A little fear is no bad thing .....

ref :- "Watch the bond market, not equities" , Comment by Gillian Tett in the Financial Times

On Wednesday we brought up the question of whether  a significant rise in bond yields might cut the legs from under the stock market, as Jeff Gundlach believes it will in the second half of this year. It was a long-held if slightly simplistic market adage that rates of interest and equity prices generally move inversely, and in truth in broad terms it was an accurate one. Not now though ...... the Fed has raised rates five times in the current cycle, and thinks it most likely that it will do another three times this year. Under the old rules that would be seriously bad news for equities, and yet in reality the opposite is true : stock markets continue to reach for the sky.

There are a number of powerful reasons behind the equity boom, even if you are one of those who worry about it getting overcooked. But as far as the rates higher / stocks lower argument goes, the reason why that theory has gone astray is of course because although short-term rates are climbing, by historical standards longer-term bond yields are still extremely low. That naturally means that the yield curve is flattening, and since the curve and longer yields make up a sizeable proportion of any measure of financial conditions, those financial conditions (as opposed to short-term rates) remain very close to being at their most accommodative, historically speaking.

The task that faced the Fed (and is about to be taken on by other central banks) is to gradually withdraw the stimulus injected after the financial crisis and ultimately return to more "normal" monetary policies WITHOUT panicking investors. A gradualist, market-sensitive approach and good "forward guidance" has allowed them to achieve this with seemingly barely a flicker of concern among investors so far. But a wobble in the bond market that has seen 10yr yields rise towards 2.60% at one stage raises concerns about where we go from here, and whether the long bull market in bonds is in fact over. Plainly Mr Gundlach thinks so, as does rival Bill Gross and other market heavyweights.

The Fed might not be displeased with high-profile sages expressing such views, in that the more prepared that investors are for what's coming, the more likely they are to take it in their stride. And even if it's true that what constitutes a  "normal" rate structure will be lower than we were used to, some adjustment to the upside is inevitable. These ultra-low rates, if left in place for the longer-term, do damage to the financial infrastructure (not just banks' share prices) and breed potentially disastrous asset bubbles. Handled with care, there's reason to think that a steady rise in rates and yields is not only desirable but should also be eminently manageable with undue market reaction.

Anything unexpected  --  in terms of the pace, size or likelihood of rate hikes  --  well, that could provoke something far more explosive, and not in a good way for markets. You don't necessarily have to be bearish to recognise that these bond markets are vulnerable (though it helps). They're vulnerable because inevitably some investors will be complacent after such a long period of ultra-low rates. They're vulnerable because investors, driven by the search for yield, have taken on bigger credit risks susceptible to upward moves in rates. And they're vulnerable because they've used derivatives to magnify their exposure (and potential return).

And it's not just investors ..... leveraged corporate borrowers should fear a panicky spike in yields. Governments too ,,,, the Congressional Budget Office calculated that costs on the US federal debt will rise from $270bn to $712bn over the next decade if 10yr yields were to rise from 1.8% to 3.6%  --  and that was before the likely rise in the deficit resulting from President Trump's tax cuts. If such a spike in yields was to happen in just one year, that could spell trouble.

If that sounds a bit dark, we should remind ourselves that so far the bond market has handled rate hikes with absolutely no sign of distress, or even undue discomfort. It's possible that the factors that have kept yields so low, such as mysteriously low inflation and remarkable investor appetite, will continue to exert their benign influence. But given what's at stake, the authorities might be grateful that the potentially adverse effects of their policy path could be cushioned by the advance warnings of Messrs Gundlach, Gross and Co.

