Friday, August 26, 2011

How is MENA destabilization affecting global markets for oil, energy, etc.?

QUESTION: With continuing uncertainty in the Middle East – in places like Libya, Syria, and Yemen – how is this destabilization affecting global markets for oil, energy, and other goods and services? What do you think are the important issues that are not being covered in the media?

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1  Effects of instability in energy markets

There are two kinds of effects: The easily measurable ones, and the subjective, or irrational, ones.

The first are easy to see. If any of these countries of the table below [1] stop (partly or completely) their oil exports, the effects are, depending of disruption time, going to be more or less close to last column's values:





This is the table for gas [1]:




You can run your models to try to estimate how big will be the final effect in prices, and further run the models to try to ascertain the impact on growth, inflation, employment, etc., making use of the rational expectations principle.

Recent comments by Ms Jean Boivin, Deputy Governor of the Bank of Canada, at the Canadian Association for Business Economics this week [2] explains that rational expectations (in its stronger form) means that we assume that people is very sophisticated: individuals "fully understand how economies and markets work, take into account all the information available, fully appreciate the future consequences of their actions today, and make decisions that are fully consistent with this understanding."

Now, this is just a starting point, the dominant undercurrent of people's actions in economic tasks. Analysts pour over the tables above and other data to try to objectivize behaviors. But there are "perturbations" to the mathematical equations that introduce a distance between the ideal (rational expectations) and the real thing. Unfortunately, there is no easy way to introduce into the models the non-objective part.

So the summary is this: effects will gravitate around the values in the tables above, but there is a volatility in the final values that depends of how fearful are investors, and fear is non-computable.


2  Important issues not being covered in the media

Most issues not covered in the media are, IMHO, due to lack of familiarity with the MENA countries. There is not enough knowledge among investors, policymakers, and citizens of those societies: their culture, their history, who are powerful and why.

So most commentary on the risks of a jihadist takeover, or the lack of attention to countries like Mauritania, ignore basic data about those societies and the interactions in the area.


Data like this, which shows efforts (and their relative weight) to influence North Africa by countries outside the area [3], are not being discussed:




References

[1]  Michael Ratner & Neelesh Nerurkar: "Middle East and North Africa Unrest: Implications for Oil and Natural Gas Markets." Congressional Research Service, March 10, 2011.

[2]  Jean Boivin: How people think and how it matters. Remarks by Ms Jean Boivin, Deputy Governor of the Bank of Canada, presented to the Canadian Association for Business Economics, Kingston, Ontario, August 23, 2011.

[3]  The Moor Next Door, Oct 17, 2010, http://themoornextdoor.wordpress.com/2010/10/26/experiments-in-map-making > map in section 5 (http://themoornextdoor.files.wordpress.com/2010/10/screen-shot-2010-10-27-at-10-53-20-am.png?w=700&h=386)

Obama Is Too Good For Us

Obama Is Too Good For Us. By Charles Fried
http://www.thedailybeast.com/articles/2011/08/06/obama-is-too-good-for-us-charles-fried-on-the-debt-fiasco.html
The debt deal fiasco proved that any decent, honest politician like the president simply doesn’t stand a chance against the likes of Michele Bachmann. Charles Fried on how the Tea Party ruined America.The Daily Beast, Aug 6, 2011 1:02 AM EDT

Barack Obama is not a skillful strategist like Bill Clinton. He is not a gifted rhetorician like Ronald Reagan. Nor is he a bold and inspiring leader like Abraham Lincoln. And he can’t seem to shake himself loose from the strings that attach him to the trial lawyers, to big labor, and, surprisingly, to the standard banker-economists who got us into the mess we are in now. But he is an honest man. He is intelligent, analytical, and knowledgeable. And he tries hard to think through the dilemmas which confront us and to tell us clearly and straightforwardly what he wants to do and why he wants to do it.

But it doesn’t seem to work.

Contrast this to the politicians he is up against. When John Boehner at the height of the debt ceiling crisis answered him on the national media he simply did not tell the truth. He said that the president would not compromise, would not take yes for an answer, and wanted it all his own way. But he cannot have forgotten that he had negotiated Obama into far more cuts than Obama and his caucus had wanted, thought wise or even palatable in return for a modest increase in revenue to be achieved by closing egregious and unfair loopholes in personal and corporate taxes. This is the same compromise recommended by the “Gang of Six,” which included the extremely conservative and admirably patriotic Senator Tom Coburn, by the bipartisan Bowles-Simpson group, and by Republican economists like Martin Feldstein. It was the Speaker who, Arafat-like, walked away from that deal because he concluded he lacked the skill or the muscle or the spine to sell it to his own caucus. Let it be said that this compromise included recalculating the cost of living formula for social security—a change every responsible economist recommends—but the equally rigid Nancy Pelosi rejected.

And Mitt Romney, supposedly a man experienced in business realities, in a parody of himself, has pronounced that he opposed the deal reached on the very eve of default—because it did not go far enough in the direction of what the Tea Party wanted.

Where can we find leadership that fits today’s circumstances, as Obama’s cool, rational approach and clear-headed rhetoric apparently do not?

I turn to the ancient Greek comic author, Aristophanes, speaking at what must have seemed a similar time. In his play The Knights two citizens are looking for a leader fit for the times. They come upon a sausage-seller and propose him as ideal for the job.

“Tell me,” asks the astonished man, “how a sausage-seller can become a great man.”

“You will be great,” they answer him, “precisely because you are a sad rascal without shame, no better than a common market rogue.”

The dialogue shifts to fit exactly the situation of Sarah Palin (remember the Katie Couric interview), the god-parent of the Tea Party. The sausage seller objects: “But I have not had the least education. I can only read, and that very badly.” And he is answered: “That is what may stand in your way, almost knowing how to read. A demagogue must be neither an educated nor an honest man; he has to be an ignoramus and a rogue. But do not, do not let go this gift, which the oracle promises. . . Politics these days is no occupation for an educated man, a man of character. Ignorance and total lousiness are better. Don’t jettison such god-given advantages.”

Look at the roster of leaders vying for my party’s nomination. At the top of the list stand Mitt Romney, who will say anything, and Michele Bachmann, who assured us that defaulting on the national debt is no big deal, while a sensible man like Jon Huntsman is in single digits.

Oh, I know: it’s not funny, but one must either laugh or weep.

Thursday, August 25, 2011

CPSS-IOSCO releases report on requirements for OTC derivatives data reporting and aggregation

CPSS-IOSCO releases report on requirements for OTC derivatives data reporting and aggregation
http://www.bis.org/press/p110824.htm
August 24, 2011

The Committee on Payment and Settlement Systems and the Technical Committee of IOSCO have today released for comment a report on the OTC derivatives data that should be collected, stored and disseminated by trade repositories (TRs).

The committees support the view that TRs, by collecting such data centrally, would provide the authorities and the public with better and timely information. This would make markets more transparent, help to prevent market abuse, and promote financial stability.

