FSI #3

th e fi n an ci al wo r l d fsi the financial world | #3 May 2008

May 2008 | #3

Testing times European Commissioner Charlie McCreevy seizes the

opportunities of SEPA Brent Bellm, PayPal, sees

Ronald Ketellapper, Erasmus Verzekeringen, profits from

plenty of scope for growth

cutting-edge technology

fsi the financial world | #3 May 2008

In this issue 03

Testing times

‘Seize the opportunities of SEPA’ Interview Charlie McCreevy, European Commissioner

SEPA: to know it is to love it Article Eddy Ouwendijk and Hans Honig

Tax verdict strenghtens Hong Kong’s off-shore potential Article Lee Chee Weng, Sarah McGrath, Davy Yun and Finsen Chan

The real challenge for banks Column Harry Smorenberg

IFRS7: driver for further development of riskmanagement article Raf Bervoets

Getting the juice out

Article Patrick Callewaert and Frederic Verheyen

How to become a risk intelligent enterprise

News & Research

Article Harold Malaihollo and

Offshoring saves FSI £4.5 billion a year

Evert van der Steen

Confidence private equity firms decreased The challenge for banks: compliance

Towards harmonisation of the taxation of UCITS in the EU Article Raymond Adema

Precautions that pay off Article Arjan Gras

Effective pricing in the banking industry article Patrick Callewaert and Marc Abels

Infrastructure funds: are they on the right track? Article Philippe Lenges and David Capocci

Chain reaction or slow burn Article Pablo A. Castillón and Cormac Petit

Some 50 to 70% of mergers and acquisitions disappoint Article Lucas van der Drift

Closing the gap Article Anneke Holwerda

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'Still plenty of scope for growth'

Interview Brent Bellm, PayPal

Using cutting-edge technology to cut out competitors Article Ronald Ketellapper, Erasmus Verzekeringen

Testing times By Rob Stout, Deloitte Industry Leader for the Financial Services Industry in the Netherlands

The period we are now in is destined to go down in the history books of finance. Indeed, the recent dramatic events and hefty corrections in financial markets have rocked the planet.

What started as a typically American problem now threatens to spread to every corner of the globe like a financial version of the deadly virus SARS. Big names are teetering on the brink of collapse and investor concerns about valuation and risk are easily transferred to other financial products and market participants. This uncertainty and risk aversion is undermining trust in the FSI industry. A very dangerous situation, which, if it lasts too long, could have knockon effects on the global economy, causing a further slowdown with all its consequences. Financial markets and governments will have to join forces to break the deadlock. Essential teamwork in a world where we all turn out to be linked together. The repricing of assets and risk is in full swing all around us. From our perspective, we at Deloitte are keeping a careful eye on the valuation of positions in the various instruments featuring in the annual accounts of our customers. Quite a challenge, as one may question whether under current conditions their value can be assessed with any accuracy. The commonly used concept of “fair value” is really being put to the test. This places considerable demands on valuation systems, internal audit systems, et cetera. The market, Deloitte has found, is clamouring for precisely this kind of expertise at valuing assets. Annual accounts auditors are very much in the picture.

Valuation, financial reporting and risk management systems will definitely be put under a magnifying glass. Expectations are that new regulations will be introduced in the US that will change the face of the financial services industry (as SOX did before). It is not yet clear what these new regulations will be, but their influence will extend from investment banking, structured finance, hedge funds and private equity to monoline and other insurance. We reckon this will greatly increase the need for specialist know-how. And Deloitte is investing to be able to offer this kind of knowhow on a broad and international scale. The interrelatedness of financial markets is another fact of life for Deloitte. In the financial services industry, national borders are irrelevant. Deloitte’s specialists increasingly operate in international teams. The issue of opportunity transcends borders between competencies and countries. In this issue of FSI magazine, you will see that our expertise comes from all over our international network. Deloitte believes in seamless teamwork between specialists to produce the best possible solutions for our customers. In these testing times, I wish you wisdom, and hope you enjoy reading Deloitte’s FSI magazine.

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European Commissioner Charlie McCreevy:

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‘Seize the opportunities of SEPA’

By Jon Eldridge

The Single Euro Payments Area (SEPA) is expected to save consumers and businesses €50-100 billion a year, but some countries have been slow in implementing the initiative. While barriers towards SEPA still remain, Charlie McCreevy, EU Commissioner for internal market and services, says that the benefits of SEPA are already apparent and that the creation of a level playing field in the eurozone is on track. As a market-driven initiative, is SEPA developing as intended? 'I think we have got off to a very good start. The European Payments Council (EPC) has developed the basic rule books for credit transfers and direct debits. More than 4,000 European banks have now adhered to the EPC credit transfer scheme and SEPA credit transfers were successfully launched on 28 January. As can be expected the actual number of SEPA credit transfers is relatively small, but this will increase over the next three years. Even so, the actual volume of transfers is significant and already exceeds 100,000 on a daily basis. For full direct debit migration we will need to wait till the deadline for the implementation of the Payments Services Directive (PSD), 1 November, 2009. However, it is encouraging that some countries may already use the SEPA Direct Debit for national direct debits before that date. The position for cards is perhaps more nuanced, but I am aware of at least three potential new entrants to the pan-European debit card market. So that is very positive. However, we still have a long way to go, and I will be closely following market developments to see, for example, how the improved EPC governance arrangements work out in practice.

The aim of SEPA is to create a level playing field in the eurozone. What would be a realistic target date for achieving such a goal given the existing big differences in fees and interchange fees between southern Europe and northern Europe? In reality will SEPA be only created after 2015? 'Yes, it is true that we have different business models for payments in Europe. SEPA will place these models in competition and customers should benefit from the increased competition. However, I think once the market becomes more familiar with SEPA, with banks actively marketing the new SEPA products, and customers, particularly corporates, making the investments to seize the opportunities of SEPA, then migration could occur a lot faster than many people think. Clearly, direct debit migration will take longer than credit transfers but 2015 seems unduly pessimistic.'

To realise the SEPA vision, strong commitment from all the stakeholders is required. What is the European Commission doing to encourage national governments and public authorities to move towards SEPA? 'SEPA is a market-led initiative. Therefore, in the first place banks should develop attractive products and market them actively so that there is a natural momentum for customers to migrate to SEPA. These efforts need to be tailored to the national situation. However, I recognise that SEPA can bring very significant benefits to the wider economy and that public authorities can play a strong role in kickstarting migration and achieving critical mass. Therefore, I have sought to raise the political profile and awareness of SEPA at the European level. I think we have been successful, as can be seen from the Ecofin conclusions adopted last January. We intend to closely monitor SEPA migration by public authorities and to coordinate our communication efforts with the EPC and the European Central Bank. For example on 28 January, we successfully ➦

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hosted a SEPA launch event, "SEPA Goes Live", and last year I hosted a major conference for public authorities. The conference showed that while public authorities strongly support SEPA, concern about the pricing and performance of SEPA products may, sadly, create a negative climate for early migration. But SEPA is a market-driven process, and in a market driven process, suppliers should persuade customers of the merits of new products so that migration occurs naturally. Banks should espouse the non-deterioration principle, namely that the new SEPA products should have price/performance characteristics at least as good, and preferably better, than existing products. Ecofin has already highlighted its importance in its conclusions last year and the Commission will continue to monitor this issue and, at the same time, will strive to promote the role of public administrations in the timely and successful implementation of SEPA. Finally, we can, of course, encourage by example, by being early adopters of SEPA products ourselves.'

'Public authorities can play a strong role in kick-starting migration and achieving critical mass' Are you concerned about national debit cards? 'Within SEPA, functionality will undoubtedly be expanded so that a card can in principle be used at any terminal in the eurozone. Unlike the comprehensive rule books for credit transfers and direct debits, the SEPA Cards Framework does not develop any detailed rules and standards, but rather

describes three options for attaining SEPA compliance. There is a justifiable concern that under current market developments, this increased functionality could come at the cost of increased market concentration and the risk of a more expensive payment card for the merchant and consumer. At the heart of this issue is our concern that national card schemes should not be replaced by more expensive payment card schemes, using SEPA as some sort of pretext for increasing prices. More competition in the EU payment cards landscape should mitigate against such tendencies.'

In a more cross-border integrated banking landscape, is the current primarily domestically oriented banking supervision the right model? Do you foresee changes in this model in the next five to ten years? 'We are engaged in discussions on this issue with finance ministers in the Ecofin Council. A single supervisor is not on the horizon, but I am in favour of deeper and quicker supervisory convergence.'

Is there sufficient transparency of the real costs of payments services for consumers? For example, Dutch consumers and traders fear a level playing field since a balance would imply a considerable rise in banking fees. As a result, banks have informed their clients that payments are cheap because of efficient processing and technologies? â&#x20AC;&#x2DC;Transparency of real costs is a general problem in payments markets. There are hidden costs and cross-subsidies. For example, banks can use float income to offset direct payment costs. Consumers often do not recognise these costs. On the other hand, some consumers may unreasonably expect payments to be free. Clearly, banks have to cover their costs somewhere. However, I agree that the Dutch market is probably one of the most efficient. Markets with more expensive payment products have

fsi the financial world | #3 May 2008

greater potential to gain. But SEPA is about increasing competition to arrive at a "best-of-breed" level, not about regression to some average EU level.'

Payment costs for end users are still not very transparent. Can you foresee governments or the EU putting pressure banks to open up further and increase the efficiency of the European payment sector? 'One of the main objectives of the PSD is to increase transparency and the quality of information provided to customers. SEPA will intensify competition and further improve efficiency through increased economies of scale. These effects are already visible in the payments processing market. I think the merger of Dutch Interpay and the German Transaktionsinstitut in 2006 to create Equens is a very good illustration. Clearly, I prefer market-led solutions, but the Commission has always reserved the right to propose further legislation to attain the full potential of SEPA, if necessary.'

Increasingly, banks are working towards – or have begun – cross-border consolidation. Do you expect a further acceleration driven by the EU agenda for a fully harmonised financial services market? 'At the start of this mandate, in December 2005, we published our strategy for the financial services 2005-2010. The strategy explores the best ways to effectively deliver further benefits of financial integration to industry and consumers alike. These remain our priorities. The No 1 priority is to dynamically consolidate progress and ensure sound implementation and enforcement of existing rules. Our second priority is to drive through the better regulation principles into all policymaking. Third, we are working to enhance supervisory convergence. Fourth, we are aiming to create more competition between service providers, especially those active in retail markets. Finally, we are seeking to expand EU’s external influence in globalising capital markets.'

'SEPA is about increasing competition to arrive at a "best-of-breed" level'

To what extend will competition authorities monitor SEPA? 'This question is best answered by my colleague Neelie Kroes, EU Commissioner for competition, with whom I enjoy close cooperation on SEPA issues. From our contacts, I know competition authorities at both the European and the national level are closely monitoring SEPA, as am I.'

What happened to cause PSD to be delayed, and how does that relate to direct debit for example 'I am pleased that we are able to find a successful compromise on the PSD between member states, which preferred a more traditional approach and those that favoured a more innovative approach to payments. The PSD provides the legal foundation for SEPA. This is absolutely crucial for direct debits where we need to harmonise the authorisation, revocation and refund rules at European level to make a SEPA direct debit possible. Consequently, full direct debit migration requires the implementation of PSD. We appreciate the importance of consistent, correct and timely implementation of the PSD to provide a common legal framework for the launch of the SEPA Direct Debit scheme. We are working closely with member states and business through transposition meetings and our interactive website on PSD implementation to achieve this result.' ➦

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‘A single European supervision on banking is not on the horizon’

What other barriers do you see on the path towards a level European market playing field? 'The Commission is actively committed to identifying and proposing the removal of significant barriers to the completion of the internal market in financial services. The most important remaining barriers are in the retail area where cross-border transactions are less developed. Taxation and especially VAT was one of them, and the Commission proposed in November, 2007, to modernise the existing provisions of the VAT Directive concerning financial services to have a consistent regime across the EU. The Commission also identified others barriers in the mortgage market in a white paper published in December, 2007, and in customers’ mobility related to bank accounts.'

How do you see the EU market growing over the next few years in relation to those countries that just joined the EU and those that are eager to join? 'Between 2001 and 2006, the EU financial service industry has been growing more rapidly than the global EU GDP. Although this growth was fuelled by many factors, such as increased demand for more sophisticated products, financial innovation and strong real estate markets, the EU financial integration has played a decisive role. Therefore, the Commission expects the financial service industry to continue to grow significantly, especially in the new member countries and the neighbouring countries as financial services were generally less developed in these countries.'

Apart from SEPA, what do you think will influence the internal economic market most in coming years? 'Concerning the financial services internal market, the Commission expected the integration of retail markets to progress further both with an increase in cross-border trade of financial services and the consolidation among the financial service companies. In the context of the current financial turmoil, the Commission is also pressing for deeper and quicker convergence and integration of supervisory practices across the EU. If adopted by the Council and the European Parliament, the new risk-based prudential regime, Solvency II, should foster a more competitive EU insurance industry for the benefits of all its customers.'

The Solvency II Directive is expected to transform insurance and reinsurance regulation in Europe. How will this directive be adopted? 'Our key priority for this year is ensuring that the Solvency II Proposal is adopted without the substance of the proposal being compromised. 2007 was a key year with the Commission adopting the proposal in July. The Portuguese Presidency did an excellent job in negotiating it. The Commission’s Proposal is innovative and responds to a real need to improve the regulatory framework in the EU. The negotiations in the Council are now continuing under the Slovenian Presidency. Two Council meetings have already taken place and the Presidency has scheduled several other meetings. I am confident that good progress will be made.

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It is also our key political priority that the Solvency II Project proceeds according to the timetable. Otherwise the directive will not enter into force in 2012 as expected. This would be detrimental to both EU industry and policyholders. We therefore need to meet all the deadlines. Key milestones will be the votes in the Council and the European Parliament. In February this year the Peter Skinner, the Parliament rapporteur, will present his report to the Committee on Economic and Monetary Affairs. A vote in ECON is expected in the summer of 2008 and a vote in the Plenary in the autumn of 2008. The Council and the European Parliament are expected to adopt the directive by the end of this year. The adoption of the Level 1 Framework Directive is not the end of the Solvency II Project. As you are aware, Solvency II is adopted under the Lamfalussy procedure. It is very important for the Commission that the Level 2 implementing measures, which give further detail to the directive, are also developed and adopted according to the timetable. We expect that the implementation measures will be adopted by the European Parliament in 2010. The Committee of European Insurance and Occupational Pensions Supervisors (CEIOPS) has already started working on the areas where it is likely that implementing measures are needed. We have asked CEIOPS to deliver advice on these measures by October 2009.'

