Risk Rap

Rapping About a World at Risk

Big Data for a Small World: SMEIoT

smeiotIoT

The world is a great big database and algorithmic wizards and mad data scientists are burning the midnight oil to mine the perplexing infinities of ubiquitous data points.  Their goal is to put data to use to facilitate better governance, initiate pinpoint marketing campaigns, pursue revelatory academic research and improve the quality of service public agencies deliver to protect and serve communities. The convergence of Big Data, Cloud Computing and the Internet of Things (IoT) make this possible.

The earth is the mother of all relational databases.  It’s six billion inhabitants track many billions of real time digital footprints across the face of the globe each and every day.  Some footprints are readily apparent and easy to see.  Facebook likes, credit card transactions, name and address lists, urgent Tweets and public records sparkle like alluvial diamonds; all easily plucked by data aggregators and sold to product marketers at astonishing profit margins.  Other data points are less apparent, hidden or derived in the incessant hum of the ever listening, ever recording global cybersphere.   These are the digital touch points we knowingly and unknowingly create with our interactions with the world wide web and the machines that live there.

It is estimated that there is over 20 billion smart machines that are fully integrated into our lives.  These machines stay busy creating digital footprints; adding quantitative context to the quality of the human condition.  EZ Passes, RFID tags, cell phone records, location tracking, energy meters, odometers, auto dashboard idiot lights, self diagnostic fault tolerant machines, industrial process controls, seismographic, air and water quality apparatuses and the streaming CBOT digital blips flash the milliseconds of a day in the life of John Q. Public.  Most sentient beings pay little notice, failing to consider that someone somewhere is planting the imprints of our daily lives in mammoth disk farms.  The webmasters, data engineers and information scientists are collecting, collating, aggregating, scoring and analyzing these rich gardens of data to harvest an accurate psychographic portrait of modernity.

The IoT is the term coined to describe the new digital landscape we inhabit.  The ubiquitous nature of the internet, the continued rationalization of the digital economy into the fabric of society and the absolute dependency of daily life upon it, require deep consideration how it impacts civil liberties, governance, cultural vibrancy and economic well being.

The IoT is the next step in the development of the digital economy. By 2025 it is estimated that IoT will drive $6 Trillion in global economic activity.  This anoints data and information as the loam of the modern global economy; no less significant than the arrival of discrete manufacturing at the dawn of industrial capitalism.

The time may come when a case may be made that user generated data is a commodity and should be considered a public domain natural resource; but today it is the province of digirati  shamans entrusted to interpret the Rosetta Stones, gleaning deep understanding of the current reality while deriving high probability predictive futures.  IoT is one of the prevailing drivers of global social development.


SME

There is another critical economic and socio-political driver of the global economy.  Small Mid-Sized Enterprises (SME) are the cornerstone of job creation in developed economies.  They form the bedrock of subsistence and economic activity in lesser developed countries (LDC).  They are the dynamic element of capitalism.  SME led by courageous risk takers are the spearhead of capital formation initiatives.  Politicians, bureaucrats and business pundits extol their entrepreneurial zeal and hope to channel their youthful energy in service to local and national political aspirations.  The establishment of SME is a critical macroeconomic indicator of a country’s economic health and the wellspring of social wealth creation.

The World Bank/ IFC estimates that over 130 million registered SME inhabit the global economy. The definition of an SME varies by country. Generally an SME and MSME (Micro Small Mid Sized Enterprises)  are defined by two measures, number of employees or annual sales.  Micro enterprises are defined as employing less than 9 employees, small up to 100 employees and medium sized enterprises anywhere from 200 to 500 employees.  Defining SMEs by sales scale in a similar fashion.

Every year millions of startup businesses replace the millions that have closed.  The world’s largest economy United States boasts over 30 million SME and every year over one million  small businesses close.  The EU and OECD countries report similar statistics of the preponderance of SME and numbers of business closures.

The SME is a dynamic non homogeneous business segment.  It is highly diverse in character, culture and business model heavily colored by local influence and custom. SME is overly sensitive to macroeconomic risk factors and market cyclicality.  Risk is magnified in the SME franchise due to high concentration of risk factors.  Over reliance on a limited set of key clients or suppliers, product obsolescence, competitive pressures, force majeure events, key employee risk, change management and credit channel dependencies are glaring risk factors magnified by business scale and market geographics.

In the United States, during the banking crisis the Federal Reserve was criticized for pursuing policies that favored large banking and capital market participants while largely ignoring SME. To mitigate contagion risk, The Federal Reserve  quickly acted to pump liquidity into the banking sector to buttress the capital structure of SIFI (Systemically Important Financial Institutions). It was thought that a collateral benefit would be the stimulation of SME lending.  This never occurred as SBA backed loans nosedived. Former Treasury Secretary Timothy Geithner implemented the TARP and TALF programs to further strengthen the capital base of distressed banks as former Fed Chairman  Ben Bernanke pursued Quantitative Easing to transfer troubled mortgage backed securities onto Uncle Sams balance sheet to relieve financial institutions  of these troubled assets. Some may argue that President Obama’s The American Recovery and Reinvestment Act of 2009 (ARRA)  helped the SME sector.  The $800 billion stimulus was one third tax cuts, one third cash infusion to local governments and one third capital expenditures aimed at shovel ready infrastructure improvement projects.  The scale of the ARRA was miniscule as compared to support rendered to banks and did little to halt the deteriorating macroeconomic conditions of the collapsing housing market, ballooning unemployment and rising energy prices severely stressing SME.

The EU offered no better.  As the PIGS (Portugal, Ireland, Greece, Spain) economies collapsed the European Central Bank forced draconian austerity measures on national government expenditures undermining key SME market sensitivities.  On both sides of the Atlantic, the perception of a bifurcated central banking policy that favored TBTF Wall Street over the needs of  an atomized SME segment flourished.  The wedge between the speculative economy of Wall Street and the real economy on Main Street remains a festering wound.

In contrast to the approach of western central bankers, Asian Tigers, particularly Singapore have created a highly  supportive environment for the incubation and development of SME. Banks offer comprehensive portfolios of financial products and SME advisory services. Government legislative programs highlight incubation initiatives linked to specific industry sectors. Developed economies have much to learn from these SME friendly market leaders.

The pressing issues concerning net neutrality, ecommerce tax policies, climate change and the recognition of Bitcoin as a valid commercial specie are critical developments that goes to the heart of a healthy global SME community.  These emerging market events are benevolent business drivers for SME and concern grows that legislative initiatives are being drafted to codify advantages for politically connected larger enterprises.

Many view this as a manifestation of a broken political system, rife with protections of large well financed politically connected institutions. Undermining these entrenched corporate interests is the ascending digital paradigm promising to dramatically alter business as usual politics. Witness the role of social media in the Arab Spring, Barack Obama’s 2008 election or the decapitalization of the print media industry as clear signals of the the passing away of the old order of things.  Social networking technologies and the democratization of information breaks down the ossified monopolies of knowledge access. These archaic ramparts are being gleefully overthrown by open collaborative initiatives levelling the playing field for all market participants.

SMEIoT

This is where SMEIoT neatly converges.  To effectively serve an efficient market, transparency and a contextual understanding of its innate dynamics are critical preconditions to market participation.  The incubation of SME and the underwriting of capital formation initiatives from a myriad of providers will occur as information standards provide a level of transparency that optimally aligns risk and investment capital. SMEIoT will provide the insights to the sector for SME to grow and prosper while industry service providers engage SME within the context of a cooperative economic non-exploitative relationship.

This series will examine SME and how IoT will serve to transform and incubate the sector.  We’ll examine the typology of the SME ecosystem, its risk characteristics and features.  We’ll propose a metadata framework to model SME descriptors, attributes, risk factors and a scoring methodology.  We’ll propose an SME portal, review the mission of Big Data and its indispensable role to create cooperative economic frameworks within the SME ecosystem. Lastly we’ll review groundbreaking work social scientists, legal scholars and digital frontier activists are proposing to address best governance practices and ethical considerations of Big Data collection, the protection of privacy rights,  informed consent, proprietary content and standards of accountability.

