Kpmg Banking Report 2009

| frontiers in finance – June 2009

frontiers in finance for decision makers in financial services June 2009 FINANCIAL SERVICES

The long road to recovery Making it a reality Major changes ahead Making sense of regulation Clarity and reality The role of the auditor in financial services Jump start Reviving the US financial system Confidence must return An investment management perspective



foreword frontiers in finance June 2009

Brendan Nelson Vice Chairman, KPMG in the UK Global Chairman, Financial Services

The long road to recovery

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he financial services sector – like the global economy as a whole – faces a long and potentially bumpy road to recovery. One of the foundations for long term stability should be regulatory reform. While regulation cannot eliminate all risk from financial markets, the old regime was in need of some redevelopment. Regulators in many jurisdictions are struggling to formulate new frameworks which will prove robust and effective. As yet, it is not clear that there is agreement on basic principles. Furthermore, solutions are likely to differ between the banking, investment management and insurance sectors. I believe the audit profession has much to contribute and hasty and ill-considered action should be avoided. At the same time, the speed at which new regulations may be brought in means that firms do not have the luxury of waiting until the dust has settled. Some preparatory work has to start now. In this issue we highlight this from a range of perspectives. The US remains the engine of the global economy, and so the success of the Financial Stability Plan will be crucial for us all. We look at some of its key features and implications. More generally, we recognize

recovery requires that trust in the financial services industry be rebuilt. This is equally true in investment management – where there are exciting opportunities ahead – as is the case in banking and insurance. Also in this issue, we focus on two contrasting economies: Canada, where the financial services environment has remained largely intact; and India, which despite suffering a battering from the crisis, is still on course for enviable growth this year. At KPMG, our member firms work with leading financial services institutions across the world, providing an opportunity to explore in detail how companies are coping with these turbulent times. A number of recent KPMG surveys – in investment management, insurance and payments also assist in offering valuable insights. On this journey to recovery, the financial services sector is going to need all the insight and advice that is available. I hope this issue of frontiers in finance goes some way to meeting that need. Brendan Nelson

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

Contents | frontiers in finance – June 2009

In this issue

12

For your information fyi…

2

Topics Major changes ahead: Making sense of regulation

4

Perspectives on regulation in banking, investment management and insurance

8

Clarity and reality: The role of the auditor in financial services

2

Jump start – Reviving the US financial system: The Financial Stability Plan

4

Economic turmoil: The US commercial real estate perspective

7

Topics: Clarity and reality: The role of the auditor in financial services

18

Confidence must return: An investment management perspective 8 Renewing the promise: Time to mend relationships in investment management

2

Act now: The implications of Basel II revisions

22 Topics: Confidence must return: Investment management

Quietly prospering: Canadian financial services

24

A glimmer of hope

28

Show me the money: Insights into global payments

30

Addressing the trust gap: Renewing confidence in the financial services industry

34

Separating value: Getting the most from your disposals

38

Changing for the better

42

Getting ahead – UCITS IV: Putting the potential into action

44

24

Topics: Quietly prospering: Canadian financial services

48

Order returns… An economic overview 46

Series Emerging markets: India: A brighter future?

48

Insights Updates from KPMG member firms, thought leadership & contacts

52 Series: Emerging markets: India: A brighter future?

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



frontiers in finance – June 2009 | For your information

fyi...

At your finger tips

frontiers in finance online

With our audience growing rapidly, we wanted to make frontiers in finance more accessible to you, our readers. The frontiers in finance team is pleased to bring you KPMG’s first online magazine. This exciting new version means you will be able to read the latest edition of the magazine at the click of a button! But not only will you be able to view the entire magazine, you will also be able to download individual articles, share them with your colleagues, view videos and podcasts on various topics and keep up to date with hot issues through our new section, frontiers supplements. These will be updated regularly to address specific aspects of interest in the financial services industry arena. Go to our online magazine now at www.kpmg.com/frontiersinfinance.

Insights in Nigerian Banking

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here is no clear leader or preferred bank for SMEs (Small to Medium Enterprises). According to the 2009 edition of KPMG’s Nigerian Banking Industry Customer Satisfaction Survey, it is evident that the SME market may not be receiving the attention it deserves from banks in Nigeria. This insightful report also highlighted a progressive rate of diminishing customer satisfaction

levels from the larger corporate respondents. Futhermore it goes on to highlight opportunities for banks in Nigeria to improve customer satisfaction and in turn, increase customer retention and loyalty, a hot topic we are seeing for financial services globally.

For more information go to www.ng.kpmg.com

Focus on next practices, not best practices

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rofessor C.K. Prahalad1, one of the world’s most influential experts in corporate strategy visited KPMG in Finland’s top executive seminar on strategy in May in Helsinki. Prahalad revealed that the key to creating value and the future growth of every business depends on accessing a global network of resources to co-create unique experiences with customers, one at a time. He argued that the nature of strategy has changed and the management focus has to be on anticipating new business opportunities and on creating next practices, not best practices. According to Prahalad, the competitive arena is shifting from a product-centric view of value creation to a personalized experience-centric view of value creation and innovation. Prahalad believes that competitive advantage will depend on a firm’s approach to business processes, that can seamlessly connect customers and resources and manage simultaneously the needs for efficiency and flexibility. It will be a race to provide a unique customer experience at the lowest cost.