How has the industry received the proposals? 'Getting buy-in from all stakeholders is one of our key priorities. There is little point in introducing a new innovative regulatory framework for insurance if only the Commission believes in its benefits. We therefore want to operate in a very transparent way and consult our stakeholders as much as possible. It is also important that national supervisory authorities embrace the fundamental changes brought about by Solvency II. We do not only want buy-in from industry and consumers but also from insurance supervisors. They will be at the forefront of the new regulatory framework. They need to demonstrate that the supervision of insurers has changed. I am encouraged by the widespread support for Solvency II. Indeed, there is significant interest also from countries outside the EU. Our regulatory framework will be, I hope, world leading, but Solvency II does give the Commission the option to recognise a third country regulatory regime as equivalent. The third country would then be able to benefit from the group supervision provisions in Solvency II.'

rules should apply to them once Solvency II is in force. Looking ahead, it will be important to ensure that pension fund regulation incorporates stateof-the-art financial supervision principles so as to achieve a high degree of pension security at a reasonable cost for employers. The issues involved are, however, highly complex and views differ markedly. In moving forward we will need to tread carefully. It is for this reason that I have asked Commission services to launch a broad consultation in order to get a good understanding of all the issues involved from the perspectives of the different stakeholders.'

Pension funds differ in countries across Europe. Is harmonisation of solvency rules in this area a possibility? 'I know that there is a great deal of interest in the UK on whether Solvency II will be extended to pension funds. The IORP Directive has now been implemented by all member states. In order not to slow down the finalisation of the Solvency II Proposal, it was agreed with member states in 2006 to come back to the issue of possible extension of the new solvency regime to pension funds in 2008 in the context of a review of the directive. In order to prepare the discussion, CEIOPS is presently examining the existing solvency rules for pension funds. It is only after this first fact-finding exercise has been finalised that we will be able to better understand which solvency rules apply to the area of pension funds. I believe that further work is needed here before we can commit ourselves to any specific regime. Stakeholders will have an opportunity to provide us with their views. But a very strong business case would be required before we start shifting Solvency II rules to pension funds, and frankly, I would be surprised if there is such a case. I have no intention of sponsoring proposals that would risk closing down defined benefit pension schemes.'

â&#x20AC;˘

'The greatest challenge for insurers and reinsurers across the EU will be to introduce a modern solvency regime'

What challenges do you see for all financial markets (including pensions and insurance) over the next two years? 'The greatest challenge for insurers and reinsurers across the EU over the next few years will be to introduce a modern Solvency regime. As you may know, the European Commission has adopted the Solvency II Directive proposal last summer and it is expected that the European Parliament and the Council will have adopted this new supervisory framework by the end of this year. In parallel, work on implementing measures has already started, and we hope that European insurers and reinsurers will be able to benefit from a new solvency regime by 2012.

Charlie McCreevy, born in 1949, qualified as a chartered accountant. In 1977 he was first elected to DĂĄil Eireann (Irish Parliament) for the constituency where he was born - County Kildare, Ireland. Since 1992 he has held various cabinet posts in Fianna Fail-led governments including: Minister for Social welfare, Minister for Tourism and Trade

Occupational pension funds are part of the pension system decided by the member states and they have a key role to play in helping economies to meet the challenges of demographic ageing. Occupational pension funds in the EU are subject to the Institutions for Occupational Retirement Provision (IORP) Directive. Given that this directive has been implemented by member states only recently, time is still needed for its full effects to unfold. At the same time, prudential regulation of these funds is linked to the prevailing life insurance directive. As a result, there is a need to decide which

and latterly (1997) Minister for Finance. In 2004 he became a Member of the European Commission, responsible for the European Unionâ&#x20AC;&#x2122;s policy on the functioning of the internal market of 480 million people across 27 Member States. Previous European Union roles include Member of ECOFIN (1997-2004) and President of the ECOFIN Council (January to June 2004).

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SEPA Survey 2007

SEPA: to know it is to love it

By Eddy Ouwendijk, Senior Manager, Deloitte The Netherlands, and Hans Honig, Director, Deloitte The Netherlands

Dutch corporates are not ready to take advantage of all the opportunities to make and save money that are coming their way thanks to SEPA, the Single Euro Payments Area. Why? The main reason is the virtual absence of communication on this topic between banks and their customers. This is one of the eyebrow-raising conclusions of Deloitteâ&#x20AC;&#x2122;s SEPA Survey, held recently among nearly 100 CFOs, financial managers, treasury managers and cash managers working for the countryâ&#x20AC;&#x2122;s leading companies and public sector organisations. Both corporates and banks have a lot to gain from investing in better communication and defining a clear SEPA strategy.

Banks are far too defensive about SEPA

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rom 2008, the Single Euro Payments Area (SEPA for short) will gradually come into force, and expectations are it will contribute in a big way to the ongoing integration of the European market. Ultimately, differences between national and cross-border funds transfers are to disappear in SEPA, and businesses, governments and consumers will be able to make payments to other SEPA countries with the same ease and at the same cost as they do within their own national borders.

Significant benefits of SEPA Politics, banking and business alike (as represented by the European Commission, the European Payments Council and the European Association of Corporate Treasurers respectively) recognise the many advantages of an integrated payments market. SEPA is expected to foster greater transparency and competition, resulting in a cheaper and more efficient payments system. European Commissioner Charlie McCreevy reckons the introduction of SEPA will save consumers and businesses some 50 to 100 billion euros a year. But the benefits won’t come to those who just sit back. Making the most of SEPA will require some upfront investment. With the introduction of SEPA, companies and public sector organisations will eventually have to conform to new standards. Their ERP systems will need adjusting, and

system updates such as switching to new interface formats and adding fields for things like IBAN/BIC codes are extremely time-consuming. Let’s just hope they start investing soon, as otherwise, to encourage the migration from today’s system to SEPA, a price tag may be attached to currently free payment services, such as IBAN-BIC conversion and format conversion. Already in January 2006, banks were given permission to charge extra for cross-border payments without IBAN/BIC information, and from January 2007, banks have even been entitled to refuse such payment orders. Eventually, domestic payments will have to meet the same criteria. Organisations that cannot comply will be confronted with significantly higher costs. In other words, corporates and public sector organisations would do well to stay ahead of the game and make the right preparations to avoid cost hikes. In view of the huge potential benefits of SEPA and the implications just outlined, Deloitte held a survey ahead of SEPA’s introduction to find out how aware the main payment service user groups are of what is coming at them, and how well prepared they are. A total of nearly 100 representatives of multinationals and public sector organisations in the Netherlands filled in the online questionnaire. ➦

SEPA and PSD: assessing the impact of an integrated payment marketplace The EU Payment Services Directive (PSD) provides the overall legal framework for funds transfers across the entire European Union. SEPA, the financial industry’s collective response, is actually narrower in scope, but has got all the press. So plenty has been published about the what, how and when of SEPA, but what do we know about the impact of PSD? PSD seeks to drive efficiency and innovation by fostering effective competition. How? • By harmonising rights and obligations (contract terms, exception processing rules) • By removing barriers to competition with the creation of a new class of regulated entity, Payments Institutions, that can provide payment services across the EU, and with a ban on discriminatory local payment network access requirements • By promoting greater transparency (contract terms, un-bundled pricing) What the precise impact is at national level is unclear, as EU member states have considerable discretion as to how they enact the directive locally. What we can be sure of, though, is that these changes have significant implications for banks and for their customers and other users of the bank-run payments system. For example, banks need to: • Ensure that they are fully compliant with their local regulations by the locally determined deadline – which shouldn’t be later than November 2009

• Review where they undertake certain payments-related activities, in other words explore possibilities for rationalising legal entity structures (such as having all their card-related credit in Europe provided through one legal entity) and opportunities for regulatory arbitrage arising from differences from country to country • Review their payments strategy and operating model, and specifically their existing correspondent banking relationships now that they have direct access to local clearing houses Users – such as pension funds, asset managers and corporates – need to: • Upgrade their payments systems to ensure that they can take full advantage of the new payment instruments and thus reduce their payments-related costs • Rationalise local payments operations • Understand the new competitive landscape as banks seek to earn a return on their regulatory-driven investments • Consider rationalising their local banking relationships

sepa and psd scans The first step for any bank, company or institution is to assess the impact of both PSD and SEPA on their own payments strategy and operating model. Deloitte has developed SEPA and PSD scans which can them do so. On the basis of such an assessment, they can then define and implement an effective and cost-efficient strategy.

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How high do you expect the total SEPA investment to be for your company? 8% 15%

More proactive approach to SEPA needed The survey revealed that the corporate and public sectors seem to be taking a passive approach to SEPA. The vast majority of respondents see it as the responsibility of their banks and their ERP providers to make appropriate preparations for SEPA.

FIGURE 1

46%

31% ฀0 < 10.000

< 100.000 Don’t know

How high do you expect the total benefits to be for your company?

38%

FIGURE 2

54%

Moreover, many organisations prove to have difficulty quantifying the costs and benefits of SEPA. Nearly half (46%) of the respondents indicate they are unable to estimate how much needs to be invested in connection with SEPA, while 31% indicates that the investment will not exceed 100,000 euros. Indeed, 15% expect the investment to be 10,000 euros or less. As for the benefits, the percentage claiming to be unable to forecast them is even higher: 54%. Over a third (38%) expects the benefits to be at most 100,000 euros. Although the aim of SEPA is first and foremost to create benefits for end users in general and for multinationals and public sector organisations in particular, the target group for now at least shows little awareness of these benefits: 29% see no business opportunity at all arising from SEPA. Most potential business opportunities suggested in the survey were acknowledged by only 20% of respondents. The top three opportunities that did get wider recognition were: • streamlining of cash management function (54%) • reduction in number of bank accounts (46%) • standardisation of payment formats (45%)

8% 0 < 100.000

< 1.000.000 Don’t know

FIGURE 3

These benefits were recognised when actively suggested to respondents, but they are not taken on board in an overall SEPA strategy for the organisation as a whole. Worse, SEPA appears to be absent on the strategic agenda of most organisations. The vast majority of respondents (93%) admit to having no SEPA strategy (see figure 3). Nor have most organisations set up a team to develop a SEPA plan of action.

Do you have a specific SEPA strategy?

SEPA-awareness among Dutch corporates and public sector organisations is extremely low

80 79%

60 40 20 0

14%

Yes

Not yet

Challenge for banks: clear communication and sepa proposition

FIGURE 4

84%

65% 54%

40 20 0

33%

26% 13% 13%

Yes

Uncertain

Did a bank approach you about SEPA? Did you approach a bank about SEPA? Were you approached by a ERP provider about SEPA?

So the Dutch corporate sector is not exactly warming up to embrace SEPA. One reason seems to be the virtual lack of communication on this subject between the users and the providers of payment services. While many Dutch banks have been preparing for SEPA for some time now and have started their communication campaign, our survey shows they have some catching up to do. A considerable majority of corporates and public sector organisations (65%) claim they have not been approached by their bank on the subject of SEPA, while only 13% indicate having proactively approached their bank themselves about it (see figure 4). Interestingly, even in cases where there had been contact between providers and users of payment services, the provider’s offer is rated by the user as unsatisfactory. Of the respondents that did discuss SEPA with a bank, 72% indicates that the bank’s SEPA offer did not suit their needs.

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The survey makes it clear that banks are taking a far too defensive approach to SEPA. Their communication targets customers that already use them as their primary bank. They are far less inclined to see SEPA as a change creating opportunities to strengthen their own position. SEPA speeds up the evolution towards a more centralised cash management model and is expected to significantly reduce the number of accounts held with different banks. For a SEPA cash management solution, canny corporates are thus looking beyond their primary bank. The result of the defensiveness of the banks is that many organisations simply do not know enough about the impact of SEPA and the potential benefits, which may explain their passive attitude.

SEPA calls for better communication and strategic vision It is surprising to observe that the parties that have the most to gain from SEPA see it as their bank’s or their ERP provider’s problem rather than as an opportunity they could and should be taking advantage of. The chief factor underlying this strategic blind spot seems to be a lack of information about the subject. It is easy to blame banks - traditionally the providers of payment services - for apparently not succeeding in getting the message across. But on the other hand, one would expect that multinationals and public sector organisations would themselves be capable of actively seeking the information they need. After all, there are potential economic benefits to be had! Market adoption is the critical success factor for SEPA. Without businesses generating SEPA transactions and sending them to a processing bank, the millions of euros these parties have already invested in SEPA-

ready transaction processing machines will be wasted. So the banks, too, have an interest in getting the migration to SEPA transactions going. Perhaps there is scope for first-mover discounts. Even without such discounts, though, it should be clear that SEPA spells not only unavoidable capital expenditure, but also considerable potential for cost savings. Ways SEPA can reduce costs include: • streamlining of cash management • reduction of the number of bank accounts • reduction of the number of banks an organisation does business with • standardisation of payment formats • standardisation/consolidation of payment systems • higher transaction volumes per bank, resulting in greater purchasing clout and consequently lower transaction costs • more straight-through processing. Banks face the challenge of improving their communication and approaching SEPA, more than they have to date, as an opportunity. Only then will banks be able to strengthen their market position in the more competitive cash management market ushered in by SEPA.

Conclusion SEPA-awareness among Dutch corporates and public sector organisations turns out to be extremely low. Moreover, perhaps due to this limited awareness, these two main target groups (in terms of transaction volumes) have done very little to prepare for the introduction of SEPA. The market is not yet sufficiently wise to the implications of SEPA, and perhaps even more surprisingly, has hardly begun to wake up to the potential for cost savings that SEPA offers.

•

SEPA Survey: European scope The European Central Bank (ECB) is responsible for monetary policy in the euro area - the world’s largest economy after the United States. The ECB has asked Deloitte to amplify on its 2007 SEPA Survey. Although the SEPA Survey focused on the corporate and public sectors, the conclusions also attracted the attention of the banks. The writers of the survey were therefore asked to help start a discussion between all of the national central banks and some large corporates at an ECB meeting in Frankfurt last 3 April. The study on the awareness and readiness for SEPA amongst corporates and public organisations in the Netherlands was performed in cooperation with ATOS Consulting. This study will be repeated in 2008, this time with a European scope. This will give more insight into the similarities and differences between the countries within SEPA. The ECB expressed keen interest in the outcome of our new European SEPA Survey. For the SEPA Survey see: www.deloitte.nl/treasury

The European Central Bank, Frankfurt

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Tax verdict strengthens Hong Kong’s off-shore potential By Lee Chee Weng, Sarah Mcgrath, Davy Yun & Finsen Chan Deloitte Touche Tohmatsu, Hong Kong - Edited by Peter De Weerd

The decision by the Hong Kong SAR Court of Final Appeal (CFA) in ING Barings Securities (Hong Kong) Limited has clarified previous uncertainties surrounding the rules used to determine the source of income. The court ruled that the disputed income in the specific case arose from activities abroad. As Hong Kong taxes only profits arising in or derived from Hong Kong, the decision may have a major impact on various types of income from a wide spectrum of businesses with cross-border transactions. NG Baring Securities (now Macquarie Securities Limited) is a Hong Kongincorporated company and par t of a global securities sub-group of the Barings group of companies. The cour t decision concerns commission, placement and marketing income deriving from securities traded on stock exchanges outside Hong Kong.