SMEIoT coalesces at the intersection of social science, commerce and technology.  History has aligned SMEIot building blocks to create the conditions for this exciting convergence.  Wide participation of government agencies, academicians, business leaders, scientists and ethicists will be required to make pursuit of  this science serve the greatest good.

 

This is the first in a series of articles on Big Data and SMEIoT . It originally appeared in Daftblogger eJournal. Next piece in series is scheduled to appear on Daftblogger eJournal within the next two weeks.

#smeiot #metasme #sum2llc #sme #office365 #mobileoffice #TARP #capitalformation #IoT #internetofthings #OECD #TBTF #Bitcoin #psychographics #smeportals #bigdata #informedconsent

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July 9, 2014 Posted by | banking, Bernanke, commerce, commercial, credit crisis, economics, ethics, Internet of Things, IoT, politics, risk management, SME, SMEIOT, Sum2, sustainability, TALF, TARP, Treasury | , , , , , , , , , , , , , , , , | Leave a comment

Economic Recovery Gathers Steam

Private-sector employment increased by 217,000 from January to February on a seasonally adjusted basis, according to the latest ADP National Employment Report released today. The estimated change of employment from December 2010 to January 2011 was revised up to 189,000 from the previously reported increase of 187,000. This month’s ADP National Employment Report suggests continued solid growth of nonfarm private employment early in 2011. The recent pattern of rising employment gains since the middle of last year was reinforced by today’s report, as the average gain from December through February (217,000) is well above the average gain over the prior six months (63,000).

The fears of a jobless recovery may be receding but the US economy has a long way to go before pre-recession employment levels are achieved. As we stated previously the economy needs to create over 200,000 jobs per month for 48 consecutive months to achieve pre-recession employment levels. The six month average of 63,000 is still well below the required rate of job creation for a robust recovery to occur. The Unemployment Rate still exceeds 9%.

The February report is encouraging because it points to an accelerating pace of job creation. The post Christmas season employment surge represents a 30,000 job gain over January’s strong report that triples the six month moving average. The service sector accounted for over 200,000 of the job gains. The manufacturing and goods producing sector combined to create 35,000 jobs. Construction continues to mirror the moribund housing market shedding an additional 9,000 jobs during the month. The construction industry has lost over 2.1 million jobs since its peak in 2008.

The robust recovery in the service sector is welcomed but sustainable economic growth can only be achieved by a robust turn around in the goods producing and manufacturing sectors. Service sector jobs offer lower wages, tend to be highly correlated to retail consumer spending and positions are often transient in nature. Small and Mid-Sized Enterprises (SME) is where the highest concentration of service jobs are created and the employment figures bear that out with SMEs accounting for over 204,000 jobs created during the month of February.

Large businesses added 13,000 jobs during the month of February. The balance sheets of large corporations are strong. The great recession provided large corporates an opportunity to rationalize their business franchise with layoffs, consolidations and prudent cost management. Benign inflation, global presence, outsourcing, low cost of capital and strong equity markets created ideal conditions for profitability and an improved capital structure. The balance sheets of large corporations are flush with $1 trillion in cash and it appears that the large corporates are deploying this capital resource into non-job creating initiatives.

The restructuring of the economy continues. The Federal stimulus program directed massive funds to support fiscally troubled state and local government budgets. The Federal Stimulus Program was a critical factor that help to stabilize local government workforce levels. The expiration of the Federal stimulus program is forcing state and local governments into draconian measures to balance budgets. Government employment levels are being dramatically pared back to maintain fiscal stability. Public service workers unions are under severe pressure to defend employment, compensation and benefits of workers in an increasingly conservative political climate that insists on fiscal conservatism and is highly adverse to any tax increase.

The elimination of government jobs, the expiration of unemployment funds coupled with rising interest rates, energy and commodity prices will drain significant buying power from the economy and create additional headwinds for the recovery.

Macroeconomic Factors

The principal macroeconomic factors confronting the economy are the continued high unemployment rate, weakness in the housing market, tax policy and deepening fiscal crisis of state, local and federal governments. The Tea Party tax rebellion has returned congress to Republican control and will encourage the federal government to pursue fiscally conservative policies that will dramatically cut federal spending and taxes for the small businesses and the middle class. In the short term, spending cuts in federal programs will result in layoffs, and cuts in entitlement programs will remove purchasing power from the demand side of the market. It is believed that the tax cuts to businesses will provide the necessary incentive for SME’s to invest capital surpluses back into the company to stimulate job creation.

The growing uncertainty in the Middle East and North Africa is a significant political risk factor. The expansion of political instability in the Gulf Region particularly Iran, Egypt and Saudi Arabia; a protracted civil war in Libya or a reignited regional conflict involving Israel would have a dramatic impact on oil markets; sparking a rise in commodity prices and interest rates placing additional stress on economic recovery.

Political uncertainty tends to heighten risk aversion in credit markets. The financial rescue of banks with generous capital infusions and accommodating monetary policies from sovereign governments has buttressed the profitability and capital position of banks. Regulatory uncertainty of Basel III, Dodd-Frank, and the continued rationalization of the commercial banking system and continued concern about the quality of credit portfolios continue to curtail availability of credit for SME lending. Governments are encouraging banks to lend more aggressively but banks continue to exercise extreme caution in making loans to financially stressed and capital starved SMEs.

Highlights of the ADP Report for February include:

Private sector employment increased by 217,000

Employment in the service-providing sector rose 202,000

Employment in the goods-producing sector declined 15,000

Employment in the manufacturing sector declined 20,000

Construction employment declined 9,000

Large businesses with 500 or more workers declined 2,000

Medium-size businesses, defined as those with between 50 and 499 workers increased 24,000

Employment among small-size businesses with fewer than 50 workers, increased 21,000

Overview of Numbers

The 202,000 jobs created by the SME sectors represents over 90% of new job creation. Large businesses comprise approximately 20% of the private sector employment and continues to underperform SMEs in post recession job creation. The strong growth of service sector though welcomed continues to mask the under performance of the manufacturing sector. The 11 million manufacturing jobs comprise approximately 10% of the private sector US workforce. The 20 thousand jobs created during February accounted for 10% of new jobs. Considering the severely distressed condition and capacity utilization of the sector and the favorable conditions for export markets and cost of capital the job growth of the sector appears extremely weak. The US economy is still in search of a driver. The automotive manufacturers have returned to profitability due to global sales in Latin America and China with a large portion of the manufacturing done in local oversea markets.

The stock market continues to perform well. The Fed is optimistic that the QE2 initiative will allay bankers credit risk concerns and ease lending restrictions to SMEs. A projected GDP growth rate of 3% appears to be an achievable goal. The danger of a double dip recession is receding but severe geopolitical risk factors continue to keep the possibility alive.

Interest rates have been at historic lows for two years and will begin to notch upward as central bankers continue to manage growth with a mix of inflation and higher costs of capital. The stability of the euro and the EU’s sovereign debt crisis will remain a concern and put upward pressure on interest rates and the dollar.

As the price of commodities and food spikes higher the potential of civil unrest and political instability in emerging markets of Southeast Asia, Africa and Latin America grows. Some even suggest this instability may touch China.

The balance sheets of large corporate entities remain flush with cash. The availability of distressed assets and volatile markets will encourage corporate treasurers to put that capital to work to capitalize on emerging opportunities. The day of the lazy corporate balance sheet is over.

Solutions from Sum2

Credit Redi offers SMEs tools to manage financial health and improve corporate credit rating to attract and minimize the cost of capital. Credit Redi helps SMEs improve credit standing and demonstrate to bankers that you are a good credit risk.

For information on the construction and use of the ADP Report, please visit the methodology section of the ADP National Employment Report website.

