiative in ACP countries: European Financing Partners and in energy efficiency: Interact Climate Change

Facility. EDFI seeks to support economically, environmentally, and socially responsible development by fostering the growth of the private sector in developing countries, and do so by

providing capital for long-term investments. EDFI member institutions often join forces to finance larger projects, which will serve their clients, while achieving higher development impact. Approximately €375 million has been approved for 26 projects under the EFP through 2011, 20% of which has been committed to power or energy projects. On the individual projects, this funding is complemented by additional financing coming directly from individual EDFIs. With the success of EFP, EDFI decided to create the same type of co-investment facility focused on energy efficiency and climate change projects. Interact Climate Change Facility was created in February 2011.

to growth of Zambia’s most important export sector, mining, and the government’s plans to double the contribution of mining to GDP by 2015. The Rabai project may never have been completed without DFI finance due to the high political risk in the country at that time, whereas for CEC, the acquisition arrangements would likely have been sub-optimal without DFI finance. Through the EFP cooperation and financing arrangement, the three financially sustainable energy projects are making important contributions to development outcomes in two energyconstrained countries in sub-Saharan Africa. Energy infrastructure projects can provide very high development returns on investment, due to the potential for high multiplier effects, and there is a clear role for EDFI financing in the private sector.

“Energy infrastructure projects enable DFIs to achieve public sector scale, with private sector efficiency.” Dalberg Global Development Advisors, EFP evaluation, 2012

ADDITIONALITY IN INVESTMENTS EDFI members are bilateral institutions funded by government resources. The EDFI members provide their financing to projects on commercial terms. An overall criterion for the decision to participate in the financing of a project is that the EDFIs are additional to commercial funding available in the market. In general, the EDFIs will engage with the commercial institutions willing to participate in the funding and, if sufficient resources are available from these, EDFIs will refrain from participation. However, the capital markets of most African countries are simply not able to provide adequate long-term financing for infrastructure projects. EDFIs have very strict environmental and social requirements for projects they finance in order to ensure that the highest standards are applied for the benefit of the host country and its citizens. EDFI 156

financed projects are committed to mitigating any negative effects of their operations and improving the community in which they find themselves. EDFIs are in most investments actively involved in the establishment of environmental and social management systems as well as providing training to the staff of the investee company. The EDFI institutions will continue to finance energy projects such as Rabai, Copperbelt and Olkaria. But Africa needs much more than that. The country has extraordinary energy resources but most remain untapped. In the 90 percent of rural sub-Saharan Africa that depends on traditional biomass energy for energy supplies, even modest improvements in access to modern energy services can have a big impact. The major question is: how can access to modern energy services be improved on the huge scale needed to attain the UN goal of sustainable energy for all by 2030? More institutions financing infrastructure projects and prioritizing energy access as a key driver of social and economic development is undoubtedly the first step towards achieving universal energy access. The governments and public sectors also need to be onboard as the private sector will not step in to finance energy access for the poor without governmental policies and regulations to remove barriers, such as prohibitive tariffs, weak off takers or weak structural frameworks. i CFI.co | Capital Finance International

EDFI, the Association of European Development Finance Institutions, is a group of fifteen bilateral European development finance institutions, whose members provide long term finance for private sector enterprises in developing and emerging economies. The main objectives of EDFI, which was founded in Brussels in 1992, are to foster cooperation among its members and to strengthen links between these and EU institutions. At the end of 2011, the total investment portfolio of EDFI members was €23.7 billion in 4 421 projects. The EDFI members are: BIO, Belgium – CDC, United Kingdom – COFIDES, Spain – DEG, Germany – FINNFUND, Finland – FMO, Netherlands – IFU/IØ, Denmark – NORFUND, Norway – OeEB, Austria – PROPARCO, France -SBI/BMI, Belgium – Sifem, Switzerland – SIMEST, Italy –

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Investments

14th National Meeting of IR and Capital Markets held on July 2-3, 2012.

Brazilian Investor Relations Institute (IBRI): Access to International Capital Markets Connecting Brazilian Investor Relations (IR) professionals with global capital markets is a key objective for IBRI (Brazilian Investor Relations Institute). With this objective in mind, every two years, IBRI hosts Brazil Day, an international forum in which the country’s leading publicly listed companies present themselves in New York as investment opportunities for American investors. In pursuit of the same objective, IBRI organizes Tarde de Brasil en Latibex (an Afternoon of Brazil on Latibex) jointly with the Madrid Stock Exchange in line with the principles of institute’s mission statement: stimulating and promoting exchange between Brazilian IR and capital markets’ professionals and the overseas markets. (Note: Latibex is a stock market for Latin American stocks; based in Madrid since 1999). The Brazilian IR profession has successfully penetrated new markets in addition to those that are already part of a permanent agenda such as the United States and Europe. Capital markets such as those in the Middle East and Asia are beginning to emerge 158