The report addresses Recommendation 19 in the October 2010 report of the Financial Stability Board (FSB), Implementing OTC derivatives market reforms, which called on the CPSS and IOSCO to consult with the authorities and the OTC Derivatives Regulators Forum in developing:

1    minimum data reporting requirements and standardised formats, and
2    the methodology and mechanism for data aggregation on a global basis. A final report is due by the end of 2011.

The proposed requirements and data formats will apply to both market participants reporting to TRs and to TRs reporting to the public and to regulators. The report also finds that certain information currently not supported by TRs would be helpful in assessing systemic risk and financial stability, and discusses options for bridging these gaps.

Issues relating to data access for the authorities and reporting entities are discussed, including methods and tools that could provide the authorities with better access to data. Public dissemination of data, it is noted, promotes the understanding of OTC derivatives markets by all stakeholders, underpins investor protection, and facilitates the exercise of market discipline.

The report also covers the mechanisms and tools that the authorities will need to aggregate OTC derivatives data. It advocates a system of standard legal entity identifiers (LEIs) as an essential tool for aggregation of such data. It further recommends that TRs actively participate in the LEI's development and use the system once it becomes available. As the implementation of a universal LEI will require international cooperation, it is noted that further international consultation would be beneficial.

Finally, the report recommends that CPSS-IOSCO or the FSB make a public statement calling for timely industry-led development, in consultation with the authorities, of a standard classification system for OTC derivatives products.

Published along with the report is a cover note that sets out specific issues on which the committees seek comments during the public consultation period.

Comments on the report are invited from all interested parties and should be sent by 23 September 2011 (see note 1 below).

After the consultation period, the CPSS and IOSCO will review all comments received and publish a final report by the end of 2011.


Notes

1    Comments on the report should be sent by 23 September 2011 to both the CPSS secretariat (cpss@bis.org) and the IOSCO secretariat (OTC-Data-Report@iosco.org). The comments will be published on the websites of the BIS and IOSCO unless commentators have requested otherwise.
2     The CPSS serves as a forum for central banks to monitor and analyse developments in payment and settlement arrangements as well as in cross-border and multicurrency settlement schemes. The CPSS secretariat is hosted by the BIS. More information about the CPSS, and all its publications, can be found on the BIS website at www.bis.org/cpss.
3    IOSCO is an international policy forum for securities regulators. The Technical Committee, a specialised working group established by IOSCO's Executive Committee, is made up of 18 agencies that regulate some of the world's larger, more developed and internationalised markets. Its objective is to review major regulatory issues related to international securities and futures transactions and to coordinate practical responses to these concerns.
4    Both committees are recognised as international standard-setting bodies by the Financial Stability Board (www.financialstabilityboard.org)
5    The Task Force that carried out the work on behalf of the committees was chaired by Frédéric Hervo of the Bank of France, Sujit Prasad of the Securities and Exchange Board of India and David Van Wagner of the Commodity Futures Trading Commission.

Wednesday, August 24, 2011

Scott Belsky Says Managers Need to Avoid Distractions and Take Time to Focus on Their Long-Term Aims

How to Make Your Dream Project Happen. By Javier Espinosa
http://online.wsj.com/article/SB10001424053111903327904576524253193112770.html
Author Scott Belsky Says Managers Need to Avoid Distractions and Take Time to Focus on Their Long-Term Aims WSJ, Aug 24, 2011

Even the most successful managers sometimes struggle to turn their ideas into reality. But some authors, creative teams or companies manage to be more productive than most. So, what distinguishes them from the rest, and what can we learn from them?

Over the past 5½ years, Scott Belsky, author of "Making Ideas Happen," met with hundreds of individuals and teams at companies such as Google and Apple to find out how they go about executing their projects. He is the founder and chief executive of Behance, a self-described New-York based "creative professional platform." whose main aim is to help creative thinkers see their ideas develop into actual results.

"We spend too much time focused on innovation and creativity and not enough time on the execution side. Ideas don't happen because they are great or by accident. They happen because there are other forces at play," he says.

In an interview with The Wall Street Journal in London, Mr. Belsky shared some of his tips for turning ideas into concrete outcomes. The interview has been edited.

Embrace 'micro action'

A lot of the creative teams [I met with] will find micro actions to push ideas forward, rather than always sitting back and waiting for the perfect time. We are often are told to "think before you act" but I found it's never the right time to do something new. In fact, it's always the wrong time because you always find a reason why you should wait.

Escape the 'reactionary' workflow

Everyone is struggling right now with the same thing. We have entered the era of reactionary workflow. We are constantly connected, have our devices with us at all times. Right now you are probably receiving emails, voice mails, text messages, Facebook messages…all of this stuff is coming to you. You could live a life of simply reacting to what's coming in rather than being proactive in what matters most to you. You can slip into reactionary workflow the minute you get up in the morning with your phone and everything else. You can never have an impact on your long-term stuff. We will never push an idea forward unless we find ways to manage it.

Book time to think about the longer term

Executives I work with preserve what I call windows of nonstimulation in their day. They book themselves two- or three-hour chunks and they don't focus on their to-do list or their email. Instead, they are focusing on two or three things that important to them over the long term. They are revisiting their business plan during this enforced period of [thinking] time.

How to avoid the 'project plateau'

If you have an idea to write a novel, your energy and excitement will be extremely high. You are willing to stay up until three in the morning writing that first chapter. But then four days later your energy is going to start going down. You will realize that you are behind on your other deadlines and you are going to find a million reasons to get back to what's urgent. You then enter the "project plateau" where most ideas die.

The one thing that's really important to keep yourself engaged with a project even though it's no longer new is to kill off [subsequent] new ideas. The whole premise of the project plateau is that there is a lot of energy and excitement when a new idea comes but it's really important to work with people who are doers. If we spread our energy too thinly the main project suffers.

'Insecurity work' is bad for you

Five or 10 years ago, when you wanted to know how things were doing you waited for the data to get to you. You got a weekly report, or a quarterly report. Today, executives walk around with applications that allow them to see to the minute the number of visits to their website.

The problem with this is that there is a new type of work that we are starting to do. I call it insecurity work. It's stuff that we do repeatedly throughout the day: searching Twitter for a keyword. When you are leading a bold creative pursuit you always want to know that it's OK. We should really delegate this work to somebody else. If your job is to lead a creative project, you shouldn't be filling your day with this stuff. I

The power of accountability

The power of accountability was a big theme that I saw in everyone that I met. They all had stories of having an idea within a company but not sharing it. And then suddenly for some reason putting it out there and being held liable for it. That was always a good turning point for them. Chris Anderson, author and editor-in-chief of Wired magazine, says every time he has an idea he puts it out on his blog. People ask, first of all, aren't you afraid somebody is going to steal your idea and, second of all, aren't you worried that you are sharing it prematurely? The answer: the more I share the idea, the more likely people are to hold me accountable and help me refine it.

