Month: December 2015

Central Counterparties and the Too Big to Fail Agenda

In a speech by Andrew Gracie, Executive Director of Resolution of the Bank of England, at the 21st Annual Risk USA Conference, he outlines some of the elements in the Too Big To Fail (TBTF) resolution agenda. The aim is to ensure that in the event that a global systemically important financial institution (G-SIFI) fails there is minimal interruption of the activities of a firm that are critical to the functioning of the broader financial system. And achieving that outcome without recourse to taxpayer bailouts, as public authorities were forced to during the crisis.

He says that progress in developing a new paradigm for global systemically important banks (G-SIBs) has been impressive. Key Attributes of Effective Resolution Regimes for Financial Institutions1 were agreed by G20 leaders around this time four years ago. Statutory regimes consistent with this standard are now in place in the US, EU and Japan – in fact in all but a handful of jurisdictions where G-SIBs are headquartered. Crisis Management Groups (CMGs) have been working on resolution plans for each of the G-SIBs. The authorities participating in the CMGs have committed at a senior level in a resolvability assessment process (RAP) to the resolution strategies emerging for each of the G-SIBs. These CMGs work towards identifying barriers to making resolution work and how these should be removed. Often these barriers are consistent across firms. Perhaps most notable is the requirement for loss absorbency – establishing a liability structure for G-SIBs that is consistent with bail-in, not bail-out. Again, there has been significant progress here. The Financial Stability Board (FSB) issued a consultation document2 on a minimum standard for Total Loss Absorbing Capacity (TLAC) last November and is committed to producing a final standard ahead of the G20 summit next month in Antalya. This will be a major step on the road to ending “Too Big to Fail.”

He goes on to discuss the same TBTF agenda for other types of G-SIFIs, in particular central counterparties (CCPs). CCPs form a key part of the global financial landscape. They have become ever more important since the crisis. This will continue as mandatory central clearing is introduced around the world. These entities are an essential part of the international financial system, and need appropriate regulation and viable resolution paths in an event of failure, without causing a cascading crash. This aspect of the international financial markets and their control bears close watching.

Addressing the systemic risks associated with over-the-counter (OTC) derivatives markets is one of the reasons why G20 leaders introduced mandatory central clearing. People tell us that we have thus created in CCPs concentration risk and critical nodes. This is true in part, but we did this on the basis that in CCPs risks could be better recognised and identified, better managed and reduced via better netting. Nonetheless, as many before me have commented the largest CCPs are becoming increasingly systemic and interconnected such that their critical services could not stop suddenly without risk of wider contagion. Thus, not only do we have to ensure that the level of supervisory intensity matches the risks, something my supervisory colleagues are very focused on, we must also address the issue of what should happen if a CCP were to fail.

This is already widely recognised. So too is the need for an international solution to the questions that CCP recovery and resolution presents. The largest CCPs are systemically relevant at a global level, important for financial stability in multiple jurisdictions due to the nature of their business and the composition of their members and users. They serve multiple markets, having dozens of clearing members from different countries and clearing products in multiple currencies. A patch-work of approaches to recovery and resolution would risk regulatory arbitrage and competitive distortion and so, whilst the fiscal backstop against the unsuccessful resolution of a CCP is ultimately a national one, it is best that the answer on how to avoid this backstop ever being used is developed at a global level.

Fortunately, that work is already underway and CCP recovery and resolution forms an important part of the Financial Stability Board’s (FSB) continuing agenda to end Too Big To Fail (TBTF). In October 2014 an Annex was added to the Key Attributes of Effective Resolution Regimes to cover their application to Financial Market Infrastructures (FMIs). More recently, the FSB published its 2015 CCP workplan. As part of this, a group on financial market infrastructure (fmi CBCM), equivalent to the Cross-Border Crisis Management Group (CBCM) that I chair for banks, has been established within the FSB to take forward international work on CCP resolution. Authorities in a number of jurisdictions are responding to the need for effective resolution arrangements for CCPs, with legislative proposals expected in the EU, Canada, Australia, Hong Kong and elsewhere to add to existing regimes, including in the US under Title II of Dodd Frank. In the UK, the Bank of England has formal responsibility for the resolution of UK-incorporated CCPs. To aid us in drawing up resolution plans for UK CCPs, we have established the first Crisis Management Group for a CCP. We hope and expect it to be the first of many.

But work on CCP resolution needs to be seen in the broader context of financial reform:

The Committee on Payment and Market Infrastructures, along with the International Organisation of Securities Commissions (CPMI-IOSCO) is continuing its work on CCP resilience and recovery. Work is in train on stress testing, on loss allocation and on disclosure requirements, as well as on ensuring consistent application of the Principles for Financial Market Infrastructures (PFMIs) which set regulatory expectations for CCPs at a global level. All of this is important not only in its own right, but also to provide the market – the users of CCPs – with the tools and incentives to monitor resilience and drive effective risk management in CCPs themselves. To encourage competition between CCPs on resilience, not cost.