For more information contact: KPMG in Finland www.kpmg.fi/en

1. For further reading: The New Age of Innovation – Driving Co-Created Value through Global Networks, C.K. Prahalad, M.S. Krishnan, McGraw-Hill 2008.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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For your information | frontiers in finance – June 2009

Global Financial Forum

2009 frontiers in tax Restructuring, consolidation and government intervention

Taking stock and looking ahead In New York recently, The Foreign Policy Association, Chatham House, and British American Business, supported by KPMG International, organized the Global Financial Forum.

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orld economic leaders gathered to discuss the state of financial services and what is needed to move forward. Christine Lagarde, The French Minister for the Economy, Finance and Employment pointed out that what is unprecedented today is not so much the consensus on a need for stimulus, but rather the consensus on a need for financial services regulation. Lord Turner, Chairman Financial Services Authority (the UK regulator), highlighted three areas of regulatory reform needed; a macro-prudential approach, capital reform and a mechanism to reverse the funding of long term obligations by short term risk. President of the European Central Bank, Jean-Claude Trichet, noted the over-arching need to restore confidence in financial services. Some of these key themes are discussed later in this edition.

For more discussion on regulation, see page 4.

The 2009 issue of frontiers in tax, our sister title, looks at the impacts and consequences of the financial crisis and identifies some of the longer term tax risks and opportunities.

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hrough the global network of KPMG member firms, our colleagues take a forwardlooking view of the tax consequences of major developments in the industry such as the draft UCITS IV directive. This is a major development in the establishment of a single market in mutual funds within the EU which has wide-reaching effects. Our colleagues look into recent reforms and tax changes in the Chinese insurance market which give rise to interesting opportunities

for foreign investors. In addition a recent trend in South East Asia sees authorities taking a stricter line on foreign investors using treaty networks for cross-boarder transactions. Finally, this issue discusses proposed changes to indirect tax for financial services that could have some unforeseen consequences for the industry.

For further information visit www.kpmg.com/tax

Governance, risk and reporting Draft EC Directive for Alternative Investment Fund Managers

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n late April the European Commission published new legislation for the regulation of Alternative Investment Fund Managers. This follows global calls for reform to risks taken by financial institutions, which have been linked to the credit crisis1. The proposals would require the alternative fund managers, not the funds, to register and seek government authorization which would include elements of reporting, governance and risk management standards2. Tom Brown, partner KPMG in the UK noted “while we can welcome the directive from the perspective of

supporting the industry’s own agenda of building good practice, and while the better run hedge funds will likely find little change from many of the measures being introduced, the real challenge is one of implementation. Politicians need to ensure that the political agenda doesn’t end up destroying the European hedge fund industry by imposing sweeping changes that are unworkable or unnecessary”. 1. ‘Hedge fund managers warn on EU plans’, www.ft.com, April 29, 2009. 2. ‘Hedge fund managers warn EU rules will cripple their industry’, www.ft.com, April 30, 2009.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



frontiers in finance – June 2009 | Topics

Brendan Nelson

Major changes ahead Making sense of regulation

In some respects, the likely shape of the financial services industry after the crisis may remain unclear. But one thing seems certain: the nature, scope and purpose of regulation will change substantially. Politicians, regulators and treasury officials across the developed world are setting out proposals for a more robust and effective regulatory regime to improve protection against future crashes. The failure of the authorities Responsibility for the crisis may reasonably be shared among a number of interests. Central bankers declined to assume responsibility for the growth of unsustainable asset bubbles; governments failed to tighten policy when public finances allowed and regulation failed in its key task of maintaining stability and confidence in markets and the financial system.

The dangers of systemic risk were ignored, and the need for macro-prudential oversight forgotten. As a consequence banks, especially, are now coming under huge pressure from regulators to significantly improve their capital and liquidity positions and demonstrate sound and prudent management. A major drive for regulatory reform is already under way.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



Topics | frontiers in finance – June 2009

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



frontiers in finance – June 2009 | Topics

A great deal of detailed discussion and drafting will be needed to ensure that an effective and unambiguous system emerges.

Regulatory reform In the US, Treasury Secretary Tim Geithner is calling for comprehensive regulatory reform: “not modest repairs at the margin, but new rules of the game”. The European Commission’s de Larosière report suggests the creation of a European Systemic Risk Council to oversee a new system of regulation and supervision. In the UK, the Turner Review calls for higher minimum capital requirements, counter-cyclical capital buffers and limits on gross leverage. What is still unclear is how all of the proposals currently being formulated and discussed can be integrated into an effective global framework which also reflects individual national priorities. The dangers of confusion, incoherence and promotion of regulatory arbitrage are real. At the G20 London Summit in April, world leaders pledged action to build a stronger, more globally consistent supervisory and regulatory framework for the future financial sector:

‘Strengthened regulation and supervision must promote propriety, integrity and transparency; guard against risk across the financial system; dampen rather than amplify the financial and economic cycle; reduce reliance on inappropriately risky sources of financing; and discourage excessive risk-taking.’ G20 Final Communique, April 2009

