Archive for the 'Social and Governance' Category

Are capital markets taking a wrong turn? Soul-searching on short-termism after UK’s Kay Review

Lots of useful commentary is published this week about what’s going wrong with the world’s leading capital markets and finance. This new bout of soul-searching follows the publication of Prof John Kay’s “The Kay Review of UK Equity Markets and Long-Term Decision Making” on 23 July and available here (and the Interim Report, published in February, with much of the evidence is available here.
The Prof says that equity markets are not working as effectively as they could. “We conclude that short-termism is a problem in UK equity markets, and that the principal causes are the decline of trust and the misalignment of incentives throughout the equity investment chain”. He says that successful financial intermediation depends on: “Trust and confidence are the product of long-term commercial and personal relationships: trust and confidence are not generally created by trading between anonymous agents attempting to make short term gains at each other’s expense.”
He blames the prevailing culture and says that people don’t only work for financial incentives, as widely promoted in current City culture – “Most people have more complex goals, but they generally behave in line with the values and aspirations of the environment in which they find themselves.” Prof Kay puts forward a series of 17 recommendations on how to make things better and this could be useful reading for anyone involved in developing capital markets with an aiming to help grow savings and create better performing businesses. This includes fiduciary standards of care if you manage other peoples’ money, diminishing the current role of trading and transactional cultures, high-level statements of good practice, improving the interactions of asset managers and other investors with investee companies, and tackling misaligned incentives in remuneration, and reducing pressures for short-term decision making. The Guardian newspaper’s Nils Pratley has a useful summary of some of the best recommendations here, ironically coupled with a beautiful rosy photograph of the City!
One background comment is by Evening Standard columnist Anthony Hilton here. He says “The behaviours that led Deputy Governor of the Bank of England Paul Tucker to use the word “cesspool” when giving evidence to the Treasury Select Committee on Libor come in a straight line from the reforms imposed on the Stock Exchange by the then Prime Minister Margaret Thatcher in 1986 when she forced it to open up membership to all comers, and in particular to abolish single capacity — the arrangement under which firms had to confine themselves to a single activity in which they acted for themselves or for the client, but not both… From being a servant of the real economy, finance began its journey towards becoming an end in itself, with deals done not because they had economic rationale but because they made money for bankers and costs, both direct and indirect, that impose a colossal and unnecessary burden on that real economy.” He adds that this kept the system honest “or rather it was dishonest in a less poisonous way. Until Big Bang, the problems came from dishonest people working in honest firms; today the problems are caused by honest people working in dishonest firms. The culture is rotten.” This brought world-beating businesses low “by policies designed to pander to the stock market rather than secure the businesses’ long-term future for its customers, employees and indeed the country.” He says the rewards of finance should belong to customers, not their advisers.
Kay also notes that index investing, as growing popular in some African markets with the rise of ETF (exchange-traded funds) and other derivatives, may not represent a strategy for representative returns, see this Financial Times summary. He also urges less securities lending.
Most of the leading commentators though conclude that the view is rather rose-tinted, and not in touch with the real world. The Financial Times Lex Column says (unfortunately this link may be subscribers only, but you did not miss much if you don’t find a way around): “Dig a little deeper though and this vision – which includes an attack on the efficient markets hypothesis – is flawed”. It says although investors should engage more with companies a falling share price is better incentive for a manager to perform well than a phonecall and that quarterly reporting helps people see what’s going on and reduces insider trading. It points to the UK’s “shareholder spring” in which investors forced change at companies such as Aviva and AstraZeneca. Another Financial Times summary of reaction is that Kay is “no silver bullet” and while people may agree with his views “some.. may prove challenging to implement in practice”. Some recommendations can be implemented by the industry, including investors’ forums for collective long-term engagement and good stewardship, others such as calls for asset managers to disclose all costs, including transaction costs and performance fees charged to funds, may be carried out voluntarily. Only a few may be carried out through legislation, and many others (apart from Lex) support removal of obligations for quarterly reporting and argue that managers’ time could be better spent elsewhere.
It’s a week of interesting reading for people, including many in Africa, building capital markets that are meant to serve economies, the creation of business growth and jobs, and also to encourage more long-term savings.
Discussion is very welcome!