—"Making Ideas Happen: Overcoming the Obstacles Between Vision and Reality" is published by Penguin.

Views on the balanced budget amendment

1  In favor: Considering a Balanced Budget Amendment: Lessons from History, by E Istook, http://www.heritage.org/Research/Reports/2011/07/Considering-a-Balanced-Budget-Amendment-Lessons-from-History (Spanish: http://www.libertad.org/lecciones-de-la-historia-sobre-la-enmienda-del-presupuesto-balanceado)

Abstract: Attempts at passing a balanced budget amendment (BBA) date back to the 1930s, and all have been unsuccessful. Both parties carry some of the blame: The GOP too often has been neglectful of the issue, and the Democratic Left, recognizing a threat to big government, has stalled and obfuscated, attempting to water down any proposals to mandate balanced budgets. On the occasion of the July 2011 vote on a new proposed BBA, former Representative from Oklahoma Ernest Istook presents lessons from history.


2  Against from a conservative or libertarian viewpoint: The Balanced Budget Amendment's Fatal Flaw. By PETER H. SCHUCK
http://online.wsj.com/article/SB10001424053111903554904576459902841916850.html
Nothing would give judges more policy-making power.
WSJ, Jul 22, 2011

A balanced budget amendment (BBA), a hardy perennial in Congress, is once again in the headlines. This is entirely understandable. The public trusts neither the president nor Congress, regardless of the party in control, to strike and maintain an economically healthy, sustainable balance between federal spending and revenues. Thus, the idea of tying them to the constitutional mast, Ulysses-like, so that they cannot succumb to the inevitable temptation to spend more and tax less is itself tempting to many reformers and voters.

Nevertheless, many sound objections to a BBA exist, which the current version—indeed, any version—cannot adequately address. Many of these objections, such as the need for deficit spending in a recession, are hoary Keynesian pieties and will resonate only with liberals and moderates. But one objection, largely absent from the debate so far, should convince even the most hidebound conservative to strongly oppose the BBA.

I can think of no other law that would empower judges to exercise more political and policy-making discretion than a balanced budget amendment. It would quickly realize every conservative's fears of an "imperial judiciary" that "legislates from the bench"—even if the courts simply did their job and did not grasp for that power.

First, the courts would be swamped with challenges to every governmental decision with significant budgetary implications, which means almost all important decisions. As federal Judge Ralph Winter pointed out long ago, the judges would have to decide who, if anyone, would have standing to sue and who the proper defendant would be. If they ruled that no one had standing, then the amendment would be legally unenforceable, a dead letter. If the judges found standing, however, a host of exceptionally controversial legal-interpretation issues would arise.

Perhaps the most fundamental questions have been posed by Rudy Penner, who was Congressional Budget Office director in the Reagan years: What is a "budget," and which budgets are covered by the amendment? This is pivotal because the amendment would create an irresistible incentive for politicians to expand "off-budget" programs or establish new ones.

Social Security, Fannie Mae, Freddie Mac, the Postal Service and the new Consumer Financial Protection Bureau are all off-budget and constitute a huge share of federal fiscal commitments. The BBA does not even mention this multitrillion-pound gorilla, nor does it deal with the creation of new off-budget spending programs which would certainly proliferate in its wake, so a judge would have to decide whether they are included. (The state and local equivalent dodge of balanced budget rules is the "special district"—some 40,000 nationwide—which often has taxing power. )

The BBA also uses the basic term "tax" as if it were self-defining, but of course it isn't. Indeed, one of the key issues in the legal challenge to ObamaCare is whether the spending mandates in the legislation constitute a tax (as the administration argues) or a penalty (as its opponents claim). Only the courts can decide—and so far they have split on the issue. This is political power of a high order, given the importance of the legislation.

Then there are the classic ploys that governments use to evade budgetary restrictions, about which the BBA is also silent. Does the amendment's term "outlay" apply to long-term capital investments such as infrastructure spending, of which the Obama administration is so fond? If not, we can anticipate lots more spending being called capital investment. The judges will have to decide whether the amendment applies or not.

Does "outlay" cover government loan guarantees—a form of subsidy used promiscuously by government to avoid budgetary constraints? Does "revenue" include so-called "offsetting receipts" such as the large amounts that Medicare beneficiaries pay for their physician and drug benefits? If so, we can expect Congress to use more of them. Again, the courts will have to decide.

It does seem clear that the amendment would not cover private expenditures mandated by government regulation of individuals and firms. After all, regulations affect private budgets, not governmental ones; that is part of their political appeal. If the BBA passes, then look for the politicians to transfer much of their spending desires into a burst of new regulations. For conservatives, this should be a nightmare.

The political pundits report that there is no chance that the balanced budget amendment will pass. This should be cause for conservative celebration, not disappointment.


Mr. Schuck is a professor at Yale Law School and the co-editor, with James Q. Wilson, of "Understanding America: The Anatomy of an Exceptional Nation" (PublicAffairs, 2008).

Tuesday, August 23, 2011

The Gulf economies of the Middle East are forming partnerships with other emerging markets, redefining the ancient trade routes

The New Web of World Trade, by Joe Saddi, Karim Sabbagh, and Richard Shediac
http://www.strategy-business.com/article/11310
The Gulf economies of the Middle East are forming partnerships with other emerging markets, redefining the ancient trade routes that once linked East and West.

When King Abdullah bin Saud, the current ruler of Saudi Arabia, came to power in August 2005, he wasted little time in demonstrating his vision for the country’s future. His first official overseas visit, in January 2006, was not to U.S. president George W. Bush, U.K. prime minister Tony Blair, or German chancellor Angela Merkel — but to Chinese president Hu Jintao.

The meeting reflected both countries’ desire to forge closer economic ties. Before King Abdullah went on to other emerging markets, including India, Malaysia, and Pakistan, he and President Hu signed an agreement of cooperation in oil, natural gas, and minerals. This agreement built on existing relationships between the countries’ national energy companies, Saudi Aramco and Sinopec, which had formed a partnership in 2005 to construct a US$5 billion oil refinery in eastern China’s Fujian province. In 2011, they signed a memorandum of understanding to build a refinery in Yanbu, on the west coast of Saudi Arabia. Sinopec is also engaged in a joint venture with Saudi Arabia’s petrochemicals giant SABIC; in 2010, they began producing various petrochemical products in a $3 billion complex in the city of Tianjin in northeast China, and have recently announced that they will build a $1 billion–plus facility there to produce plastics.

The rise of emerging markets in the global economy has sparked a great deal of discussion, particularly in the wake of the worldwide financial crisis. The implications are often framed in terms of the potential impact on the economies of the U.S. and Europe — for instance, business leaders discuss whether emerging nations’ consumers might be interested in purchasing American products, or whether European telecom operators can counter stagnation in their own markets by investing in new mobile networks in Asia.

