Volatility can hurt – personally or corporately

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

Personally I am short Sterling and long U.S. and Canadian dollars.  Therefore I am intimately, sometimes painfully and always nervously acquainted with the recent volatility of currency exchange rates.  I wake up in mornings wondering if next week’s credit card bill or next month’s property tax can get paid. 

Against the U.S. dollar Sterling is way off where it was a couple of years ago but still significantly higher than 8 years ago.  The strength of the Loonie (Canadian dollar) is a blessing that I currently enjoy.  However, whenever news like the latest inflation figures come out (not good) or Gaddafi kills civilians, I either take a deep breath or heave a sigh of relief. 

So far I have kept out of the local mission but my concerns are a microcosm of those that all treasurers should be familiar with, whether it is currency volatility or related to commodity prices, interest rates or any other such variable. 

I feel comfortable when I manage or hedge my position in some way.  This might be converting in advance of my needs when rates are favourable or incurring an expense in dollars or gaining some income in sterling.  This is short term.  In the longer term, I might take the option I have to move back to North America! 

I do know that I am aware of my position and risks and am doing just about everything I can and that I am constantly reassessing and looking for better ways to do things.  I am also often seeking other views and ideas. 

The question every financial executive and treasurer should be asking themselves is do they have the same satisfaction that they know their risk exposures and are managing them the best they can?

In today’s Oz, Dorothy’s new chant: “Oil and coffee and beer, oh no!”

by Michael Arbow MBA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

 

In the 1939 movie classic The Wizard of Oz (my personal all time favourite), Dorothy, the Scarecrow and the Tin Man are walking along the Yellow Brick Road towards the Emerald City: when they enter a dark forest they begin to chant “Lions and tigers and bears, oh no!”. Putting a “liquid” commodity spin on that today, the refrain maybe: “Oil and coffee and beer, oh no!”. The move up in oil and coffee is well discussed in other RSD blogs but it appears barley can now be added to the mix with expectations of price increases hitting the consumer by 2011 year end or early next year. Better “drink-up” while you can because the Wicked Witch is heading this way. How are you preparing?

 

Asia’s next export: Inflation. G20 response: Increase interest rates

by Michael Arbow MBA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

Here in the rich western world, consumers are witnessing an interesting disconnect; namely the difference between what we see at the gas pump and grocery store and what we hear when our government’s announce inflation rates.  The disconnect stems from the definition of core verse headline inflation rates. The core rate strips out the so-called "volatile energy and food prices". Luckily, for many in the West the rising cost of food and energy is an annoyance and living with the core rate of inflation – from which the countries’ central banks base their interest rates on, is grudgingly accepted. 

On the other hand however, in the emerging economies where household incomes are lower and food and energy consumes a substantial portion of household income; national governments consider these elements as part of core inflation. Thus you are finding increased pressure for the central banks of emerging economies to raise interest rates to tame inflation and protect their currencies. The local trickle down effect of this will be for consumers to seek higher wages.  Higher wages, when combined with higher (commodity) input cost will translate into higher prices charged on manufactured products.  Once exported Asia’s pivotal role as deflation exporter will change; for their manufactured exports help constitute core inflation in the developed economies. 

As core inflation rises, so to will interest rates. If your firm is highly leveraged and thus sensitive to interest rates what steps are you taking today to reduce this future financial risk?  For the consumer, perhaps locking in longer terms rates is starting to look more attractive. 

 

For more on this follow the link to Pimco’s Mihir P. Worah’s viewpoint:

 http://tinyurl.com/4jcjnqd

 

Casino Risk Management

by Stephen McPhie, CA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

Firstly, sorry to all you guys that like to have an occasional flutter on the horses or big game.  This blog is about banking and bit of a digression from our usual blogs that focus on corporate risk management.  However, there are lessons for everyone and every company. 

Banks have been a favourite and easy target for politician and the press.  There is a lot of misinformation around, although it is hard to view the scale of some of the remuneration packages around as anything other than obscene – almost as obscene as that of some football (soccer to you guys across the pond) players!  Investment banking is now routinely referred to as “casino banking” and derivatives as evil.  As most of the general public have no idea what investment banks do, politicians and the popular press can get away with this, whether or not it is true.  They also generally overlook the fact that the problems of the British banks arose mostly from traditional lending activities. 

The clamour against the banks has been less muted than the action taken against them in spite of a public mood that would seem ripe for lynching all bankers.  Banks are useful to politicians who are masters of finding anyone but themselves to blame for anything that goes wrong … and if nothing goes wrong, then for anything that doesn’t go wrong! 

Nevertheless, there has been some action by government trying to keep a fine balance between satisfying the public demand to do something and penalising the banks too much and threatening London’s pre-eminence as a financial centre, and with it the loss of substantial tax revenues, employment and economic activity generally.  Essentially this has resulted in piecemeal actions with lack of a coherent vision and therefore market uncertainty.  Perhaps this can be viewed as casino risk management by government. 

Now things could be becoming unbalanced. 

It is rumoured that HSBC, Britain’s largest bank, is about to move its head office to Hong Kong.  HSBC moved its head office to London in the 1990’s after acquiring one of England’s largest high street banks, Midland Bank.  At that time the regulatory and tax environment in the UK was favourable and getting more so.  Also, Hong Kong was about to be handed back to China with all the uncertainties that created.  At the time, London probably seemed a good place for executives to base themselves. 