At the same time, the first line of defence for a CCP lies in the resilience of its members. Ongoing work to raise the prudential standards for banks on capital and liquidity, among other areas, should greatly reduce the risk of CCPs having to deal with a failing clearing member. And the progress I mentioned before on G-SIB resolution should help to ensure that, where a firm does fail, its payment and delivery obligations to the CCP continue to be met. I should add as an aside that there is more still to be done internationally in terms of removing technical and other obstacles to maintaining continuity of access to CCPs and other FMIs in the context of bank resolution. That continuity is not just essential to the bank in resolution but may also be critical for clients. If there is doubt about continued access to clearing services from a bank in resolution, clients may look to migrate rapidly to another provider. These issues around continuity and portability will be the subject of work within the FSB over the course of the coming year.

Together, these initiatives to improve the resilience and recovery arrangements for CCPs and their members will help to reduce the probability of CCP default. But while improvements to resilience are necessary they may not by themselves be sufficient. No institution is “fail safe”. Ultimately, we need to have a credible resolution approach for CCPs.

If we do, resolution should offer a continuing benefit in helping to incentivise recovery by removing expectations that the taxpayer will be compelled to step in. By contrast, if we do not have a credible regime in resolution, we run the risk of weakening the incentives both to manage a CCP prudently, as well as incentives for clearing members to contribute to a CCP’s recovery should it get into trouble. The benefits of resolution to market discipline and recovery are common to all financial institutions. But that is not the only insight from banks that is relevant to CCPs.

Before going too far in talking up the similarities, I should note – although it should go without saying – that CCPs are very different from their bank clearing members in many important respects, including their business models, legal structures and balance sheets. CCP recovery and resolution therefore poses some specific issues, some of which I will touch on today. However, at base there are principles that are common to the resolution of any systemically important institution.

Perhaps the most obvious similarity between the resolution of banks and CCPs is in the common objective: resolution should deliver continuity of critical economic functions without reliance on solvency support from taxpayers to achieve it. For that continuity to be achieved it is not enough that the financial losses of the institution are fully absorbed; the going-concern resources of the institution, or of any successor institution, must be restored to a sufficient level to command market confidence prior to any post-resolution restructuring or wind-down.

In the case of banks, this means that when a bank suffers losses eroding its going concern capital to the point where triggers for resolution are met, (i) it enters into resolution; (ii) its creditors are bailed in to recapitalise the firm; and (iii) this bail-in replicates what would have happened in a court-based commercial restructuring or insolvency. In other words, losses are allocated according to the creditor hierarchy but without the value destruction created by the hard stop of insolvency. This ensures that the resolution provides continuity and meets the safeguard that creditors are not worse off than in insolvency. While these are the essential elements of a resolution, they are likely to play out differently in the context of a CCP.

Intervention by a resolution authority, especially at a point where default management procedures have yet to be exhausted is action that cannot be taken lightly. Nor can the discretion of a resolution authority to deviate from the existing rules of the CCP be unbounded. Appropriate creditor safeguards are central to ensuring that an effective resolution regime does not unduly interfere with property rights or undermine its own value by introducing unnecessary uncertainty into a financial institution’s contractual relationships both in resolution and outside of it.

Perhaps the most fundamental safeguard to creditors in resolution is that the actions of the resolution authority will not leave them worse off than if the authority had not intervened and the firm had instead entered a liquidation proceeding. For the purposes of determining this No Creditor Worse Off protection, bank resolution takes an insolvency counterfactual; recognition that a failing bank that meets the conditions for resolution would in most likelihood lose its licence at that point if not resolved, thereby tipping it into insolvency (whether cash-flow, balance-sheet or both) if it was not there already. That insolvency counterfactual requires an ex post assessment of the value of assets and liabilities of the firm. That is no easy task but one that can, and has been, credibly undertaken.

For CCPs the task of assessing an insolvency counterfactual is likely to be harder still – particularly if it must rely upon a forecast of how the rest of the waterfall would have unfolded, the behaviour of the CCP’s participants and the movements of the markets in the days that would have followed if resolution had not taken place. A liquidation counterfactual must also confront the argument that the CCP would have protected itself from insolvency through full tear-up.

Given these valuation challenges, I suspect there will need to be careful further consideration given to the formulation and practical application of the NCWO safeguard; we must end up with a safeguard that is sufficiently certain and capable of estimation in advance that both creditors and resolution authorities are able to make sensible decisions before, during and after resolution.

 

With that, let me conclude by summing up some key points:

  • CCP resolution is both a necessary and inevitable part of the overall post-crisis reform agenda to end Too Big to Fail. As private, profit-making enterprises CCPs must be allowed to fail, but, given their systemic importance, many will need to be allowed to do so in a manner that maintains the continuity of their critical functions.
  • Having a credible resolution regime for Clearing Members is a big step forward in helping to reduce the risk of clearing member default and from that the risk of CCP failure.
  • But reliance on successful resolution of members does not negate the need for CCP resolution arrangements to be capable of responding to both default and non-default losses emerging from both systemic and idiosyncratic shocks.
  • In thinking about the underlying objectives and needs of a CCP resolution regime, there are many similarities to bank resolution and these should not be forgotten, but clearly there are many differences too and we need to recognise that.
  • Effective resolution requires the ability to act promptly and before the point at which the chance of stabilising the CCP is lost. The resolution authority must have a variety of tools at its disposal to enable it to respond to the reason the CCP failed. It should be able to intervene in a timely and forward-looking way before the end of the waterfall – but incentives must be aligned and we want this to be set up in a way that promotes CCP resilience and makes recovery work.
  • In order to continue a CCP’s critical services in resolution, there must be an ability both to cover the losses credibly in a failure scenario and to recapitalise the CCP’s going concern resources – i.e. its capital, margin and default fund. How we achieve this is something for FSB to address so that the shared interest in maintaining stability in the global financial system can be realised.