But a closer look reveals a separate trend that could shift the economic focus away from the West. Emerging markets are building deep, well-traveled networks among themselves in a way that harks back to the original “silk road,” the network of trade routes between East Asia, the Middle East, and southern Europe, some dating to prehistoric times and others to the reign of Alexander the Great. Most of these routes were central to world commerce until about 1400 AD, when European ships began to dominate international trade.

Today’s new web of world trade is broader and more diverse than the old silk road. It is a network among emerging markets all over the world, including China, the Middle East, Latin America, and Africa. It is a path not just for expanded trade in goods, but for short-term and long-term investment and the transfer of technological and managerial innovation in all directions. Witness, for example, China’s investments in Africa, where the construction of roads, railways, and communications infrastructure provides revenue to China’s state-owned enterprises and also facilitates China’s access to the continent’s natural resources and its consumers. Or consider the fact that in 2009, China surpassed the U.S. to become Brazil’s primary trading partner; bilateral trade between the two countries grew more than 600 percent between 2003 and 2010, from $8 billion to $56 billion. Also in 2009, the Korea Electric Power Corporation, a state-owned South Korean firm, won a $40 billion contract to build nuclear reactors in the United Arab Emirates (UAE), beating out French and U.S. companies that had bid on the opportunity. And in 2010, Russia and Qatar announced that they would work together to develop gas fields on Russia’s Yamal Peninsula.

Such developments remain largely separate activities in the global economy, but taken together, they are early evidence of a pattern that public-sector and private-sector leaders in every part of the world should take into consideration.



An Important Stop on the Road

The countries of the Gulf Cooperation Council (GCC) — Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the UAE — represent one regional powerhouse whose relationships with emerging peers can offer valuable insights into the way such alliances are forming. In the last five years, ties between the GCC and the BRIC countries (Brazil, Russia, India, and China) as well as the “Next 11” countries (Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey, and Vietnam) have expanded strongly. (See map.) The speed with which the new silk road is being constructed between the GCC and these other rapidly emerging economies is a clear indicator of the GCC’s rising importance. Even the recent unrest in the Middle East, which included a few of the GCC nations, has not impeded the Gulf’s global ambitions.

[http://www.strategy-business.com/media/image/11310-ex01b.jpg]

The GCC is also noteworthy because of its traditionally strong relationships with the U.S. and Europe. The Gulf nations have to maintain their relationships with these large but relatively stable economies while fostering new relationships with the high-growth economies in emerging markets. This balancing act could lead to a new set of policies and ambitions in the region, with significant implications for companies that hope to enter this market, and for the nations (which include the U.S., China, Japan, and most of Europe) that compete for the GCC’s oil and gas resources and have a vested interest in ensuring that regional security issues do not destabilize global oil prices.

By analyzing the dynamics behind the growth of the GCC’s alliances with other emerging countries, GCC leaders can see where there could be potholes in the new silk road and what reforms will be necessary to avoid them. At the same time, the companies and governments of Europe and the U.S. can develop a better understanding of what they will need to do to ensure that their own opportunities in the GCC are not lost in the years to come. The primary drivers of the relationships between the GCC and the BRICs and Next 11 countries are trade, people, and capital; equally important, though more difficult to track with data, is the exchange of knowledge and technology.

1. More than oil. The top item on the strategic agenda for every GCC country is to diversify its economy and thus decrease its dependence on oil. Despite significant efforts, achieving this goal has so far proven challenging: Oil and gas accounted for 38 percent of GDP in the GCC in 2000, 42 percent in 2005, and 39 percent in 2010. The governments in the region are eager to continue investing their oil revenues in knowledge-intensive industries that will create jobs for local populations, and they will cultivate trade partners that help them.

This is one major reason that 19.4 percent of the GCC’s trade flows now involve the BRIC countries, compared with just 8.9 percent involving NAFTA countries. And GCC trade flows with BRIC countries are also more diverse than those with the United States. For example, Saudi Arabia’s exports to the U.S. still revolve around oil, whereas its exports to BRIC countries include chemicals, plastics, and minerals. The UAE’s exports to China, similarly, are split among a range of products, led by plastics (28 percent), electronic equipment (15 percent), and vehicles (9 percent).

The GCC’s non-oil exports to the Next 11 countries are also on the rise. Such exports (including chemicals, plastics, and aluminum) from the GCC to Vietnam, Indonesia, and Turkey are still quite small in absolute terms, just $11.6 billion in 2008. However, they increased by 389 percent between 2001 and 2008, an indication of things to come.

In future years, GCC companies will be looking to expand in a number of directions that will affect their exports. They will build manufacturing bases, as well as act as importers and resellers for automobiles and other advanced manufacturing products; they will also continue developing expertise in critical areas such as water desalination and complex infrastructure and construction projects, and may begin looking outside the region for destinations for those services. Trade partners that support the GCC’s economic goals will find themselves in favorable positions.

2. Rich in talent. As goods and services flow across the borders of the GCC and other emerging markets, so do people. Air arrivals in the GCC from China more than tripled between 2005 and 2009; arrivals from India, which historically has had deep ties to the GCC, increased by 35 percent. Arrivals from Turkey, Egypt, Indonesia, Pakistan, and Iran are on the rise as well: The GCC saw 2.2 million visitors arrive from Egypt in 2009, compared with 1 million in 2005. During the same period, the number of visitors from Pakistan increased from 769,000 to 1.4 million.

The most significant aspect of this change is the skill level of many of the people entering the GCC. No longer do executives come from the West and laborers from the East; instead, skilled individuals from emerging markets are deepening their impact in the GCC with influential positions in the region’s financial, energy, transportation, and public sectors. India, in particular, has a large community of professional expats in the region, stretching back several decades.

Because GCC countries do not publish data on the types of jobs that expats come to the GCC to perform, this trend is difficult to quantify; we are discussing it here primarily on the basis of our own extensive experience and observations. One indicator of the size and status of the Asian expat population, though, is the fact that this group’s private wealth (for which data is available) is now equal to or greater than private wealth among Western expats, and private wealth among Arab expats from outside the GCC is rapidly catching up. In Saudi Arabia, for example, Asian expats held $46 billion in private wealth in 2009, compared with $41 billion for Western expats and $21 billion for Arab expats. In the UAE, Asian expats also led the pack at $27 billion, followed by $20 billion for Western expats and $17 billion for Arab expats.

As countries that are poor in resources but rich in talent send their people to the GCC, they not only further the GCC’s own growth aspirations; they also put their expats in a strong position to encourage and maintain the GCC’s relationships with their countries of origin.

3. New sources of capital. GCC nations have long been investors in other countries — primarily in the U.S. and Europe — via their sovereign wealth funds and other state-owned entities. Although Western countries are still the primary recipients of GCC investments, accounting for 71 percent of capital outflow from the GCC between 2003 and 2008, they are slowly losing share to other Middle East countries and Asia. In light of the strong role that GCC governments play in determining the direction of their countries’ capital investments, this trend could accelerate if GCC governments decide that other emerging markets are a better strategic destination — both economically and politically — for their riyals, dirhams, and dinars.