The BG Consulting Financial Modelling Primer

An Essential Resource for Anyone Managing Juniors Who Are Developing Their Modelling & Valuation Skills

The BG Financial Modelling Primer is a useful resource for anyone managing juniors who are developing their modelling and valuation skills.  The primer describes: 1. What is a financial model? 2. Why modelling is an essential part of a banker's technical toolkit 3. The stages involved in learning efficient financial modelling 4. A skills map for juniors from 1 to 6 years into their roles 5. A typical 12-18 month learning pathway 6. Types of financial models 7. Modelling glossary Please click here to access a full copy of the BG Financial Modelling Primer BG Consulting Are Leaders In Financial Modelling Training Please contact BG Consulting to find out more about our approach to achieving excellence in corporate, financial institutions and project finance modelling & valuation: Highly effective trainers with considerable experience who have the skills and ability to achieve your learning objectives Our training encompasses a combination of learning solutions which create highly interactive sessions Trainers with considerable experience in banking and other areas of finance allowing the trainers to challenge and stimulate more experienced audiences

Best Practice Financial Modelling Training

Real Estate Finance Training - May You Live In Interesting Times

The Need to Ensure All Staff Engaged in Real Estate Lending Are Able to Fully Evaluate Opportunities and Assess Risks Has Never Been More Relevant and Necessary Than It Is Today

We all know of the supposed ancient Chinese curse “May you live in interesting times…”   Well, for real estate professionals these are certainly interesting times!

There is the political impact of Brexit to play out in the UK and Europe, the impact of lower oil prices impacting real estate prices in parts of the Middle East, long term low interest rates in most markets, the increased capital costs of Basle III and with the impact of a divisive US election still unclear.

There are also fundamental long term changes occurring in the industry itself with the trend to shorter commercial leases with more frequent breaks, the continuing movement of demand from high street retail to distribution centres as internet retail continues to grow, and movements in residential markets from build to sell to new professional build to rent models.

It is at times of market disruption like this that the principles of good risk management come to the fore, and the high levels of current uncertainty should be causing Banks to stop and think how they respond to these changes to ensure they manage this difficult but important asset class through the cycle. 

This course is not about trying to predict what might happen next – it is about ensuring you are prepared whatever happens next.

So What Is the BG Training Solution to These Issues?      

   

BG Consulting has many years real estate experience and can tailor make a real estate course to client’s specific needs dependent on both their existing exposures and their ambition for the future.

It can also be designed as either an introductory programme for new staff less familiar with the real estate market and working with SME businesses, or as a master class programme for those more familiar with the sector and currently working with Corporates or looking to do so.

The programme covers the four main asset classes of:

•       Commercial Investment
•       Commercial Development
•       Residential Investment including the rapidly growing Purpose Built Private Rented Sector (PBRS)
•       Residential Development

The course will be based around the three fundamental of good real estate lending which are an understanding of:

•       Asset quality
•       Counterparty risk
•       Deal structure

BG Consulting adopts a practical approach to learning and the course includes a balance between instruction, group discussion and exercises and real life case studies.

Please view the full outline of the training programme here.

About BG Consulting

BG Consulting is a leading global provider of bespoke training for financial institutions, offering our clients trainers who are proven leaders and experts in their field.  Our trainers have worked for the leading global banks and have experience of the full range of real estate deals from small local SPV developments through the to major cross-border syndications.

For more information, or to register an interest please contact us at marketing@bgconsulting.com

The Evolution of International Banking, the Impact of The Euro and the Likely Impact of Brexit

The Evolution of International Banking, the Impact of The Euro and the Likely Impact of Brexit

By Richard Bottomley

During the summer months, I was able to spend some quality time with graduate recruits, all aspiring to be the coverage bankers and transaction banking experts of the future. I believe it is worthwhile to record the issues they raised and some of the discussions we had during that time.

The Bedrock: Domestic Banking

Once upon a time, banking used to be a domestic activity. In these good old days, banks largely (sometimes exclusively) serviced their own domestic market places. The accounts of the banks themselves were safely housed within their own Central Banks. The banks’ Clients held their own bank accounts at “home”, within their own financial centre (for each currency), domestic clearing and settlement systems efficiently processed domestic payables and receivables (from cash, to cards, to wire transfers) and domestic single currency liquidity solutions offered Clients robust opportunities to optimise their overall cash positions. “Cash is King, I used to be taught.” “Richard, 98 % of companies go bust because they run out of cash, not because they are unprofitable.”