Debt Overhang and Deleveraging

What is the relationship between high consume debt levels, and consumption? This is an important question for Australia, given the current record levels of personal debt, and sluggish consumer activity. Also, what will happen should house prices slip back, and households shift to a deleveraging mentality? The short answer is it will have a significant depressive economic impact – if insights from a newly published paper are true.

In a Bank of Canada Staff Working Paper, “Debt Overhang and Deleveraging in the US Household Sector: Gauging the Impact on Consumption” they use a dataset for the US states to examine whether household debt and the protracted debt deleveraging helps to explain the dismal performance of US consumption since 2007, in the aftermath of the housing bubble. By separating the concepts of
deleveraging and debt overhang—a flow and stock effect—they conclude that excessive indebtedness exerted a meaningful drag on consumption over and beyond income and wealth effects.

The leveraging and subsequent deleveraging cycle in the US household sector had a signifi cant impact on the performance of economic activity in the years around the Great Recession of 2007-09. A growing body of theoretical and empirical studies has therefore focused on explaining to what extent and through which channels the excessive buildup of debt and the deleveraging phase might have contributed to depressing economic activity and consumption growth.

They use panel regression techniques applied to a novel data set with prototype estimates of personal consumption expenditures at the state-level for the 51 US states (including the District of Columbia) over the period from 1999Q1 to 2012Q4. They include the main determinants as used in traditional consumption functions, but add in debt and its misalignment from equilibrium. They conclude that excessive indebtedness of US households and the balance-sheet adjustment that followed have had a meaningful negative impact on consumption growth over and beyond the traditional effects from wealth and income around the time of the Great Recession and the early years of the recovery. The e ffect is mostly driven by the states with particularly large imbalances in their household
sector. This might be indicative of non-linearities, whereby indebtedness begins to bite only when there is a sizable misalignment from the debt level dictated by economic fundamentals. They show that some states experienced significant deleveraging and a fall in household wealth.

Canada1Canada2 They argue that the nature of the indebtedness determines the ultimate impact of debt on consumption. The drag on US consumption growth from the adjustments in household debt appears to be driven by a group of states where debt imbalances in the household sector were the greatest. This suggests that the adverse e ffects of debt on consumption might be felt in a non-linear fashion and only
when misalignments of household debt leverage away from sustainable levels – as justfi ed by economic fundamentals – become excessive. Against the background of the ongoing recovery in the United States, where the deleveraging process appears to be already over at the national level, one might expect house-hold debt to support consumption growth going forward as long as the increase in debt does not lead to a widening of the debt gap.

Note that Bank of Canada staff working papers provide a forum for staff to publish work-in-progress research independently from the Bank’s Governing Council. This research may support or challenge prevailing policy orthodoxy. Therefore, the views expressed in this paper are solely those of the authors and may differ from official Bank of Canada views. No responsibility for them should be attributed to the Bank of Canada, the European Central Bank or the Eurosystem.

Housing Price and Household Debt Interactions

A newly published IMF working paper looks at the relationship between house prices and household debt, in Sweden. The work is interesting because house prices have risen significantly, and household debt has risen substantially at a time when supply was limited. Australia is not the only country with these synonyms!

Sweden1The swings in house price growth have had wider amplitude than those of credit growth since the GFC. Whilst a loan-to-value ratio cap of 85 percent on all new mortgage loans was introduced in 2010 which may have affected lending growth, they still have tax relief on mortgage repayments.

Sweden-2The question the paper examines is the relationship between these higher prices and household debt levels. A common interpretation of the link between these markets is that mortgage lending drives housing prices up, motivating measures to curb credit. Yet, mortgage lending can also be driven by rising housing prices through the wealth
and collateral channels. Home ownership generally requires debt financing, especially as households usually acquire this major asset early in their life cycle. When house prices appreciate, households who own housing may perceive that their higher wealth allows for greater lifetime consumption, inducing households to borrow and spend more. At the same time, the higher value of housing assets expands the value of collateral against which borrowing is generally much cheaper than unsecured credit. Relaxing this collateral constraint thereby expands households’ borrowing capacity, which could be reflected in a combination of higher consumption and larger asset holdings. For households that do not yet own a house, higher prices increase the need to borrow but also relax collateral constraints.

The paper examines the interactions between housing prices and household debt using a three-equation model, finding that household borrowing impacts housing prices in the short-run, but the price of housing is the main driver of the secular trend in household debt over the long-run. Both housing prices and household debt are estimated to be moderately above their long-run equilibrium levels, but the adjustment toward equilibrium is not found to be rapid. Whereas low interest rates have contributed to the recent surge in housing prices, growth in incomes and financial assets play a larger role. Policy experiments suggest that a gradual phasing out of mortgage interest deductibility is likely to have a manageable effect on housing prices and household debt.

Note that IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

Why Taking a Small Biz Loan is Better Than Crowdfunding

From Kabbage.