Commission income was generated when stock orders placed by Barings clients outside Asia were channelled through the ta xpayer, which then executed the orders through a broker on the relevant Asian stock market. The cour t ruled that this income arose from activities outside Hong Kong because it considered the crucial step in the earning of the income to be the sale and purchase transaction, which in this case took place outside Hong Kong. A similar reasoning was followed in respect of placement income. When new

shares were issued or listed on a foreign stock exchange, usually in Asia, interested clients of the ta xpayer or other members of the Barings group applied for allotments through the ta xpayer. Marketing income was also generated if the ta xpayer introduced a client to another group company operating in a foreign market and the client successfully traded in that market through the group company. According to the CFA, the introduction itself did not result in commission being paid to the ta xpayer. Instead, the commission was payable only upon completion of the securities trade, which took place on an overseas stock exchange. The ta x payer’s activities giving rise to the marketing income were consequently deemed to be conducted overseas. This verdict encourages a depar ture from the cumbersome ‘totally-of-facts’ approach in favour of the ‘operations test’.

The Hong Kong Inland Revenue Depar tment (IRD) has frequently applied the former approach when determining the ta xabilit y of income, and its detailed questioning about operations has of ten placed unreasonable demands on ta xpayers seeking to discharge their burden of proof. Of fshore claims have of ten also been disallowed because the IRD placed undue weight on minor or unimpor tant factors. It is therefore encouraging that the CFA decided to apply the operations test in this case and determine the source of income solely on the basis of the place where the transactions were executed. The High Cour t’s decision in this case will strengthen Hong Kong’s competitive position as an of fshore territorial ta x regime.

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The real challenge for banks

s conference theme, the Single Euro Payments Area has been flogged to death and is disappearing from agendas - just when it ’s star ting to get interesting! With most banks claiming to be SEPA-proof, it ’s the business communit y’s tur n to jump on the bandwagon. For banks, SEPA is more a mat ter of creating the right conditions - the focus is on standardisation, for mats and systems. But for businesses, the Payment Ser vice Directive (PSD) opens up a goldmine: it creates a level playing field in Euro pe for all modes of payment. You might call it a European payments supermarket, with cash and treasur y managers shopping around for the best combination of price, per formance and qualit y. Among banks, we will see keen competition on ser vice and price. Companies can easily shif t their banking business to the branch that of fers them the best deal. For example, a Dutch trading company might be much bet ter of f choosing one Nor th-Italian bank for its cash concentration instead of the seven banks in and outside the Netherlands that it currently does business with. The financial professionals in these companies will have quite a job just finding out what oppor tunities the new EU banking landscape of fers. For a while, companies’ lack of awareness, force of habit and discounts from their cur rent providers are likely to keep them from breaking out of the local structures, but before long I expect a race to the bottom. All the more reason for fur ther rationalisation of payments at Europe’s smaller and larger banks. The other impor tant change will relate to standardisation. For years, emphasis has been on ef ficiency in the financial supply chain. The buz z word ‘e-invoicing’ is on ever yone’s lips, and behind it is the desire for no-fuss, direct data transfer and transactions. Until now, this was a utopia. Des pite many desperate at tempts to achieve at least some standardisation

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in the business models of banks and their trading par tners, solutions all too of ten remained isolated and fragmented. Within SEPA, one universal message standard has been introduced: the ISO 20 022 (also k nown as UNIFI). E xpectations are that within a few years, all banks will be able to process it.

By Harry Smorenberg harry@smorenberg.nl

But standards alone are not enough. Ef for t must also be put into creating a suitable exchange net work, comparable to the postal ser vice for sending paper documents. A net work with a clear and globally valid address standard, and above all a low barrier to entr y. This is the only way to keep small and medium-sized businesses on board in the nex t phase of digitisation, and give them the means to escape the current realit y of ‘big B’s’ (big buyers and billers). E-mail is proof how quickly a worldwide net work for personto-person communication can evolve, so why is a machine-to-machine net work taking so long? The new status quo will be ideal for companies that already have standards and an open net work and thus enjoy direct and fully automated data reconciliation, including direct for ward integration of data from invoices, contracts, trade docu ments, pay ments, etc. bet ween all relevant par ties. Needless to say, the first companies to profit will be those with a professional cash and treasur y management function and back of fice (in-house bank /payment factor y). But here, too, I expect a rapid spread of these functions and the at tending benefits to the medium business segment. So I see plent y more excitement ahead for banks catering to the business market. They’ll need to discuss how to position themselves to deal with the challenges they will inevitably be encountering.

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Why is a machineto-machine network taking so long?

fsi the financial world | #3 May 2008

Risk intelligence for competitive advantage

How to become a Risk Organisations that are most effective and efficient at managing risks to existing assets and future growth will, in the long run, outperform those that are less so. Putting it simply, businesses make money by taking intelligent risks and lose money by failing to manage risks intelligently.

By Harold Malaihollo, Senior Manager, Deloitte Netherlands and Evert Van Der Steen, Manager, Deloitte Netherlands, with contributions by the ERS FSI Risk Intelligence Team Illustrations: Michiel Vijselaar

raditional approaches to risk management emphasise mitigation and focus on the readily apparent risks facing a business in important areas such as security, privacy, credit, regulation, technology and fraud. These threats are obviously important and must be addressed. But enlightened risk managers (in other words, the entire C-suite and not just the chief risk officer) do not just worry about the bad things that could happen, such as theft of sensitive customer data. They also consider the good things that might occur, like introducing a hit product or service to the FSI market. While it is important to evaluate potential crises, it is equally critical to consider the risks linked to success so you can capitalise on opportunities.

Reward and lack of reward What if, for example, your IT or business architecture does not support a new blockbuster product or service? You have just squandered an opportunity. We refer to these two aspects of risk as “rewarded risk” and “unrewarded risk.” Unrewarded risk represents risks that do not have an upside; even if you handle them perfectly, there is no reward. There are numerous examples of unrewarded risk in business, including IT privacy and security, work place safety and so on. Yet companies performing all these tasks in a timely

and competent manner do not see their share price surge as a result. These kinds of activities simply meet the expectations of shareholders, regulators, suppliers, analysts and other stakeholders. The attendant risks cannot be ignored, but the primary incentive for addressing them is value protection, not value creation. Conversely, rewarded risks are the decisions you make when developing new products, entering new markets or acquiring new activities. The primary motivation for taking rewarded risks is to spur value creation. Fixate on just one side of the coin and you will get a one-sided result. Focus on value creation (“rewarded risk”) to the exclusion of value protection (“unrewarded risk”) and you will quickly find yourself on the slippery slope of non-compliance, litigation, reputational risk and other such nastiness. Similarly, address only unrewarded risk and ignore rewarded risk, and your business may survive, but it will never thrive.

Why you should care If risk is not on your radar screen, it is time to upgrade your detection equipment. A convergence of factors has turned risk management programmes from a “nice to have” option to a “can’t live without” imperative.

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Intelligent Enterprise

These factors include the following. • Regulatory pressures have increased: The New York Stock Exchange now requires all listed companies’ audit committees to evaluate their risk management practices. • Stakeholders are flexing their muscles: Institutional investors now routinely include risk management considerations in their investment decisions. Money will gravitate toward companies with sound practices in place. • Impact on the cost of capital: Moody’s and Standard & Poor’s now include enterprise risk management (ERM) capabilities in their evaluation criteria. Companies deemed deficient can face an increase in their cost of capital. • The internet has changed the game: With news, data and even cell phone video clips crossing the globe in mere seconds, businesses can no longer deal with threats to their reputation discretely. • Corporate risk has become personal: Out-of-pocket settlements in recent US shareholder lawsuits have had directors and executives clutching their wallets all across the country. In most executive suites,

you hear little talk of failure around the boardroom table. Failure is simply taboo. Only “negative thinkers” and “naysayers” raise the spectre of something going wrong, and usually at their peril. Instead, discussions usually focus on the positive aspects of the company’s strategy and the need to rally around the strategy, with little consideration of the downside possibilities. But at some point, you have to push the head-nodders and “yes” people aside because it is time to put failure on the agenda. Only by first ➦

Companies need to work towards shared values, based on respect, trust, cooperation and ambition

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acknowledging and then analysing risks and uncertainties threatening the achievement of corporate objectives can companies manage them effectively. Only by challenging the assumptions that underlie strategic planning can the prospect for success be strengthened. Only by recognising the potential for failure can failure itself be avoided. Organisations that do not address failure in advance often find themselves feeling the effects later. For many businesses, the failure to conceive of failure represents a gaping void. The fundamental questions to be asked and not avoided include asking what could cause a business to fail in: • attaining and sustaining revenue growth? • increasing operating margins and improving the eficiency of assets? • meeting key stakeholders’ expectations? By asking these questions, and understanding how an enterprise can fail, planners and decision-makers can then decide how to prevent it, how to detect early warning signs more quickly and how to implement course corrections. This ability to conceive of and then prevent failure must be incorporated into the strategic planning process. Organisations need to be intelligent about the risks they take to gain and sustain competitive advantage, as well as the risks they avoid or mitigate to protect their existing assets.

Risk Intelligent Enterprise We refer to this type of organisation as a Risk Intelligent Enterprise. These exceptional organisations have attained high states of risk management capabilities. A Risk Intelligent Enterprise displays characteristics such as the following: • It develops full-spectrum vision. An abundance of risks assaults businesses every day, including compliance, competitive, environmental, security, privacy, strategic, reporting and operational risks. Yet, in our experience, it is rare for a business to keep them all in view. Financial services companies, for example, may have a comprehensive grasp of interest rate, currency and credit risks, but how many of them are properly equipped to deal with a ‘flu pandemic that incapacitates a high percentage of the workforce? While acknowledging that there is no such thing as perfect protection, a Risk Intelligent Enterprise adopts management strategies that address the full spectrum of risks. • It bridges silos. There is nothing wrong with risk specialisation. Indeed an in-depth knowledge of specific risks and responses is essential in today’s high-risk environment. But problems arise when risk specialists work in divisional or geographic isolation, unaware of each other’s activities. Risk Intelligent Enterprises systematically build bridges between these risk “silos” so as to open lines of communication and share information. This involves more than a couple of risk managers meeting over an occasional cup of coffee. Building a “portfolio view” of risk demands a risk management charter that requires the full roster of specialists to conduct frequent, formal, structured and documented meetings. Management and the board should be regularly advised of these meetings and their outcomes.

• It speaks a common language. One by-product of risk specialists’ tendency to work in silos is that this insular world becomes its own ecosystem, with its own language, customs and metrics. This results in a fragmented view of risk, confusion for those outside the silo and a duplication of effort in risk assessment activities. Risk Intelligent Enterprises develop common risk terminology so that everyone in the organisation speaks the same language. They also adopt similar metrics so that the risks facing one division can be reliably compared to those facing other parts of the business. • It assesses impact. With businesses facing an almost infinite number of risks, planning for every single risk is a near-impossibility. Instead, we recommend that business leaders focus on the finite impacts that could result from multiple threats. Addressing the impact rather than the cause allows one contingency plan to accommodate multiple threats. • It cultivates risk consciousness. If risk management is seen as something for internal audit or corporate counsel or that the chief risk officer

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By understanding how the enterprise can fail, planners and decision makers can decide how to prevent it

Striding toward risk intelligence Here are the first few steps on the path to risk intelligence. Some are simple and intuitive, while others are more complex and challenging. But all represent small steps leading to a big reward. Try tackling one a week or one a month.

has under control, the chances are that a significant exposure will remain. Risk management should instead be seen as an organisationwide responsibility and competency. Only when risk management practices are infused into the corporate culture, so that strategy and decision-making evolve out of\ a risk-informed process, can a business truly be considered risk intelligent. Those who traditionally focus on strategy while leaving risk considerations to others – the CEO, the CFO, the board and other key executives – need to develop a risk awareness of their own. • It pursues risk-taking for reward. As mentioned earlier, Risk Intelligent Enterprises practice not only risk mitigation but also risk-taking as a means to creating value. These enterprises value their ability to capitalise on market opportunities as highly as they do their preparedness for potential disruptions. In other words, a risk intelligent approach is not simply about bad outcomes to be avoided but also about good outcomes to be attained.

1. Think through risk. Read everything you can and determine how it applies to your situation. 2. Get risk into the conversation. Engage peers, superiors and subordinates. Talk it up to the executives and the board. Don’t miss an opportunity to discuss risk and risk intelligence. 3. Have a one-day off-site meeting to address risk. 4. Create crisis response and escalation procedures. Who is monitoring the early warning signs? Who needs to know what and when? Who is in charge? 5. Go for growth, but imagine failure and how you can overcome it. Challenge your most basic business assumptions. What could cause you to fail? 6. Differentiate between rewarded and unrewarded risk. What risks do you need to take to succeed? What risks do you need to avoid? 7. Improve risk knowledge. Share intelligence and understand the interdependencies. 8. Stress-test your resilience in different scenarios. Improve flexibility to deal with uncertainties. 9. Focus on finite effects rather than infinite causes. Understand critical assets and dependencies and how long you can go without them. 10. Prioritise. Focus on the vital few rather than the trivial many. 11. Speak the same language. Harmonise (ensure risk managers all speak the same language), synchronise (coordinate across institutional boundaries) and rationalise (eliminate duplication of effort) existing risk management functions to drive down the cost of good risk management. And don’t forget the two faces of risk. You are in business to make money, to increase shareholder value and to beat the competition. Consider the risks that could prevent you from achieving these objectives. Risk-taking for reward is a fundamental premise of capitalism. Use risk intelligence to make good things happen.