They announced that regulation and oversight would be extended to all ‘systemically important’ financial institutions, instruments and markets, including hedge funds. While the principles of the G20 declaration are to be applauded, a great deal of detailed discussion and drafting

will be needed to ensure that an effective and unambiguous system emerges. The criterion of systemic importance, while intuitively clear, is merely the most high-profile concept over which fierce debate is inevitable. There is also a risk that the real progress made over the last 20 years towards harmonization of global standards will be undermined or thrown off course. Capital adequacy The G20 proposals for a counter-cyclical capital adequacy regime are likely to be among the least contentious in principle, since they are consistent with current thinking from a number of sources. But they are likely to result in a more formulaic regime, which could constrain scope for flexibility at the same time as imposing more stringent overall capital requirements. It remains to be seen whether any new system will be truly balanced, or will simply be used to impose higher limits during the good times. Nor is it clear that it will be easy in practice to track the economic cycle with sufficient precision. The rate and extent to which capital requirements are tightened as we emerge from recession will be a particularly sensitive decision. One of the more challenging commitments of the G20 Communiqué is that all G20 countries should progressively adopt the Basel II framework. However, no timetable for this has been agreed. One of the obvious major stumbling blocks is that the US has, to date, failed to make any commitment to Basel II at all. In addition, it is not obvious that imposing Basel II on all banks, whatever their size and degree of cross-border exposure, will turn out to be realistic.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



Topics | frontiers in finance – June 2009

Political considerations and public anger are giving extra force to demands for tighter regulation.

Hedge funds Political considerations and public anger are giving extra force to demands for tighter regulation. Although hedge funds have had only a minor role in causing the crisis, they are widely criticized – and misunderstood – and are going to be drawn more tightly into the new regulatory framework. Funds and their managers can expect to be registered and subject to new disclosure requirements. The adequacy of risk management systems will likely be probed. Institutions which have hedge funds as their counter-parties will likely need to develop mechanisms to monitor the funds’ leverage and set limits for single counter-party exposures. Once again, though, the detail will be critical. There is not yet even an agreed definition of what is, or is not, a hedge fund, let alone which criteria would identify one as systemically significant. In the UK, Lord Turner notes that hedge funds in general are not like banks; the implication is that they should not be regulated in the same way as banks. The UK’s Hedge Fund Standards Board, while operating a voluntary framework, has established a sound foundation which global regulators could profitably build on. Remuneration There is also widespread public concern – and anger – at the remuneration of those bankers perceived to have caused the crisis; some extension of regulation to include salaries and bonus arrangements is politically inevitable. The argument seems even more compelling in relation to those institutions which have been bailed out or taken into public ownership. The argument that compensation arrangements should properly reflect risk and, in particular, match the time horizon of risks – so that payments

should not be finalized over short periods where risks are managed over long periods – is surely sound. Similarly, recent high-profile controversies have accentuated the need for non-executive directors and shareholders to be more fully involved in and appraised of remuneration arrangements before irrevocable awards are made. However, it will be important that decisions in this area are fair, reasonable and proportionate, and do not succumb to ‘bash the bankers’ prejudice. The G20’s proposal that supervisors should, where necessary intervene in compensation policies (with responses including increased capital requirements) could be seen as a veiled threat. The Turner Review concluded that remuneration structures played a less important role in contributing to the financial crisis than inadequate approaches to capital, accounting and liquidity. Overall Nobody can argue that the current systems of regulation are sustainable. They have very dramatically failed to prevent one of the worst financial crises in many decades. Financial services institutions have to brace themselves for a much more muscular and interventionist regime in future. But what that regime ultimately looks like will depend on a great deal of argument and compromise, which is a process only just beginning. Moreover it is essential that it avoids giving the impression that all risk can be eliminated from financial markets.

For more information please contact: Brendan Nelson Vice Chairman, KPMG in the UK Global Chairman, Financial Services Tel: +44 20 7311 6157 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



frontiers in finance – June 2009 | Topics

Perspectives on:

regulation in banking, investment management and insurance David Sayer

Dave Seymour

Frank Ellenbürger

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



Topics | frontiers in finance – June 2009

From left to right: David Sayer, Dave Seymour and Frank Ellenbürger.

Many authorities across the world are seeking to formulate new regulatory frameworks in the wake of the crash. But the final shape of any new system remains quite unclear; and it is unlikely to remain free of political distortion and interference. David Sayer, Global Sector Leader, Retail Banking, Dave Seymour, Global Sector Leader, Investment Management (IM) and Frank Ellenbürger, Global Sector Leader, Insurance, met recently to compare and contrast their different perspectives. David Sayer (Banking) Looking at what’s happening at the moment, it seems to me important that this crisis is seen to have been caused by the banks. So the diagnosis is focused on bank failures and the need to stop this happening again, often to the exclusion of other potential causes of the crisis including: trade surpluses, fiscal deficits, regulatory policies and so on.

Dave Seymour (IM) I agree. Just following up on the political dimension for a moment, there is a great deal of debate over the extent to which US executive and legislative policies during the mid 1990s, such as the modifications made to regulate and strengthen the Community Reinvestment Act anti-redlining procedures, as well as other legislative actions, may have impacted the crisis. Policy makers are now trying to fix it, but given the complexities, it is difficult to know what, or how much to regulate.