In the past five years, we’ve seen a plethora of crowdfunding platforms hit the internet. And, the popularity of these “open source” funding sites seems to only be increasing, particularly with those within art communities and the tech industry.

While the goal of these platforms is to connect small business owners with investors looking for opportunities to back promising ventures or ideas, many small business owners wonder if this source of financing is a viable option for securing working capital.

Certainly, crowdfunding can be a great way to get friends, family, colleagues and peers excited about a promising new or developing business. Yet, it can be a mixed bag when it comes to actually obtaining capital to support day-to-day operations.

If you’re a business owner who is tempted to try crowdfunding to “find out” how much capital you can generate, it may be well worth your time to consider the drawbacks of launching a campaign, as well as the advantages of taking a small business loan instead.

Time and Effort to Create a Campaign
The most successful crowdfunding campaigns are those that include eye-catching content to support them. This makes sense when you consider that your campaign is actually competing against others on the platform. Campaigns that stand out in the crowd and have a particularly compelling message will get noticed and receive more funding than those that don’t quite have the same “wow” factor.

Once a campaign is launched, it then needs to be promoted. If you’re a savvy social media marketer, creating buzz on Facebook and Twitter can propel your brand to new audiences and potentially generate investor interest. If you’re not into online pitching, this can be a tedious, painstaking task that doesn’t always generate sufficient results.

In other words, you may be incredibly excited about your machine fabrication business and how you’ll be able to help manufacturers in your industry with your amazing products. However, crowdfunding investors might be more drawn to the solo business owner who is making unique purses crafted from beads sourced from a local village and sharing photos of them on Instagram.

If you’re going to try crowdfunding, you’ll definitely want to consider the time and money you’ll need to create and promote your campaign. This includes photos, a video, social media channels, the development of a website and maybe even a second microsite that is focused on your crowdfunding efforts.  This can cost hundreds, if not thousands of dollars, along with many hours of your time. When you tally the costs for launching a campaign, it may be faster, easier and more effective to obtain capital from a lender that doesn’t require these efforts.

No Guarantees You’ll Be Funded
When you peruse the many campaigns on a crowdfunding site, you’ll see some are incredibly well-funded, while others haven’t received even their first dollar. There are no guarantees that you’ll secure funding, even if you’ve invested in creating a compelling campaign.

If you have a set amount that you need for specific goals you’re trying to achieve such as hiring more staff to cover a seasonal uptick or buying a new piece of equipment, rolling the dice with a crowdfunding campaign is not the right choice for you. An option like Kabbage that lets you apply and receive funding in a matter of minutes may be a better choice that can enable you to plan and budget what you need to succeed. It’s also important to remember that if you don’t reach your funding goal on a crowdfunding site, funds raised typically have to be forfeited.

Are you seeking a large amount of capital? Startups and small businesses are only allowed to raise up to $1 million annually from “small-dollar” investors on web-based platforms, according to the JOBS Act which passed in 2012. Thus, if you’re looking for a substantial capital infusion, crowdfunding definitely isn’t the right choice. You’ll be better off working with a private venture capital company.

Fees

Like with other types of small business financing, there are fees for raising capital via crowdfunding. Most platforms charge a percentage of funds raised that typically ranges from five to twelve percent. There are also other fees to consider such as those to process contributions.

When you add these costs to what you’ll spend on creating and managing a campaign, it may work out to be more costly than what you’ll pay to a lender for a small business loan.

The Cost of Rewards

Rewards-based crowdfunding is particularly popular with startups and new businesses because it also offers a way to test market products. Individuals contribute money to a campaign, and in return, the business provides “rewards.” For example, a jewelry designer may reward each contributor a handmade necklace. Or, a new bakery may offer each contributor a voucher for a free loaf of bread.

Any business that goes the route of offering rewards as part of a crowdfunding campaign needs to also include the investment in supplying rewards when it comes to tabulating the total cost for securing capital.

Time Constraints

Every business owner who is seeking working capital needs to carefully consider their time limitations. Applying for a traditional bank loan is a notoriously slow process that can span weeks or even months before an approval decision is made. Likewise, crowdfunding can also be slow and tedious, requiring daily monitoring and promotion.

For business owners that need money quickly, securing a source of working capital that can be accessed when it is needed is often a strategically smart decision.

Although these reasons certainly highlight why a small business loan can be a better decision for many small businesses, there are benefits to crowdfunding that can’t be denied. For some, being able to leverage the benefits of both may even be the right option. The key is considering your specific business needs, industry, and target market and choosing the right funding option that helps you achieve your goals.

Was the housing boom in Sydney and Melbourne driven by foreign buyers?

From The Conversation.

House prices rose by an average of 64% in Sydney and Melbourne in the decade from 2004 to 2014. At the same time foreign investment proposals in developed real estate rose by almost tenfold. This correlation led to a lot of anecdotal stories of Chinese buyers driving up prices and to a Parliamentary Inquiry.

How much can we attribute the decade-long housing boom in Sydney and Melbourne to foreign buyers? The numbers are hard to find and a little rubbery, but our best econometric estimate is that about one quarter of the growth in house prices in Sydney and Melbourne can be attributed to foreign investment.