New directions for giant CDC: targets poor with $3.1 bn

Giant UK development finance institution the CDC Group has announced a radical new business plan after a review of its organization and activities, following media and political criticism. Chief changes for the leading private equity investor are a return to direct investing from a fund of funds approach, and focusing only on low and lower-middle income countries in sub-Saharan Africa and South Asia.
At the end of 2010, CDC group was invested in a portfolio worth £1.9 billion ($3.1 billion), according to its website www.cdcgroup.com, invested in 143 funds managed by 71 managers and these funds had invested into 930 portfolio companies in 70 different countries. CDC had started investing into funds in 2004 after selling off stakes in Actis and Aureos funds. Like other leading development fund managers it aimed to build capacity among African fund managers.
The change comes after the review in 2010 by the Secretary of State for International Development, Rt Hon Andrew Mitchell MP. A new CEO is to be appointed.

Direct investments and ESG
According to the new business plan, as outlined in a press release, direct investments will be 20% of the portfolio by 2015, and CDC will target businesses with high potential development impact and manage these investments in a hands-on way to gain more expertise. Debt investments will be up to 20% of CDC’s total portfolio by 2015, so that CDC can target frontier markets where investment infrastructure is underdeveloped. Small and medium enterprises are a key target and it will offer guarantees to help businesses to obtain credit, commercial bonds and trade finance. CDC will also explore the role of technical assistance to make capital more developmentally effective. It will aim to match all its funding with equal amounts of third party capital.
In future CDC will concentrate exclusively on the low- and lower-middle income countries in sub-Saharan Africa and South Asia where 70% of the world’s poor live. In lower-middle income countries, CDC will focus on regions and sectors of need where capital is scarce and will avoid sectors which are already attracting capital from other investors.
The group will step up standards of environmental, social and governance (ESG) at investee businesses and there will be independent valuations of the development impact of funds. It says it will “lead the way among DFIs on openness and accountability”. CDC will update its investment code regularly and disclose more information about the organization, its investee businesses and its partners.

Innovation in deals and “appropriate” pay

It will also set up a new innovative finance division to explore opportunities in exceptionally challenging investment circumstances, which need innovation in deal origination and the ability to draw on a wide range of financing approaches.
It will also change the way it pays staff: “Remuneration will be appropriate for a publicly-owned body whose purpose is poverty reduction. CDC must be able to recruit and retain people with the right approach and skills to deliver the company’s development mission. CDC will follow applicable FSA guidance and EU legislation so that variable performance pay will be largely deferred and based on long-term performance.”
Andrew Mitchell MP, Secretary of State for International Development said: “This is a bold and exciting new departure for CDC. The reforms will help them direct their capital better, fostering economic growth in countries which need it most. CDC will be better able to drive investment into areas currently starved of capital. It will become more nimble, flexible and transparent, able to influence and control the impact of their capital and measure its success in reducing poverty, not simply in turning a corporate profit.”

The action begins
The new business plan is already in action. CDC this year invested $30 million in funds helping provide long-term loans and guarantees to address an acute shortage of capital for green energy in developing countries. CDC is investing $30m in a new agribusiness fund in Africa focusing on Zambia, Tanzania, Malawi and Mozambique. A further $30m has been invested in basic African infrastructure such as toll roads, ports, railways and energy.
Richard Gillingwater, CDC’s chairman says: “These reforms deliver a more versatile and pioneering CDC. Our ambition is make the biggest difference possible to lasting development.”
According to a story on the leading website www.privateequityafrica.com, CDC currently has an African private equity portfolio worth £877million, which includes the £122 million it invested in new businesses in 2010. The investor additionally committed funds to 8 Africa-focused managers in 2010, including a maiden fund Catalyst Principal Partners I focused on East Africa.