To some degree, of course, all governments play a role in their national economy. In the aftermath of the global financial crisis, most governments’ roles are larger than they used to be, thanks to bailouts of critical industries in Western countries. But major emerging economies such as China, Russia, Brazil, and Mexico, and the countries of the GCC, among others, are active proponents of “state capitalism” — defined most recently by political risk expert Ian Bremmer as a system in which governments direct state-owned companies, private companies, and sovereign wealth funds in ways that will maximize the state’s resources and power. (See “Surviving State Capitalism,” by Art Kleiner, s+b, Summer 2010.) These countries approach state capitalism not as a last resort in times of crisis but as a sensible policy for protecting national interests while still encouraging economic growth.

For decades, the prevailing view in Western capitalist societies has been that this model cannot succeed — that the bureaucratic nature of government agencies could never compete against a nimble free market. And certainly, some state-owned enterprises in the GCC have stumbled, such as the real estate companies in Abu Dhabi and Dubai that required bailouts. In recent years, however, the track record of some state-supported sectors in the GCC shows that the issue is not quite so black and white. The state-owned airlines in the UAE and Qatar — Emirates, Etihad, and Qatar Airways — have quickly achieved global prominence. In fact, some European carriers (many of which used to be state-owned themselves) complain that it is unfair to have to compete against airlines with the power, and perhaps the economic support, of the state behind them. Thanks to strategic global investments, the size of the GCC’s sovereign wealth funds has nearly tripled in the last decade; they now hold approximately $1.1 trillion, compared with just $321 billion in 2000. And the GCC’s oil companies — the original source of the region’s wealth — are renegotiating their contracts with the foreign oil companies operating within the countries’ borders in ways that give them greater control over national resources while still allowing them to exploit the foreign oil companies’ technology and expertise.

4. Getting connected. As GCC countries seek to branch out and build relationships with other emerging markets, they have found one point of entry in the information and communications technology (ICT) sector. Like many other developing nations, they have recognized the importance of building knowledge economies to accelerate their development, and have made infrastructure investments and policy changes accordingly. Their rankings on the World Economic Forum’s Networked Readiness Index, which measures “the degree of preparation of a nation or community to participate in and benefit from ICT developments,” reflect their efforts: The UAE moved from number 28 on the list in 2005 to number 24 in 2010 (out of 138 nations on the list that year); Qatar jumped from number 40 to number 25 during the same period; and Saudi Arabia, which made its debut on the list in 2007, improved from number 48 in that year to number 33 in 2010.

In making these advances, GCC countries have frequently looked to their counterparts among other emerging nations, many of which have similar initiatives under way. As a result, the nations of the Gulf and their partners in other emerging markets have collaborated to boost their ICT development in ways that they might not have been able to do alone.

Shared infrastructure, for instance, has been crucial. The new silk road runs underwater, in the form of submarine cables that connect the GCC to countries including India, Thailand, Malaysia, South Korea, Pakistan, South Africa, Nigeria, and Sri Lanka. Chinese companies Huawei and ZTE have provided equipment for GCC telecom networks; Huawei has even gone beyond infrastructure to invest in talent in the GCC, sponsoring an academic chair in information technology and communication at the UAE’s Higher Colleges of Technology.

Telecom operators, too, are looking to emerging markets to drive their business. Since the GCC deregulated its own national telecom markets in the 1990s, local operators have been on an acquisition spree, expanding their international footprint from 28 markets in 2005 to 44 markets today. These new outposts are mostly in emerging markets, spanning Indonesia, South Africa, South Asia, the Middle East and North Africa region, and sub-Saharan Africa. These investments run the other way, too, as companies like India’s Bharti consider investments in the GCC. For emerging markets to play any significant role in the global economy of the 21st century, they will need to invest in ICT infrastructure and talent. Pooling their resources to do so can advance them more effectively.


Global Relationships for the 21st Century

The bonds between the GCC countries and the BRIC and Next 11 nations are growing stronger — a development that Western countries to date have viewed with trepidation, fearing that a zero-sum game will leave them cut off from increasingly significant consumer markets and sources of natural resources, goods, and services. But in an interconnected world, unexploited opportunities await players all over the globe.

The fact that these emerging alliances are still in their infancy means that companies and governments in the U.S. and Europe can act now to formulate a response. In doing so, they will need to recognize that the weakening of their own economies during the financial crisis has undermined their historical advantages in the GCC region and has enhanced the appeal of fast-rising emerging markets. To succeed, then, developed economies will need to capitalize on the strengths that their emerging competitors cannot yet match. For example, the U.S. and Europe are still world leaders in terms of building the capabilities and infrastructure that are crucial for innovation, and they have a history of helping GCC countries develop these assets as well. Many of the region’s oil companies relied heavily on contributions from their international partners in their early years, exchanging access to oil resources for foreign talent and technology. This trend continues today: For instance, King Fahd University of Petroleum and Minerals in Dhahran, Saudi Arabia, has formed a partnership with U.S.-based Cisco Systems to create a regional Cisco Networking Academy, which is intended to ensure that the university’s students are prepared to succeed in the digital economy. Companies in developed countries can also build on their extensive global supply chains to easily integrate new partners — whether as suppliers or as customers.

For their part, as the nations of the GCC look around the world to develop their network of relationships, they will find many opportunities with partners in both developed and developing nations. In order for these relationships to have the greatest impact in the GCC, the Gulf nations must seek the investors and trade partners that can help them address their pressing priorities: the creation of new jobs, competition that will spur their own national champions to greater success, and investment in their physical and educational infrastructure.

Gulf nations have begun building these relationships already, and in doing so their economies have become much less insulated than they were in the 1970s and 1980s. However, to increase their appeal to international partners, GCC countries will need to continue making progress on the internal reforms that are under way. Of the six nations in the GCC, only Saudi Arabia ranks in the top 20 countries in the 2010 World Bank Doing Business report, at number 11; Bahrain comes in at number 28, the UAE at number 40, and Qatar at number 50. They need to reduce the amount of red tape required to start or invest in a business, provide more transparency in business fundamentals, and invite more private-sector investment in industries that still have substantial government involvement. They should also expand their overall talent base by making it more appealing for foreigners who have critical skills to live in the region, while simultaneously developing their own people and ensuring that they have the right capabilities to build critical sectors such as energy, education, and communications.

GCC countries will also need to keep pushing forward on economic integration within the region, which will bolster their presence on the world stage. The countries of the GCC have much more clout as an economic bloc than as six separate entities, and they must continue to implement policies that reflect this perspective. A recent Booz & Company study assessed the progress of the GCC toward regional integration on a number of measures using a scale of 1 to 5, with 1 indicating “major setback to the goal” and 5 representing “accomplishment or near completion of the goal.” When all measures were taken into account, the study found that the GCC had achieved an overall score of just 2.9 out of 5. The Gulf nations must redouble efforts toward the creation of a monetary union, improve the coordination of customs and border policy, promote greater intra-regional investment, fulfill joint infrastructure commitments, and increase collective efforts in research and development. If the GCC can become a stronger economic bloc, the entire region will become a less risky, more attractive proposition for investment.