This means that if foreign investment had been steady over the period, average house prices would have grown by about 50% compared with the actual growth of 67%. In the other capital cities, by the way, the growth in house prices was much less and it was not possible to find any econometrically significant effect of foreign buyers.

This amounts to a modest effect of foreign investment on house prices in Sydney and Melbourne. The hype about Chinese buyers driving up house prices appears to be overstated – at least in terms of the effect on average house prices – there may have been more significant effects in certain locations.

The quality of data however is a failure of public administration. The Parliamentary Inquiry essentially came to this conclusion. It found that there is no accurate data on foreign investment in Australian real estate and therefore “no-one really knows how much foreign investment there is in residential real estate”.

The Inquiry also noted there had been no court action by the Foreign Investment Review Board (IRB) since 2006 in relation to foreign real estate investment. The Australian Taxation Office has however moved since then to force the sale of a property bought by a foreign buyer without government approval.

The law prevents foreign citizens from purchasing established housing for their own homes or as investment properties, except for one or two narrow exemptions. Clearly there has been inadequate monitoring of purchases to enable this law to be enforced. However if the concern is about house prices and the effect on affordability, then the role of foreign purchases is not at all clear.

If foreigners buy a house to rent out to someone who is already in the housing market such as a non-citizen student in Australia, there is no net increase in the demand for housing and therefore no pressure on house prices. Nor is there any net impact on housing demand and therefore on prices if foreign buyers eventually become foreign sellers. And again, if foreign buyers eventually become permanent residents their purchases represent a shifting forward of housing demand rather than a long run increase in housing demand.

All of which is to say that simply looking at foreign purchases of real estate does not give us a very accurate guide as to the net impact on house prices.

Then there is the tenuous link from house prices to housing affordability. First home buyers generally purchase the cheaper dwellings and established rather than new dwellings, both of which are housing categories where foreign investment is less evident. In any case, other work by the Reserve Bank of Australia finds that house price growth over the past 30 years can be largely explained by fundamental factors such as financial deregulation, the ability of housing supply to respond to demand, and population growth driven by immigration. This suggests that foreign direct investment may have played relatively minor role in explaining house price growth.

If the public policy concern is more about housing affordability, then policies that aim to boost housing supply and that address tax and retirement income policies favouring housing over other asset classes would be more effective than a clamp-down on foreign real estate investment.

Some people seem to worry not so much about housing affordability but about foreigners gaining control over Australian real estate assets. This is hard to fathom because when foreigners buy an asset in Australia, whether it is a real asset like property or a financial asset like shares or bonds, there is no transfer of wealth to foreigners. Indeed quite the reverse – if foreigners are willing to pay more for our assets than any Australian citizen, this cannot be a loss of wealth to Australia.

Despite all of these qualifications and complications, we need to know more about foreign purchases of residential real estate. The Parliamentary Inquiry’s recommendation seems sensible: to establish a national register of land title transfers that records the citizenship and residency status of all purchases of Australian real estate.

 

uthors: Ross Guest, Professor of Economics and National Senior Teaching Fellow, Griffith University,  Nicholas Rohde, Lecturer in Economics, Griffith University.

 

Four in Five Retailers Say Mobile Is Having a Major Effect

Mobile’s importance is becoming undeniable according to eMarketer.

Mobile still accounts for a fairly small share of total retail sales, and, in many markets, even of digital retail sales. But retailers are feeling the impact of mobile devices.

In 2014, a little over half (57%) of retailers worldwide surveyed by payment solutions provider Payvision reported experiencing major growth in mcommerce sales. Among the total, 33% strongly agreed that growth was significant—already a sizeable share.

But by 2015 the evidence in favor of mcommerce was overwhelming. Nearly half of respondents were now in the “strongly agree” group, with an additional 34% agreeing more generally. Overall, 79% of retailers worldwide were undergoing major mcommerce growth this year.

More retailers around the world are getting into omnichannel as a result. This year, 91% of respondents said they offered customers the option to shop and pay across multiple devices. That was up from 84% last year.

Nearly three in four respondents reported this year that such an option had boosted sales via digital devices. In addition, 71% of retailers surveyed said they were focused on offering seamless shopping across multiple devices as well as offline sales channels.

eMarketer estimates that in 2015, US consumers bought $74.93 billion worth of goods and services via mobile devices, up 32.2% over 2014 spending levels. This year, mobile accounted for 22.0% of all retail ecommerce sales in the US, up 3 points since last year. It still made up a tiny portion of total retail sales, however, at just 1.6%.

In some other world markets, mcommerce is a bigger part of the picture. In South Korea, for example, mcommerce sales made up 46.0% of retail ecommerce sales and 5.1% of total retail sales this year, according to eMarketer estimates. In China, 49.7% of retail ecommerce sales and 7.9% of all retail sales occurred via mobile devices in 2015.

Facing the Threat of New Regulations, Airbnb Continues to Disrupt Industry

From Brandchannel.

Airbnb launched in 2008 and seven years later, has more than 1.5 million listings in 34,000 cities and 190 countries. No longer a trend, the brand now bears the moniker of major industry disruptor as it serves more than 60 million guests worldwide.

From college students renting out dorm rooms to small-scale hotels and motels, Airbnb is the best bang-for-the-buck marketing tool in decades. Airbnb charges hosts a 3 percent fee for every completed booking, way less than Expedia and Priceline that charge hotels up to 25 percent.