on the list of countries of interest to Brazilian companies. Improving and cultivating the relationship with analysts and investors internationally requires knowledge of specific of foreign culture and thus IR professionals with these skill sets are increasingly in demand. The IR profession in Brazil is increasing their profile in society. An example hereof is the recent appointment an IR professional, Leonardo Pereira, to assume the Presidency of the Brazilian Securities and Exchange Commission (CVM). IBRI has been fostering discussions and inviting professionals of the highest caliber such as Jeffrey Morgan, President of NIRI (National Investor Relations Institute), and Duncan Niederauer, Chairman of NYSE Euronext, as a means of bringing Brazilian IR professionals closer to the new trends in international Investor Relations. IBRI intends to continue its important work of elevating the professional standards for the IR profession and of supporting the promotion of Brazilian companies overseas. i

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About IBRI IBRI was founded on June 5, 1997 to enhance the role of Investor Relations professionals in the Brazilian capital markets and contribute to strengthening and improve the IR community. IBRI’s philosophy of work includes raising the profile of partnerships with entities in the domestic and international markets which have common objectives in the IR area. In this context, IBRI believes that the partnerships which have been established have generated value for the members as well as contributed to enriching the technical discussions with official bodies – with which IBRI has signed agreements – such as the CVM (Brazilian Securities and Exchange Commission). On July 2 and 3, 2012, the 14th National Investor and Capital Markets Relations Meeting was held. This annual event is the largest of its kind in Latin America with an audience of more than 700 professionals. The 15th National Investor Relations Meeting is scheduled to take place on July 3 and 4, 2013 in São Paulo, Brazil.

Autumn 2012 Issue

Investments

> InvestKL:

Kuala Lumpur: ‘The Next Big Thing’ in Asia-Pacific Business Circles Zainal Amanshah, CEO InvestKL

It is Asia’s best-kept secret: business insiders are shunning the cost and congestion of Asia’s mega-cities and plumping for Kuala Lumpur’s strengths: cost competitiveness, profit potential and a first-rate lifestyle – a combination unmatched anywhere else in Asia. InvestKL CEO Zainal Amanshah describes it this way: “In today’s world, any discussion of a corporation’s ability to drive profit in a new city, let alone in Asia, really has to be a function of a number of factors. Will it be prohibitively expensive to set up shop? Can I manage my costs? Will my staff be happy? Will things work? Will we do business in a stable environment, free of socio-political, sovereign risk? Above all, will my family adjust well, and will they enjoy living here? We have found that for those who have made the leap, the answers to these questions have been an emphatic affirmative. Here are some headline stats we are especially proud of: • 16.4%: The cost of starting a business in Malaysia as a percentage of income per capita. By contrast, the East Asia and Pacific average is 22.7%. For Indonesia it is 17.9%. (2012 World Bank ‘Ease of Doing Business’ report) • 102nd: Kuala Lumpur’s ranking in terms of cost of living. By contrast, Singapore is the No. 3 most expensive city in Asia for expatriates and the sixthmost expensive overall. (Mercer’s 2012 cost of living survey) • ‘A’: Malaysia’s local currency rating, according to Standard & Poor’s. S&P also gives Malaysia a foreign currency rating of A- and a transfer and convertibility (T&C) assessment of A+ • Top three for Best Retail Property Investment Destination (Pacific Star Group’s Asia Property Outlook and Strategy Report, 2011) • 21st: Malaysia’s ranking out of 183 nations (sixth in the Asia- Pacific region and second in Southeast Asia), in the World Economic Forum’s 2011-12 “Global Competitiveness Report”

In the words of some satisfied KL-dwellers: Q: WHY DID HSBC CHOOSE TO PLACE THE GLOBAL CEO FOR HSBC’S SHARIAH FINANCE ARM OUT OF KUALA LUMPUR? Mukhtar Hussain, Global Chief Executive Officer, HSBC Amanah: “The basis of the decision was really a reflection that Malaysia is today the intellectual centre of Islamic finance worldwide. It is the country where there is the greatest institutionally coherent approach towards the development of the industry, and we’ve seen tremendous steps taken by Bank Negara to grow the industry, very successfully, to sit alongside the conventional industry. HSBC felt it was right to be at the nerve centre of where the industry is growing and developing the fastest – and we are delighted to be here!“

HSBC and Kuala Lumpur: 1910: HSBC opens its first branch in KL. 2007: HSBC Bank Malaysia becomes the first locally incorporated foreign bank to be awarded an Islamic banking subsidiary licence in Malaysia 2011: Wins Best Islamic/Most Innovative Islamic Finance Deal of the Year in Southeast Asia (Government of Malaysia’s $1.2 Billion & $800 Million Wakala Global Sukuk. HSBC were Joint Lead Managers and Joint Bookrunners. (Alpha Southeast Asia)

drive the decisions. And we have proficiency in English, which is quite important to us, because communication is everything. Liveability? I rate KL very high. It’s not a major city like Shanghai, but it has absolutely everything you might need.”