You Tube Video: John Handy, Hard Work

Risk: unemployment, recession, recovery, SME, political

March 3, 2011 Posted by | commerce, credit, Credit Redi, economics, government, lending, manufacturing, recession, risk management, SME, taxation, Tea Party, unemployment, unions | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Credit Redi Helps Spot Small Business Credit Risk

The recession and credit crunch have shifted financial risk from banks to small and midsized businesses (SME) that often must extend credit to customers to make a sale. When companies extend credit, in effect making unsecured loans, they’re acting like banks but without the credit management tools and experience of a banker.

Credit Redi is designed for small businesses to quickly spot customer credit risk. Small businesses typically don’t have access to information that provides transparency about customer credit worthiness. Credit Redi is a credit risk management tool for small and mid-sized businesses. It only takes one or two bad receivables to damage an SME’s financial health. Market conditions quickly change and its critical to have some type of business insight into the businesses SME’s work with.

Credit Redi is also an excellent tool to determine the financial health of critical suppliers. A key supplier going out of business could have disastrous consequences for SMEs. Credit Redi monitors the financial health of existing suppliers and help managers make wiser choices in supply chain and business partner decisions.

Get Credit Redi here:

Risk: SME, credit risk, supply chain, partnerships, customers, receivables

January 10, 2011 Posted by | banking, commerce, credit, credit crisis, Credit Redi, customer risk, risk management, SME, Sum2, supply chain | , , , , , | Leave a comment

Leaky Reactors, Cyber Terror and Police States

This is how the world ends
This is how the world ends
This is how the world ends
Not with a bang but a whimper
The Hallow Men TS Elliot

A few interesting  news items recently passed without much notice.  Two nuclear reactors located in the Northeast had to be  brought offline due to operational failures.  The Vermont Yankee reactor sprang a leak and had to be shut down.  The other incident occurred at the thirty six year old Indian Point reactor located about twenty miles north of New York City.  The cause of the problem at Indian Point was a transformer fire.  Both reactors  are owned and operated by Entergy and mirror similar problems at the Excelon operated Oyster Creek reactor located in south central New Jersey.

These incidents are endemic to aging nuclear power facilities.  These plants came on line during the the 1970’s and are now approaching the half century mark of service.  When these plants were commissioned it was believed they would have a shelf life of 40 years.   As the expected useful life span of these facilities approach regulators routinely grant extensions to the operators.  Operating these facilities past that point heighten potential risk factors.  As nuclear reactors age, the stress on these complex systems and containment facilities raise risk factors heightening the potential of system failure that lead to catastrophic events.

Leaky plumbing at the Oyster Creek nuclear plant is the culprit in poisoning the Cohansey Aquifer with 180,000 gallons of tritium contaminated water.  Regulators and environmental officials assert that the level of radio active isotopes in the water supply that serves South Jersey and parts of Philadelphia is well within acceptable levels for human consumption.  I guess that all depends on your definition of human; but I and many others remain skeptical on the subject of drinking radioactive laced water.

The aging nuclear infrastructure of the United States is a growing cause for concern.  The nuclear power industry was halted in its tracks in the 1980’s by a strong No Nukes environmental movement.  At the time it was generally understood that the cost of catastrophic risk and the industries inability to solve the long term problem of disposal and management of nuclear waste turned the public against the industry.

The Three Mile Island accident in Pennsylvania and the disastrous meltdown at Chernobyl in the Russian Caucuses led to a moratorium on new plant construction in the United States leading to the actual abandonment of plant construction in the Washington and New York.  It created a capital market crisis as the fear of defaults on WPPSS  revenue bonds spread to cast long shadows on the entire Muni Bond market.  The state of  New York stepped in to purchase the facilities of Long Island Power in order to make bondholders of the closed facility whole with tax payer money.  It was kind of like socialism for investors.

While most of the world has continued to build nuclear plants to address growing energy needs; the United States has not built a nuclear plant since the 1980’s and has lagged the world in using nuclear power to address energy needs. Sentiment on the desirability of nuclear power is beginning to change.  The Pickens Plan, former VP Dick Cheney’s secret meetings to develop a national energy strategy, the Gulf Oil Spill, the need to reduce dependence on foreign oil and the growing acceptance that the burning of fossil fuels is slowly cooking the planet has placed nuclear power back on the table as a viable component of America’s energy portfolio.

China is committed to building 100 nuclear power plants to wean itself from its crippling dependence on coal.  The United States is charging hard to keep up with its fast growing Asian competitor in a 21st Century nuclear power race.  The aggressive pursuit of nuclear plant development will increase the power and control of corporate entities charged with their construction, management and on going administration.  To accomplish a dramatic build-out in nuclear infrastructure large areas of  land situated near a plentiful water supply will need to be secured.   Environmental impacts, regulatory oversight and public transparency will be sacrificed at the alter of cost efficiency, expedience in implementation and security to protect the vulnerable facilities against the pervasive armies of terrorists that lurk in the shadows near every nuclear plant.

The controversy surrounding the collusion of government and business to exploit the Marcellus Shale natural gas vein is an instructive model of what we can expect from the stakeholders pursuing an aggressive campaign to develop Americas nuclear power infrastructure.  The dismissal of regulatory controls, the eminent domain of corporate interests, the opaque wall that shrouds risks factors and hides the environmental degradation resulting from the practice of fracking and the sacrifice of watersheds and aquifers to the expeditious extraction of natural gas are some of the documented behaviors of  a wanton corporate will imposed on the body politic.  Tragically this near sighted perspective willfully sacrifices the sustainable ecology of communities to the sole purpose of the profitable extraction of resources to serve shareholders of private corporations.   The nature of the nuclear beast will require that its interests be enforced by courts of law guided by extreme prejudice and protected by police battalions, state  guard units and private security groups in the name of national security interests.

The recently discovered Stuxnet computer virus is an indication of how the stakes are being raised in the nuclear power shell game.  The launch of a successful cyber attack on a nuclear facility anywhere in the world is a real game changer.  Self deluded uber patriots act more  like real pinheads if they believe that the destruction of Iran’s nuclear power capability is a harbinger for Middle East peace or enhances the   security of either Israel or the United States.  A nuclear event in Iran or North Korea are real game changers for the course of human history and the well being of  humanity. A clandestine service that can take out Iranian nuclear reactors can also be deployed to take out a reactor that is twenty miles north of New York City.  Or consider the consequences of a summer heat wave ravaging the citizens Philadelphia dying of thirst because the water supply is contaminated with radiation.  The extent of civil unrest would be extreme overwhelming the local law enforcement and judicial capabilities.  If these bleak scenarios come to pass,  Americans will be pining away for the good old days when a quick feel up at the airport by a TSA gendarme is fondly recalled like a high school make out session.  The pernicious yoke of marshal law under the nuclear challenged corporate security state will be incessant in practice and swift, sure and dire in its execution.

You Tube music video: No Nukes Concert 1979: Doobie Brothers Taking it to The Streets

Risk: democracy, energy policy, nuclear power, civil liberties

 

November 22, 2010 Posted by | community, culture, democracy, disaster planning, ecological, energy, environment, government, military, nuclear, regulatory, risk management | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Regulation and Social Democracy

Last year during the height of the banking crisis I remember Larry Kudlow stating that the US market has a choice. It could pursue the EU model of high regulated markets producing low consistent returns or the American model of less regulation and volatile cycles of high risk and potentially higher returns. If the sole focus of government was the peace of mind and well being of investors Mr. Kudlow’s observation would be valid. Government however must consider a larger community of stakeholders in its scope of concern. Regulatory oversight, the harmony of capital and labor and the incubation of an economic culture that is favorable to and supportive of SMEs are the critical questions confronting all governments particularly those in developed economies.

The EU’s social democratic economic models embody the best and worst aspects of these issues. The social democratic state attempt to combine entrepreneurial impulses of capitalism with the management and administration of social welfare for all its citizens. Democratically “elected administrators” use the apparatus of the state to facilitate and manage the competing interests of capital and labor, free markets and regulation while seeking to balance an entrepreneurship friendly culture with long term sustainability.