“The commission is so much more attractive,” said Stephan Westman, a hotel industry consultant who has listed hotel rooms on Airbnb, reports Fast Company. “Any hotel that needs to fill rooms, I don’t understand why they wouldn’t need to use it as one of their marketing arms.”

From boutique-style hotels geared toward millennials to traditional landlords renting multiple units (causing issues recently in Los Angeles) and old-school bed-and-breakfasts, Airbnb is upending spend-the-night-while-traveling behavior.

Fast Company reports that Eduardo, a student living in a New York City dorm room, listed an extra bed for $80 per night in a space “about 150 sq. ft. with ample closet space” and has made about $400 so far. Tuition costs have risen by 46 percent between 2001 and 2012, and Eduardo’s quite small dorm room costs him almost $9,000 per school year.

However, when Fast Company called his campus’ housing department, they said it was not permissible. “I don’t even know which reason to start with…If you’re not signing paperwork to make the sublet legal, you’re an illegal tenant.”

Pushing back against criticism of hurting the housing market, Airbnb denies being a ringleader for illegal rentals and announced last month it would start collecting hotel taxes, sharing anonymized data and asking hosts to verify they’re renting their primary residence rather than additional properties owned solely for rental purposes.

Airbnb calls it a “Community Compact” and shared the number of New York City’s 59,242 active listings posted by hosts renting out more “entire home” properties beyond their own residence. From November 2014 until November 2015, nearly 75 percent of revenue earned by active hosts in New York City came from people who have only one or two rental listings on the platform, reports The New York Times.

Expedia CFO Mark Okerstrom said, “We should take it seriously, and I think at the same time, we look at what Airbnb is doing, and we look at that as a potentially attractive opportunity for us,” reports Skift. Expedia last month acquired Airbnb’s direct competitor HomeAway for $3.9 billion.

New York State Attorney General Eric Schneiderman said that 72 percent of New York City’s Airbnb rentals are illegal, so state legislators are preparing a bill to prohibit hosts from advertising illegal units and those in violation of a 2010 hotel state law that bars the renting out of units for less than 30 days could face fines of up to $7,500 per violation.

New York would be the first state to enact such a law. An Airbnb spokesman countered: “We should be working on some common-sense changes that help middle-class families who share the home in which they live and depend on Airbnb to pay the bills,” according to the New York Daily News.

Like it or not, the Airbnb model offers valuable lessons for traditional hoteliers suggests Tnooz, including personalizing offerings, better communication via social media and building loyalty.

“The communication involved in an Airbnb transaction goes a long way to building loyalty with the Airbnb brand,” notes Tnooz. “There is no hotel name, yet Airbnb aficionados are loyal to the system, to the ‘community’ and what it represents—individual travelers looking for an individual experience. Airbnb resonates with the curious, inquisitive traveller and the company is growing at a pace never seen before. Hoteliers can ill afford to look the other way.”

Non-Majors Strike Back – AFG

The AFG Competition Index for the last quarter of 2015 shows that non-major lenders have made up ground after a punishing few months for the challenger sector.

AFG General Manager of Sales and Operations said the recent turnaround had been dramatic. “We have been through a period of uncertainty and this has seen the majors use the size of their balance sheets to dominate their smaller competitors.

“This quarter the tide has turned and non-majors have had their best run since June, just prior to the regulator enforced changes to investment and interest only lending policy being introduced. Over the last 3 months we have seen the non-majors adjust to these changes and it appears that the flow of business is settling back into a more competitive pattern.

“Looking at the product categories, the non-majors have made up ground across all lending products apart from fixed. Their share of refinancing has increased from 29.8% in August to 39.5% in November. During the same period, investor lending has gone from 27.4% of the total to 29.1% while first homeowners has leapt from 27% to 32%.  The non-major’s share of fixed rates fell from 45.2% in August and a high of 56.8% in May to 42.5% for the last quarter.

“After a three year trend of declining use of fixed rate loans, the tide has turned. The corresponding increase in the major’s share of fixed rate lending has reflected that change. The next edition of the AFG Mortgage Index, due for release in mid January, will show that fixed rate lending as a percentage of AFG’s overall business, has increased from 11% to 13%.

“Borrower expectations that the likelihood of an interest rate rise in the new year has many borrowers opting to fix their home loans,” said Mr Hewitt. “Once again, the changing nature of the market means Australian borrowers are recognizing more than ever the
value of using a broker to help them navigate their way through.”

Financial Firm Regulation and External Audit

The Financial Stability Institute has issued an occasional paper entitled “the “four lines of defence model” for financial institutions.” It takes the so called three-lines-of-defence model further to reflect specific governance features of regulated financial institutions. The paper highlights issues which exist in the current “recommended” approach, and specifically limitations of internal audit. Embedding the external auditors’ role in the structure of the defence system could mitigate the shortcomings of the traditional three-lines-of-defence model and increase the soundness and reliability of the risk management framework.