Continental and Kuala Lumpur: 2003: Continental establishes a joint venture with Malaysian conglomerate Sime Darby Bhd. Operating under the name of Continental Sime Tyre Sdn. Bhd., establishes two tyre plants. May 2012: Continental AG acquires entire 100% stake in Continental Sime Tyre Sdn. Bhd. from Sime Darby, underscoring its long-term interest in the Asia-Pacific region. There is no greater proof of KL’s appeal than these real-life success stories of global conglomerates who have decided to make Malaysia’s capital their regional headquarters. From a commercial, professional and personal perspective, KL is truly a winning proposition” i

Q: HAVING LIVED AND WORKED ALL AROUND ASIA AND EUROPE, WHY DO YOU DESCRIBE MALAYSIA AS “EASY ASIA”? Continental Tires Malaysia Sdn Bhd CEO Benoit Henry:

From a business perspective, will KL be a place where multinational corporations can carve a niche?

“Malaysia is ‘Easy Asia’ when you compare it to some other places around Asia. In terms of infrastructure, Malaysia is really a great place. The basic services are guaranteed.

Forge ahead, innovate and develop a world-class product?

Also, you have a stable political system. This is of course, for investors, an element that will CFI.co | Capital Finance International

InvestKL Focuses on attracting Fortune 500 and Forbes 2000 companies to strategically grow their businesses by setting up operational headquarters, international procurement centres and/or regional shared services in the Greater Kuala Lumpur and Klang Valley areas.

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> Huong Vu – Tax Partner of Ernst & Young Vietnam: From a Consultant’s Point of View, Some Thoughts About the Foreign Investment Environment in Vietnam

s a legal consultant on tax and investment for foreign enterprises for almost 20 years, the experience I have as an insider regarding the changing business environment of Vietnam in those years gives me clear insight. During the very early years of my career, what we would often say when advising clients was that “this issue is ambiguous, we will take the opinions of the competent authorities and refer to common practice in order to provide advice in detail for the company”. It is easy to understand because in the initial stage of open integration and building relationships on trade and economic matters with partners from all over the world, it was impossible for Vietnam to accommodate and adjust the legal framework right away in response to diversified cases. If the beginning stage of integration is compared to the anxious feelings of a new bride moving into the husband’s home, foreign investors at that time could easily sympathise with the complicated procedures for investing in Vietnam.

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As time goes by, the integration of economic rights has become a motivation for trust and change. The Vietnam legal system has improved significantly with some breakthroughs in creating a healthy investment environment to attract more foreign investors. In parallel with the issuance of the Law on Enterprise and the Law on Investment, the tax legal system also has been improved significantly. Accordingly, foreign investor and local investor are having the same legal framework in terms of legal, tax and finance matters. In general, the improvement in policy is in conformity with international rules. Regulations are clearer, more explicit and stricter. A bundle of administrative procedures has been removed and enterprises are now allowed to be more active in deciding their own business operation. As an example in tax policy, a self-declaration mechanism has created a convenience to tax payers and, at the same time, resulted in better controlled tax payment and collection and prevention of loss CFI.co | Capital Finance International

in collection. The developed countries are also applying this mechanism. Besides simplifying administrative procedures, Vietnam has pilot projects to modernise administrative procedures such as e-custom procedures and a system of online tax declaration. Those systems will surely bring considerable benefit to all enterprises in general and foreign investors in particular. While reforming for a standardised system, the Government still considers special cases where specific guidance and particular adjustment is required to ensure attractiveness to the potential foreign investor. The above mentioned efforts of the Government in reforming the legal framework provided the foundation for the success of Vietnam in attracting foreign investment. As the legal framework has become more and more complete and clear, the unexpected potential risks due to misapplication of policies are also reduced. Consultants are no longer dependent on the old