In the 1970s and 1980s, cash management became a vibrant domestic specialisation and the role of the Corporate Treasurer morphed from the Finance Department into a specialist role, so as to ensure each company was able to “meet the obligations of the company as and when they fall due”, still to this day a primary role of the Corporate Treasurer.

Domestic banking capabilities and activities form the bedrock of the banking market place and still dominate the transaction volumes of banking as a whole.

Where is the Real Money?

Whether we are talking about my personal account, or the accounts of a large company or institution, our real money is represented by a computer entry in the books of bank ABC, or bank XYZ. Bank ABC and bank XYZ both hold their domestic currency account with their own Central Bank. So when a client of bank ABC pays a client of bank XYZ, then bank ABC’s account at the Central bank is debited and bank XYZ’s account is credited, resulting (at the moment of settlement) in something called “Finality”, when the real value exchanges hands.  In reality, the money never really leaves the Central Bank. Everything else is just a series of book entries. These principles help me to lead on to explain the workings of international banking.

The Evolution of International Banking

In the 1970s/1980s, “trade” instruments were becoming expensive and international trade was growing rapidly. As both sellers and buyers expanded internationally, the cost of trade instruments was becoming prohibitive.  Both sellers and buyers wished to move to “open account” settlement, particularly with counter-parties they trusted, having traded with each party for a growing number of years. Cash based Foreign Currency Accounts (FCAs) increased in number rapidly, initially still in the “home” financial centre of the companies concerned, to facilitate foreign currency payables and receivables. However, these payables and receivables were still made on a cross-border basis, with cross-border access to the clearing and settlement systems for the currencies concerned, all based upon washing funds through the “nostro” accounts of bank ABC, XYZ.

These latter accounts were held either directly with the Central Bank in the country/currency concerned, or with “Correspondents”, a chosen partner bank in each financial centre. As cash payments grew and grew, as international trade activity grew and as more traditional Trade instruments became less and less popular, the incidence of these FCA based solutions also grew. Time zones impacted heavily on solutions of this nature and “cut-off” times within both financial centres were key drivers behind services of this nature.

Now, the cost of cross-border wire payments also became prohibitive and both banks and Cients sought to re-locate these FCAs from the “home” financial centre, to the appropriate financial centre for the currency concerned, what we used to call “away”.  This logical next step gave Clients in-border access to clearing and settlement systems, in-border payables and receivables and in-border single currency liquidity solutions for the currencies concerned.

I hear you ask “and where is the real money behind all of these transactions?”

The answer my friends is that the real money is always with the Central Bank for the currency concerned, because International Banking is 100 % based upon the Domestic Banking principles described above.

So, the saying “all US Dollars are in New York” is 100 % correct. No matter where you are told your US Dollar account is based, the actual dollars are in a bank’s account in New York City and their account is with The Federal Reserve Bank (FRB), thus proving the theory.

Technology and connectivity.

I won’t spend much time in this part of the journey, particularly as, unlike some of my colleagues in Moneta I am not really known as an expert in this field.  Suffice it to say that with one bank domestically with a fully functional domestic banking based “electronic banking system”, built upon and operating to single country domestic formats, is a much more simple solution to provide than those involving multiple currencies, in multiple locations, possibly with more than one bank involved.

Indeed, there was a time when multiple bank systems/platforms were a common sight within a Corporate Treasury Department. Through the passage of time, a few global banks have evolved these systems, improved them, given access to bank accounts based in many different locations, together with host to host systems for high volume transaction processing, all formatted in compliance with local standards.

For the top end of the Corporate and Institutional market, however, it is likely that SWIFT will become the selection of choice.

The Euro: How is it different?

Simply put, because now nineteen countries (and growing by the day) have the same currency.

So, how do I apply my golden rule of “All US Dollars are in New York” to The Euro? Where is the financial centre of The Euro? In which country does it reside?

The answer of course is that The Euro still works to exactly the same principles described above, in that Euros never really leave The European Central Bank(ECB), being in the accounts of bank ABC, bank XYZ within the ECB, just as in our previous, past experiences. The real difference with The Euro is in the ability to effect payables and receivables as in-border transactions, despite the accounts debited/credited being in different countries within the Eurozone.