Frank Ellenbürger (Insurance) Of course by contrast with the huge stress and uncertainty in the economy caused by the banks, insurance and the insurance markets have continued to operate normally, without any major disruption. The same is true for reinsurance markets. The impact of the crisis on insurers has mainly been on the life side, with the value of investments tumbling. Those that have been most affected deviated from their core operations into financial products developed without understanding the risk that underpinned them. But the business model of insurers and the largely uncorrelated relationship between insurance risk and market risk have so far been stabilizing factors; hence insurance is much lower on the political and risk radar.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.



frontiers in finance – June 2009 | Topics

There is always a political dimension to financial markets. The world has discovered not only how dangerous financial markets can be, but how valuable functioning financial markets are to economies. Dave Seymour

Sayer In the case of the banks, though, there is huge pressure now for taxpayers to provide guarantees and bailouts. These include liquidity support through guarantees and protection of savers and borrowers, asset purchases, forced recapitalization, bad bank schemes and so on. But the big questions that I think should still be answered are to do with how to reduce systemic risk in the banking system. This involves a range of issues: the nature of financial regulation; strengthening regulators; reducing the impact of failure of financial firms; protecting and supporting customers; improving competition. Seymour And this raises the key issue of whether we can recreate a fiduciary society with a common framework and set of rules, or whether we are inevitably faced with a much more rigid, strict set of rules. Do we really need more regulation?

Ellenbürger Before any action is taken, it should be well thought through and balanced, taking into account the macro-economic considerations. Intervention should not create an uneven playing field between different sectors of the financial services industry. Although banking has been the crux of the crisis, a new framework or set of rules should look beyond this sector; introducing a ‘one-size-fits-all’ response will only lead to future complications. Each industry will require separate revisions. Sayer In the banking sector, some trends are clear. The quantity of capital required will be high, and countercyclical requirements will be imposed to make banks hold more capital in the good times (unlike the Basel II framework, which is pro-cyclical). But it is yet unclear how this is going to work in practice, and in different economies. The other problem with imposing counter-cyclicality is that cyclicality will always be there. Someone has got to turn the lights out just as everyone else is enjoying the party. And that’s really difficult. Looking back, it’s hard to see how macro-prudential regulation would have been accepted in say 2005 or 1987 when the last booms were getting going.

Ellenbürger It will be interesting to see how the banks adapt to the anticipated counter-cyclical requirements requiring them to significantly shore-up their capital holding. Intrinsically insurers have always had to calculate their capital adequacy because of their exposures to risk when underwriting. But with the 2012 EU-wide implementation deadline of Solvency II, Europe’s insurers will have to fundamentally review their capital requirements and risk management standards. Whether other key global insurance markets look to replicate this framework locally remains to be seen, and undoubtedly regulators will be heavily involved. Seymour And that makes it even more difficult to see how greater regulation can effectively be extended to investment management. The G20 couldn’t agree on regulating hedge funds. The European countries are pushing for regulation, while the US is looking for registration. The European Commission’s draft directive on the issue is itself proving highly contentious among member states. Investment funds are products, not companies, and this makes providing safeguards for investors a different matter than in the banking sector. There is as yet no clear idea of how to tie investment funds into the systemic risk argument, especially in view of the easy flow of funds into and out of different economies and jurisdictions.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Although banking has been the crux of the crisis, a new framework or set of rules should look beyond this sector. Frank Ellenbürger

Ellenbürger Nevertheless, the systemic risks resulting from an overtly complicated banking system with an inadequately developed regulatory framework have been one of the causes of the current crisis, and these need to be addressed. The precondition for creating an anti-cyclical regulatory environment is to obtain transparency and a holistic view of the global financial system, without leaving large parts unregulated. Sayer The debate over whether or not a global regulator is necessary, or possible, will inevitably go on. But however global the framework, it’s a fact that global institutions come home to die. In the end, failing banks are the responsibility of their home regulators. In my view, the global role should be about ensuring consistency between national frameworks and limiting the scope for regulatory arbitrage. Regulation itself needs to remain local. In Europe, though, there is a particular problem caused by the single market. Since the single market requires free and open movement of capital, the case for a single European regulator may be stronger. It’s not going to be politically easy to achieve, but the potential accession of Iceland to EU membership may be a trigger.

Ellenbürger International groups may benefit from diversification effects but also be exposed to accumulation or contagion risks. Those need to be mirrored by supervision on a cross-border basis. Seymour Any regulatory reform must look to prevent the next crisis, not the last one.

In my view, the global role should be about ensuring consistency between national frameworks and limiting the scope for regulatory arbitrage. David Sayer

Sayer It’s also important that regulation avoids the moral hazard problem, and avoids giving investors and customers the impression that all risk has been removed from financial markets. Seymour I guess one thing that we have certainly learned is that there is always a political dimension to financial markets. The world has discovered not only how dangerous financial markets can be, but how valuable functioning financial markets are to economies. Sayer It’s going to take time to work out solutions in the banking sector. What has happened by way of emergency action was what needed to happen, but the rest, a new approach to regulation, will take time. And that’s a good thing. We need to take the time to get this right.

For more information please contact: David Sayer Partner Global Sector Leader, Retail Banking KPMG in the UK Tel: +44 20 7311 5404 e-Mail: [email protected] Wm. David Seymour Partner Global Sector Leader, Investment Management KPMG in the US Tel: +1 212 872 5988 e-Mail: [email protected] Frank Ellenbürger Partner Global Sector Leader, Insurance KPMG in Germany Tel: +49 89 9282 1867 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Topics

Brendan Nelson and Scott Marcello explore the possible need to expand the future role of the auditor in financial services.

Brendan Nelson

Scott Marcello

The role of the auditor in financial services: Is reform desirable?