The GCC is at a critical juncture as it determines the parameters of its relationships with partners both old and new, Western and Eastern. But there’s no doubt that the new silk road can be a path toward future prosperity for the GCC countries, building trade and creating wealth as powerfully in the 21st century as the old silk road did in ages past.


Author Profiles:

    Joe Saddi is the chairman of the board of directors of Booz & Company and the managing director of the firm’s business in the Middle East. His work covers multifunctional assignments in the oil, gas, mining, water, steel, automotive, consumer goods, and petrochemical sectors.
    Karim Sabbagh is a Booz & Company senior partner based in Dubai. He leads the firm’s work for global communications, media, and technology clients. He is a member of the firm’s Marketing Advisory Council and the chairman of the Ideation Center, the firm’s think tank in the Middle East.
    Richard Shediac is a senior partner with Booz & Company based in Abu Dhabi, where he leads the firm’s Middle East work for public-sector and healthcare clients. He has led and participated in strategy, operations improvement, and organization projects in the Middle East, Europe, and Asia.
    Also contributing to this article were Booz & Company principal Mazen Ramsay Najjar, Ideation Center director Hatem A. Samman, and s+b contributing editor Melissa Master Cavanaugh.

Wednesday, August 17, 2011

USAID Expands Life-Saving Malaria Prevention Program in Africa

USAID Expands Life-Saving Malaria Prevention Program in Africa


FOR IMMEDIATE RELEASE
August 17, 2011
Public Information: 202-712-4810

http://usaid.gov/press/releases/2011/pr110817.html


WASHINGTON, D.C. - The U.S. Government, through the U.S. Agency for International Development (USAID), announced the expansion of its Indoor Residual Spraying (IRS) program. IRS is the application of safe insecticides to the indoor walls and ceilings of a home or structure in order to interrupt the spread of malaria by killing mosquitoes that carry the malaria parasite. Malaria is the number one killer in Africa.

Through the new IRS contract, the President's Malaria Initiative, led by USAID and implemented together with the Centers for Disease Control and Prevention (CDC), will provide technical and financial support to the Ministries of Health and National Malaria Control Programs in African countries to build country-level capacity for malaria prevention activities. The $189 million, there-year contract awarded by USAID to Abt. Associates will cover the implementation of IRS activities in Angola, Benin, Burkina Faso, Ethiopia, Ghana, Liberia, Madagascar, Mali, Mozambique, Nigeria, Rwanda, Senegal, Zambia, and Zimbabwe, with the possibility of expansion based on malaria control needs and availability of resources.


Activities include assessing the environment to ensure safe and effective use of insecticides, evaluating mosquito abundance and susceptibility to the insecticides, educating residents about IRS and how they should prepare their house for spraying, training spray teams, procuring insecticide and equipment, and monitoring and evaluating spraying activities.

"Here in Washington, a mosquito bite is a fleeting nuisance. But in all too many places, that sudden sting and scratch can be a death sentence. In a world being bound ever closer together, those places do not seem so far away," said Rear Adm. (RET) Tim Ziemer, U.S. Malaria Coordinator. "Preventing and treating malaria saves lives, contributes to a reduction in all-cause under-five mortality, improves the health of children in malaria-burdened regions, and contributes to socioeconomic development in areas most affected by malaria."

The United States is focusing on building capacity within host countries by training people to manage, deliver, and support the delivery of health services, which will be critical for sustained successes against infectious diseases like malaria. PMI continues to introduce and expand four proven and highly effective interventions in each of the target countries. Scale-up of the four interventions is complemented by a strong focus on extending expanding access in rural and underserved communities and further expanding community engagement for malaria prevention and control.

According to the World Health Organization, the estimated number of global malaria deaths has fallen from about 985,000 in 2000 to about 781,000 in 2009. In spite of this progress, malaria remains one of the major public health problems in sub-Saharan Africa, where malaria is the leading cause of death for children under five. Because malaria is a global emergency that affects mostly poor women and children, malaria perpetuates a vicious cycle of poverty in the developing world. Malaria-related illnesses and mortality cost Africa's economy alone $12 billion per year.

Tuesday, August 9, 2011

Possible effects of the S&P's downgrade in Main Street

QUESTION: What impact with the US downgrading have on the global markets?
And how will it impact Main Street?

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Quick ideas on the downgrade:

1  The effects in the global markets: Current knowledge status do not let you give an informed opinion. This extreme volatility is forcing many investors (individuals and corporations) to park their money, idling at accounts that yield little benefit. See BNY Mellon, which last week announced that some depositors, above $50 million, will be charged for having the money there.

2  The effect in Main Street: Some changes will affect it indirectly, so it will take a time to clearly see the effects (months, maybe a year). Changes in monetary policy (e.g., new rounds of so-called quantitative easing due to concerns of slowdown) can increase inflation. With positive inflation surprises come redistribution of wealth from some lenders to some borrowers (negative inflation surprises do the opposite). Such redistributions will increase bankruptcies, which means some providers (Main Street's) will not get paid, and some financial institutions will see that loans' quality will worsen, all of this in excess of normal problems.

Of course, there are also risks if we overshoot while fighting inflation due to the central bank's panic for previous high inflation: with lower inflation rates, holding cash is more appealing, so more depositors work partially outside banks, which see their earnings go down -- a few will run into insolvency sooner or later in excess of normal mortality of banks. This will mean that some Main Street customers will see more disruptions in their payments and other transactions (and possibly lose some money). Also, customers with a good credit history will see that reputation lost when switching to a new bank.

If stocks go down due to the downgrade, more people will lose money in the short term, and will have less to spend in Main St. Also, fear will rise, and that will change prospects for consumers, and that will take a toll too. This can be pretty quick, maybe weeks.

There are other ways for the downgrade to affect Main Street, of course.

Weathering the financial crisis: good policy or good luck?

Weathering the financial crisis: good policy or good luck?, by Stephen Cecchetti, Michael R King and James Yetman - BIS Working Papers No 351 - August 2011

Abstract: The macroeconomic performance of individual countries varied markedly during the 2007-09 global financial crisis. While China's growth never dipped below 6% and Australia's worst quarter was no growth, the economies of Japan, Mexico and the United Kingdom suffered annualised GDP contractions of 5-10% per quarter for five to seven quarters in a row. We exploit this cross-country variation to examine whether a country's macroeconomic performance over this period was the result of pre-crisis policy decisions or just good luck. The answer is a bit of both. Better-performing economies featured a better-capitalised banking sector, lower loan-to-deposit ratios, a current account surplus, high foreign exchange reserves and low levels and growth rates of private sector credit-to-GDP. In other words, sound policy decisions and institutions reduced their vulnerability to the financial crisis. But these economies also featured a low level of financial openness and less exposure to US creditors, suggesting that good luck played a part.