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IFRS 7: driver for further T he most fundamental goal of financial reporting is to provide stakeholders with meaningful information on a business so that they can take rational decisions. Obviously this information can only be meaningful if it is comprehensible and provides an understanding of management’s perspective on historical results and operations and its view on existing risks and uncertainties for the business going forward. In the past, financial reporting often failed to include this prospective information and view on the business. The implementation of IFRS 7 has to some extent remedied this major shortcoming. By Raf Bervoets, Deloitte Belgium

istorically financial reporting has focused on providing a retrospective view on the financial performance of business activities. The value of this type of reporting is obvious, and it has the significant advantage that it can be verified for completeness and accuracy by internal and external parties before being used by stakeholders. The amount and level of detail of the financial information required to be publicly disclosed has consistently increased over time and evolved into a set of standards of which the application has ensured a more or less comprehensive overview of the reporting entity’s past financial performance.

The focus on backward-looking financial information contrasted heavily with the absence of meaningful disclosure requirements on the existing operational and financial risks of the underlying business. This, combined with very poor disclosures on prospective business expectations, left stakeholders (with access to publicly available reporting only) largely unable to assess the relationship between the future profitability potential of the business and its existing risk profile. A changing business environment characterised by globalisation and increased use of sophisticated derivatives (triggered by advances in financial risk measurement techniques and the availability of powerful infor-

mation techno logy) has, however, increased the awareness among regulators and market participants of the need for a proper understanding of the risks embedded in any business activity. This evolution of increasing risk awareness was accelerated by various wellpublicised fraud cases and resulted in a focus on strengthened corporate governance concepts and procedures such as the notorious Sarbanes-Oxley legislation in the US (which has a global impact) and the Lippens Code, which is commonly accepted as a benchmark for these purposes in Belgium. In addition to an increased focus on corporate governance, the general awareness of risk as a persisting element in business created the mindset needed for regulators and market stakeholders to develop a more comprehensive vision of and approach to dealing with risk within corporate organisations. This translated into the introduction of new reporting requirements such as IAS 39, IFRS 7, Basle II and Solvency II.

Added value of risk information Benchmark information for public reporting can arguably consist of three types of complementary information. These can be categorised under the following headings: • Financial accounting information • Risk reporting • Measurement error information.

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development of management Financial accounting information describes income, profitability, balance sheets and cash flows at specific points in time and has by far the longest tradition in public reporting. Although this information is backward-looking to a greater (historical cost principle) or lesser (fair value) degree, it also includes a number of forwardlooking elements such as tests for impairment, the valuation of provisions and the fair value of financial instruments. A major deficiency of traditional reporting concepts is, however, that the information on recognition and measurement of some types of financial instruments is insufficient to provide external stakeholders with a proper overview of the risk exposure (i.e. the potential impact on earnings and cash flows) of certain types of financial instruments, such as derivatives with non-linear pay-offs. Risk reporting can be introduced to deal with these shortcomings as it is designed to capture a prospective range of outcomes

(or statistical dispersion) for the variables measured at particular points in time. To the extent that the behaviour of these variables can be represented by a probability distribution, risk information will ideally provide the best estimate of the corresponding probability distributions for variables such as future earnings or interest expense. Risk reporting should also include infor mation that is not easily captured by probability measures, such as the outcomes of stress tests and sensitivity analyses. Measurement error information can be included as a means of assessing the reliability of risk reporting as it measures the margin of error or uncertainty in the measurement of variables in the financial reporting, including those quantifying risk. Uncertainty in this context means the randomness of future outcomes. The need for this type of information arises when variables have to be estimated. Measurement

For the first time ever, disclosure of some risk and measurement error information has become mandatory for all public entities

error is, therefore, zero if market data can be used. It arises, however, whenever modelling is used and assumptions have to be made. Error can be the result of imperfect modelling of a variable. In other words, model error (“model risk”). Alternatively it can be caused by reportiing bias error, or the intentional misreporting of information used as input for the model. Measurement error can be made explicit by using a confidence interval around the estimated point, a back test or a sensitivity analysis for the model variables.

IFRS 7’s contribution to current reporting practices Reporting standards for accounting information have been comprehensively articulated and codified through the creation and adoption of accounting standards such as local GAAP, IFRS and US GAAP. The basic building blocks for this reporting are the income statement, balance sheet and cash flow statement. Risk reporting on the other hand is far less developed. In the past the development of this type of risk information was mainly limited to financial institutions and prompted by regulatory supervision, with the most visible example of risk reporting being the Basle I and Basle II risk-based minimum capital adequacy requirements. Measure ment error information is even less developed, and was until recently only available and used within dedicated risk management departments in the financial sector. ➦

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Within this context, the introduction of IFRS 7 can on the one hand be seen as simply a further step in the process of refining financial accounting information, but on the other hand as a giant leap forward for disclosure requirements on risk and measurement error information. For the first time ever, disclosure of some risk and measurement error information has become mandatory for all public entities applying IFRS. This will enable external stakeholders to form an initial impression of the entity’s risk appetite and the quality of its existing risk management organisation.

The adoption of IFRS 7 will provide valuable information to investors and other stakeholders on the quality of existing risk management

IFRS 7 headlines IFRS 7 contains additional disclosure requirements that enable stakeholders to evaluate: • the significance of financial instruments for the entity’s financial position and performance; • the nature and extent of risks arising from financial instruments to which the entity is exposed during the period and at the reporting date; • tools and procedures used by the entity to manage the above risks. IFRS 7 essentially presents risk information "through the eyes of management", which means that the type of risk information to be disclosed will depend on the existing risk information used for management reporting purposes. The quality of the disclosures will, therefore, shed light on the quality of the underlying risk management process. In addition to the qualitative description of the risk management organisation, the main impact of adopting IFRS 7 will be the sensitivity analyses of equity and net result that have to be provided for the different types of market risk (i.e. price, interest and foreign exchange risks).

Conclusion: will anyone care? The adoption of IFRS 7 will provide valuable information to investors and other stakeholders on the quality of existing risk management and will, therefore, be an important driver for the further development of the risk management process, including risk measurement and monitoring tools. A business with a similar financial performance compared to its competitors, but a better risk profile and resulting lower sensitivity to market risks (which was less visible in the past because of the lack of this type of information) will obviously be more appreciated by potential investors and will consequently create added value for its shareholders. This conclusion, however, is only valid in the longer term as implementing a benchmark risk-management organisation and the additional reporting introduced by IFRS 7 will require substantial investments in additional tools and resources in the short term.

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Short News 2008 GFSI Summit, Rome:

Formulas for success in financial services Different economic landscapes plus different regulations plus different cultures. These are some of the challenges facing global financial services institutions. How can firms succeed in a global environment that is so complex and ever-changing? Deloitte’s Eleventh Annual Global Financial Services Industry Summit, which was held on 8-10 May 2008 in Rome, Italy, focused on formulas for success in financial services. This exclusive event created for senior executives at the leading global financial services companies was designed to allow leading players in the financial services industry share their views on emerging trends, keys to succeeding in such a highly competitive industry and the current regulatory landscape. The summit brought together CXOs from our largest global clients for two days of discussions on topics affecting our industry. Speakers included: • José Antonio Alvarez, Chief Financial Oficer, Banco Santander • Michael Downer, Senior Vice President, Capital Research and Management Company • Steven Fradkin, Executive Vice President and Chief Financial Oficer, Northern Trust Corporation • Stephen Green, Group Chairman, HSBC • George Möller, Chief Executive Oficer, Robeco • Anthony “Buddy” Piszel, Executive Vice President-Finance and Chief Financial Officer, Freddie Mac • Dr. Jonas Ridderstråle, International Business Consultant and Author • John Tiner, Former Chief Executive Oficer, UK Financial Services Authority • Dr. Richard Ward, Chief Executive Oficer, Lloyds of London

Hedge funds:

Deloitte Touche Tohmatsu No. 1 ‘Big Four’ accounting firm

Besides we hosted Leadership Discussion Forums focusing on the following topics: • Is ERM an effective tool to respond to systemic risk? Guest speaker: Barbara Stymiest, Chief Operating Officer, Royal Bank Financial Group • Where is the convergence of capital markets and insurance heading? • What are the current trends in M&A? Guest speaker: David King, Senior Managing Director, Bear Sterns Merchant Banking • How can companies keep their expense management sustainable?

According to the top 100 hedge funds worldwide, Deloitte Touche Tohmatsu is the No. 1 "Big Four" accounting firm in the category for Best Hedge Fund Accounting Firms. Deloitte Touche Tohmatsu came out first in this subcategory of the Alpha Awards™ for the third consecutive year. These awards are sponsored by Alpha Magazine, a monthly publication dedicated to the hedge fund industry.

For more information: visit our website at www.dttgfsi.com/summit or contact Monique Levels at mlevels@deloitte.nl.

For more information: www.alphamagazinerankings.com/ alphaawards/hffavorite.asp

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Brent Bellm, PayPal:

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'Still plenty of scope for growth ' In its early days PayPal was the maverick of the financial services industry. Now it’s an eBay subsidiary and has been granted a European banking licence. We asked CEO Brent Bellm if this means that PayPal will be shifting its focus to more traditional financial products. It’s intrinsic to the PayPal business model that we work together closely with existing and established banks and credit card companies.

In May 2007 PayPal obtained a European banking licence in Luxembourg, and subsequently moved its European headquarters to the Grand Duchy. Does the acquisition of this licence mean that PayPal is seeking to offer a broader range of financial products to consumers and businesses alike? Does PayPal want to become a regular bank? ‘No, we wanted this banking licence purely for regulatory reasons. Until last year PayPal was, in Europe, officially regarded as an electronic money issuer. And this severely limited our operational scope. We weren’t, for instance, allowed to offer interest on accounts, set up branches or expand beyond electronic money. That, of course, makes it very hard to optimally build relationships with our customers. As an electronic money issuer we were also required to hold "qualifying liquid assets" _ broadly speaking, short-term bank deposits _ equal to our customer e-money liabilities. And this, combined with the delay in receiving customer funds, resulted in a very high capital requirement. In contrast, as a bank, it

By Peter de Weerd Photography Serge Waldbillig

is the risk profile of our business and assets that now determines our capital requirement. This means a significantly lower capital requirement, approximately 20 per cent of the capital we required as an electronic money issuer. Needless to say, this banking licence leverages our investment capabilities and increases our flexibility. It is also purely a European thing. We don’t need it and haven’t sought it in the United States or Asia. This also means we won’t be using it to become something like a regular bank. We have no interest in doing so. It’s intrinsic to the PayPal business model that we work together closely with existing and established banks and credit card companies. After all, a PayPal account is linked to and funded by a bank or credit card account. And in situations where we offer more traditional banking products - for example, a PayPal credit card in the States - we do this in close cooperation with banks and credit card companies. We also see these products as a side business, not as our core activity. These products account for just a small percentage of our total annual revenues. They’re simply ways of offering additional services of value to our most loyal users.’ ➦

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What is this loyalty built on? ‘Consumers see PayPal as a simple and safe way of paying on the internet. Our clients only have to give us their personal details once. They don’t have to fill out a form every time they buy something on the net. This also means they don’t have to share their financial details, such as their credit card number, with the merchant. Their payment gets made directly from a PayPal account to a PayPal account, and recipients never get any details of buyers’ cards or bank accounts. This makes identity theft virtually impossible. In Europe, PayPal also makes cross-border shopping easier and safer because you can receive money from and pay money to most countries in the world, and in seventeen different currencies.’

‘We have no interest in becoming a regular bank’

Doesn’t SEPA make this a vanishing strategic advantage, at least in Europe? ‘I don’t think so. SEPA will certainly create panEuropean payment systems. But there’ll still be multiple systems in operation, both for bank and credit card accounts. This means there’ll still be a need for a payments service provider like PayPal to link them on the internet.’

costly one too. The European market is simply too big for this, even with SEPA. In the Netherlands, because it’s a small market, the banks have successfully worked together to set up IDeal, an interbank e-payments infrastructure. But IDeal doesn’t include card schemes. In Germany the big banks also tried to set up a similar structure, but it hasn’t taken off. What PayPal does benefits all banks and credit card companies. We are expanding both bank account and card use by making them simpler and safer. Why bite a hand that feeds you? Banks benefit from this, and so our interests are well aligned.’

So you don’t have any competition? ‘We have plenty of competition. For individuals and small sellers on eBay, cheques and cash are our competitors. For small and mediumsized businesses, we compete against and collaborate with bank card acquirers. We compete as a sole solution, but we also collaborate as an additional means of payment within the merchant checkout. For large merchants, our competition is the merchant checkout itself. Large merchants that have a merchant account and also take PayPal offer their customers a choice: pay by card or bank through our merchant checkout or through PayPal. We hope many customers prefer PayPal because of the benefits it offers in terms of safety and simplicity relative to retyping and sharing their details with the merchant. The merchant checkout is a nice competitor to have because its owner, the merchant, doesn’t care how the sale gets completed as long as it gets completed.’

And will PayPal beat this competition? But with fewer systems left, won’t these institutions one day set up their own interbank and credit card e-payments infrastructure? ‘Why would they? The coordination needed between all these different players would make it a very difficult and complex project, and a very

‘I hope we will prosper over the years to come. At the moment PayPal is accepted on roughly 20 to 25 per cent of all vendor websites worldwide. Our business accounts for 8 per cent of all internet payments. So there’s still plenty of scope for growth. Certainly if you take into account that e-commerce is achieving

PayPal offers a universal e-wallet service to consumers and businesses. An owner of this e-wallet can send money to and receive it from another PayPal accountholder over the internet (p2p) simply by sending an e-mail. You can also send a PayPal payment to an individual or business that does not have a PayPal account, although they will first have to open a PayPal account to accept and receive the payment. As every PayPal wallet has to be connected to its owner’s credit card or bank account, PayPal links all the major payments service systems in the world. With a PayPal account, you can make payments to and receive them from 190 countries and markets in seventeen different currencies.

double-digit growth rates year on year and is expected to keep this pace up for the time being. In Europe we’re strengthening our foothold significantly. We saw clear and tangible signs of success for PayPal in 2007. We’ve been focusing our marketing efforts on the big commercial websites, such as those of the airlines. And that has certainly paid off as websites like Boots, Harrods, Monarch Airlines, Fnac, Cdiscount and Pixmania are now all using PayPal as a method of payment.’

You’re now talking about Europe. Isn’t Asia a much more exciting, but uncharted market? What are the opportunities for banking for the unbanked? ‘Asia is certainly a very interesting market. But also a very difficult and diverse market. The opportunities available to us differ from country to country. You’re talking, for instance, about Australia as well as China. The Australian market is like that of the United Kingdom, where PayPal is the number one e-payments method. China is a completely different story. A few years ago we were allowed to process domestic payments there, but then the law changed and domestic payments businesses now have to be domestically owned. So now we’re focusing on international credit card payments. That in itself is, of course, a potentially gigantic market. So yes, Asia is exiting and interesting. But it’s not a foregone conclusion that PayPal will establish itself as a broadly used and accepted method of payment there.’