Since the Global Financial Crisis of 2007–09, the design and implementation of internal control systems has attracted serious academic and professional attention. Much research on the effectiveness and characteristics of internal audit functions has been conducted under the sponsorship of the Institute of Internal Auditors Research Foundation (IIARF) and published in academic and professional journals. The guidelines issued by the Basel Committee on Banking Supervision (BCBS) in 2015 on corporate governance principles for banks emphasise the importance of proper risk management procedures, including, in particular, “an effective independent risk management function, under the direction of a chief risk officer (CRO), with sufficient stature, independence, resources and access to the board.” Furthermore, “the sophistication of the bank’s risk management and internal control infrastructure should keep pace with changes to the bank’s risk profile, to the external risk landscape and in industry practice” so as to identify, monitor and control risks on an ongoing bank-wide and individual-entity basis.

Despite these efforts, there has been little systematic analysis of how the design of an internal control system affects the efficiency and effectiveness of corporate governance processes, especially at financial institutions such as banks and insurance companies. The “three lines of defence model” has been used traditionally to model the interaction between corporate governance and internal control systems.

Thee-LinesRecent significant risk incidents and corporate scandals caused by misconduct in financial market operations indicate that banks need to further enhance corporate governance measures. But, most importantly, such incidents have led to a further prioritisation of governmental and supervisory agendas relating to the potential systemic implications of weak internal control systems. This calls for a greater prominence of microprudential policies relating to misconduct at banks. It also calls for closer cooperation between regulators, and external and internal auditors, so as to win back public trust in financial institutions.

Specifically, four areas of weakness exist:

  1. Misaligned incentives for risk-takers in first line of defence
  2. Lack of organisational independence of functions in second line of defence
  3. Lack of skills and expertise in second line functions
  4. Inadequate and subjective risk assessment performed by internal audit

In order to account for the specific governance features of banks and insurance companies, they outline a “four lines of defence” model that endows supervisors and external auditors, who are formally outside the organisation, with a specific role in the organisational structure of the internal control system.Four-LineBuilding upon the concept of a “triangular” relationship between internal auditors, supervisors and external auditors, they examine closely the interactions between them. By establishing a fourlines-of-defence model, they believe that new responsibilities and relationships between internal auditors, supervisors and external auditors will enhance control systems. That said however, they also highlight the risk that new problems could be caused by inadequate information flows among those actors.

Regulatory capital ratios, as well as other indicators of financial strength, such as liquidity and leverage ratios, are produced alongside banks’ standard financial reports but are not audited in the same way. This may create an expectations gap for society: what may be a bank’s most looked-at indicator is not audited. External auditors could perform assurance tasks related to such regulatory requirements (including capital ratios and risk-weighted assets, and leverage and liquidity ratios). Requirements for the independent scrutiny of regulatory capital information have evolved piecemeal across the world; some countries mandate publically available assurance reports, some only require financial institutions to inform regulators while others have no reporting requirement whatsoever. Given the size and importance of the banking sector – and the systemic risk posed to global financial markets – credibility and reliability are crucial.

They explored developments in a number of countries to illustrate the importance of increased cooperation between bank supervisors and external auditors:

1. United Kingdom:
The Prudential Regulation Authority (PRA) of the United Kingdom recently issued a consultative document59 laying out the rules for external auditors of the largest UK banks for the provision of written reports to the PRA as part of the statutory audit cycle. The PRA asked external auditors to contribute to its supervision of firms by directly engaging in a pro-active and constructive way to support judgment-based supervision and help promote the safety and soundness of firms supervised by the PRA. The insights gained by auditors when they carry out high-quality audits should help enhance the effectiveness of the relationship between the auditors and the supervisor.

There have been improvements in the last few years such as a closer and more frequent engagement between supervisors and external auditors. The PRA keeps monitoring the quality of auditor-supervisor dialogue. In a survey of external auditors, it was noted that the vast majority of engagements was considered only ‘reasonable’ and that the PRA’s aim was to improve this engagement in the longer term. In particular, in individual cases both supervisors and auditors considered that there was room for improvement in the frankness with which information was shared, how often it was shared and what was covered in bilateral meetings.

2. Switzerland:
For many years, the Swiss Financial Market Supervisory Authority (FINMA) has adopted a dualist approach whereby on-site examinations are outsourced to approved and licensed external auditors. A recent IMF assessment 60 noted significant weaknesses in Swiss supervision. FINMA should provide more guidance to auditors to ensure greater supervisory harmonisation across entities and should complement the auditors’ work with its own in-depth examinations of selected issues. In addition, the payment of auditors by a supervised entity was viewed critically as auditors should not be paid by a supervised entity but rather by a “FINMA administered bank-financed fund”. The IMF also noted that FINMA’s on- and off-site supervisory resources had been increased in recent years but still needed to be strengthened. Resources were insufficient to supervise and regulate the entire banking system in a way that met the Core Principles for Banking Supervision, including sufficient in-depth on-site work and oversight of supervisory work done by external auditors, particularly for small- and medium-sized banks.

3. United States:
A recent IMF report examined the relationship between supervisors and external auditors, and noted “that supervisors meet periodically with external audit firms to discuss issues of common interest relating to bank operations”. It also noted that there was no “safe haven” protection for external auditors in reporting issues to regulators. However, according to Part 363 of the Federal Deposit Insurance Corporation (FDIC) rules, a bank must inform its supervisor within 15 days of having received written information from the auditors about a violation that was committed. This gap is somehow mitigated by the frequent contact between supervisors and auditors in the course of examinations and planning. Furthermore, although the supervisors cannot set the scope of the external audit, they could encourage the auditors to include new issues. However, the report highlighted weaknesses relating to the fact that supervisors do not have legal powers to add specific issues to the scope of the external audit in order to address issues that are not normally covered by such an audit.