Yesterday a toxic tsunami of aluminum sludge coated 16 square miles of pristine Hungarian countryside. It is a telling example of a severe risk event that confronts modern life. A lassiaz-faire approach to the event is not viable and offers no solace to those harmed by this assault. Communities cannot be asked to suffer a market response that promises to correct the problem of the next instance of this event. The construction of better berms and the implementation redundant protection devises to safeguard against this risk for the future is little compensation to those who were killed, injured and lost property or livelihoods as a result of MAL Zrt poor risk management practices.

Better to suffer a regulatory initiative that is based on an understanding of an economic ecosystem as complex and inhabited by competing interests of diverse stakeholders. The ecosystem including the shareholders of MAL Zrt, residents of the surrounding communities, plant workers (also community residents), small businesses (SME) and down stream farmers making a living on arable land and access to clean water all have a stake, albeit competing, in the safe operation of the plant. The possibility that the toxic sludge may find its way into the Danube poses a threat to the water supply of other eastern European nations. This elevates this catastrophic event to other EU jurisdictions. The inter-dependencies and interconnectedness of the pan-regional and larger global economy requires vigorous regulatory safeguards, mitigation initiatives and enforcement response.

The true cost of this event is potentially staggering. It supersedes the narrow interest and economic value of shareholders rights and capital invested in MAL Zrt. Bad economic behavior exemplified by BP’s Horizon Deepwater failure to install redundant protective devises to keep production costs to a minimum, ended up costing BP shareholders and Gulf Coast stakeholders dearly.

State intervention in markets and the reemergence of managed economies is a reality of the global economy. The “managed economy” of the Peoples Republic of China places western style “free market” economies at a disadvantage. The managers of the PRC efficiently deploy and manage capital, effect trade and market protections and scrupulously manage currency valuation. It has created enormous social wealth for China and has contributed to its rapid rise as a preeminent world power. China’s rise requires better coordination of private capital and government to marshal a competitive market response to the challenges posed by managed economies to free and open markets of western democracies. The massive pools of capital deployed by sovereign wealth funds of oil producing regencies and the growing insurgency and power of underground economic activity also pose significant challenges to the viability of unregulated markets.

America’s free market model that eschewed regulation since the 1980’s evolved into a mercantile economy with a weakened economic base. The outsourcing of manufacturing infrastructure loosened free market impulses that left in its place a debtor nation whose warped economy depended on housing/commercial real estate construction (collateral creation/securitization), credit marketing, retailing and a service sector that was designed to support the new economic paradigm. It is a model that has proven itself to be wasteful, costly and unsustainable.

Deregulation has led to the dislocation of the capital markets from the real economy. It has contributed to the massive disparities in social wealth and a crumbling infrastructure. Milton Friedman’s mistaken belief that free market impulses would preserve infrastructure investment has been proven incorrect. Ironically this has added to the government’s burden to provide social assistance to segments of the population disenfranchised from economic participation. Some believe that the basis for the prosecution of the wars in Iraq and Afghanistan are economic stimulus programs designed to keep the economy going due to the vacuum created by the loss of manufacturing.

China’s example nor the resurrection of the soviet socialist model is not a desirable alternative for western democratic capitalist societies. Centralized control and state economic planning is rife with inefficiencies. State run economies threatens liberty, stifles innovation and encumbers economic dynamism. The virtues of capitalism (innovation, dynamism, liberty) needs to be encouraged and blended into the new economic reality of a highly dependent and interconnected world that requires cooperation, coexistence, sustainability, fair asset valuation, and the equitable sharing of resource and responsibility. SME’s are at the forefront of innovation, value creation and dynamism and will play a leading role in the creation of new social-political values as sources of sustainable growth and wealth in the emerging economic paradigm.

You Tube Music Video: Franz Liszt, Hungarian Rhapsody No.2 Orchestra

Risk: regulatory, capitalism, sustainability

October 6, 2010 Posted by | democracy, economics, government, labor, politics, real estate, recession, regulatory, risk management, SME | , , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Healing the Breach: An Essay on Sound Practices for Fund Managers

…“the “money-management business” (with its plethora of mutual funds, investment counseling firms, and hedge funds) has so many practitioners who’ve grown up in an era where it’s all been about marketing and not risk management,…” “If 2004 goes bad, it will go really bad “ Bill Fleckenstein Contrarian Chronicle

This candid remark is an astonishing observation. The assertion that money management is more about marketing then risk management is a bit disconcerting. The most recent Security Exchange Commission’s (SEC) announcement concerning its investigations of brokerage firms for receiving commission payment premium’s by asset management firms for directing investors into purchases of preferred mutual funds is the latest example of how this statement is a tragic reality for investment product consumers.

We live in the era of radical capitalism. It is characterized by fierce political pronouncements of the sanctity of laissez-faire principles and the ultra aggressive pursuit of free markets, resulting in the increased rationalization of the market mechanism into our culture and daily lives. For many readers this statement is not surprising or profound. Marketing is king, and if you have any doubts about it, try locating a music station in New York City that is not wed to a Top 40 play list or Talk Radio format.

However, as this Milton Friedman vision of utopia continues its inexorable march of rationalization, a strange alchemy is taking place. As businesses damn the torpedoes to pursue markets, ethical business practices and sound corporate governance principles are being sacrificed at the alter of EBITDA, ROE, P/E’s and the Holy of Holies those sacred stock options. The ironic twist to all this is that these aggressive business practices defended on the grounds that they enhance shareholders value are actually seriously eroding the values of brands, profit margins and market capitalizations. Ask a shareholder of Enron, Parmalat or WorldCom about the clever corporate stewardship of these company’s former management teams and you’ll get a resounding thumbs down.

But there is something deeper going on here. When investors entrust their money to an investment manager, they may be attracted to the sizzle (remember past performance is not indicative of anything) but what they want is still the steak. Investors want an investment manager that can understand their investment goals and risk tolerance and provide them with an investment vehicle that can balance that risk tolerance with the capability of realizing an expected return. The act of giving a manager discretionary power over an individuals retirement fund, a union’s pension portfolio, a family office or child’s educational financing vehicle is a tremendous act of faith that requires an extraordinary degree of confidence in the manager’s ability to provide an acceptable return, but to also be a trusted fiduciary that has the requisite operational support and controls in place that will safeguard and honestly seek to grow and protect an investors capital.

Mr. Fleckenstein’s assertion that risk management has taken a back seat to marketing and product placement is unfortunately an accurate assertion. The financial services industry is unique in the sense that it is the loam of all capitalist constructs. Yet as a business, financial services companies are no different from any other economic enterprise. All companies create products and differentiate themselves through the value proposition incorporated into their product. Intrinsic to the product creation process is a determination of the type of materials that will form its composition. A conscious decision is made as to how the product will be positioned and marketed, its performance metrics determined, customer service resources required to support the product as consumers use it and how it will be distributed. Once those variables have been determined, a profit margin is added and a value proposition to potential customers is conveyed. The value proposition that is communicated to consumers comes to be known and identified as the product brand. An investment product is designed to essentially address current and future financing requirements and the risk profile of the consumer are central to the design and purpose of the product. That is why this bifurcation is so dangerous. It undermines the inherent purpose of the investment product and should more truthfully be marketed as a product that enriches the commission merchant that may over a specified period of time garner a return for the investor. Think about all the Enron employees who had their 401k’s invested entirely in Enron stock.

This is probably the most significant point and primal differentiator of companies that manufacture financial products with that of companies that manufacture consumer durables. Financial products facilitate the flow of capital through the markets. It feeds the invisible hand that guides and directs all economic activity. If the flow of financial products is impeded, or abates due to consumers lack of confidence, a consumer driven economy like that of the United States will suffer greatly. Foreign governments and institutions buy US Government bills, bonds and notes because of the well-earned confidence they have in Uncle Sam’s stable currency and it’s ability to pay it’s debt and provide a fair return to all note holders. However if that confidence goes away, Uncle Sam will have to curtail its deficit spending, raise taxes on its people and enter into other messy measures to remain economically viable. Confidence is a lovely thing both for nations and companies and once that confidence is lost it is a difficult, if not an impossible thing to regain. Confidence is the basis of risk management. Credit risk and rates of return, the key variables of risk management, all start with the certainty of confidence.