So, in a nutshell, PayPal’s strategy is to further expand its current business and stay an eBay subsidiary? ‘That’s certainly our aim. We’re very happy with our current position. But gaining more market share is not our only goal. As I said earlier, we’re also developing new products. Some of them, like our credit card, will always remain side products, while we still need to establish the potential of other products. In the UK we’re experimenting with the mobile payments technology Text-to-Buy, which enables you, for instance, to buy the CD recorded at the rock concert you’re attending. You just have to send a text message to the phone number shown on the screen during the show. And there are, of course, countless other possibilities. There’s no reason why this technology couldn’t also be used for supermarket payments. The concept is basically the same as our PayPal e-payments service. Customers connect a PayPal account on their mobile phone

fsi the financial world | #3 May 2008

to a bank or credit card account. By sending a text message they can pay money to and receive money from any other mobile phone with a PayPal account. But this, of course, doesn’t mean that our technology will establish itself as the mobile payments standard, if indeed there’s a need for such a standard. A competitor could launch a challenging, disruptive new technology tomorrow. Maybe consumers don’t see any need for a new payment method. And it’s also possible that the market will be too busy implementing legal requirements like those of SEPA to embark on this adventure. So, for now, PayPal will stay focused on the internet. There’s still plenty of scope for growth there.’

•

‘For now, PayPal will stay focused on the internet’

Brent Bellm has been Vice President and General Manager of PayPal Europe since October 2005. He joined eBay Inc. as Director of Corporate Strategy in April 2001 and played an active role in the acquisition of PayPal. After completing this acquisition, he transferred to PayPal in October 2002 and led its global strategy from 2003 - 2005. Before joining eBay, he worked at the management consulting firm McKinsey and Company from 1993 - 2000, where he focused on the retail, e-commerce and payments industries. He has also worked for three banks, including Credit Suisse in Switzerland, Goldman Sachs in New York and the community bank founded by his great-great-grandfather in Illinois. Mr Bellm obtained a BA in Economics and International Relations from Stanford University and an MBA from Harvard University, both with highest academic honours.

fsi the financial world | #3 May 2008

Reorganising capital market groups to increase revenues

Getting the juice out By Patrick Callewaert and Frederic Verheyen, Deloitte Belgium

fsi the financial world | #3 May 2008

Innovation-commoditization lifecycle has accelerated in the past decade Defensive Innovation

Leading-edge Adoption

Democratization & Commoditization

Enmeshing

Credit Default swaps market has seen tremendous growth and rapid commoditization in the past decade...

Margins

Volume 1995 IB innovates to reduce balance sheet risk and commands high margins

1996

1997

Sophisticated clients and competitors adopt CDS, reducing margins

1998

1999

Broad acceptance brings liquidity, regulatory scrutiny

New Products (credit default swaptions)

The window of profitability for new products in the capital markets is shrinking and mature products are being commoditized increasingly rapidly.

emand for innovative, complex products is rising, while the lion’s share of profits is usually made in the introductor y phase, before competitors can mimic the new of ferings. This dynamic is also being fuelled by the growing pool of private equit y, hedge fund players and af fluent investors seeking above-market retur ns. In such an environment, we believe the way to achieve significantly higher revenues is simple: find a way to distribute high-margin products faster and to more customers before margin compression sets in. Then, as volumes increase, stay ahead of the competition by lowering the cost of your product deliver y. We have seen investment banks respond by increasing their focus on inter nal product development. However, a key aspect has apparently escaped their at tention – their channels. The complex products that investors crave are still being delivered via channels ser ving the internal structures of banks rather than the needs of their customers. We believe a fundamental reconfiguration of the way channels are organised is needed so as to disconnect them from individual products and allow them to suppor t multiple of ferings. In other words, tailoring go-to-market strategies to customers rather than to products in order to create new oppor tunities for profit grow th. This client-centric structure can enable investment banks to make more ef fective use of channels and so bring more products to more customers more quickly, with a direct impact on the top line.

2000

2001

2002

CDS market used as reference for marking other products spurring second generation innovation

... And the innovation to commoditization has only intensiied as other products come to market

Moving toward a channel approach Our experience shows front-office integration to be currently in its early stages, focusing primarily on reorganising product groupings and internal reporting structures. However, we believe it will soon shift to channel management. An analysis of how retail banking channels have converged offers some clues about changes in the securities industry. Originally, the various retail banking channels – branch, ATM, call centre, online portal – were conceived with specific and narrow product and service parameters. Over time, these channels began to operate independently from their original, narrow purposes. ATMs, for example, were designed to automate customer service. They were first used to dispense cash and are now used for a host of other services. Call centres were introduced to improve customer service, and are now used for inbound and outbound marketing. This shows how retail banks bundle products, services, sales and service processes to provide customers with a consistent experience across multiple channels. ➦

The complex products that investors crave are still being delivered via channels serving the internal structure of banks rather than the needs of their customers

fsi the financial world | #3 May 2008

Channels in capital markets may evolve similarly to retail banking

RETAIL BANKING

ATM + originate other products

Channel Independence

ATM + dispense cash

CAPITAL MARKETS

WEB + originate other products

SALES TRADER + portfolio support

WEB + wire transfers

Capability Extention

Tight Integration

ATM automate cust. svc

SALES TRADER + execution consulting

SALES TRADER trade execution

WEB + automate cust. svc

? DMA + algo trading

DMA provide market access

TIME

IMPLICATIONS

Studies show that as channels became independent of

Banks can find competitive differentiation from

the products/services that flowed through them, banks

increased speed-to-market that comes from channels’

reorganized their processes, then incentives and finally

independence from product and service design

organized structures around them DMA=Direct Market Acces

Clearing the hurdles

Preparing for the front-office integration future

Groups contemplating changes to their channels in order to increase their front-office integration face four main obstacles: organisational, cultural, regulatory and technical. • The most substantial impediments are cultural and organisational. Investment banks’ siloed structures work against front-office integration and channel independence because new cross-product services have to “loop back” into standard processes such as risk review and compliance. Effective front-office integration consequently demands a fundamental shift from concentrating almost exclusively on top-line revenues to a stronger focus on margins and the bottom line, with an increased emphasis on understanding profitability at a transactional and client level. This also requires appropriate attribution of sales credit across the product silos. Some banks have made progress in this area by establishing bilateral credit-sharing arrangements, but we believe the answer lies in rewarding client service teams that transcend product lines. • From a regulatory perspective, there are potential conlicts of interest when banks move into areas such as running their own hedge funds in competition with external clients, but improved front-office integration can support increased regulatory demands for counterparty risk analysis. • There are also technical roadblocks to full-scale integration: the configuration of many products does not allow for consolidation of different trading platforms, while databases distributed across business silos are generally not integrated.

We recognise this front-office vision is a radical departure from how capital market groups work today. Non-trading teams (including technology, risk and compliance) within investment banks will no longer align around products, but around channels. New resources will be devoted to adapting channels to new products and integrating them into mid and backoffices. Incentive structures to promote cross-product innovation will be easier and likely to obtain better results. To make cross-selling a success, we regard commitment from C-suite and the aligning of sales objectives to top management objectives as essential. As a conclusion we recommend a change of mind set: employees and managers must believe that tomorrow’s success is everybody’s success. All the links in the production and distribution chains should be interdependent. We see, for example, that via private banking a capital market group can establish itself in a new sector, such as family businesses. Work performed in silos should, therefore, be discouraged, while teamwork should be promoted through cross-business unit cooperation, global incentives for cross-selling, internal job bridges and employee empowerment in order to optimise the service provided to clients.

•

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fsi the financial world | #3 May 2008

News & Global Financial Services Offshoring Report Global Financial Services Industry

Offshoring saves FSI £4.5 billion a year

Global Financial Services Offshoring Report 2007 Optimizing offshore operations A Deloitte Research Report

Offshoring is saving the financial services industry an estimated £4.5 billion a year, up from around £2.5 billion a year ago, propelled by an 1800% increase in headcount over the last four years, according to the latest Global Financial Services Offshoring Report by Deloitte. The industry’s savings have risen exponentially from around £250 million globally in 2003 as the average number of staff employed offshore has increased from 150 to 2700 in just four years. Over the last year alone, this has led to the average proportion of group headcount in lower cost countries doubling from 3% to 6%. Over 75% of major financial institutions now have operations offshore, compared to less than 10% in 2001. UK and US banking and capital market institutions are leading this shift, but mainland Europe is showing increasing interest. Deloitte’s research finds that more than half of all financial institutions are now saving more than 40% against their onshore costs for every business process offshored. In 2004, the figure was just 32%. However, the range of savings is polarising, and is now between 20 and 70 per cent per business process. Chris Gentle, associate partner, financial services, at Deloitte and author of the study, said: “Offshoring is maturing at a rapid pace but, in future, the best offshoring strategies will not, and cannot, be based on labour arbitrage alone. Financial institutions need to re-engineer business processes, or risk simply transferring offshore the legacy inefficiencies of older, onshore processes.”

Financial institutions offshoring one or two business processes are saving 20% less, on average, than companies with over five business processes offshore. In 2003, two-thirds of activity offshore was IT-related. By 2006, over 80% involved a full range of business processes. Offshoring has spread across nearly all business functions, with significant growth around transaction processing, finance and HR. Knowledge-process offshoring, such as investment banking analytics and research has also grown. This reflects a transition from a relatively tactical, arbitrage-driven approach to a focus on improving quality and processes. Chris Gentle added: “The industry’s star performers have successfully deployed aggressive offshoring strategies, transferring more than 5% of group headcount offshore and achieving bottom line savings of over 40%. In some cases, the savings are equivalent to 3% of the total cost base. However, at the other end of the spectrum, institutions that have failed to adopt best practices are experiencing a decline in operational performance. While most major financial institutions now have a sizeable offshore delivery function, the gap between the best and the worst is widening. We believe it is critical that a business builds a platform for success, based on relocating at least five per cent of the total group’s headcount offshore. The best performing institutions offshore around 12% of group headcount and, on average, save 55% on each business process. The companies whose offshoring programmes are suffering, offshore less than 5% of headcount and typically save 32% per process. The most efficient offshorers take just 15 months to migrate each process, compared to around 25 months for poorer performers.”

. .

Audit Tax Consulting Corporate Finance

While India remains the prime location for offshoring, with around two-thirds of global offshored staff employed in the sub-continent, it is in danger of losing its crown to China. China’s share of offshored labour is already rising. One third of financial institutions now have back-office (mainly IT) processes in China. Some 200 million Chinese people are currently learning English, providing a pool of skilled labour that may compete with India over next 10 years. China’s growing competitiveness may dampen salary inflation among Indian offshoring industry workers.

Please contact Hans Honig (hhonig@deloitte.nl) for more information or go to our financial services site at www.deloitte.com for the full report

fsi the financial world | #3 May 2008

Research Central European Private Equity Confidence Survey

Navigating the Compliance Labyrinth

Confidence private equity firms decreased

The challenge for banks: compliance

After hitting an all-time high in summer 2007, in October our Central European Private Equity Confidence Index saw an expected downturn with sentiments following activity and market conditions corresponding with global developments in major private equity markets.

Based on a survey among chief compliance officers and other senior executives at twenty of the top 50 financial institutions in the United States, Navigating the Compliance Labyrinth claims that US financial institutionsâ&#x20AC;&#x2122; compliance costs have risen significantly faster than their net income over the past five years. While compliance spending as a percentage of net income for the financial institutions surveyed was 2.83% in 2002, by 2006 it had increased to 3.69%.

Navigating the Compliance Labyrinth The Challenge for Banks Produced by the Deloitte Center for Banking Solutions

Global mergers & acquisitions activity exceeded its 2006 annual figure of USD 3.55 trillion by the end of October 2007, but deals activity was significantly depressed by financial market developments during late summer. This is confirmed by the findings of Deloitteâ&#x20AC;&#x2122;s latest Central European Private Equity Confidence Survey.

January 2008 Private Equity

$FOUSBM &VSPQFBO 1SJWBUF &RVJUZ $POGJEFODF 4VSWFZ

Compliance is also an increasingly time-consuming process, with 70% of respondents claiming that the time they devoted to their legal/compliance functions had risen by more than 25% since 2002. And the increase in time spent was not confined to functions where compliance is a core responsibility. About 40% of respondents reported that the time their management and administrative staff spent on ensuring compliance had also increased by over 25% since 2002. These trends are not specific to the US, as a recent Deloitte survey among financial institutions in Luxembourg showed that these institutions had spent an average of â&#x201A;Ź4 million on complying with new rules and regulations since 2003. Similarly, a Deloitte study commissioned by the UK Financial Services Authority showed a clear increase in regulatory costs for the UK financial services industry.

For the full survey go to www.deloitte.com

Why have compliance costs risen so sharply? Is it simply a question of more regulation? The Deloitte Center for Banking Solutions survey suggests that this is not the full story. Financial institutions have tended to respond to increased regulations by adding people, rather than by leveraging technology and improving processes. Many banks and financial institutions also have a tendency to duplicate compliance processes, leading to different groups in one and the same organisation gathering the same data and making the same analyses. In other words, there may be significant opportunities for financial institutions to reduce the costs of compliance by focusing more on improving process management and by making better use of available technologies.

Please contact Annelien de Dijn (adedijn@deloitte.com), research coordinator Deloitte Belgium, for more information or go to our financial services site at www.deloitte.com for the full report

fsi the financial world | #3 May 2008

Towards harmonisation of the taxation of UCITS in the EU

By Raymond Adema*

The European Council sought in the 1985 UCITS Directive to remove restrictions on the free circulation of units in undertakings for collective investment in transferable securities (UCITS) and to establish a European capital market. Despite the aim of the Directive, trade in UCITS units is still largely fragmented by the national borders of the member states. Asset managers have identified taxation, which is not covered by the UCITS Directive, as one of the factors obstructing the cross-border trade in these units. Taxation of UCITS

Taxation differences distort the cross-border trade in UCITS units in Austria, Germany, the Netherlands and the United Kingdom

The taxation of dividends, interest, capital gains and other portfolio income derived by way of UCITS in Austria, Germany, the Netherlands and the United Kingdom differs substantially for resident and non-resident UCITS and also between non-resident UCITS. These differences depend on: (i) the state in which the jurisdiction of an investment is situated (“source country”); (ii) the state of residence of the UCITS (“UCITS country”); (iii) the state of residence of the unit holder (“unit holder country”). Taxation differences distort the cross-border trade in UCITS units in Austria, Germany, the Netherlands and the United Kingdom. Dividends, interest, capital gains and other portfolio income derived by way of non-resident UCITS are in many cases subject to more taxation (“tax advantage”) or less taxation (“tax disadvantage”) than if derived by way of resident UCITS. As a result, the competitive playing field for UCITS in Austria, Germany, the Netherlands and the United Kingdom are not the same.