Autumn 2012 Issue

Ho Chi Minh City Hall, Vietnam

saying that “this issue is not yet regulated by laws”, instead there is more confidence when quoting legal documents and practical cases have been resolved. However, it seems that the challenge has been transferred from law making to law implementation. Policy being legalised is only the starting point. What decides the success of a policy still lays in the implementation stage at each level. Arising from different reasons – partly due to the insufficient understanding of legal documents, partly due to the way of thinking and behaving – some local officers have not yet fulfilled their duties in a responsive manner – causing unnecessary difficulties for foreign investors. The difficulty facing consultants is now expressed as follows: “this issue is in favour according to laws, however the interpretation of the law by local authorities usually lacks consistency and there is a high chance of it not being accepted”. Unfortunately, in order to find a satisfying answer to investors, the expense and time spent to file a complaint might well outweigh the benefits earned and accordingly – and in many

cases – silence is gold. It has been more than 25 years since Vietnam applied open policy and more than 5 years since she joined the WTO. Looking back to the first analogy, there has been sufficient time for the bride to show her cleverness and make a good impression on the husband’s family. Beside the effort of Vietnam that is acknowledged by foreign investors, expectation from foreign investors for a favourable investment environment has become more and more demanding – especially when there are many other options from new emerging markets. Changing the way of thinking and working is always a great challenge. In order to create motivation for change, should there be an independent information source allowing enterprises to report difficulties and the inadequacies of local authorities responsible for implementing the laws. This hotline needs to have relative independence and calls for expertise, understanding of laws so as to issue unbiased CFI.co | Capital Finance International

conclusions which take into account both the interests of the Government and the enterprises. When performing its own function, this authority can consolidate all issues in which the law is not really of practical help and then recommend in good time appropriate amendments to improve the prevailing regulations. Nearly 20 years in the field, with all the ups and downs of policies as well as the consultancy career, the dream of the consultant from the beginning is still very simple. That is to be confident to say to clients that “this issue is clearly stipulated by laws, we will assist the company in realising all the benefits allowed by laws”. The road to achieving that simple dream still seems to involve a long journey… i

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Investments

> Ethiopia Infrastructure:

Investors Circling Consumer Potential By CFI

Lacking the natural resources of other African countries, Ethiopia faces a monumental challenge – to lift itself out of poverty with almost no modern infrastructure. Even with a large consumer market, finding investors is hard. But the Chinese are here in force. apping into Ethiopia’s pent-up consumer demand requires infrastructure, currently lacking. Ethiopia’s 80 million population is such a huge potential market it is considered a holy grail in the region. How to access it without basic power, transport and communication networks is the driving force behind much of today’s infrastructure investment in the country. The challenge is huge, with the World Bank estimating that Ethiopia, one of the poorest countries in the world, needs to spend $5.2bn (€3.6bn) every year for the next decade. And attracting investment is tough.

Ethiopia lacks the natural resources of other African countries so hasn’t drawn the global investment community. Nor has the government set about courting private investors. Prime Minister Meles Zenawi, who has led the country for almost 20 years, has fashioned an interventionist and extended role for the state which has kept many investors at bay. Yet donor organisations, investment from China and the government’s own determined budget allocation – with the latest fiveyear Growth and Transformation Plan promising more money to power and railway projects – are slowly transforming the landscape in an effort to throw off the yoke of poverty and famine. Ethiopia’s smallholder farmers, who account for

an open outcry trading pit where buyers and sellers bid on coffee, sesame, maize and wheat. Exchange infrastructure includes 60 warehouses throughout the country where farmers can store their crops until they decide to sell, and live price screens in regional towns – there are 31 so far, with another 150 awaiting cable infrastructure. An IVR system fields around 20,000 calls a day, updating farmers with the latest price news in what the ECX’s CEO, former World Bank economist Ms. Eleni Gabre-Madhin, calls a determined policy to flood the market with information. Her passion is driven by a desire to help solve the challenge of food distribution and Ethiopia’s tendency for pockets of glut and deficit that led to the 1994 famine. More than a million died, she says, not because there wasn’t enough food (there was a surplus in fertile southern areas), but because people in the north couldn’t access that food. The exchange is already encouraging farmers to invest in production and more modernday techniques. “We are seeing the effects of better price information,” she says. “A group of cooperative coffee growers in Oromia realised they were getting less in the local market than prices quoted on the exchange because of coffee’s different qualities and grades. They set about introducing post-harvest processing to get a higher

“Ethiopia Commodity Exchange (ECX) determined policy to flood the market with information is encouraging farmers to invest in production and more modern-day techniques.” ECX’s CEO, former World Bank economist Ms. Eleni Gabre-Madhin

almost all agricultural production, still till their land behind oxen and haul their wares to market on the backs of donkeys. New infrastructure is starting to push subsistence farmers into the commercial economy and will be the main driver of the 11% economic growth the government ambitiously targets – the IMF expects it to be around 7%. The new Ethiopia Commodity Exchange (ECX), housed in a tall, glass-fronted building in the capital, has