Yes, from an investment performance point of view 2003 was a terrific year. All major equity indices were up. Thanks in large part to a federal tax rebate program the US economy grew by 8% during the 3rd quarter, prompting Mr. Greenspan to proclaim with a certain degree of confidence that the recession had ended. Yet from corporate governance, business confidence point of view, 2003 business news makes the turn of the century robber barons look like acolytes of Mother Teresa. To restore confidence investment managers need to develop a Sound Practice program that will repair the breech and bridge the bifurcation of marketing and risk management within the investment management enterprise. Lets turn our focus on how and why this bifurcation must be bridged.

Sound Practices Builds Confidence

The explosive growth of the global hedge fund industry and the important role it plays in providing market liquidity and as an alternative asset class for high net worth investors and institutions is increasingly placing the industry in the global spotlight and many regulators, interest groups and institutional consumers are demanding greater transparency and advocating increased oversight and government regulation.

The Long Term Capital Management debacle, George Soros’s unilateral assault on and profitable dismantling of the Pre-Euro Exchange Rate Mechanism, numerous hedge fund blow-ups through poor management controls or outright fraud, and the most recent disclosure of the widespread collusion of hedge fund arbitrageurs and mutual fund managers to conduct market timing trading, is seriously eroding investor confidence in financial institutions. This is creating a political climate favorable to enhanced regulation and oversight of financial institutions. The recent investigative actions of New York State Attorney General Elliot Spitzer, and the appointment of William H. Donaldson to head the SEC are clearly political responses to the crisis in corporate governance and regulatory malfeasance.

At last count, there are approximately 20,000 companies engaged in investment management within the United States. Some investment companies are regulated by the SEC, some by the Commodities Futures Trading Commission (CFTC), some by the National Association of Securities Dealers (NASD), some conform to best practices required by custodial counter-parties, and some are guided solely by the good conscience of the fund manager.

In this rapidly expanding market, managers are seeking to differentiate themselves and attract investors assets through slick marketing campaigns, presentations, road shows, and shameless boasts about a mangers progeny, experience and past performance. Attestations of operational readiness and management’s commitment to ethical corporate governance is usually covered with a statement that lists the prime broker, the accounting firm for auditing and the administrator for transfer agency and shareholder communications. The manager believes that by listing the service providers (corporate brands) they convey a message to the investor that they are operationally sound and have the operational controls in place to satisfy all contingencies. Unfortunately, these service providers are retained for a very specific purpose and taken in aggregate do not amount to the implementation of a unified sound risk management program. Indeed, Arthur Anderson was a leading provider of services to the alternative investment management market and reliance on this brand to infer regulatory compliance or adherence to sound operational practices was clearly a miscalculation.

In the day-to-day operation of the business the tension between regulatory compliance and entrepreneurial zeal is usually resolved in favor of doing the transaction. When we asked an executing broker working a large sale transaction for a first time hedge fund customer if the hedge fund identity had been properly documented and verified in conformance with the rules of the USA PATRIOT Act he stated, “They’ll never answer these questions and if we ask they’ll simply go to another broker to work the order. We’ll take the hit to do the deal.” Yes this broker made a calculated decision based on the potential that the hedge fund was not entering into this transaction to launder money through the capital market system or was a front for terrorist financing. He was probably right, and earned his firm a nice commission for working the 100,000-share block at $.05 per share. But what if he was wrong? Was the premium commission rate a fair return for a ruined reputation, a million dollar fine, the revocation of your industry license, a lifelong ban from the industry, or even a prison sentence?

What are Sound Practices?

Sound Practices are a set of standards and operational controls that mitigate numerous risk factors in the investment management enterprise. Sound Practices address the investment process, its decision and operational support functions, capital introduction, compliance requirements, business continuity, fund strategies and investor communications within a set of defined expense ratios.

What’s the difference between Sound Practices and Regulatory Compliance?

If we accept the definition that compliance is a set of externally imposed rules required to insure that counter-parties of a transaction and the rules governing the transaction meet acceptable minimum standards to facilitate an ethical and efficient exchange of value; I think we come pretty close to the meaning and nature of compliance and the purpose of the functions required to support it.

In the United States, depending upon the type of products a financial services firm offers, there may be or may not be a governmental agency or Special Regulatory Organization (SRO) that is charged with compliance oversight and enforcement of its business practices. The Office of the Comptroller of the Currency (OCC) is charged with the responsibility to oversee compliance with regulatory statutes for savings and loans, thrifts and banks. For broker/dealers the NASD is the SRO oversight body. For mutual fund companies and publicly listed companies, the SEC is the regulator. Future Commission Merchants are regulated by the CFTC; and hedge funds, -sometimes referred to as an Unregistered Investment Company (UIC)- at present escape any formalized regulatory oversight body.

Each regulatory body has its own set of compliance rules, guidelines and enforcement mandates. One can imagine the overlap and confusion that occurs when a bank owns a broker dealer, which owns an asset management firm, that offers mutual funds and off shore hedge fund products to institutional, retail and high net worth investors. The maze of regulators and the differing and sometimes contradictory regulatory requirements creates a reactionary and possibly antagonistic response to regulatory examinations and demands. At the very least, compliance is a significant cost of doing business and adds little to the intrinsic value of the product offered by the institution. The added expense of compliance deals with the structural aspects of the market, not the intrinsic value of the product. This is a dangerous bifurcation in its own right. A financial product, (specie for the capital markets) requires a denigration of value to assure a controlled velocity through a regulated market structure.

For companies that view regulatory compliance as a necessary evil that tempers entrepreneurial pursuits and whose function is an added cost of doing business; these organizations will develop a best practice culture that is inherently restrictive. This type of corporate response to regulatory or best practices initiatives will always be overwhelmingly reactive and places the enterprise at great operational and regulatory risk.

Sound Practices are different. Sound practices are a set of internally (organically) developed operating principles that inform the values of ethical corporate governance, is enforced by internal management and seeks to become invisible as it ingrains itself into the operational and business culture of the firm. Sound practices must be viewed as fundamental to a firm’s value proposition, organically grown and endemic to the corporate culture and proactively conveyed to the market as a premium brand.

The internal development or organic growth of best practices as a central desire and objective of the corporate enterprise is revealed as central to product brand and the value proposition offered in the market. This positions the firm and its products as a premium brand. The business benefits of a sound practice program are enhanced margins, product performance and the attraction of quality clients and vendor relationships. More importantly it differentiates the firm in a crowded market because its quality brand is perceived by the market as endemic to the firm’s corporate culture and as such is inherently superior to something that is externally imposed by some governmental or regulatory body. On a macro-economic level the socialist or state capitalist experiments in highly regulated planned economies are the logical extreme and true antithesis of a sound practice culture.

Within the hedge fund industry in the United States the concept of Sound Practices first surfaced in an industry study entitled Sound Practices for Hedge Funds. The study was an industry response to the Clinton Administration’s request to examine the lessons learned from the Long Term Capital Management implosion and recommend basic guidelines to avoid similar disastrous occurrences in the future. The paper was a breakthrough on a number of fronts, placing the science of risk management and the utilization of risk measurement tools at the center of the investment management enterprise. Though the study was a political response to a catastrophic market event, the real purpose of the study was to temper the drive to regulate the hedge fund industry. In essence, the authors of the study asserted that regulatory oversight is not needed if hedge funds implement and maintain a sound practices program. Sound practices will allow investment companies to remain unregulated and will assure that the industry is fully capable of self-policing through the creation of practice standards. Indeed, any regulation or governmental oversight will further drive the industry offshore to more discreet and tax friendly domiciles and could potentially drain capital and liquidity from the US capital markets.