This will enable banks and their Clients to rationalise their respective bank account structures and payables/receivables flows markedly over time. Furthermore, liquidity structures in Euro will be greatly enhanced under these enhanced capabilities and these simplified resultant structures.

My real concern with the Euro is over its longevity. A shared currency is a big undertaking. It works in GBP because the four countries have learned to “share” the good times and the bad times, with surpluses in one of the four countries being used to cover the deficits of others, possibly rotating in the short term, for example with Scottish oil revenues. However, over the longer term, the four support each other. In The United States, not all States generate surpluses, but again “the common good” created by a single market alleviates the burden on the “surplus” States, making their willingness to support the whole structure a viable alternative.

In 2015, Germany and The UK together represented almost 35 % of EU GDP.  In my view, given the relatively small size of certain “surplus” nations, the burden upon Germany and the German people will become intolerable. Therein lies the real problem with The Euro, namely its’ sustainability!

Brexit: A Contentious Issue!

In my view, not really. The UK banks were never “in” The Euro, and yet still offered(offer) Euro based products and services, as they do with US Dollars. The major UK banks will look to continue offering these, possibly through “partner” bank arrangements, possibly directly through a branch or subsidiary. The European reaction to the latter possibility is awaited.

Again, in my view, London will always be in The Euro. Indeed, it will be difficult for London to function without The Euro, but equally The Euro cannot fully function without London. London is not a UK city, it is a global city!

A Crash in the Pound Will Affect your Profits

A Crash in the Pound Will Affect your Profits
by Raymond Moore

The Sterling has had its worst week since the Brexit vote falling by 6% against the dollar in 2 minutes on Friday. Can a Supply Chain Finance solution offset increases in the import price of goods due to the weakening pound? 

 As GBP continues to weaken, UK importers are increasingly exposed to "margin pinch”. Supply Chain Finance “SCF” could be potentially be a solution that allows some or all of this "pinch" to be recovered without the need to revise contracts with suppliers and create a 'win win' solution for both buyer and supplier.

How does it work? 

Basically it is an arbitrage play on the interest rate differential between the buyer's and supplier's relatively cost of borrowing, the buyer's typically being a lower cost. A financial institution whether it be a bank or a specialist trade finance house, sits in the middle of the buyer and supplier and makes available non-recourse finance to the supplier once the buyer has approved the invoices submitted to it by that supplier. Let's consider a simple example. 

A supplier submits and invoice to their buyer for $100,000 with 90 days terms. The supplier's cost of borrowing is 4% pa. Hence if it were to fund the invoice via a working capital line with one of it's partner banks it would get a discounted receivable of $99,014 against the invoice equating to a cost financing of $986.

Alternatively the buyer has a cost of borrowing of 2%. The $100,000 invoice is included in a SCF solution provided by a bank/trade house who on presentation of the invoice to them by the buyer make available non-recourse financing to the supplier. As it is non-recourse and the bank/trade house credit risk is with the buyer, the cost of borrowing is 2% (i.e. the buyers cost), the discounted receivable to the supplier against the invoice is is $99,507 equating to a cost of financing of $493. 

The difference in the cost of financing between the 2 scenarios of $493, and overall the solution provides a win for the supplier (reduced borrowing cost on its debtor position), a win for the buyer (ability to share in the interest rate differential and thus potentially offset some or all of the margin pinch) and lastly a win for the Bank or Trade Finance House providing the solution (it will have a potential annuity stream of income from the provision of a SCF solution and a very “sticky" client). 

How can we help?

 Implementing an SCF provision is not easy.  There are legal documentation and supplier on boarding problems to overcome together with ensuring the Trade credit Taken position on the buyers balance sheet remain undisturbed, i.e. there is no reclassification of Trade Credit Taken to Bank Debt. That said with the continued potential for margin pinch and the increasing differentiation between credit spreads/costs borrowing it is likely that the upward trend in the market for using this sort of solution will continue.