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price for their coffee. Overall there has been a tripling of volumes of higher-grade coffee.” A more pertinent reason for stifled enterprise is government ownership of land. Since mass nationalisation in the 70s, all land is owned by the state and farmers are given the right to use it. It’s a system that has made it much easier for the government to set about boosting investment

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in another, radical fashion: doling out licences for large-scale farms. Bangalore-based Karuturi Global, the world’s largest grower of roses with operations in Ethiopia since 2004, is now leasing vast tracts in the Baka and Gambella regions where Karuturi tractors and well-digging rigs are transforming the pastoral landscape to harvest agricultural crops. “We have leased 300,000 hectares for cultivation of rice, maize, palm oil and sugar cane and plan to invest $350m (€240m) in phase one of the project, which will be complete by December 2012,” says CEO Ram Karuturi at the company’s Addis Ababa headquarters. “We will sell our product in Ethiopia and through the regional common market, Comesa.” In another move, Saudi Arabia’s Saudi Star Agricultural Development Corporation, owned by billionaire Sheikh Mohammed al- Amoudi, recently announced a $2.5bn investment through to 2020 in rice-farming projects in Gambella. Al-Amoudi is one of Ethiopia’s biggest investors through his Midroc Ethiopia group. It is this kind of commercial agriculture that Zenawi believes will help get Ethiopia off food aid in the next five years, in another ambitious pledge. Nearly 10% of the population relied on emergency food aid last year and donors believe Ethiopia is still in desperate need. The UK government has just pledged to increase aid to Ethiopia over the next four years to £1.3bn (€1.5bn) despite austerity back home. “Our programme in Ethiopia will help provide food for 1.2 million poor people facing hunger each year and enable more than 2 million children – half of them girls – to go to school by 2015,” says international development minister Stephen O’Brien. In rural Ethiopia, people traipse for miles to reach the nearest paved road. Helping farmers get their produce to market lies behind steady investment in the country’s road networks. Funds have mostly come from multilateral banks and the government has also funnelled 3% of GDP into road-building, putting in place reforms such as a road fund to pay

Autumn 2012 Issue

Investments

for maintenance. Much of the construction is going to Chinese firms that see offrivals in the bidding process with their access to cheaper, long-term capital and low-cost skilled labour. “These firms are using Ethiopia as a commercial launch pad to cut their teeth,” says Ato Gedion Gamora at the UN Economic Commission for Africa in Addis Ababa, observing what he calls the emergence of the next generation of multinational companies. “Addis is strategically significant in Africa and construction projects like roads, and symbolic buildings like the African Union conference centre, give China a chance to showcase its infrastructure to the rest of the world.” More recently China has also been funding infrastructure through soft loans that go hand-inhand with procurement, requiring projects to use Chinese companies and equipment suppliers. China’s ExIm Bank is funding construction of the 12m-wide, 79km highway between Addis Ababa and Adama, a business hub in the east, which China Road and Bridge Corporation (CRBC) is due to complete by 2014. The government is also trying to improve coverage and services in its state-run telecom sector. Ethio Telecom is the sole operator and mobile penetration, at just 5%, is one of the lowest in Africa. In 2008, Chinese telecoms equipmentmaker ZTE bagged a contract to build a nextgeneration national network covering 14 cities. Prices are already coming down; a sim card costs 60 birr (€2.40) today compared to 400 in 2007 Zenawi has refused to liberalise the market like other African countries where private operators have rolled out infrastructure and prices have tumbled, arguing with enthusiasm and a characteristic attention to history that it was only after they had built their telecoms backbone that developed countries dismantled their own state

monopolies. His supporters point to signs of change too. The management of Ethio Telecom has been taken over by France Telecom in a two-year deal worth €30m to modernise and improve the company and help it straighten out its books. Tourism infrastructure is improving as Addis Ababa’s diplomatic importance brings the conference circuit. Luxury hotel options in the capital are about to triple; it used to just be the Sheraton but now a Hilton and a Radisson are opening soon. Investment in hotels outside the capital is being led by Al-Amoudi’s Midroc Ethiopia, the group behind the Sheraton in Addis, building new hotels on Lake Tana and in the towns of Debre Zeit and Arba Minch. Most hotels are being built by wealthy Ethiopians rather than foreign investors. Olympic marathon runner Haile Gebrselassie – who is also one of the country’s most successful