Harmonisation or coordination of UCITS taxation Some of the tax disadvantages are the result of discrimination caused by a country treating non-residents or foreign income differently from residents or domestic income (“discrimination”). However, the majority of the tax disadvantages are the result of differences between members states’ national tax legislations (“disparities”). Positive harmonisation is the only way to remove these differences between national tax legislations. It is, therefore, recommended amending the UCITS Directive or drafting a new Directive on the taxation of UCITS. If member states cannot agree on amending the UCITS Directive or drafting a new Directive on the taxation of UCITS, tax coordination may be an alternative way to standardise the methods used to ensure that income derived from UCITS investments is not subject to more or less tax than direct investments. Otherwise, any standardisation of the taxation of income derived by way of UCITS will depend on spontaneous amendments of member states’ national tax legislations.

•

* Raymond P.C. Adema is Assistant Professor in the Department of Tax Law at the Law School of the University of Groningen and also works as a tax lawyer for Deloitte’s Financial Services Tax Group. On 3 April he will defend his dissertation on the taxation of UCITS in Austria, Germany, the Netherlands and the United Kingdom, which will be published by Kluwer Law International in autumn 2008.

fsi the financial world | #3 May 2008

Hedge Fund and Risk Management Seminar

Precautions that pay off

By Arjan Gras

The financial markets are in crisis. Hedge funds such as Carlyle Capital are experiencing major problems and some are even on the brink of collapse. Deloitte’s Hedge Fund and Risk Management Seminar held on 6 March at the Hilton Hotel in Amsterdam was, therefore, an excellent opportunity for investors to get answers to pressing questions.

o many participants flocked to Apollolaan – the approach road to the Hilton – that traffic was almost gridlocked. And the numbers of people arriving meant the organisers suddenly had to move to a larger room. These unexpectedly high levels of interest made one thing apparent: investors are racking their brains about what is the sensible thing to do in these critical circumstances.

Special attention for risk management and valuation In his preliminary analysis entitled ‘Precautions that pay off’ Stuart Opp, partner in Deloitte UK and global leader of the Deloitte Hedge Fund practice, described the current market. He listed all the points needing attention, outlined the various obstacles and provided the hedge fund advisers with the advice they needed on precautionary measures that will repay their investment. Opp discussed the changes in the market in which the hedge funds operate. ‘Competition is becoming increasingly fierce, institutional investors – who are more demanding – are growing in importance, and regulators are looking ever more closely at what is going on. The parties that will thrive in this new competitive environment will be those that devote specific attention to risk management and valuation practices as they will be able to attract institutional funds, understand the risks they are taking and make informed trade-offs between risk and return.’

Recommendations Opp made eight recommendations to the hedge fund advisers: 1. Ensure your governance model establishes accountability for risk management and has the effectiveness to enforce a risk framework. 2. Address operational risk challenges that can prevent effective risk management and accurate valuation. 3. Consider technology enhancements to address ‘red flags’ and stimulate transparency. 4. Implement appropriate risk metrics for the products and strategies covered. 5. Adopt a limit framework that effectively manages risk while still supporting fund performance. 6. Establish policies and procedures to validate current risk measurement and valuation processes: models, assumptions and data. 7. Ensure adequate expertise to determine fair value in the current market, including full understanding and acceptance of thirdparty valuations. 8. Ensure documented controls, policies and procedures are in place to demonstrate monitoring/overview of the valuation process. One thing became clear during the gathering: ‘There is no return without risk’. As well as having all the appropriate valuation tools and governance procedures in place, it is also vital for investors to use their common sense, be aware of what they don’t know, diversify and show discipline.

•

The Amsterdam Hilton

No return without risk

In the next FSI magazine, we will discuss the seminar and recent developments relating to hedge funds in more detail.

fsi the financial world | #3 May 2008

Leveraging price to achieve profitable growth in lending and deposits

Effective pricing in the banking industry The financial industry has experienced several changes in recent years

By Patrick Callewaert and Marc Abels,

that have presented new challenges to its ability to generate revenues

Deloitte Belgium Illustration: Michiel Vijselaar

and profits. Mergers, acquisitions, the complexity and variety of financial products, the huge numbers of transactions, the information transparency provided by the internet and new competitors have all forced financial institutions to focus on innovation in their products and services and on ensuring properly conceived marketing strategies.

Pricing even more powerful in financial services

Achieving pricing excellence is a journey

While traditional banks concentrate on traditional “cost-plus” or “risk-based” approaches, some innovative organisations that have implemented appropriate pricing strategies have seen their revenues increase by one to five percentage points and their profitability rise by at least twenty percentage points, which is an impact five times greater than in other industries.

A step-by-step pricing programme for a financial institution could involve: • establishing a greater understanding of the profitability dynamics and, therefore, the management of leakages; • improving the organisation’s ability to set list prices (rate sheet rates and so on); • more powerful and managed execution of pricing guidelines.

Pricing programmes offer significant benefits for most major financial products, whether they relate to lending, investments or transaction services. A top-10 bank in the US achieved increases of no fewer than 10 basis points on its existing rates, thanks to various market-based analyses that allowed a more balanced approach to rates, points and fees. Understandably, negotiations with some of these jurisdictions (specifically Switzerland) were lengthy and tough. In the end, all the Third Countries and the majority of Dependent and Associated Territories agreed to introduce ‘transitional’ savings withholding tax regimes similar to those applied by Austria, Belgium and Luxembourg instead of exchanging information.

Measuring the amounts of withholding tax retained by the main jurisdictions is, however, easier. Based on available information or estimates, the levels of savings tax withheld by the various countries were as follows: Pricing & profitability analytics involve indepth quantitative studies of the relationships between variables such as products, geographies, customer segments and time periods. The results of this analysis help banks to gain insight into price and margin variability across these variables.

fsi the financial world | #3 May 2008

The optimisation of list prices in the financial industry typically requires a thorough understanding of demand elasticity. Price leaders tend, therefore, to invest initially in mapping elasticity values at the lowest possible level, such as geography and loan-to-value ratios. List price management and profitability analytics alone do not automatically result in improvements in the field. This is where the third aspect becomes important, namely the appropriate execution of pricing policies and management of exceptions.

An illustration of reducing rate overrides One banking client analysed its bottom-line profitability at the lowest level of granularity for operations in a specific market and identified two pricing issues. The first related to non-optimal rate sheets, with two thirds of loan transactions showing negative profitability within acceptable rate-override levels. Secondly, some loans showed considerable overrides against the rate sheet. Although some of these remained profitable, a critical area of unprofitable loans was identified for detailed rate sheet cell analysis. This was performed from two perspectives: sales subsidiaries and their loan products sold. The unprofitable loans were quantified at each intersection. This resulted in recurring issues being identified for a number of subsidiaries (with issues across products) and a limited number of products (with issues across subsidiaries).

Specific measures were taken to correct this situation, including increased monitoring of overrides. This still allowed branch flexibility and judgment, but within a more strictly applied price corridor. Extensive training and communications were devised for the products with the recurring issues in order to clarify their pricing.

Bottom line Improved pricing provides an effective vehicle for senior management to meet increasingly challenging growth objectives. A mix of “pricing analysis”, “price optimisation” and “price execution” activities, supported by granular data and systems, can substantially improve performance and establish a basis for continuing and profitable organic growth.

•

Banks implementing appropriate pricing strategies have seen revenues increase by one to five percentage points and profitability rise by at least twenty percentage points

fsi the financial world | #3 May 2008

Infrastructure funds: are they on the right track? Countriesâ&#x20AC;&#x2122; need for infrastructure in the form of roads, airports,

By Philippe Lenges, Audit Partner, Deloitte Luxembourg,

schools, hospitals, energy distribution networks and so on is

and David Capocci, Tax Partner, Deloitte Luxembourg

intensifying as the worldâ&#x20AC;&#x2122;s population increases and the quality of life around the world improves. Constraints on government budgets and fiscal pressures mean, however, that the investments required cannot be funded solely from public sources. Private finance can be seen as the solution to the gradual decline in the availability of government funding, and one that creates new investment opportunities for pension funds, investment banks and other asset managers. Indeed infrastructure funds and assets are now playing an increasingly important role in the alternative investment family. 1

39 39

fsifsi thethe financial financial world world | #3| #3 May May 2008 2008

nitial nitial figures figures published published confirm confirm thethe popularity popularity of this of this new new asset asset class. class. TheThe OECD OECD believes believes that, that, between between now now andand 2030, 2030, member member states states willwill spend spend over over US$ US$ 50 50 trillion trillion on on infrastructure infrastructure assets. assets. TheThe EuroEuro2 2 pean pean Union Union predicts predicts infrastructure infrastructure spending spending of €300 of €300 billion billion by by 2013, 2013, while while thethe Asian Asian Development Development Bank Bank forecasts forecasts thatthat projects projects in Asia in Asia willwill require require annual annual investments investments of around of around US$250 US$250 billion. billion. TheThe launch launch of 72 of 72 new new funds funds raised raised US$160 US$160 billion billion for for infrastructure infrastructure investments investments in 2006 in 2006 3 3 while while thethe sector sector also also sawsaw mergers mergers andand acquisitions acquisitions totalling totalling - 2007, - 2007, over over US$145 US$145 billion billion in 2006. in 2006. 4 Australia: Australia: infrastructure infrastructure fund fund pioneer pioneer

Fund Fund investments investments may may be be made made directly directly in infrastructure in infrastructure assets assets such such as as roads, roads, airports, airports, carcar parks, parks, prisons prisons andand so so on on or indirectly or indirectly through through infrastructure infrastructure development development or management or management companies. companies. There There areare generally generally twotwo main main types types of infrastructure: of infrastructure: • • Social Social infrastructure, infrastructure, such such as as schools, schools, hospitals hospitals andand infrastructure infrastructure used used by by thethe police police or fire or fire services; services; • • Economic Economic infrastructure, infrastructure, such such as as roads, roads, airports airports andand energy energy or or telecom telecom networks. networks.

Economic Economic infrastructure infrastructure comprises comprises regulated regulated assets, assets, public public utility utility as-asAustralia’s Australia’s introduction introduction of of compulsory compulsory pension pension savings savings in the in the midmid- sets sets andand “natural “natural monopolies”. monopolies”. Each Each type type of asset of asset hashas its its own own specific specific 1990s 1990s created created substantial substantial demand demand among among pension pension funds funds for for long-term long-term level level of risk, of risk, as as thethe following following model model illustrates. illustrates. investments. investments. This, This, in combination in combination with with thethe government’s government’s mass mass divestdivestment ment of of infrastructure infrastructure assets assets andand their their attendant attendant renovation renovation costs, costs, prompted prompted thethe establishment establishment of what of what would would become become known known as as “infra“infrastructure structure funds”. funds”.

 



Certain Power Generation Energy trading

Infrastructure Certain Power Generation

Airports Certain Communication Infrastructure Certain Communication

Rail Airports

Road Rail

Water and sewerage Road

Distribution assets Water and sewerage

Assets Assets

Transmission Assets Distribution assets

Competitive Competitive

Assets Assets

Police and army Transmission Assets

UserUser Demand Demand

Assets Assets

Schools Police and army

Regulated Regulated

Hospitals Schools

Social Social

Energy trading

 

Infrastructure Infrastructure

Courts Hospitals

TheThe Australian Australian investment investment bank bank Macquarie Macquarie seized seized thethe opportunity opportunity in in 1996 1996 to purchase to purchase its its firstfirst infrastructure infrastructure assets assets through through its its investment investment funds, funds, with with units units being being subscribed subscribed for for by by Australian Australian pension pension funds. funds. AndAnd today today Macquarie Macquarie owns owns no no fewer fewer than than 108108 infrastructure infrastructure assets assets worldwide, worldwide, accounting accounting for for $22$22 billion billion in assets in assets under under management. management. Over Over thethe past past eleven eleven years, years, these these investments investments have have generated generated annual annual 5 5 The The assets assets in the in the portfolio portfolio include include Sydney, Sydney, returns returns of around of around 19%. 19%. Brussels Brussels andand Copenhagen Copenhagen airports, airports, thethe Thames Thames Water Water distribution distribution network network in the in the UKUK andand thethe Chicago Chicago Skyway Skyway toll toll road. road. Other Other parties parties active active in this in this market market feature feature a roll a roll callcall of Australian of Australian pioneers, pioneers, such such as as Babcock Babcock & Brown & Brown andand Hastings. Hastings.

Courts

 

Increasing Increasing Risk Risk

International International expansion expansion TheThe rolerole of the of the state state as as thethe provider provider of socio-economic of socio-economic infrastructure infrastructure is fading is fading as as private private operators operators come come to the to the fore. fore. AndAnd thisthis is prompting is prompting thethe creation creation of of international international infrastructure infrastructure funds. funds. More More andand more more governments governments in developed in developed countries, countries, unable unable either either to increase to increase national national debt debt or raise or raise taxes, taxes, areare faced faced with with infrastructure infrastructure badly badly in need in need of an of an overhaul. overhaul. Privatisation Privatisation seems seems thethe ultimate ultimate solution solution to this to this challenge. challenge. And, And, as as in Australia, in Australia, many many investors, investors, notnot least least thethe pension pension funds, funds, areare looking looking for for new new types types of inflation-linked of inflation-linked assets assets offering offering attractive attractive longlongterm term returns. returns. Another Another reason reason for for thethe growing growing success success of infrastructure of infrastructure funds funds is new is new 6 of6 assets of assets thatthat were were previously previously legislation legislation thatthat allows allows thethe privatisation privatisation thethe preserve preserve of the of the State. State. Lastly, Lastly, private private finance finance for for infrastructure infrastructure investment investment is also is also important important for for developing developing countries countries as as it offers it offers them them opportunities opportunities to establish to establish basic basic transport, transport, water water andand energy energy facilities facilities without without going going further further intointo debt. debt.

Source: Source: Macquarie Macquarie

Infrastructure Infrastructure funds funds may may specialise specialise in ainparticular a particular type type of asset of asset or reor region, gion, or alternatively or alternatively operate operate a diversified a diversified investment investment policy. policy.