Clarity and reality

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inancial Reporting today is clearly complex and often not well understood. Why is this the case? One key reason is that we often lose sight of what should be the overriding objectives. Too often, we succumb to treatments and positions that we believe to be conceptually pure or technically superior but that are potentially less than relevant and all too often not understandable. In the extreme, what good is served if each and every accounting pronouncement is perfectly consistent, globally harmonized, and aligned with well developed conceptual underpinnings, if users find that information wholly irrelevant and incomprehensible? Adding to this, the objectives or underlying concepts used to develop accounting standards are not really agreed; this is particularly true when you consider issues from a global perspective. This was evident in the recent debate in the US regarding fair

value accounting for investments. Some people strongly support the use of fair value, others hate it. Probably a majority believe it is a valid principle, but have significant concerns about when it should be viewed as the most relevant attribute for measurement in financial statements. Vast amounts of energy have been invested in this issue but confusion remains. Another issue is, frankly, who reads all of this information anyway? Annual reports today have grown to hundreds of pages, including information of widely varying importance and relevance. How many people read and really understand all of this information? Is it more than a handful of people? And how many is that when you exclude the auditors, certain members of management and certain regulators? The role and involvement of the auditor with respect to information also may often be poorly understood. Most people recognize the technical content an auditor provides: their opinion on the

fair presentation of a company’s financial statements and, in some cases, the internal controls relevant for financial reporting. But there is a vast amount of information included in companies’ filings that is not subject to audit work. Users of financial statements may be quite surprised to learn that many pieces of information that they view as being very significant to their analysis are not covered by the audit – liquidity for example. So how can the auditing profession contribute to improving the global paradigms for regulation and financial reporting? Accountants, when you think about it, can help in leading the debate. When it comes to accounting rules and financial statement reporting, they can help keep the real goals in sight and in proper perspective. Apart from the regulators, accountants are one of the few groups uniquely qualified to understand complex financial institutions and provide genuine insight about their business, their operations and their

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Apart from the regulators, accountants are one of the few groups uniquely qualified to understand complex financial institutions and provide genuine insight about their business, their operations and their reported information. They can bring a varied and global perspective, and professionalism and objectivity to important and challenging debates. reported information. They can bring a varied and global perspective, and professionalism and objectivity to important and challenging debates. Progressing that thought, together, management, regulators and auditors have to move toward providing insight and important perspective rather than expanses of accurate, but possibly less relevant information: more relevant and important information has to be prioritized and unimportant, obvious, or

redundant information has to be eliminated from the equation second guessing should be minimized while still respecting the need to protect stakeholders it needs to be recognized that the role of financial reporting is to provide relevant and reasonably reliable information, not to predict the future with certainty and it’s important to recognize the judgment and intellectual capital that can be added by management, regulators and auditors

On this last point, a critical question is whether this intellectual capital will flow freely and to its full extent if it is hampered by the potential for significant legal liabilities. The potential liability issues that prevail, particularly in America, may now need to be finally and fully addressed. Now you could argue we would say this wouldn’t we? But we genuinely believe that reform is desirable and that the auditing profession can and should make a significant contribution.

For more information please contact: Brendan Nelson Vice Chairman, KPMG in the UK Global Chairman, Financial Services Tel: +44 20 7311 6157 e-Mail: [email protected] Scott Marcello Joint Regional Coordinating Partner, Financial Services, Americas region Tel: +1 614 249 2366 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Topics

Jump start Reviving the US financial system: The Financial Stability Plan

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Howard Margolin

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Calls to action in combating the ongoing economic crisis are coming from all parts of the globe. In particular, governments are faced with far-reaching policy decisions to try to stem the tide of foreclosures, job losses, and disappearing savings. With the US financial system taking much heat for its role in the recent economic turmoil, many acknowledge that a strong US financial system is also one of the keys to recovery. Howard Margolin explains.

n February 17, 2009, President Barack Obama signed into law the Financial Stability Plan (FSP) to help stabilize the US financial system and restore confidence in the markets. The FSP is a multipronged offensive designed to boost the nation’s economy by eliminating the uncertainty surrounding financial institution assets and stimulating lending while imposing new measures around financial service industry accountability, oversight, and transparency. The FSP includes the following components:

Should the results indicate that capital is inadequate, such institutions will have six months to raise the necessary capital buffer via private funds. Lacking such private funds, they may access capital through CAP in the form of convertible preferred stock.

Capital Assistance Program As a means of reducing uncertainty over whether certain financial institutions have sufficient capital to weather the financial storm, the Capital Assistance Program (CAP) requires US banking organizations with assets of US$100 billion or more to undergo a more thorough regulatory review. This includes a comprehensive ‘stress test’ designed to asses the balance sheet exposures of these institutions, should there be a greater than expected decline in the economic environment.

The stress test results were released on May 7, 2009, indicating that the largest banks had adequate capital to meet adverse (not ‘worst case’) economic conditions. Capital shortfalls for the largest banks totaled approximately US$75 billion. Many banks have issued, or plan to issue, common stock to meet the shortfalls. Others plan to convert preferred stock to common stock or sell assets. A limited number of more capitalconstrained banks may be forced to sell operations or curtail certain activities.

Capital shortfalls for the largest banks totaled approximately US$75 billion. Many banks have issued, or plan to issue, common stock to meet the shortfalls.