Only 10% of Ethiopia’s population has access to electricity. businessmen – has opened the Haile Resort in Hawassa. Sketchy government figures say tourism accounts for 2.5% of GDP. Ethiopia’s mainstream appeal has never been in doubt, with ancient religious sites such as Lalibela’s fabled rock-hewn churches, nomadic desert tribes and a vital culture that has never experienced colonialism. It is a uniqueness government officials will sell in the first UK-Ethiopia Tourism Forum in London this month. But existing infrastructure and fragile environments like Lalibela

can’t cope with mass tourism. Ethiopia should model itself on Botswana or Zambia and develop a controlled, upmarket niche. “Most of the people who come here are older. They are curious about Ethiopian history and culture rather than seeking a family holiday,” says British hotelier Nick Crane, who opened a lodge in the Simien Mountains three years ago. In an effort to solve Ethiopia’s energy crunch, where only 10% of the population has access to electricity, the government is pushing ahead with ambitious hydropower projects. It plans to spend $12bn over the next 25 years to kick-start a hydro economy that can feed local demand as well as export power to the wider region, harnessing Ethiopia’s 45GW hydro potential. There are already seven dams but over the next 10 years the government plans further cascades that will increase power production from 2GW today to 10GW. But securing finance for the more ambitious projects is proving tough. Financing of the €1.4bn, 1,8000MW Gibe III on the Omo river has stalled since construction began in 2006 because of an international campaign on the project’s environmental viability. The government’s latest pledge to build another dam in the Nile river basin near the Sudanese border has the potential to be even more controversial. With the capacity to generate more than 5GW of electricity, the $4.76bn (€3.25bn) project has provoked fears in downstream Nile basin countries Sudan and Egypt, with the latter lobbying strongly against developments in arguments informed by centuries of conflict. Selling the power could quickly recoup the cost of the project but the need for a regional approach and a guaranteed market beyond Ethiopia’s own, still limited, demand through power-purchase agreements with other countries is essential to make it attractive for investors. Development banks and Chinese investors will be cautious of lending to the project until the impact on Sudan and Egypt of any dam is clear. “The international community will only fully engage in this project when there is harmony between the different countries,” says Richard Taylor from the International Hydropower Association, advising on the different projects. It could force Ethiopia to look at funding alternatives, including selling government bonds. Poverty-stricken Ethiopia is a county of contradictions. Boundless wealth lies in its hydro resources, fertile agricultural land and the size of its market, yet most of these opportunities remain frustratingly out of reach. New and revitalised infrastructure is the key to unlocking its potential – a process that has already begun. i

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Investments

> Michael Gestrin, OECD: Ominous Signs for International Investment

fter two years of steady gains, international M&A activity plunged by $107 billion, or 45%, in the first quarter of 2012. This is the second lowest level of international M&A since the start of the global economic crisis.

The magnitude of this sharp reversal is due to its global reach, with countries from all regions simultaneously pulling back. The biggest industrialised outward investors accounted for most of the declines. The United States, the United Kingdom, and Japan reduced the most â&#x20AC;&#x201D; $76 billion in Q1. This time the emerging economies also joined the trend. As a group they accounted for $12 billion of the total global decline, a share of 11%. This contrasts with the counter-cyclical role they played at the start of the crisis in Q1 of 2008. At that time, international M&A from the emerging economies increased by $6 billion, or 7%, while overall international M&A declined by $235 billion, or 37%. This is the second lowest level of international M&A since the start of the global economic crisis. The biggest change between these two periods is China (including Hong Kong, China). In Q1 of 2008, as the crisis started and global M&A fell by 37%, China (including Hong Kong, China) grew its international M&A by 70% to $33 billion. This year it contributed to the downward trend, reducing its international M&A by 36% to $19 billion. The sharp decline in international M&A investment in Q1 of this year didnâ&#x20AC;&#x2122;t come completely unannounced since it was preceded by softer declines in Q3 and Q4 of 2011. This trend is also evident in data on foreign direct investment

(FDI) flows, a broader measure of international investment that includes international M&A. Given that FDI flows and international M&A tend to move in lock-step, it is likely that global FDI flows have also declined sharply in 2012. Just as the declines in outward M&A have been global in nature, inward M&A has also declined across all regions, with only one exception (table 3). Inflows of M&A into Europe, North America, Latin America, and Asia all declined by around 50%. The Middle East has been hardest hit, seeing M&A fall by 82% due to the combined effect of the downward cyclical trend and heightened political and economic instability in the region. The best performer was Africa, which enjoyed a 133% increase in inward M&A. A feature of the crisis has been the growing importance of international M&A by state-owned enterprises (SOEs), a trend first reported in IN13 (June 2010). When international M&A reached its lowest point in 2009, international M&A by SOEs reached 30% of the global total, an historical record. This government-driven investment would seem to be motivated in part by bargainseeking strategies. As the crisis reached its peak in 2009, SOEs mobilised their cash to acquire distressed international assets. The latest sharp downturn in international M&A has been accompanied by another sharp increase in international M&A by governments. These accounted for 15% of total international M&A in Q1, the highest share since the record levels reached in 2009. Although it is too early to predict whether to the steep decline in Q1 marks the start of a new downward trend, the magnitude of the decline in Q1 and continued sluggishness half-way through Q2 do not bode well for international investment in 2012. On current trend, international M&A would fall to levels not seen since 2004. i