Characteristics Characteristics of of thethe investment investment In addition In addition to capital to capital growth, growth, thethe investments investments generate generate stable stable andand prepredictable dictable returns, returns, as as wellwell as as regular regular cash cash flows flows of around of around 6%6% - 8%, - 8%, thanks thanks to the to the “essential” “essential” nature nature of the of the assets assets under under management, management, their their long-term long-term duration duration andand thethe factfact thatthat they they often often represent represent a natural a natural mo-monopoly. nopoly. These These investments investments enjoy enjoy significant significant economies economies of scale of scale in that in that although although thethe original original investment investment willwill be be substantial, substantial, thethe marginal marginal proproduction duction costs costs areare relatively relatively low.low. There There areare also also major major barriers barriers to entry to entry thatthat protect protect operators operators from from potential potential competitors, competitors, thus thus enabling enabling them them to charge to charge high high prices prices andand generate generate sizeable sizeable profits. profits. TheThe extent extent of their of their monopoly monopoly position position may may vary, vary, depending depending on on thethe level level of state of state regularegulation. tion.

Characteristics Characteristics of of infrastructure infrastructure funds funds An An infrastructure infrastructure fund fund is an is an investment investment fund fund thatthat seeks seeks to offer to offer invesinvestorstors thethe benefits benefits of infrastructure of infrastructure asset asset management, management, while while ensuring ensuring a a rational rational sharing sharing of risks. of risks. There There areare currently currently twotwo types types of infrastructure of infrastructure funds: funds: • • Listed Listed funds, funds, which which have have diversified diversified portfolios portfolios andand thus thus offer offer greater greater liquidity liquidity andand lower lower risks; risks; • • Unlisted Unlisted funds, funds, which which areare marketed marketed to to institutional institutional investors investors andand where where thethe vehicles vehicles andand structuring structuring methods methods areare modelled modelled on on pri-private vate equity equity funds. funds.

TheThe essential essential nature nature of infrastructure of infrastructure requirements requirements also also means means thatthat thethe level level of returns of returns hashas littlelittle correlation correlation to the to the macro-economic macro-economic situation situation andand other other types types of of alternative alternative investment. investment. Nevertheless, Nevertheless, thethe investinvestments ments areare in certain in certain respects respects linked linked to inflation, to inflation, andand thisthis represents represents an an advantage advantage for for investors, investors, such such as as pension pension funds, funds, looking looking for for long-term long-term returns. returns. There There is also is also littlelittle volatility volatility in the in the investments investments because because thethe risks risks areare predictable predictable andand cancan be be quantified quantified andand contractually contractually adjusted. adjusted. In In thisthis respect, respect, infrastructure infrastructure investments investments cancan be be seen seen as as a defensive a defensive position position within within a global a global portfolio. portfolio. ➦ ➦

fsi the financial world | #3 May 2008

Summary of investment characteristics Investment cost

Maturity

Return

Volatility

Correlation

Risks

High

Long term

Stable and predictable

Low

High

Major barriers to entry/

Return consists of:

Foreseeable risks

Lack of correlation

Political and

competitive advantage

(i) increase in value at a

with macro-economic

regulatory risks/

("natural monopoly")

speciied maturity;

cycles

tendency to decrease

/signiicant economies

(ii) regular cash lows

of scale

(6% - 8%)

These investments contain specific risks relating to the design of the infrastructure project (construction or renovation), its execution and how the assets under management are operated. These risks tend, however, to decrease as the investment progresses, given that they are primarily concentrated in the construction phase. The higher the initial investment, the greater the risk represented by the additional cost of borrowing in the early years, although this will fall as the marginal production costs decrease over the years. Lastly, these investments involve a certain exposure to political and regulatory risks, although investors may see the varying degree of regulation as a benefit in that it acts as a form of security for their returns.

Market outlook Activity levels in recent months suggest that the market is preparing for the wholesale acquisition of global infrastructure (primarily in India, other Asian countries, the Middle East and Europe). This is evidenced by leading investment banks and asset managers, including CVC Capital Partners, 3i, KKR, Carlyle Group, Goldman Sachs and Babcock & Brown,7 stepping into the picture and announcing the launch of infrastructure funds. Transaction volumes are currently still relatively low owing to the lack of supply. The subprime crisis will undoubtedly also affect levels of activity. Given, however, the developed countries’ strong preference for private financing of infrastructure projects and the high demand for infrastructure in emerging and developing markets, transaction volumes are likely to

Private equity, real estate and hedge funds.

Financial Times, October 2007.

The Rise of Infra Funds, Global Infrastructure Report 2007, Project Finance Inter-

Although American International Group set up AIG Infrastructure Fund in 1994,

over time

reach record levels over the next ten years. Indeed Michael Queen (Managing Partner of 3i) recently announced that the infrastructure market had already reached the stage that private equity was at fifteen years ago and that within ten years it would catch up with, if not exceed, the levels in the private equity market. Infrastructure funds will increase in scale. New challenges in the form of commercial and tax structures will undoubtedly arise and demand the appropriate expertise and resources. The regulatory environment, debt structuring and management of refinancing flows are just some of the commercial considerations that will need to be taken into account. Similarly, the distribution of returns must also be properly analysed so as to minimise deductions at source. Under-capitalisation regulations will also require special attention during debt structuring. And this will increase the demand for wide-ranging expertise in the early stages of investment projects. Luxembourg’s experience in real estate and private equity means it already has this expertise. Its investment vehicles, such as the specialised investment funds (SIF), can meet the needs of the market and offer ways of benefiting from the growth in infrastructure funds. The country’s venture capital companies (SICAR) are also particularly well suited to the risks inherent in the early stages of investment (i.e. substantial initial investments and the political and regulatory risks). Luxembourg would therefore seem the ideal environment, offering investors diversified investment vehicles tailored to their individual needs.

•

The Rise of Infra Funds, Global Infrastructure Report 2007, Project Finance Inter-

Governments in countries such as the UK have set up structures such as Public-

national.

national. Australia is seen as the country where infrastructure funds really took off.

Private Partnerships (PPP) and Private Finance Initiatives (PFI), in which private companies are awarded contracts for public works. 7

The Rise of Infra Funds, Global Infrastructure Report 2007, Project Finance International.

fsi the financial world | #3 May 2008

Short News Video interview:

Deloitte is voted

Global Economic Outlook 2008

Deloitte’s take on the credit squeeze

'Corporate Finance Advisory Team of the Year'

Consequences of the U.S. housing bubble for the global economy

The credit crunch and its effect on the economy made headlines in 2007, but what is the outlook for 2008?

Deloitte’s Corporate Finance Advisory practice has been voted “Corporate Finance Team of the Year” at the prestigious Private Equity News Awards for Excellence in Advisory Services Europe 2007, for the second year running.

The global economy is undergoing a transition from one era of economic expansion to another. This transition was brought on by the bursting of a bubble in the U.S. housing market.

David Williams, national managing principal of the Advisory Services practice at Deloitte Financial Advisory Services LLP in the USA, talked with Riley McDermid from Marketwatch and Wallstreetjournal.com in a video interview. He discussed the following credit issues: • His views on some of the dangers surrounding the credit crunch • Historical comparisons • The likelihood of government intervention • Some of the sectors that are being, and may be, impacted

To watch the full interview go to www.deloitte.com and search for “credit squeeze”

Paul Zimmerman, Deloitte Partner, who collected the award, commented: “We are delighted to win this award in recognition of our outstanding achievements with our Private Equity clients in the last year. We constantly strive to deliver exceptional results for our clients, and have recently strengthened our offering through introducing services such as Debt Advisory and Fund Placement. Our focus on Disposals has also proved very successful.” So far this year, Deloitte’s Corporate Finance team has advised on over 100 deals, including 35 disposals, the largest of which was the £783m Disposal of Keepmoat Plc to Bank of Scotland Integrated Finance. Our success is also reflected in the industry league tables. FiDeloitte has maintained its position of No.1 Fi nancial Adviser in the M&A league tables for UK and Europe (by volume) in Q2 and Q3 of 2007 (MergerMarket and Thomson Finan cial).

Global Economic Outlook 2008

A Deloitte Research Study

Yet bubbles don’t emerge at random. They are usually caused by an economic event. In this case, the event was the huge flow of liquidity from China to the United States. And, of course, bubbles always eventually burst. In the Global Economic Outlook 2008 Deloitte examines how the economic imbalance between the United States and China contributed to the U.S. housing bubble and how the bursting of that bubble is having important consequences for the global economy. More importantly, we offer our view on how the continuation and eventual unwinding of global imbalances will affect the future direction and structure of the global economy. We also examine the future direction of China and the United States, along with the implications for the rest of the world as well as the economic outlook for other major economic players.

For the full survey go to www.deloitte.com and search for “economic outlook”

fsi the financial world | #3 May 2008

Rapidly changing market forces Dutch life insurers to adapt strategy

Using cutting-edge technology to cut out competitors By Ronald Ketellapper, Director, Erasmus Verzekeringen, Eric Vennix, Manager, Deloitte, Stef Oud, Partner, Deloitte and Raymond Hartmans, Senior Manager, Deloitte Photography Marcel Bekedam

Ronald Ketellapper

fsi the financial world | #3 May 2008

Ronald Ketellapper (Erasmus Verzekeringen, 2nd from left) has joined forces with Stef Oud, Eric Vennix and Raymond Hartmans (Deloitte)

The increasingly complex environment in which life insurance companies in the Netherlands operate has created a clear need for action if the companies

he Dutch life insurance market is saturated. Achieving grow th means cut ting out competitors. This in turn puts pressure on prices and margins. The decrease in the rates applying on life insurance-related products has been par ticularly spectacular. We see this as the first driver for change.

A third driver for change is the general public’s demand for transparency in insurance products and also their distribution. This is specifically reflected in the new legislation that requires commission payable to insurance intermediaries on complex life products to be explicitly stated in pre-sales information.

The fiscal landscape has also been changing dramatically. Many of the ta x relief facilities available to life insurance policyholders have disappeared over the past t wo decades, with a major change coming into ef fect in Januar y 20 08. Since then, the ta x relief available on private pension plans and mor tgage-related capital grow th plans has been identical, irrespective of whether the products are supplied by insurance companies or banks. Insurance companies have consequently lost their monopoly in this fiscal playing field, which can cer tainly be regarded as sizeable, given the €0.8 billion of premiums generated on new business in 20 06. This radical change in ta x legislation qualifies as a second driver for change.

Radical changes are, therefore, needed in order to maintain insurance companies’ grow th prospects and resist the competition that is expected from banks. These changes involve the business model itself, the product, the distribution and the processing of the business.

are to maintain a solid client base and increase their competitive edge. The main drivers of this action are the increased competition from the banking industry, changing fiscal legislation and public demands for greater transparency in life insurance products. Dutch life insurers are having to adapt their strategy in order to survive in this rapidly changing market.

Embedding the strategy for growth As the economy is forcing the financial ser vices industr y to face up to these new challenges, many companies, including Erasmus Ver zekeringen, have ex tended their traditional strategy by switching to managing and reducing costs (i.e. improving the bot tom line), while simultaneously developing and introducing new products and ser vices (i.e. improving the top line). ➦

fsi the financial world | #3 May 2008

figure 1 Shareholder Value

Operating Margin (after taxes)

Revenue Growth

Volume

Acquire New Costumers

Retain & Grow Existing Customers

Price Realisation

Investment Returns

Improve Pricing

Strenghten Investment Performance

Marketing & Sales

Product & Service Innovation

Policy Charge Optimization

Distribution Management

Customer Management

Portfolio Acquisition

Cross-Sell Up-Sell

Product & Service Innovation

Retention

Acquisition & Maintenance Costs

Improve Customer Interaction Efficiency

Benefit Costs

Improve Corporate/Shared Service Efficiency

Improve Claims & Reserve Management

Income Taxes

Improve Risk Transfer

Marketing, Advertising & Sales

IT, Telecom & Networking

Claims Management

Reinsurance

Demand Management

Customer Service & Support

Real Estate

Reserving Management

Policyholder Risk Transfer

Underwriting & Price Optimization

Policy Administration

Human Resources

Asset Management

Procurement

Business Management

Financial Management

Strategic decisions have created a lowcost distribution channel, with a product based on a low-cost principle

Improve Income Tax Efficiency

Income Tax Management

fsi the financial world | #3 May 2008

Capital Efficiency

During the strategic intent workshops the project team identified a solution that involved working with a scalable and reusable internet por tal based on ser vice-oriented architecture. This approach cleared the way for a low-cost product, based on a straightthrough processing philosophy that seeks to reduce manual inter ventions to a minimum.

Expectations

Capital Requirements

Capital Resources

Company Strengths

External Factors

Reduce Capital Requirements

Improve Capital Efficiency

Improve Management & Governance Effectiveness

Improve Execution Capabilities

Governance & Regulatory Compliance

Risk Insight

Insurance Risk Management

Business Planning

Operational Excellence

Group & Operational Risk Management

Program Delivery

Partnership & Collaboration

Business Performance Management

Relationship Strength

Financial Risk Management

Capital Management

Agility & Flexibility

Strategic Assets

Simultaneously the Erasmus Ver zekeringen product exper ts developed a highly competitive product appropriate for the selected target group. The clear demarcation of the product is designed to optimise use of the established por tal and fur ther minimise human inter vention in the sales and administrative processes. This approach minimises human inter vention throughout the transaction process and also the surcharge on the E-wize product, thus allowing the launch of a highly competitive, low-cost life insurance product.

Executing the strategy Af ter identif ying the main focal areas and strategic goals Deloit te’s Enterprise Value Deliver y (E VD) approach outlined the roadmap to follow when implementing the strategy. The methodology determines and groups all the required actions into clear and quantifiable targets and priorities for each business process group, thus forming the basis for a project team. In order to ensure that all business process groups are involved in the project, the E VD approach specifies the components to be taken into account during the project. The project encompasses all activities from strategy to operations (building a por tal and adapting processes) and so requires the involvement of three teams: • marketing (including product development); • process redesign & organisational change; • information technology. Each team consists of client personnel and Deloit te consultants, all with clearly defined responsibilities and provided with the proper coordinating bodies.

Over the years Deloit te’s business case and implementation approach – the Enterprise Value Map (E VM) – has evolved into a framework that can successfully manage changes of this nature. In addition to the framework, an in-depth k nowledge of the market and also the Erasmus Ver zekeringen organisation are needed in order to set the direction of the new strategy, allocate budgets and launch new initiatives. The challenges facing Erasmus Ver zekeringen mean the objective of the E VM has essentially been to determine how the overall strategy of increasing the focus on Revenue Grow th and Operating Margin can be successfully introduced without neglecting the t wo other impor tant drivers for shareholder value: Capital Efficiency and E xpectations. The focal areas identified as a result of initial strategic intent workshops are shown in Figure 1.