Public-Private Investment Program The Public-Private Investment Program (PPIP) has been created to address the challenge of cleansing balance sheets of ‘legacy’ assets. PPIP seeks to lure new private capital into the market by providing government equity coinvestment and attractive private financing to reduce the risks inherent in investing in these legacy loans and securities. Equity co-investment is intended to protect US taxpayers from overpaying for assets through a marketbased valuation approach – as opposed to prices being set by the public sector – and taxpayers stand to benefit by sharing in any profits derived from these assets. Both potential sellers and buyers are still seeking clarification on many fronts, such as pricing mechanisms, the accounting impact of such transactions on capital levels, and other sale terms. The impact that recent changes by the Financial Accounting Standards Board – relating to the recognition and measurement of credit impairment losses on debt securities – has on the demand for this program remains to be seen. Additionally, the impact of the stress test results on PPIP participation has yet to be determined.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Term Asset-Backed Securities Lending Facility This joint initiative of the Federal Reserve and the Treasury Department seeks to encourage consumer and business lending through the renewed issuance of certain asset-backed securities (e.g. those supported by auto, credit card and student loans, mortgages, and other assets) at reduced interest rate spreads. Already in existence, funding for the Term Asset-Backed Securities Lending Facility (TALF) has been greatly expanded under the FSP.

Those receiving FSP funds will be required to engage in mortgage foreclosure mitigation efforts; whether other lenders may be required or otherwise encouraged to participate in these efforts remains to be seen. Mortgage Loan Modification Program The FSP includes a proposal to reduce mortgage rates through Federal Reserve and Treasury Department purchases of up to US$600 billion of Government-Sponsored Enterprise mortgage-backed securities and debt. Additionally, the FSP calls for issuance of formal loan modification guidelines and standards applicable to government and private programs. Those receiving FSP funds will be required to engage in mortgage foreclosure mitigation efforts; whether other lenders may be required or otherwise encouraged to participate in these efforts remains to be seen.

Small Business and Community Bank Lending Initiative In light of the increased capital pressures on lending institutions and the lack of demand for Small Business Association (SBA) loans in the secondary markets, the FSP addresses the precipitous decline in SBA lending. A joint Treasury Department and SBA initiative will seek to increase such lending by financing the purchase of AAA-rated SBA loans and pursuing efforts to increase the Federal guarantee up to 90 percent for eligible loans.

Transparency and Accountability Agenda The Treasury Department will require all FSP fund recipients to conform to intensified requirements for transparency, accountability, reporting, and monitoring. Reporting requirements include a one-time plan discussing the recipient’s intended use of government funds to preserve and strengthen lending capacity. Further, there will be monthly reporting on new lending activities and tracking of CAP funds separate from other assets. Additional FSP conditions include restrictions on dividends on stock repurchases and acquisitions, limitations on executive compensation, and restrictions on lobbying.

Each FSP component will have unique accounting, tax, and financial considerations depending on a company’s particular circumstances.

Implications These far-ranging initiatives have broad consequences for both financial institutions and government agencies. Each FSP component will have unique accounting, tax, and financial considerations depending on a company’s particular circumstances. Management should consider these implications as strategic decisions are surrounding participation in the FSP. Similarly, assessments of modeling techniques, expanded data and disclosure requirements, systems capabilities, and staffing will be essential to plans for moving forward. The sheer magnitude of changes and level of regulatory scrutiny will present sizable implementation challenges, and companies may find the need for project management teams to try to keep all initiatives on track. The private sector now has multiple fronts through which to cleanse its balance sheets and reinvigorate lending activities. At the same time, these initiatives significantly expand the role and power of government, necessitate changes to current processes and controls, and place additional requirements on both financial institutions and government related to reporting, monitoring, and compliance activities. Over the coming months, additional details will emerge regarding these programs, and institutions should remain vigilant to the strategic opportunities that could result, while maintaining appropriate discipline and controls to satisfy the attendant increased reporting and compliance activities.

For more information please contact: Howard Margolin Partner Financial Services KPMG in the US Tel: +1 212 954 7863 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

The US commercial real estate perspective

Ray Milnes

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Economic turmoil

s numerous US public and private enterprises work to jump-start the national economy – much attention has been paid to restoring the health of the residential real estate market and the banking system. Yet, as the global recession has deepened, the commercial real estate market also faces distinct hardships. A core challenge has been the lack of available liquidity for transactions. For instance, securitizing commercial loans, especially via Commercial Mortgage-Backed Securities (CMBS) has been a significant source of liquidity, fueling the prior growth in commercial real estate transactions. However, the freezing of the CMBS marketplace (issuances decreased from US$237 billion in 2007 to US$12 billion in the first half of 2008 with virtually nothing since then, according to JPMorgan Chase & Co. data) has caused transactions to grind to a halt. This lack of transactions further complicates the ability to properly value property in the current marketplace. Real estate values have plummeted, and investors are waiting to see how low they will go. There is a fear among industry specialists that this investor