The Organisation for Economic Co-operation and Development (OECD) is an international economic organisation of 34 countries founded in 1961 to stimulate economic progress and world trade. It is a forum of countries committed to democracy and the market economy, providing a platform to compare policy experiences, seek answers to common problems, identify good practices, and co-ordinate domestic and international policies of its members.

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Autumn 2012 Issue

Some Final Thougths

> Christine Riordan: Leading Rapid Change

n today’s accelerated business environment, the ability to anticipate and actively lead change on a daily basis is essential for leaders. John Kotter is a well-known expert on how to lead change. He lays out six important areas for effecting change: creating a sense of urgency, creating a compelling vision, forming a guiding coalition, communicating widely to gain alignment, gaining short-term wins and momentum, and integrating the changes into the culture. His advice is invaluable for understanding the process and leadership of change. However, to successfully direct change, you must go beyond Kotter’s six areas and manage yourself. As a leader, you must also understand your own personal reactions to transitions and adaptations, because your own actions are viewed as symbolic and inspire emotion and action in others. Managing yourself through change is essential to leading others through change, and leading change should be a top priority in your own activities. Making it so will help others foresee and embrace the coming changes that will help your organization thrive in an accelerated environment. To make leading change one of your leadership priorities, try doing the following four things: PUT LEADING CHANGE ON YOUR TO-DO LIST. Many change initiatives fail because leaders treat them as events rather than as processes. You must manage change continuously. Leading change should be a category on your to-do list. Write out the daily actions you will take toward change, and update the list every week. In a research study on change, ninety-six percent of participants suggested that there is a need for a continuous message of change—with change readiness becoming a daily part of the organizational culture. Kevin Reddy, the chief executive officer of Noodles & Company, leads change every day. Noodles & Company is one of the fastest-growing restaurant chains in the United States. Reddy and his team keep disciplined growth, innovation, and execution at the top of their to-do-lists. Reddy notes, “It takes an incredible amount of effort to keep all of your talent moving in the same direction with change efforts, and it is important for leaders

to make this a priority.” He would know. Since he took the helm in 2007, the chain has grown from 100 stores to 290, with continuous positive sales trends in all units. That hasn’t happened by accident. It is a progressive expansion that Reddy aggressively manages.

his job now involves examining data on fast-paced trends that may alter hotel use. He notes, “There are a lot of data and information coming at you quickly. The key to success is to not get buried in the fast pace but to rise above it and detect trends to help your business change and thrive.”

CHECK YOUR OWN REACTION TO CHANGE. Leaders must constantly engage in new activities and thinking as part of change. This often requires them to break habits, change behaviors, and adjust attitudes themselves. People’s responses to change vary. Identify your own. Are you a proponent? Are you an advocate? Are you a passive resister, not leading change as you should? Leading others is difficult if you don’t embrace change yourself. Recent research found that leaders who don’t love change increase their employees’ resistance to it, and leaders, who focus on creating a positive vision, lower their employees’ resistance to it. When a leader does not buy into the change, it is hard to get others to buy in as well. If you are feeling particularly negative about a change, learn how to positively reframe it in your own mind. You must tell a compelling story and share what is changing, what is not, why change is urgent, and why employees should change. And as a leader, you must show that you believe in that change. Shaping a compelling picture of the future shows organizational members that there is a better place to go and that as a leader you are confident in the future.

CREATE A NETWORK OF CHANGE ENABLERS. Leading change is not the exclusive responsibility of an organization’s top people, so change occurs easily only when the organization has a strong network of change enablers. Leaders should recognize that informal followers and advocates of change are quite powerful. Listen to what they have to say, and let them help drive the change. Launa Inman, the new CEO of the surf-wear company Billabong, uses this technique. The company is currently suffering from a drop in profit and flat sales. Inman, formerly with Target Australia, has long advocated asking people within the company for ideas that may solve problems and lead to success. She listens to everyone—senior leaders, middle managers, sales staff, customers, operations partners—and everyone has a chance to weigh in and help lead the change. Inman is counting on this network of leadership to revitalize Billabong. Research supports this approach, documenting the fact that front-line opinion leaders help create positive change within organizations. Make leading change a top priority for yourself and put it on your daily to-do-list. Facing the ever increasing pace of change and overcoming obstacles to successfully lead change is important to the development of all leaders. As Niccolo Machiavelli points out, “There is nothing more difficult to take in hand, more perilous to conduct, or more uncertain in its success, than to take the lead in the introduction of a new order of things.” i