At BG we have recent hands on experience of developing and delivering SCF solutions for some of the world’s largest companies. Whether a bank, trade house or end-user, we can partner with you to devise solutions and identify other areas of working capital optimisation. 

Two Asset Management Simulations to Bring Your Training to Life

Portfolio Trader

Portfolio Management Simulation

Description

Portfolio Trader lets you gain valuable knowledge and experience in the process and execution of portfolio management. You are given a certain (fictive) amount of capital which you can invest in a variety of securities. The goal is to maximise your returns while adhering to your clients’ portfolio objectives and balanced trading risks. The online simulation uses real market instruments in a real-time environment.

You will get the opportunity to see which market theories work as you expected and what happens when a theory breaks down in practice. You will gain an in-depth understanding of market dynamics and create and follow (your own) market expectations as well as experience the emotions involved in managing a portfolio of real instruments in real time.

Duration

The simulation software is Internet-based and runs ‘live’ (either with a 15-minute delay or in real time) over a period of at least four weeks. The length of a session can vary considerably depending on the experience of, and time available for, the participants. A normal length is five to eight weeks.

A standard session would require either one hour of e-learning or a classroom presentation before the start of the simulation.

After a simulation session, the group feedback takes on average two hours. Individual feedback (partly given during a session), can range from ten minutes to two hours per participant depending on the required depth of coaching.

Key Issues Covered

• Active management of a portfolio of various instruments
• Risk and return appetites of clients
• Formulating of investing and trading strategies to build a balanced portfolio
• Establishment of risk parameters, trading limits and goals
• Selection of target instruments, sectors and companies
• Analysis of expected returns, volatility and portfolio ’fit’ for each investment
• Instruments to hedge or leverage a position
• Realistic ‘take profit’ and ‘stop loss’ levels 

Evaluation

The instructor will interact with you and the other participants by analysing your strategy and performance and give continuous feedback. During and after a session you are reviewed individually by an instructor on specific aspects including the following:

• Profit and loss (volatility)
• Risk management
• Identification of (own) trading styles
•  Knowledge and awareness of market developments/products
•  Reaction to news and market changes
• Liquidity management
• Fundamental and technical analysis

Portfolio Manager

Asset Management Simulation

Description

Portfolio Manager gives you the opportunity to gain valuable knowledge and experience in the process of portfolio management and strategic asset allocation.

You are given a certain (fictive) amount of capital which you can strategically invest over asset classes and their constituents. The goal is to maximise your returns while adhering to your fund objectives and risks.

You will gain an in-depth understanding of market dynamics and can create and follow (your own) market expectations as well as experience the emotions of managing a fund over a longer time horizon. You will get the opportunity to see which market theories work as you expected and what happens when a theory breaks down in practice.

Duration

The simulation software is Internet-based and is normally played over a period of one full day. The portfolios are constructed in a simulated environment that spans over five years, which translates to one simulated month per five minutes. The duration may be adjusted to match the participants’ experience and available time.

A standard session would require either one hour of e-learning or a classroom presentation before the start of the simulation.

After a simulation session, the group feedback takes on average two hours. Individual feedback can range from ten minutes to two hours per participant depending on the required ‘depth of coaching’.

Key Issues Covered

• Active management of a portfolio of various instruments
• Risk assessment and rating
• Risk and return appetites of clients
• Pricing, covenants and collateral
• Formulation of investing and trading strategies to build a balanced portfolio
• Establishment of risk parameters, trading limits and goals
• Credit portfolio management
• Selection of target instruments, sectors and companies
• Analysis of expected returns, volatility and portfolio ’fit’ for each investment
• Instruments to hedge or leverage a position
• Realistic ‘take profit’ and ‘stop loss’ levels

Evaluation

The instructor will interact with you and the other participants by analysing your strategy and performance and give continuous feedback. During and after a session you are reviewed individually by an instructor on specific aspects including the following:

•  Profit and loss (volatility)
• Risk management
• Identification of (own) trading styles
• Knowledge and awareness of market developments
• Reaction to news and market changes
• Liquidity management
• Fundamental and technical analysis
• Fund strategy handling