inertia may cause a continuing downward spiral in prices, or, at a minimum, prolong the lack of activity. Stimulating Credit Markets One potential solution for this bleak situation is the inclusion of CMBS financing in the US-governmentsponsored Term Asset-Backed Securities Loan Facility (TALF). Designed to stimulate the credit markets and restore stability by providing financing to purchase asset-backed securities, TALF was expanded by the Treasury Department to earmark US$100 billion to leverage US$1 trillion of lending. While TALF’s inclusion of CMBS should stimulate the market, debate remains over how vigorously the various players will embrace the program. Purchasing Legacy Assets The US Government’s Public-Private Investment Program (PPIP) provides public-sector equity and debt financing to private-sector investors to achieve two critical goals: attracting idle assets back into the market by tackling the inertia of private investors, while also freeing up embedded capital from the balance sheets of institutions. This mechanism will hopefully achieve the goal of creating a market for

these real-estate-related assets, enabling institutions to funnel funds into new credit formation. It is hoped that restoring liquidity for new transactions – including those involving commercial real estate – will ultimately stimulate the economy. Additionally, greater clarity about asset values – gleaned from the resulting transactions – should boost investor confidence, increasing the amount of investment in the market for further transactions. While investors and asset holders are still waiting for greater clarity on these programs to help determine the extent of their participation, the US Government has taken an activist stance to help resolve some of the core issues that initiated the global economic crisis. With financial leaders worldwide watching and evaluating what happens in the US economy, it remains to be seen whether the depth and breadth of this situation can be significantly affected by the actions of government.

For more information please contact: Ray Milnes Partner Building Construction & Real Estate KPMG in the US Tel: +1 312 665 5023 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Everybody has been hurt by current market conditions. For example, hedge funds, traditionally focused on absolute rather than relative returns, have inevitably been hit hard, although a number of funds are continuing to do well in attracting new investment. Dave Seymour argues that investment management is likely to emerge changed but probably stronger from the crisis. There are exciting opportunities ahead. But success will depend critically on rebuilding trust and confidence. © 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Confidence must return Dave Seymour

An investment management perspective

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he simplest way of summarizing the current state of the investment management industry is to say it is confused. A large part of the industry is still sitting on the sidelines. Funds with private capital reserves still have investable resources. But they can’t be sure the market has bottomed out, and are wary of investing into assets which may lose further value. Overall, there is a lot of uncertainty over where the market is going and how to respond.

Historically, the most successful investment management firms have been those which focus clearly on their customers. This is going to be even more important in the future. Getting in shape One sensible and effective strategy is to concentrate on getting into shape for the upturn, when it comes. Here, one of the most important challenges is to rebuild trust and confidence by strong customer relationship management.

Historically, the most successful investment management firms have been those which focus clearly on their customers. This is going to be even more important in the future. Whether they are private capital investors or retail investors, customers are increasingly going to demand better, more frequent and more transparent communication. The crash, exacerbated by high-profile frauds has made investors very nervous. Risk management processes have been called into serious question. Perceptions of risk have changed. The investor community is rattled, and confidence will not return easily. The firms which come through the crisis best are likely to be those which are currently investing in creating or growing meaningful customer relationships. Successful firms are taking the opportunity to improve the organization, build new skills and capabilities, and perhaps acquire complementary expertise or capacity through corporate restructuring. Those who have been badly burned by the crisis need to rebuild and re-organize their operations for the new risk environment. As ever, it’s the simple things which can count for most. After a period of irrational exuberance, focusing on execution will be the key to achieving returns.

Many firms are already beginning to restructure themselves, their products, teams and capabilities. In an industry where many players don’t have deep in-house infrastructures, instead relying on networks of third party vendors for many operational activities, focusing on execution also means ensuring that the total risk profile is effectively managed. The future of regulation The chorus of calls for tighter regulation should be met with care. Many of the participants at the G20 London meeting are seeking to build new regulatory frameworks, to curb what they see as the excesses of ‘Anglo-Saxon’ capital markets. There is a tendency to characterize hedge funds, in particular, as opportunist players who damage rather than support local economies. Tighter regulation is an understandable and instinctive response. A risk with stand alone or knee-jerk regulatory changes is that they can open up arbitrage opportunities between different markets and stimulate firms to find alternative ways of investing capital in situations which match their risk appetite. Financial markets are very creative, and will seek to invent new structures, products and techniques in the pursuit of a return on investment.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Smaller, nimbler firms will increasingly dominate the market in the years to come. And customers will find it easier to relate to and understand simpler, more focused firms as well. Furthermore, traditional regulatory frameworks, from the Securities Exchange Commission (SEC), Financial Services Authority (FSA), the G10’s Basel Committee and the like, are focused on corporate entities. But investment funds are not companies, and are not like companies. They are products. Any move to greater regulation may be more appropriate if it follows the model of consumer product safety regulation in order to satisfy the objective of protecting investors. The authorities need to move carefully if they are to avoid frustrating the market’s natural recovery and readjustment after the crisis. They should also seek to guard against appearing to guarantee investor protection, since this could lead to distorted consumer behavior. In the particular case of hedge funds, there is a risk that if these are more tightly regulated it could give investors the false illusion that this type of investment has the same risk profile as a traditional fund for example. People could then misunderstand the risk of hedge fund investing – mistaking higher regulation for lower risk.