Operational Risk Mitigation

As previously stated, developing and adhering to a set of best practices principals and guidelines will add intrinsic value to product and corporate brand. The purveyors of Business Performance Management (BPM) solutions routinely boast the claim that publicly listed companies that practice BPM have P/E ratios that trade at a 15% premium to industry peers who have not implemented a BPM strategy. The question whether BPM is a silver bullet to enhance market value or whether BPM practitioners are leading companies dedicated to implementing programs and mechanisms to build shareholder value are irrelevant. What is important is that BPM practitioners are implementing processes and tools to understand and isolate operational risk to create product delivery and decision support mechanisms that build intrinsic product and corporate brand value. Thus at its heart, BPM practitioners seek to heal the bifurcation of marketing and operational risk management and firmly establish and display the synthesis as central to the value proposition a company delivers to its clients.

Operational risk factors in the investment management complex are numerous. They include valuation practices, system infrastructure, business continuity contingencies, vendor and service provider dependencies, risk management tools, risk management function segregation and asset gathering or capital introduction and investment acceptance principles. All of these risk factors are significant and each one on its own could threaten the ongoing viability of the enterprise. Each risk factor must be addressed in detail with a comprehensive programmatic approach to develop and implement processes and controls to enhance best practices to support the function and mitigate the risk factor associated with the business process. The Basel Capital Accord (Basel ll) proposes the introduction of a capital charge related to the operational risks of financial institutions. Basel II defines operational risk as “the risk of direct or indirect loss resulting from inadequate or failed internal processes, people and systems or from external events.”

As an example, poor record keeping or an honest miscalculation on a corporate action treatment or security valuation can be forgiven. After all, the restatement of earnings -even during the Sarbanes Oxley Era- in corporate America is common. Laundering money for criminal enterprises, or heaven forbid, financing terrorism goes way past lax controls. In the eyes of the law it is criminal, in the eye’s of regulatory authorities it’s a serious offence, and a heavy fine and asset forfeiture is possible. If this occurs, in the mind of the consumer the fund manager is guilty of two counts of treason. The first count of treason the fund manger is guilty of is against his country. The second count the fund manager is guilty of is the betrayal of a sacred fiduciary duty. A hedge fund manager would probably never recover from this type of avoidable catastrophic risk event.

Fund managers need not look at compliance with the USA Patriot Act as another cumbersome compliance requirement that will be expensive to address. The belief that compliance will antagonize or annoy potential clients and may in fact drive them to a competitor whose controls are not as stringent and whose compliance laxity facilitates transactions by making it easier for investors to place assets with the competitor may hold some truth. But shouldn’t a fund manager avoid those types of clients anyway?

Compliance with The USA Patriot Act requires that investment companies conduct due diligence and maintain and administer a Customer Identification Program (CIP). Investment companies should view compliance with the Act as an opportunity to develop a Know Your Customer (KYC) capability that enhances and enriches the client relationship with the firm. When fund managers make KYC the cornerstone of their product development initiatives marketing will then truly serve the risk management requirements of clients.

The process of conducting the KYC due diligence exercise results in a more in-depth understanding of the customer. As managers are verifying customer identification information they will routinely uncover residential, employment and family histories that give them a better perspective on the client’s needs, their appetite for risk, other fiduciary relationships the client has and the source of the clients wealth. The regulatory objective of the KYC process is to verify the clients identity and to make sure they are not a money launderer or terrorist. The sound practice objective of the KYC process is to cover the regulatory requirements and more importantly to gain insights and understandings into their personal and business motivations. Armed with this understanding the manager can design or offer an investment product that will address the client’s risk management requirement. Client’s will appreciate the fact that managers are conducting this due diligence to insure that their funds will not be commingled with money launderers or terrorists, and that the firm is taking appropriate steps to insure that they transact business with reputable clients whose ethical and moral standards are similar to their own high standards.

As clients experience the KYC discovery process, they will begin to understand that the firm is committed to delivering a qualitatively superior value proposition. The client experience will help them to understand that the marketing focus of the firm is to acquire trusted customers and the depth and quality of client relationships are established to understand client needs and requirements. The client will also gain the assurance that regulatory risk and the potential for large fines and asset forfeitures are minimized due to the care the firm has exercised in determining that its clients are the right type of clientele and that the firm’s management has created operational controls and processes to prevent the risk of money laundering within the investment management enterprise.

Furthermore, subscription and redemption releases are facilitated due to proper controls in place with administrators and custodial institutions. This places enhanced liquidity at a fund manager’s disposal allowing the manager to practice effective cash management techniques that position the manager to take advantage of investment opportunities that may arise. This raises the possibility of developing a more effective collateral management capability that will tighten spreads on haircuts and dramatically reduce financing expenses. The credit rating of the firm would improve allowing lenders to further reduce financing rates to capture the funds business in a competitive credit and financing market. The reduction in the cost of capital can dramatically affect investment performance and the marketers can truly boast of a source of alpha that is directly attributable to operational sound practice processes.

Having proper procedures and business processes in place with administrators and custodian institutions will also facilitate the transfer of shareholder data to accountants for tax and audit purposes. This will expedite the delivery of tax and performance information to shareholders, generating savings in preparation fees and lessening the possibility of costly restatements. This will reduce and maintain fund expense ratios to absolute minimums. Marketers can clearly demonstrate that the fund managers are good stewards and are as concerned with minimization of business expenses as well as investment performance and high watermarks.

Increased transparency and the opportunity to dramatically enhance shareholder communications and reporting will be a strong attraction to many investors. Indeed, many institutional investors demand a level of transparency, communication protocols, and reporting tools that would have been unthinkable only a short while ago. As sophisticated institutional participation grows within the industry, the implementation of a sound practice program will be the only way hedge fund products can incorporate the necessary value proposition that addresses their risk management profiles and requirements. Sound practices and the compliance function become significant differentiators and powerful marketing tools. At last, the bifurcation is healed.

James Wolfensohn, President of the World Bank has been quoted as saying, “Corporate governance is about promoting corporate fairness, transparency and accountability.” Sound Practices is a necessary prerequisite for effective and ethical corporate governance. Fund managers must accept it’s precepts and sell side institutions and other industry participants and service providers must demand compliance, disclosure, ethical trading principals, honest research, operational integrity and a full commitment to its implementation and adherence. Effective corporate governance practices will restore the faith of the investing public in the global financial services industry and maintain the rationality of the world’s capital markets. It will also please investors to see realized enhanced returns on investment portfolios and help fund managers to fully participate and enjoy the benefits of a thriving hedge fund practice.

Originally written January 5, 2004, the article is significant because it raises concerns about financial services product marketing practices that still need to be addressed six and half years later.

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Risk: regulatory, consumer confidence, sound practices

June 7, 2010 Posted by | AML, banking, Basel II, credit crisis, hedge funds, investments, marketing, operations, private equity, product, product liability, regulatory, reputational risk, risk management, sound practices | , , , , , , , , , , , , , , , , , , , , | 1 Comment

Hedge Funds Navigating Industry Sea Change

This years Schulte Roth Zabel’s (SRZ) 19th Annual Private Investment Funds Seminar stuck a very different pose from last years event. One year on from the global meltdown of financial markets, languishing institutional certainty and the pervading crisis of industry confidence has been replaced with a cautious optimism. The bold swagger of the industry however is gone, in its place a more certain sense of direction and expectation is emerging. Though managers continue to labor under unachievable high water marks due to the 2008 market devastation, 2009 marked a year of exceptional performance. Investment portfolios rebounded in line with the upturn in the equity and bond markets. Liquidity improved and net inflows into the industry has turned positive during the last quarter as large institutional investors and sovereign wealth funds returned to the sector with generous allocations. These are taken as clear signs that the industry has stabilized and the path to recovery and the healing of economic and psychological wounds are underway. Yes the industry will survive and ultimately thrive again but it will do so under vastly different conditions. The new business landscape will require an industry with a guarded culture of opaqueness to provide much greater transparency while operating under a regimen of greater regulatory scrutiny.