Results Strategic decisions have created a low-cost distribution channel, with a product based on a low-cost principle. Erasmus Ver zekeringen has found a way of using cut ting-edge technology to counter a rapidly changing market and beat its competitors. Benchmarks show that the low-cost Erasmus brand and products (E-wize, w w w.e-wize.nl) are currently some of the most competitive available in the Dutch market. The Delta Lloyd Group is currently assessing oppor tunities to incorporate this product into its por t folio. Erasmus Ver zekeringen and Deloit te have combined forces to devise and execute a solid strategy. The multidisciplinar y character of the project team means it has been able to merge all the important components of the strategy into a comprehensive response to achieve grow th in the increasingly complex environment of the Dutch life insurance market.

•

fsi the financial world | #3 May 2008

New rules for creating and capturing value from innovative technologies

Chain reaction or slow burn In line with the spirit of the Single Euro Payments Area (SEPA)

By Pablo A. Castill贸n, Partner Banking Solutions, IBM Global

initiative, Europe is moving steadily toward tighter convergence of

Business Services, and Cormac Petit, Banking Leader,

its physical and financial supply chains. Yet, in a 2007 IBM Financial

Financial Services sector, IBM Institute for Business Value

Supply Chain study, twenty leading European banks and corporations did not always see eye-to-eye on the topic. To remain competitive, banks must act now to prioritize collaboration in several areas: with corporate customers to create the innovative financial supply chainbased products they need, and through representative bodies, both to influence the creation of payments standards and to establish legislative consistency across borders.

The supply chainbased financial product market is largely unmoving at this time, while non-bank competitors are entering the fray and blitz market share from slow-acting banks

fsi the financial world | #3 May 2008

uropean banks and their corporate customers are familiar with the SEPA initiative’s goal of processing all Euro payments in the same way, within the Euro area or across national borders in Europe. However, its context should be considered to fully grasp its significance. The European Commission (EC) laid the groundwork in 2000 with its action plan known as The Lisbon Strategy, whose aim is for Europe "to become the most competitive and dynamic knowledge-based economy in the world” by 2010. SEPA is a key component of such effort: the European Union (EU) ultimately seeks to remain competitive in an increasingly multilateral world, and a single market for payments is expected to improve the EU position through enhanced internal competition. The effect of SEPA spans from opening up markets; providing a level playing field; encouraging new and innovative services; and increasing market transparency for both providers and users.

Financial Supply Chain study To better understand current perceptions and activities related to potential physical and financial supply chain convergence in Europe, we conducted the 2007 IBM Financial Supply Chain study, tapping into the insight of 20 leading banks and major corporations across Europe. Our study suggests that the European banking sector has yet to announce additional banking products that support or leverage greater integration of the financial supply chain. Meanwhile, non-bank competitors are entering the market and could pose a threat to the banking industry if it is too slow to act. Today’s view from the bankers and corporate treasurers we spoke with is that over the next five years, progress toward supply chain convergence will necessarily be modest and vary significantly by industry. As a result, fragmentation does not seem to be going away in the near future. Supply chain-based financial products will likely still be country-specific and solutions are expected to remain customercentered, to a high degree. However, our respondents reported that building upon SEPA’s standards could accelerate and broaden the spectrum of potential services to the benefit of the industry.

Toward supply chain convergence A combination of forces currently influences Europe’s payments landscape, including banks and their corporate customers, various legislative bodies and non-bank market entrants. As bank customers demand rapid and accurate

KEY PERCEPTIONS OF BANKS AND THEIR CORPORATE CUSTOMERS Physical and financial supply chains today are converged Banks and corporates have similar viewpoints

The convergence outlook will improve over the next five years Payments and invoicing today are integrated SEPA standardization can contribute to supply chain convergence

Banks and corporates

Banks are currently involved in initiatives to further converge supply chains

Banks Corporate customers

differ

Disagree

Agree

Source: 2007 IBM Payments Convergence study.

monetary transactions regardless of geographic distance or political boundaries, banks must remain on top of what is happening, not only to comply with “the rules”, but to profit as well. As the region moves toward improved financial supply chain convergence, new and innovative banking products and services are increasingly needed. But thus far, the majority of banks haven’t rushed forward with many offerings to fill such needs. In fact, the supply chainbased financial product market is largely unmoving at this time, while non-bank competitors are entering the fray and blitz market share from slowacting banks. Our interviews were conducted with both Tier-1 banks and large corporations. Study findings showed that banks and corporations agree that today there is limited convergence of the physical and financial supply chains, and between payments and invoicing, though both expect the outlook to improve (see Figure 1). Each also recognized that the development of standards is vital in this effort. On other points, however, the figure also highlights some very different perceptions between the two. Overall, banks were less sure than their customers to the extent to which SEPA standardization alone contributes to supply chain convergence. In another contrast, banks were much more aware of current initiatives to further converge supply chains than their corporate customers.

FIGURE 1

Important actions for banks European banks can begin moving toward improved supply chain convergence with a plan that assigns target completion dates for important high-level tasks, such as deadlines for making legacy systems SEPA-compliant, and verifying that banking CEOs and CFOs have SEPA-related items on the 2008 agenda. Beyond setting those milestones, this study leads us to five specific recommendations for banks: • Eliminate silos within inancial institutions and corporations; • Focus on core competencies; • Step up two-way communication with corporate customers; • Work through representative bodies toward regulatory standards; • Promote systems and tools that simplify processes supporting crossborder payments. Above all, banks that want to lead in the changing European payments landscape need to prioritize collaboration: to influence technology and regulatory standards, and to build trust and educate by example – developing working and extendable models with leading corporate customers.

•

fsi the financial world | #3 May 2008

Talent management in the financial services industry

Closing the gap By Anneke Holwerda, Deloitte Consulting, The Netherlands

FSI organisations will need to become more effective at hiring, developing and retaining qualified people as critical talent becomes increasingly scarce. Existing talent management practices will simply not be good enough. Instead, FSI companies will need to understand the labour marketâ&#x20AC;&#x2122;s changing requirements if they are to make themselves more attractive to top talent. Even more importantly, they will need to find ways to boost the capabilities of their existing workforce.

FSI companies must concentrate on the things that employees care most about: Develop, Deploy and Connect

fsi the financial world | #3 May 2008

Crunch time for talent

Develop

The talent crunch in the finance sector is real – and it is here to stay. Finding, motivating and retaining capable staff is one of the major issues facing top-level management. A number of external factors have moved talent issues right up the boardroom agenda:

Personal growth is a powerful motivator. Employers need to give employees opportunities to develop their skills and competencies, to grow within their roles and to achieve their personal and business goals. This kind of personal development is good for them – and good for the business. Alongside training, organisations can use the following to promote effective development:

• Baby boomers’ retirement Demographic changes – falling birth rates and rising rates of retirement – mean that, for the first time ever, more people are leaving than joining the workforce. More than 40% of managers and senior executives now expect to stop working within 2 to 3 years. And there are simply not enough professionals to fill the void left by retiring baby boomers. • Growing skills gap In addition to fewer workers to fill crucial roles, today’s workforce is plagued by a significant skills gap. It is estimated that the “optimal” skill set for finance will require employees to redevelop 58% of their skills by 2008. Technical financial acumen alone is not enough to produce high-quality results. The highly complex nature of the business environment means “soft skills” are becoming increasingly important. In order to advance in a finance career, professionals need to develop several key behavioural competencies, including leadership, the ability to manage change and strategic agility. • Changing job expectations of generations X and Y Unlike baby boomers, professionals in these generations are more than willing to work hard, but they want to work differently. Generation Y – people born after 1980 – poses particular challenges for managers as this generation wants flexible work, meaningful jobs, valuable relationships, professional freedom, higher rewards and a better work-life balance than older employees. And there is a risk of attrition if these expectations are not met.

• Stretch assignments – Challenge employees and provoke them to think and act outside of their comfort zones, while also providing the support they need to succeed. • Peer assist programmes – Seasoned practitioners and experts can share knowledge and experience with a less experienced team so that learning occurs before the new team engages in complex or expensive tasks or projects. • Mentoring and coaching – Experienced individuals share insight with those who need it. A coach guides people towards an end result by assessing their capabilities and strengths, providing advice and monitoring their progress.

Deploy Employees work harder and enjoy their jobs more if their work is interesting and challenging. Organisations need to focus on bringing out the best in their people by understanding what they are passionate about and then deploying them on assignments that align with their skills, interests and growth goals. Research shows that deployment is the most effective way of attracting and retaining talent. Organisations continually have to re-evaluate the alignment between employees and their roles to ensure a positive impact on business. They can use electronic job boards and inventories of skills and interests to create a well designed performance measurement framework that will ensure effective deployment.

Connect Traditional approaches fall short When faced with talent shortages, managers have traditionally relied heavily on acquiring and retaining talent. In a crisis they increase their investments in recruiting experienced staff by promising big salaries and large bonuses. But buying talent is no longer the answer. Research shows that, when ranking critical expectations, respondents rank salaries and benefits fifth and sixth in order of importance. Money becomes vital only when it is perceived to be inadequate. Similarly, financial rewards do not necessarily foster long-term commitment. They are also an expensive solution as the average cost of replacing employees is 1.5 times their salaries.

Focus on what matters There are a number of strategies FSI organisations can adopt to help alleviate the problem. Although employees expect compensation to be reasonable, competitive and fair, they are also looking for opportunities that money cannot buy. Rather than focusing solely on acquisition and retention, FSI companies need to concentrate on the things that employees care most about: developing (and stretching) their capabilities, being deployed in ways that engage their hearts and minds and connecting to the people who will help them achieve their objectives. Focusing on these three things automatically makes attraction and retention easier.

Personal relationships help bind employees to the organisation and create a sense of shared values and purpose. And, as business problems become more complex, who you know becomes just as important as what you know. Organisations can use coaching and mentoring programmes and social networks to help employees tap each other’s knowledge and experience and connect with each other. The concept of Connect should be considered from three dimensions: people, resources (e-rooms) and purpose (coaching for performance and career planning).

Retirees coach “generation nexxers” Although the concept of Develop, Deploy and Connect works well for all types of employees, it is particularly useful for attracting and managing the types of people who are just entering the workforce. Unlike their predecessors, many of these “generation nexxers” work to live rather than live to work. They expect work to be interesting and challenging and insist on continual opportunities to improve their competencies. One way to help these new entrants grow is to hire retirees as part-time contractors to act as their mentors and coaches. Bringing retirees back to train new staff allows organisations to harness this valuable experience, while significantly accelerating the learning process.

•

fsi the financial world | #3 May 2008

Some 50 To 70% of mergers and acquisitions disappoint Between 50 to 70 per cent of mergers and acquisitions do

By Lucas van der Drift Photography Marcel Bekedam

not deliver the hoped-for benefits. That is one of the conclusions of the latest edition of the Practitioners Day, organised by Deloitte’s industry group FSI in the Netherlands.

aurice Dercks (Par tner Deloit te Financial Advisor y Ser vices - Transaction Advisor y) and Vincent Oomes (Par tner Deloit te Consulting - FSO) first outlined trends and best practices in current M& A activit y. In banking, consolidation is the prevailing trend and is set to continue. While the United States numbers thousands of banks, a mere ten players control 49% of the market. The t wo par tners see the same thing happening in Europe. They also obser ve that shareholders, particularly hedge funds, are becoming increasingly influential. And they see some financials feeling a lit tle uncer tain: are they players or targets in the M& A game? A hot topic is the credit crisis, which has made the market a lot less transparent and has greatly increased the dif ficult y of get ting major acquisitions financed.

Ce e s H a a s noot, T h e odoor G ilis s e n B a n k ie r s

No clear strategy M a r ie - Jos é Ve le ntur f, ABN AMRO

Pr ofe s sor A r nold He e r tje

A surprising fact is that 50 to 70 per cent of mergers and acquisitions do not deliver the hoped-for benefits. When the dust has set tled, it of ten turns out that the move has contributed nothing to the company’s valuation. The reasons are various. Sometimes there is no clear strategy behind the merger or takeover, in other cases companies have paid too much. Companies smell an oppor tunit y, make optimistic assumptions (about synergy and cost savings) and star t bidding against each other. Other factors that can stand in the way of success: an acquisition may be too big a bite for the company to chew, the corporate cultures

of the companies may be too dif ferent, or a less-than-smooth integration may trigger an exodus of talent.

Success factors Banks and insurers can increase the odds of success by designing a clear M& A strategy including multiple scenarios. That way, they will know how to proceed if and when a takeover target presents itself. Another success factor is paying suf ficient at tention to post-merger integration (PMI). There should be a blueprint for the integration process: which synergy benefits is the company aiming for, and what is the timetable? Finally, open communication with employees and customers cer tainly helps.

M&A in practice Practitioners Day 20 07 was concluded with presentations by three guest speakers. Professor Arnold Heer tje pointed out that employee and customer interests are of ten ignored when companies are engaged in a merger or takeover. He wondered whether such mat ters ought to be lef t entirely to the free market. Marie-José Velentur f (Global Head CoE Talent & Leadership at ABN AMRO) told the riveting behind-the-scenes stor y of the takeover bat tle for ABN AMRO. Cees Haasnoot (CEO of Theodoor Gilissen Bankiers) described how TGB and Effectenbank Stroeve merged their organisations in 20 05. This merger had a happy ending thanks to a strong emphasis on the “sof t factors” HR and corporate culture.

•

fsi the financial world | #3 May 2008

Missed the last issue(s) of FSI magazine? Did you miss the last issues(s) of FSI magazine? Just send an e-mail to FSImagazine@deloitte.nl and you will receive a digital PDF copy. Or visit our website www.deloitte.com/FSImagazine and download the magazine(s).

FSI magazine is a Deloitte publication for the Financial

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Interviews:

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operating under the names “Deloitte,” “Deloitte & Touche,” “Deloitte Touche Tohmatsu,” or other related names. Services

Translation and language editing:

are provided by the member firms or their subsidiaries or af-

Carla Bakkum, Alison Gibbs

filiates and not by the Deloitte Touche Tohmatsu Verein.

fsi the financial world | #3 May 2008

Delivering the Deloitte difference The right combination In today’s complex business environment, it takes a team with knowledge in many areas to get the job done. And individuals with strong principles and values, to get it done the right way. The people of Deloitte member firms bring the right combination of multi-disciplinary experience and core values to deliver insights that help companies unlock the potential of their business. To experience the difference of Deloitte member firms, please visit www.deloitte.com.