Introduction

The global financial crisis of 2007–09 was the result of a cascade of financial shocks that threw many economies off course. The economic damage has been extensive, with few countries spared – even those far from the source of the turmoil. As with many economic events, the impact has varied from country to country, from sector to sector, from firm to firm, and from person to person. China’s growth, for example, never dipped below 6% and Australia’s worst quarter was one with no growth. The economies of Japan, Mexico and the United Kingdom, however, suffered GDP contractions of 5–10% at an annual rate for up to seven quarters in a row. For a spectator, this varying performance and differential impact surely looks arbitrary. Why were the hard-working, capable citizens of some countries thrown out of work, but others were not? What explains why some have suffered so much, while others barely felt the impact of the crisis?

Fiscal, monetary and regulatory policymakers around the world may be asking the same questions. Why was my country hit so hard by the recent events while others were spared? In this paper we examine whether national authorities in places that suffered severely during the global financial crisis are justified in believing they were innocent victims and that the variation in national outcomes was essentially random. Was the relatively good macroeconomic performance of some countries a consequence of good policy frameworks, institutions and decisions made prior to the crisis? Or was it just good luck?

We address this question in three steps. First, we develop a measure of macroeconomic performance during the crisis for 46 industrial and emerging economies. This measure captures each country’s performance relative to the global business cycle, which provides our benchmark. Next, we assemble a broad set of candidate variables that might explain the variation in cross-country experiences. These variables capture key dimensions of different economies, including their trade and financial openness, their monetary and fiscal policy frameworks, and the structure of their banking sectors. In order to avoid any impact of the crisis itself, we measure all these variables at the end of 2007, prior to the onset of the turmoil. Putting together the measured macroeconomic impact of the crisis with the initial conditions, we then look at the relationship between the two and seek to identify what characteristics were associated with a country’s positive macroeconomic performance relative to its peers.

Briefly, we construct a measure of relative macroeconomic performance by first identifying the global business cycle using a simple factor model. We calculate seasonally adjusted quarter-over-quarter real GDP growth rates and extract the first principal component across the 46 economies in our sample. This single factor explains around 40 per cent of the variation in the average economy’s output, but with wide variation across economies. We then use the residuals from the principal component analysis as the measure of an economy’s idiosyncratic performance. For each economy, we sum these residuals from the first quarter of 2008 to the fourth quarter of 2009. This cumulative sum, which captures both the length and depth of the response of output, is our estimate of how well or how poorly each economy weathered the crisis relative to its peers.

With this measure of relative macroeconomic performance as our key dependent variable, we examine factors that might explain its variation across economies. Given the small sample size, we rely on univariate tests of the difference in the median performance between different groups of economies, as well as linear regressions.

This simple analysis generates some surprisingly strong insights. We find that the better-performing economies featured a better capitalised banking sector, low loan-to-deposit ratios, a current account surplus and high levels of foreign exchange reserves. While the degree of trade openness does not distinguish the performance across economies, the level of financial openness appears very important. Economies featuring low levels and growth rates of private sector credit-to-GDP and little dependence on the US for short-term funding were much less vulnerable to the financial crisis. Neither the exchange rate regime nor the framework guiding monetary policy provides any guide to outcomes. Whether the government had a budget surplus or a low level of government debt are unimportant, but low levels of government revenues and expenditures before the crisis resulted in improved outcomes. This combination of variables suggests that sound policy decisions and institutions pre-crisis reduced an economy’s vulnerability to the international financial crisis. In other words, not everything was luck.


Results (excerpted)

(1) Economies where banking systems had higher levels of regulatory capital outperformed other economies in our sample, with a median CGAP of +1.5% versus ?0.7% for those that had not. These medians are statistically different from each other at the 1% level.

(2) Economies that experienced a banking crisis between 1990 and 2007 fared better, with a median CGAP of +2.6% versus ?0.7% for those that had not.

(3) Economies with a low loan-to-deposit ratio performed better than those with a high loan-to-deposit ratio. A one-standard deviation, or 51 percentage point, decrease in this ratio saw a 2.5% improvement in GDP performance over the crisis period.

(4) Economies with a current account surplus outperformed those with a deficit. A one-standard deviation increase in the current account as a percent of GDP, equivalent to 9 percentage points, resulted in a 2.4% outperformance in real GDP over the crisis period. Trade openness does not explain cross-country variation, and there was little difference between the median performance of commodity exporters and other economies.

(5) Economies with a low level of financial openness fared better than economies with higher levels of gross foreign assets and liabilities. When dividing the sample at the median level of financial openness, the half that were the most open had a median CGAP of –0.9% versus +3.0% for the half that were the least open.

(6) Economies dependent on the US for short-term debt financing fared worse. A one-standard deviation increase in US holdings of foreign short-term debt, equivalent to 2 percentage points of GDP, resulted in 2% less growth over the crisis.

(7) Economies with lower private sector credit did significantly better. When dividing the sample at the median level of private sector credit to GDP, economies in the top half, with higher private sector credit, had a median CGAP of –0.7% versus +2.9% for in the bottom half. The regression coefficient indicates that economies with credit-to-GDP one-standard deviation above the mean underperformed by 2% over the crisis period. Lower growth in private sector credit in the lead-up to the crisis also had a statistically significant effect of a similar magnitude.

(8) Countries that had a large stock of foreign exchange reserves outperformed. When dividing the sample at the median level of this variable, economies with more than the median foreign exchange reserves had a median CGAP of +2.9% versus –0.7% for economies in the bottom half. This result is not explained by whether an economy had an exchange rate peg or not. Similarly, the framework for monetary policy does not distinguish performance across countries.

(9) Countries having a small government, both in terms of low government revenues and expenditures to GDP, outperformed. When dividing the sample at the median level of either of these two variables, economies in the bottom half had a median CGAP of +3% versus –1% for economies in the top half. The regression coefficients imply that a year-end 2007 value for either government revenues or expenditures to GDP that was one-standard deviation above the sample mean was associated with lower output growth of 1.9% over the two-year period.

Taken together, these results confirm that economies with better fundamentals were less vulnerable to the crisis. Economies that experienced a banking crisis post-1990 and took steps to increase the capitalisation of their banks had superior macroeconomic performance, suggesting that prudential measures taken in response to crises improved the robustness of the financial system. A current account balance, low levels of financial openness and lower levels and growth rates of private sector credit-to-GDP helped insulate an economy from the crisis. Given that this crisis was triggered by events in the US, it also helped if an economy was not dependent on the US for short-term funding.


You can download the full paper at: http://www.bis.org/publ/work351.htm

Monday, August 8, 2011

Possible Unintended Consequences of Basel III and Solvency II

Some IMF staff published some ideas about the financial regulatory regime in a paper titled as this post:
In today’s financial system, complex financial institutions are connected through an opaque network of financial exposures. These connections contribute to financial deepening and greater savings allocation efficiency, but are also unstable channels of contagion. Basel III and Solvency II should improve the stability of these connections, but could have unintended consequences for cost of capital, funding patterns, interconnectedness, and risk migration.