The 1,900 registered attendees heard a message about an industry at a cross road still coming to terms with the market cataclysm brought on by unfettered, unregulated markets and excessive risk taking. SRZ offered an honest assessment in examining the industries role in the market turmoil. Speakers alerted attendees to an industry at a tipping point. To survive the industry must adapt to a converging world that believes that uniform market rules and regulations are the surest safeguards against catastrophic systemic risk events. A global political consensus is emerging that expresses support for industry regulation as an effective tool to mitigate the pervasiveness of fraud and market manipulation that undermines investor confidence and ultimately the functioning of a fair and efficient open free market.

Paul Roth, Founding Partner of SRZ, noted in the events opening remarks that the market is beginning to recover as evidenced by industry AUM once again exceeding the $2 trillion mark; but he warned that any exuberance needs to be tempered with the understanding that the new normal would not resemble the pre-crash world. The days of cowboy capitalism and radical laissez-faire investing are clearly over. Indeed Mr. Roth wryly observed “the industry must develop a maturity about the need for change. He concluded “that the industry must respond by playing a constructive role in forming that change.”

The conference subject matter, speakers and materials were all top shelf. Break out presentations on risk management, regulatory compliance, distressed debt deal structuring, tax strategies and compensation issues all reinforced the overriding theme of an industry in flux. The presenters passionately advocated the need to intentionally engage the issues to confront accelerated changes in market conditions. By doing so, fund complexes will be in a position to better manage the profound impact these changes will have on their business and operating culture. Subject issues like insider trading, tax efficient structuring, hedge fund registration, preparing for SEC examinations and the thrust of DOJ litigation initiatives and how to respond to subpoenas were some of the topics explored.

To highlight the emerging regulatory environment confronting the industry, a presenter pointed to the Southerization of the SEC. This is an allusion to the hiring of former criminal prosecutors from the Department of Justice, Southern District of New York to go after wayward fund managers. The SEC is ramping up its organizational capability to effectively prosecute any violations of the new regulatory codes. The growing specter of criminal prosecutions and the growing web of indictments concerning the high profile case of Mr. Raj Rajaratnam of the Galleon Group was presented as evidence of an emerging aggressive enforcement posture being pursued by regulators. Managers beware!

Presenters made some excellent points about how institutional investors are demanding greater levels of TLC from their hedge fund managers. This TLC stands for transparency, liquidity and control. Creating an operational infrastructure and business culture that can accommodate these demands by institutional investors will strengthen the fund complex and help it to attract capital during the difficult market cycle.

The evening concluded with an interesting and honest conversation between Paul Roth and Thomas Steyer, the Senior Managing Partner of Farallon Capital Management. The conversation included increased regulatory oversight, compensation issues, industry direction and matching investor liquidity with fund strategy, capacity, structure and scale. Mr. Steyer manages a multi-strategy fund complex with $20 billion AUM, his insights are borne from a rich industry experience. He made the startling admission that Farallon has been a registered hedge fund for many years and he believes that the regulatory oversight and preparation for examiners reviews helped his fund management company to develop operational discipline informed by sound practices.

Mr. Steyer also spoke about scale and that additional regulatory oversight will add expense to the cost of doing business. Mr. Steyer believes that it will become increasingly difficult for smaller hedge funds to operate and compete under these market conditions.

Another interesting topic Mr. Steyer addressed were issues surrounding investor redemption and fund liquidity. During last years SRZ conference investor liquidity was the hot topic. Fund preservation during a period of market illiquidity and a fair and orderly liquidation of an investment partnership were major themes that ran through last years presentations. Mr. Steyer struck a more conciliatory tone of investor accommodation. He confessed his dislike for the use of “gates” as a way to control the exit of capital from a fund. In its place he offered a new fund structure he referred to as a “strip” to allocate portfolio positions to redeeming partners in proportion to the overall funds liquid and illiquid positions. He stated he believed that strategy to be more investor friendly.

Schulte Roth & Zabel has once again demonstrated its market leadership and foresight to an industry clearly in flux, confronting multiple challenges. These challenges will force fund managers to transform their operating culture in response to the sweeping demands of global market pressures, political impetus for regulatory reform and the heightened expectations of increasingly sophisticated investors. The industry could not have a more capable hand at the helm to help it navigate through the jagged rocks and shifting shoals endemic to the alternative investment management marketplace.

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Risk: industry, market, regulatory, political

January 16, 2010 Posted by | commerce, compliance, corruption, hedge funds, investments, legal, off shore, private equity, regulatory, reputational risk, risk management, SEC, sovereign wealth funds | , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | 1 Comment

The Profitability of Patriotism: SME Lending

What a  difference a year makes.  A year ago the banks came crawling to Washington begging for a massive capital infusion to avoid an Armageddon of the global financial system.  They sent out an urgent SOS for a $750 billion life preserver of tax payers money to keep the banking system liquid.  Our country’s chief bursar Hank Paulson, designed a craft that would help the banks remain afloat.  Into the market maelstrom Mr. Paulson launched the USS TARP as the vehicle to save our  distressed ship of state.  The TARP would prove itself to be our arc of national economic salvation.  The success of the TARP has allowed the banks to generate profits in one of the most prolific turnarounds since Rocky Balboa’s heartbreaking split decision loss to Apollo Creed.  Some of the banks have repaid the TARP loans to the Fed.  Now as Christmas approaches and this incredible year closes bankers have visions of sugar plum fairies dancing in their heads as they dream about how they will spend this years bonus payments based on record breaking profitability.   President Obama wants the banks to show some love and return the favor by sharing more of their balance sheets by lending money to small and mid-size enterprises (SME).

Yesterday President Obama held a banking summit in Washington DC.  Mr. Obama wanted to use the occasion to shame the “fat cat bankers” to expand their lending activities to SMEs.  A few of the bigger cats were no shows.  They got fogged in at Kennedy Airport.  They called in to attend the summit by phone.    Clearly shame was not the correct motivational devise to encourage the bankers to begin lending to  SMEs.    Perhaps the President should have appealed to the bankers sense of patriotism; because now is the time that all good bankers must come to the aid of their country.  Failing that, perhaps Mr. Obama should make a business case that SME lending  is good for profits.   A vibrant SME sector is a powerful driver for wealth creation and economic recovery.    A beneficial and perhaps unintended consequence of this endeavor is  the economic security and political stability of the nation.  These  are the  worthy concerns of all true patriots and form a common ground where bankers and government can engage the issues that undermine our national security.

The President had a full agenda to cover with the bank executives.  Executive compensation, residential mortgage defaults, TARP repayment plans, bank capitalization and small business lending were some of the key topics.  Mr. Obama was intent on chastising the reprobate bankers about their penny pinching credit policies toward small businesses.  Mr. Obama conveyed to bankers that the country was still confronted with major economic problems.  Now that the banks capital  base has been stabilized with Treasury supplied funding they must get some skin into the game and belly up to the bar by making more loans to SMEs.

According to the FDIC, lending by U.S. banks fell by 2.8 percent in the third quarter.  This is the largest drop since 1984 and the fifth consecutive quarter in which banks have reduced lending.   The decline in lending is a serious  barrier to economic recovery.  Banks reduced the amount of money extended to their customers by $210.4 billion between July and September, cutting back in almost every category, from mortgage lending to funding for corporations.  The TARP was intended to spur new lending and the FDIC observed that the largest recipients of aid  were responsible for a disproportionate share of the decline in lending. FDIC Chairman Sheila C. Bair stated,   “We need to see banks making more loans to their business customers.”

The withdrawal of $210 billion in credit from the market is a major impediment for economic growth.  The trend to delever credit exposures is a consequence of the credit bubble and is a sign of prudent management of credit risk.  But the reduction of lending activity impedes economic activity and poses barriers to SME capital formation. If the third quarter reduction in credit withdrawal were annualized the amount of capital removed from the credit markets is about 7% of GDP.  This coupled with the declining business revenues due to recession creates a huge headwind for SMEs.  It is believed that 14% of SMEs are in distress and without expanded access to credit, defaults and  bankruptcies will continue to rise.  Massive business failures by SMEs shrinks market opportunities for banks and threatens their financial health  and long term sustainability.