4. Hong Kong:
The Hong Kong Monetary Authority (HKMA) devotes significant efforts to ensuring effective communication channels with external auditors. Furthermore, its powers to commission external auditor reports for supervisory purposes further supports the relationship between the HKMA and the external auditors, and the understanding of the HKMA’s supervisory concerns. However, a recent IMF report63 states that there are two areas in which the HKMA lacks powers and where the legislative framework could be enhanced: the HKMA lacks powers to reject the appointment of an external auditor, when there are concerns over its competence or independence, and it does not have direct power to access the working documents of the external auditor even though the HKMA is able to address issues that arise by indirect means. While the HKMA has been able to work around these restrictions, amendments to the relevant legislation should be made.

Building Stronger Macroprudential Frameworks

Durable financial stability requires more than microprudential standards that bolster the resilience of individual firms. It also requires a macroprudential perspective, with flexibility to respond to shocks wherever they occur; with higher standards for systemically important firms; and to increase levels of resilience when risks increase.

Mark Carney, Governor of the Bank of England, Chairman of the Financial Stability Board and Vice-Chair of the European Systemic Risk Board, (ESRB) has addressed European Parliament’s ECON Committee.

The ESRB is the only hub where all the relevant authorities are present, including central banks, bank supervisors, and securities authorities. Through our regular dialogue we can establish and update best practice.

Consider residential real estate. This year ESRB’s work emphasised how these markets were influenced by structural differences, from Loan-to-Value restrictions to tax treatments, across the EU.

Its analysis identified the tools authorities may use to respond to different vulnerabilities, ranging from capital measures to restrictions on debt-to-income ratios and collateral.

Key lessons of the analysis include that:

1. flexibility is needed in both design and calibration of macroprudential tools;

2. no single tool can combat all property risks;

3. tools need to be appropriate to domestic circumstances; and

4. domestic policies are more effective for both domestic and EU financial stability if their spillovers are managed.

The ESRB has built a framework to assess and manage such spillovers, which should be agreed soon and be operationalised early next year. Its central feature is reciprocity – eliminating regulatory arbitrage to give domestic policy greater traction. It will be member led, but, importantly, backed by ESRB recommendations. Compliance will be on an “act or explain” basis but the presumption will be that many exposure-based measures (e.g. LTV, LTI and maturity) will be reciprocated.

This is significant. The ESRB has been notified of macroprudential actions 69 times this year, and 173 times since the introduction of the CRR/CRD in 2014. Although many notices are procedural, they show the direction of travel. More countries are using macroprudential tools, creating an increasing need for a “clearing house” that is both comprehensive and timely.

The ESRB will also evaluate the ways national macroprudential authorities might apply countercyclical capital buffers against financial exposures from countries outside the EEA – a tool given to the ESRB under Union law. That will further bolster collective resilience against the global financial cycle and spillovers from outside the Union.

While risks in property markets reflect national differences, other risks such as misconduct have more common determinants.

In the past five years, misconduct penalties imposed on EU banks have totalled €50bn.

Those costs have direct implications for the real economy. At 5% leverage, that capital could have supported €1 trillion of lending capacity.

More fundamentally, repeated episodes of misconduct undercut public trust in the system.

The ESRB’s work has helped catalyse sensible actions to begin the process to rebuild that trust.

First, it has proposed capturing misconduct costs in stress tests to ensure banks remain resilient even under severe outcomes.

The Bank of England has followed this approach in its most recent stress test which included and additional £40bn of misconduct costs. These costs were calibrated to have a low likelihood of being exceeded and are therefore, by design, much larger than the amounts already provided for by banks.

Second, the ESRB has also proposed tackling misconduct at source by increasing individual accountability. This can be done by reforming remuneration – using variable pay, combined with Malus and Clawback, to hard-wire stronger incentives for good behaviour within firms. The UK is committed to this approach with the toughest remuneration regime in the EU, including the longest deferrals and claw backs.

However, the effectiveness of such measures across the EU is being tempered by the bonus cap. For example, in 2013, the ratio between fixed and variable for material risk takers at major UK banks was around 1:3 – meaning three quarters of remuneration was at risk from individual misconduct. The next year, when firms first had to apply the bonus cap, that ratio had fallen to around 1:1, with the overall level of remuneration unaffected.

Prompted by the ESRB, the FSB is now examining the impact of various compensation tools on misconduct, and if appropriate, it will recommend improvements to next year’s G20 summit.

Reforms to compensation are necessary but not sufficient. ESRB reports have rightly stressed that more should be done to hold senior individuals to account.

Prompted in part by the ESRB, the FSB members will share experiences on the role of bank regulatory powers to address misconduct and on approaches to enhancing individual accountability.

In the UK, we are implementing a new regime to ensure senior managers right across the financial system are held directly accountable for failures in their areas of responsibility. That will be buttressed by clear code of conduct, designed by practitioners, to ensure high standards are understood by all.