Excerpts:
Efforts to strengthen the quality of capital for banks and insurers through Basel III and Solvency II are well advanced. On the one hand, the Basel Committee on Banking Supervision (BCBS), the organization responsible for developing international standards for banking supervision, adopted the Basel II framework in 2004 and, in response to the financial crisis, has taken steps to strengthen it in an incremental fashion to form what is now known the Basel III framework (BCBS 2009, 2011a, 2011b, and 2011c). On the other hand, the European Commission (EC) is leading the Solvency II project, in close cooperation with the European Insurance and Occupational Pensions Authority (EIOPA), to develop harmonized standards for insurance supervision within the European Union. A directive was adopted in 2009, and work—which included a series of quantitative impact studies—has been underway to develop supporting rules.

The regional scope of application of the two accords varies. Basel is an  “accord”/agreement with no legal force but potentially global applicability, whereas Solvency II is a legal instrument that will be binding in 30 European Economic Area (EEA) countries4 (27 European Union (EU) states plus Iceland, Liechtenstein, and Norway).  However, Solvency II has also implications beyond Europe through, for example, its influence on the international standards being developed by the International Association of Insurance Supervisors (IAIS), and because external insurance groups will be more easily able to operate in the EU if their home supervisory regimes are considered equivalent.

Although these standards have much in common, differences do exist. Both take a risk-based approach to minimum capital requirements and supervision and promote the integrated use of models by institutions in managing risks and assessing solvency. However, their objectives overlap only partially. In particular, Basel III attempts to increase the overall quantum of capital and its quality as a means of protecting against bank failures, including improved quantification of risks that were poorly catered for under Basel II. However, Solvency II attempts to strengthen the quality of capital and tailor the quantity of capital within the sector as a whole. Finally, the two accords have been tailored to the business characteristics of the respective sectors, often as a result of bilateral negotiations, and shaped by the views of those involved in their development in a piecemeal manner. Accordingly, they have generated long and complex documents which define the same concepts in different ways and often deal differently with the same or similar issues.


Paper objectives: (i) to present similarities and differences among Pillar 1 requirements of the two accords; and (ii) to discuss possible unintended consequences of their implementation. In order to ensure focus in the analysis, this paper is intentionally limited to aspects related to Pillar 1 (minimum capital requirement) in the two capital accords. The paper acknowledges that there can be significant overlap in the business activities of banks and insurers. For example, consumers save with banks through deposits and with life insurers through annuity with savings products. In addition, banks and insurers invest in many of the same types of assets and they compete with one another in raising capital, both in the capital markets and within the financial conglomerates of which many are members. Due to this overlap, differences in the two accords can generate unintended consequences in the area of cost of capital, funding patterns, and interconnectedness, and promote risk/product migration across or away from the two sectors. These unintended consequences are summarized in the conclusions together with policy considerations. Finally, the paper acknowledges that other sources of arbitrage not analyzed in this paper, like differences in Pillar 2 (supervisory approach) and Pillar 3 (market discipline), as well as differences in accounting (partially discussed here) and tax treatments, could reinforce or offset the impact of differences in the capital regulatory frameworks.  required more closely to the risks of each insurer, without necessarily increasing the quantity

Conclusions (edited):
124. The nature of capital needed by banks and insurers is naturally different. [...]

125. Basel III and Solvency II both attempt to increase the quality of capital in their respective sectors, but often have different provisions for similar issues. [...]

126. Provisions that cannot be related to the intrinsic differences between the two sectors can result in unintended consequences. For instance, it is unclear whether and, if so, to what extent the cost of capital for banks is going to increase compared to the cost of capital for insurers. On the one hand (i) the lack of an explicit objective to increase capital levels under Solvency II; (ii) the more restricted geographical application of Solvency II; (iii) the less persuasive need for capital systemic risk surcharges for insurers; and (iv) the yet to be defined standards for internal models for insurers suggest that cost of capital may increase more for banks than for insurers. On the other hand, arguments in support of higher cost of capital for insurers can also be made. But in general, Pillar 1 requirements across the two sectors are too different to argue conclusively in either direction. In addition, the new liquidity standards for banks and the new credit risk charges for insurers could affect the funding patterns of banks and increase the interconnectedness of the two sectors through the sovereign balance sheet. Finally, the two accords may result in an increased use of securitization for funding purposes by both banks and insurers. Hence, these unintended consequences could translate into risk migration between or away from the two sectors. 

127. Several policy considerations stem from the aforementioned analysis:
* Basel III and Solvency II suggest a need for insurance regulators to communicate with their banking counterparts to understand the combined implications of the behavioral incentives that the two regimes may provide. This could significantly reduce the risk of unintended consequences associated with seemingly inconsistent treatment of same risks under the respective accords. This would also avoid unintentional arbitrage between internal models and the standardized approach under Solvency II, as has happened under Basel II.

* In addition, while group supervision has been strengthened, concerns about leakages still remain. This is especially a concern under Solvency II, due to its restricted geographical application and the potential use of non-equivalent jurisdictions for reinsurance. A key challenge for all groups remains what will be the approach by the EC to equivalence.

* Also, the adequacy of safety nets may need to be reviewed in the future. The likely increased use of covered bonds by banks for funding purposes would ring-fence assets so that they are unavailable to depositors and unsecured creditors in case of resolution.

* Basel III and Solvency II could further increase the need to expand the perimeter of regulation. As both Basel III and Solvency II push banks and insurers toward shorter duration and less risky business, non-regulated entities and market-based risk transfer mechanisms might evolve to fill any gap in market capacity that emerges. In addition, the likely increased use of securitization by banks and insures alike requires a strengthening in transparency and oversight of these contagion channels including securities lending-related cash collateral reinvestment programs, implementing macro-prudential measures (such as counter-cyclical margin requirements) related to securitization, repos and securities lending where appropriate, and improving market infrastructure for secured funding markets.

* Basel III and Solvency II may lead to excessive risk transfer to consumers and therefore, may require strengthening consumer protection. To the extent that the new accords increase capital and funding costs, the product mix offered by banks and insurers may change and entail additional risks for consumers. For example, excessive risk transfers could be a concern in the area of pension benefits where consumers already bear significant investment and longevity risk. Additional risk transfers to consumers may not be socially desirable from the pension policy point of view.

* Finally, there appears to be a need for empirical investigation about the magnitude of the impact of unintended consequences. There is no universally agreed set of unintended consequences and this paper is the first attempt (that we know of) to generate a set and relate it to the specifics of the Basel III and Solvency II accords. In addition, there is a general absence of empirical studies on the extent of the impact of possible unintended consequences

Order a print copy here: http://www.imfbookstore.org/IMFORG/WPIEA2011187 (broken link for now).

Or request a PDF copy from us leaving a comment to this post.