The number one reason why financial institutions turn down a SME for business loans is due to risk assessment. A bank will look at a number of factors to determine how likely a business will or will not be able to return the money it has borrowed.

SME business managers must conduct a thorough risk assessment if it wishes to attract loan capital from banks.  Uncovering the risks and opportunities associated with products and markets, business functions, macroeconomic risks and understanding the critical success factors and measurements that create competitive advantage are cornerstones of effective risk management.  Bankers need assurances that managers understand the market dynamics and risk factors present in their business and how they will be managed to repay credit providers. Bankers need confidence that managers have identified the key initiatives that maintain profitability.  Bankers will gladly extend credit to SMEs that can validate that credit capital is being deployed effectively by astute managers.  Bankers will approve loans when they are confident that SME managers are making prudent capital allocation decisions that are based on a diligent risk/reward assessment.

Sum2 offers products that combine qualitative risk assessment applications with Z-Score quantitative metrics to assess the risk profile and financial health of SMEs.   The Profit|Optimizer calibrates qualitative and quantitative risk scoring  tools; placing a powerful business management tool into the hands of SME  managers.   SME managers  can  demonstrate  to bankers that their requests for credit capital is based on a thorough risk assessment and opportunity discovery exercise and will be effective stewards of loan capital.

On a macro level SME managers must vastly improve their risk management and corporate governance cultures to attract the credit capital of banks.  Using programs like the Profit|Optimizer,  SME’s can position themselves to participate in credit markets with the full faith of friendly bankers.  SME lending is a critical pillar to a sustained economic recovery and stability of our banking system.  Now is the time for all bankers  to come to the aid of their country by opening up credit channels to SMEs to restore  economic growth and the wealth of our  nation.

You Tube Music Video: Bruce Springsteen, Seeger Sessions, Pay Me My Money Down

Risk: banking, credit, SME

December 16, 2009 Posted by | banking, credit, government, Paulson, Profit|Optimizer, recession, risk management, Sum2, sustainability, TARP, Treasury | , , , , , , , , , , , , , , , , , , , , , , , , , | Leave a comment

Day of Atonement: Al-Chet for Risk Managers

YomKippurTNToday is Yom Kippur. It is the Day of Atonement. The Jewish faith marks this day each year as a day to reflect on our sins and shortcomings we have committed during the past year. It is a day of personal assessment. Calling all to examine how we have failed to live a life in conformance to our highest aspirations and ideals. It is customary to recite an Al-Chet confession prayer. The Al-Chet is a confession of a persons past year sinful behavior. It is hoped that this admission of sin leads to reconciliation with the aggrieved and an awareness that helps to establish a pattern of improved behavior in the future.

It is good that we commemorate such a day and use it to a constructive purpose. After all, how many among us are without sin? How many of us have achieved a level of perfection that obviates the need to reflect on how we can improve and make amends to those we may have hurt? To be sure, even the best among us have fallen short of the glory of God. The divine Higher Power that keeps mere mortals rightsized and humble when our egos and perception of ourselves grows too large and burdensome. The need to keep a strong self will from running riot is critical. It is particularly dangerous when a person or corporation is unaware and ambivalent to the collateral damage its actions spawn through the naked pursuit of self interest and ambition. In a sense, God is the ultimate celestial Chief Risk Officer that keeps wanton will in check.

The Day of Atonement is an important day because it is a day of transformation. It calls for self examination and transformation. Once we have learned the nature and extent of how our actions and inaction have negatively impacted ourselves and others, we are called to make amends to set things right. It is a day that requires considered action to improve ourselves so we can become a positive force for change in the world.

Considering the year that just transpired in the financial services industry, I wonder what an Al-Chet confession for risk managers would include. We need a strong dose of atonement so we don’t repeat the egregious mistakes we committed last year.

An Al-Chet for Risk Managers:

I was not strong enough to stand up to my boss

I put selfish gain ahead of ethical considerations

I falsified or hid data to conceal results

I failed to be objective

My risk model was too subjective

I ignored warning signs

I was in over my head

I did not understand all the risk factors

I failed to get an outside opinion

I was beholden to monetary gain

I was victim to group think

I placed institutional interest ahead of ethical considerations

I failed to admit I was wrong

I was not honest with regulators

I was not honest with shareholders

I looked the other way

I failed to act

I conveniently overlooked infractions / irregularities

I made exemptions

I did not understand the depth of the problem

I know there are many more.

Please help me to uncover, understand make right and overcome.

Shalom

You Tube Music Video: Aretha Franklin, I Say a Little Prayer

Risk: compliance, reputation, catastrophic risk, moral hazards

September 28, 2009 Posted by | banking, compliance, credit crisis, culture, operations, psychology, regulatory, religion, reputation, reputational risk, risk management, sound practices | , , , , , , , | Leave a comment

Managing Pandemic Risk

pandemicThe Swine Flu outbreak carries with it the potential to severely damage the financial health of small and mid-size enterprises (SMEs). Left unmanaged pandemics can impair profits, generate losses, undermine the contribution of key employees, disrupt supply chains, halt operations and undermine an enterprises financial health that can ultimately lead to bankruptcy.

Though many consider pandemics as a force majeure risk event that lies beyond control, businesses can take steps to mitigate and manage the drastic challenges a pandemic can pose to a business. This is particularly important for businesses that find themselves in a weakened position due to the recession. Businesses that have become highly stressed due to the current business cycle are at acute risk of becoming insolvent due to the shock of this potentially catastrophic risk event. Business managers, bankers, shareholders and businesses with extended supply chains need to take steps to manage and mitigate the severe  effects of pandemic risk.

The first step is to create or update a business continuity plan. Business continuity plans need to address a range of issues that includes planning for disasters in general and planning for the unique challenges an influenza pandemic presents and integrate mitigation initiatives into critical business processes.

All businesses are unique. Addressing a pandemic risk event in your business plan will require you to conduct a risk-management assessment on all aspects of your operations, business processes and market impact to ensure continued operation and financial health of the enterprise.

Some things management must consider in its review are:

  • Assess how you work with employees, customers, contractors to minimize contagion threats
  • Determine mission critical business functions your business requires to maintain operations
  • Stress test your business operations to determine how to function with high absentee rates
  • Review inventories in case foreign or domestic suppliers and transport services are interrupted
  • Review supply chain links, determine at risk suppliers and identify backups
  • Reorganize work spaces to minimize the spread of the disease
  • Equip employees to support telecommuting
  • Develop communication strategies to update employees, customers and the media
  • Use this opportunity to expand e-commerce capabilities
  • Promote awareness of the problems associated with pandemic flu
  • Alert employees about what steps you’re taking and what they can do to limit the pandemic’s impact
  • Review sick-leave and pay policies to ensure they don’t discourage workers from staying home when they’re ill
  • Make backup plans if you need to pull people out of countries where the epidemic strikes
  • Develop a travel policy that restricts travel to areas where the virus is active
  • Stock up on masks and sanitizers, and consider staggering work hours to limit the size of gatherings

Sum2 publishes the Profit|Optimizer product series.  The Profit|Optimizer is the leading SME risk management platform that helps business managers and business stakeholders quickly assess enterprise risk factors and take considered action to mitigate and manage those risk factors. Sum2 will be releasing a pandemic risk assessment module by the close of this week.  The product will retail for $95.00 and will assist SME’s to assess, mitigate and manage the threats posed to their business by pandemics and other social disasters.

More information can be found on our website www.sum2.com.

Sum2 helps businesses assess risk and realize opportunities.

April 30, 2009 Posted by | business continuity, disaster planning, geography, operations, Profit|Optimizer, regulatory, risk management, Sum2, supply chain | , , , , , , , , , , , , , , | Leave a comment