RECOGNIZE THAT THE PACE IS FAST. Rapid change is the new normal. All leaders must keep track of trends that affect both their industries and business in general. As those trends accelerate, so does the pace of change. To adapt quickly, you must constantly look ahead. You need to ask what’s new and what’s next. Don’t hunker down with a day-to-day mentality. Rapid change can be overwhelming, but actively look around the corner to spot trends. Think about the future and what it might hold. The need to anticipate and react quickly to change has become an essential component of leaders’ roles. Pradeep Bobba, general manager of Le Meridian Hotel in San Francisco, says that much of

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About the Author Christine M. Riordan, PhD, is the dean and a professor of management at the Daniels College of Business, University of Denver, an internationally ranked business school. Dr. Riordan runs an $86 million operation and leads a global network of more than 36,000 faculty, staff, students and alumni.

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Some Final Thoughts

> Capital Finance International on .CO Internet:

Keeping it Simple By CFI

or more than two decades DOT COM has been the de facto standard top level domain name for business. One hundred million domain names later the choice of new names is at best limited or at worst involves options that are prohibitively expensive. There are several possible solutions including the new customised domain extensions to be introduced in 2013, but we think one stands out from the field.

Kelly Johnson was one of the world’s most influential engineers. He led the Lockheed team at Area 51 and helped design over 40 aircraft types during four decades with the company (including some of the world’s most iconic aircraft namely the SR71 Blackbird and the U2 Spy Plane). He coined the phrase Keep It Simple Stupid (KISS). The quote was not to suggest that anyone was stupid; it was a design ethos. Some of his aircraft would need to be maintained in the field and if frontline engineers were to be able to keep aircraft serviceable, maintenance needed to be as straightforward as possible. When it comes to domain names, exactly the same logic applies. The best domains are generally the simplest. There is now a new alternative to DOT COM and that is DOT CO, which meets Kelly Johnson’s criteria: how simple this is! With options for new DOT COM domain names severely limited, DOT CO provides businesses with a clear and simple alternative either using words in full or as acronyms. This gives new options to start-ups and allows established organisations 166

to simplify their existing domain names. Some of the best established internet domains have taken advantage and early adopters include Google and Twitter with g.co and t.co respectively.

“With over 1.3 million domains now registered, DOT CO has sufficient momentum to be recognised as a new global standard.” The company running the DOT CO top level domain is .CO Internet SAS which is a strategic partnership with Neustar Inc (NYSE:NSR), the U.S.-based global provider of managed DNS services and registry solutions who has provided domain name solutions for extensions such as DOT US and DOT BIZ. The partnership was formed to promote and manage the DOT CO extension. The DOT CO top-level-domain was assigned to the Republic of Colombia by ICANN. ICANN is responsible for allocating domain extensions around the world. The DOT CO domain – common with several other international country code extensions such as .TV for Tuvalu – has obvious global appeal. The Colombian government decided that it would facilitate the sharing of the DOT CO resources by adapting the registration policies for DOT CO to international industry standards and engaging DOT CO Internet SAS to manage both CFI.co | Capital Finance International

the operational aspects and marketing needs of the new domain extension. Juan Diego Calle is the man behind .CO Internet. Juan is a serial entrepreneur with several start-ups to his credit. It was not long before he had attracted $5 million in seed capital and brands such as Amazon, Twitter and Google were soon to go .CO. Again, the plan – just like the domain name itself – has kept it simple. The advantages of a DOT CO domain speak for themselves. What .CO Internet has done is take a strategic approach to the marketing and use of the domain. They have effectively prevented domains being parked by speculators thereby ensuring that start-ups and existing businesses can find a name that best suits their needs. Uptake has been global with registrations in over 200 counties. Of course, there are hotspots such as Silicon Valley where .CO is very much seen as the preferred extension for new start-ups. There is every chance the next Facebook or Google will be built on a DOT CO, but for any company that needs a punchy and effective web address DOT CO is the simplest, SEO-friendly and an available solution. That was why we decided to adopt a DOT CO web address ourselves: CFI. co. In the words of Kelly Johnson, we have kept it simple, stupid and fully expect millions of others to do exactly the same. When the dust settles on the availability of new top level domains you can expect DOT CO to carry on where DOT COM left off. i

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