Now regulation is about to be tightened considerably in the UK and costs and taxes have risen considerably.  We are in the second year of a “one-off” bonus tax that covers all bank bonuses wherever paid, mainly a populist political reaction to public outrage about the issue.  Regulation in Hong Kong is much friendlier and there is probably a more stable and sympathetic outlook from the perspective of banks.  Of course a 17% personal tax rate does not stand in the way. 

HSBC is very international with only about 10% of business actually in Britain.  The lion’s share of its business is in Asia.  It also weathered the crisis in good health, a reflection mainly of its Asian business.  Some institutional investors are suggesting that relocating to Hong Kong would provide an instant boost to HSBC’s share price.  HSBC denies the rumours, albeit in a fairly vague fashion, but if I were a shareholder, I would assume it to be the duty of top executives and the board to consider the matter.  Moving a head office across the world would not be expected to be cheap.  However, in HSBC’s case they have a substantial infrastructure in place.  From a brief look, their main Hong Kong premises are certainly impressive.  Of course, all this might just be an attempt to influence government policy. 

From all this certain questions arise.  Are senior bank executives looking after their own interests against those of shareholders?  Have large global banks become so powerful that they can ignore politicians?  Will anything change?  Probably at least one “no” there.

 

Untitled

by Michael Arbow MBA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

According to a study conducted at George Washington University by Jaclyn M. Jensen entitled “The Consequences of Completion: How Level of Completion Influences Information Concealment by Decision Makers”, the closer a project is to completion the less likely knowledge of a significant problem is to effect the action of decision makers. In fact even when the test project was only 10% complete, 37.5% of the test subjects said they would not bring forward negative news. This simple experiment helps support the need for a independent risk management team working directly with C-level or senior management and at the same time being involved, and in contact with, all significant operations of the company. 

How independent is your risk team and how are they keeping their finger on the daily corporate pulse? The other issue here is how does your firm and its staff deal with adverse occurrences that could jeopardize a much touted project and how can they not fall into mode of behaviour seen in the above experiment?  Finally, just how approachable is the risk team? Does your staff feel that the risk team is working with them or for C-level?

VAR Trend is Your Friend (or at least a good early indicator)

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com 

 

For some reasons a lot of stuff has come across my desk recently that is bashing Value at Risk (VAR) and saying that it is a symbol for all that is bad in risk modeling.  I think it is time for a time-out.  As risk specialists, we also have to be optimists and look for the good in everything. 

One thing that I think that VAR is good at is indicating change.  I too recognize the limitations of VAR.  (One of the reasons so much is crossing my desk is that I teach several different courses in financial risk and also in Enterprise Risk Management.)  The limitations have been well documented. 

What is less well recognized is that VAR is still a very useful tool.  One of the ways to use VAR that helps to maximize its usefulness while minimize its weaknesses is to follow the trend of how the company (or project) VAR is tracking.  Looking at the trend, rather than the absolute number, can help you to ascertain when a shift in risk exposure has occurred.  It will also help to base-line out the traditional faults such as the use of parametric statistics or the use of the incorrect distribution. 

Tracking the trend of VAR is not a perfect remedy.  Watching the trend of a bad and inaccurate model, will still give useless and potentially misleading results.  However if a decent VAR model is constructed, and if more attention is paid to the trend than the absolute VAR number, then more useful (and accurate) information will be generated.

“15 reasons to love the loonie”: Exporters and global investors take note

by Michael Arbow MBA

Partner, RSD Solutions Inc.

www.rsdsolutions.com

info@rsdsolutions.com

 

I have been blogging about the long term strengthening of the Canadian dollar (the loonie) for around 2 years now. More recently David Rosenberg summarized in 15 quick reasons why the loonie is currently rising against the US dollar (see list below). What is interesting is that 13 of the 15 reasons are arguably long term habits of the Canadian economic and political system and thus reinforce the continuing steady rise of the currency. 

What is also interesting to note about the past two weeks is that the traditional “flight to safety” to the USD in the face of geo-political and economic uncertainty has not been happening (gold, silver and the Swiss Franc are the current safe havens).  I believe that is a significant event and should have the risk managers looking more closely at their US market/investment exposure.

 

15 Reasons to love the loonie:  

1. Better growth than in the U.S.A. and without need for stimulus

2. Responsible central bank, limiting growth in its balance sheet

3. Better fiscal backdrop

4. More conservative political environment

5. Triple the exposure to raw material than the U.S.A.

6. Investors get 115 basis points premium over US Treasuries at the front end of

the government yield curve

7. Canada in the top 15 net oil exporters globally … U.S.A. top importer

8. TSX dividend yield at 2.36%; S&P 500 dividend yield at 1.82%

9. Housing market in balance in most of the metro areas; no foreclosure

supply coming

10. Inflation is low and stable with minimal risk of deflation

11. Economic recovery being fuelled principally by business spending

12. Corporate tax rates on a sliding scale down

13. Immigration and capital flows running at record levels

14. Vancouver rated top city in the world to live (Toronto 4^th, Calgary 5^th)

15. Stable banking system with consistent dividend growth”

 

from:    David A. Rosenberg  (March 2, 2011)

Chief Economist & Strategist Economic Commentary 

Gluskin Sheff + Associates Inc.