A return to boutiques One area where the market already seems to be in tune with regulators’ concerns is in the increasing move back to smaller boutique operations. The last 15 years or so have seen a great deal of consolidation in the industry, with asset managers being acquired by large institutions, financial conglomerates expanding into third party business and so on. Financial institutions have become complex and opaque, and the potential for localized risk management failure to contaminate entire corporate balance sheets has become painfully apparent. Regulators and politicians have begun to call for smaller, simpler and more transparent institutions. The market already appears to be responding. Among the major global institutions, one has exited from retail asset management; another is divesting a high-growth business to a private equity firm; continued pressure to deleverage and bolster balance sheets will inevitably lead to more de-consolidation over the next few years. Conversely, traditional fund management firms are looking to make acquisitions to develop complementary capabilities or increase capacity. Talented individuals are already moving in the same direction. Since the major investment houses became mainstream banks, a steady stream of start-ups and boutiques has been forming. The difference today is that the infrastructure of third-party vendors which has developed over the intervening period provides a ready made, mature support environment for these new boutiques. Smaller, nimbler firms will increasingly dominate the market in the years to come. And customers will find it easier to relate to and understand simpler, more focused firms as well. The future is full of opportunities The recession and its aftermath will provide great opportunities for the investment management industry, magnified by demographic and geo-political trends which have been under way for some years. We expect private capital to play a critical role in deleveraging the financial system.

Many economists argue that we are seeing not simply the bursting of another bubble like that of the dot-com crash, but a more fundamental realignment to a higher-saving world – much like the Asian markets. The consumer spending boom will give way to more restrained behavior as individuals and families respond to uncertainty and the fear of unemployment and repossession. History suggests that fundamental changes in attitude persist for many years after a major financial crisis. If savings ratios rise to consistently higher levels, more assets will be under management and the demand for investments of all types will grow. Against this, however, are some key demographic trends, especially the great transition in developed western economies as the baby-boomers move into retirement and begin drawing down, rather than building up, their savings. In addition, the long-term transfers of wealth from the developed world to the oil-rich nations and the developing world will be of crucial significance. Middle-Eastern and other sovereign wealth funds are already major players in the investment community. In the 1980s, the US was the world’s largest creditor nation. Today that role has been taken by China, overtaking Japan to hold some US$1 trillion of US debt. The US itself has become the world’s biggest debtor nation. How these unsustainable imbalances are sorted will prove of vital importance for 21st century geopolitics. While the immediate outlook remains uncertain, the medium- and long-term opportunities are tremendous, and tremendously exciting. Those investment funds which keep their nerve, concentrate on improving transparency and communication with customers, and get themselves in shape for the new financial world order stand to enjoy an exciting and profitable future.

For more information please contact: Wm. David Seymour Partner, Global Sector Leader, Investment Management KPMG in the US Tel: +1 212 872 5988 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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A recent KPMG report provides insight into the new world facing investment managers after the crisis. Reviewing its key conclusions, James Suglia, and Tom Brown argue that the key to recovery lies in mending relationships. James Suglia

Tom Brown

Renewing the promise Time to mend relationships in investment management

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he credit crisis is fundamentally reshaping investment management. A new report, drawing on the findings of a global survey of 288 investment managers, investors and senior executives working in the industry, provides valuable pointers to how the industry will develop as a result1. If firms are to grasp the potential of these changes, mending relationships with investors, regulators and other stakeholders will be key. Corporate governance and risk management Many investment managers could benefit from lifting their game in this area. Investors believe that independent assurance and adherence to a best practice code of conduct need improvement, despite investment managers believing that they are performing well in these areas. This is a disconnect that managers really need to address to avoid alienating their investors. Managers who have strong programs need to be more transparent (i.e. better at communicating them) while other managers must first work on strengthening their practices. Investment managers need to clearly articulate their risk appetite and transparently communicate this. When risk appetite is properly understood and clearly defined, it becomes a powerful tool for enhancing overall business performance. A clear and effective risk management and governance structure gives both the investment manager and investors confidence that investments can be competently managed in a controlled way.

Rebuilding trust The trustworthiness of financial intermediaries has been hard hit by the crisis. This is on top of a string of scandals in recent years, from market timing abuse to Ponzi schemes, which had already damaged this trust. Investment products can be complex and difficult to understand for most members of the general public, while failure is easy to see and measure. Investment managers need to help intermediaries, who sit with clients, to explain the risks and benefits, the costs and the small print. This should deliver the message to their investors in all of these areas. Unfortunately, the research indicates that there is still a wide gulf to bridge between investment managers and intermediaries.

Differentiation For many years, investment managers did not have to try very hard to be successful in the industry. Today, the key to success has become differentiation. The study highlights the importance of personal relationships and service quality as well as delivering on clients’ expectations. Achieving differentiation is really about getting ‘back-to-basics’: determining what clients need, getting the value proposition focussed and communicating it clearly.

Regulation There are widespread concerns about the impact of potential new regulations, especially in the areas of leverage, disclosure to clients and the external assurance. The great majority of respondents felt that regulators clamping down will seriously increase costs for investment managers. In many cases, managers will be unable to pass on these associated costs to their clients. Likely regulation in areas like shorting and leverage will damage many business models. Many hedge funds could find life very hard. Greater transparency may also mean that investors begin to question the fees they are being asked to pay for hedge and other alternative funds. In response some alternative fund managers will entrench but many will diversify and seek to migrate into more traditional activities.

Tom Brown Partner KPMG in the UK Tel: +44 20 7694 2011 e-Mail: [email protected]

For more information please contact: James Suglia Partner KPMG in the US Tel: +1 617 988 5607 e-Mail: [email protected]

1. Renewing the promise: Time to mend relationships in investment management, KPMG International, June 2009; in partnership with Datamonitor.

About the report The full report, Renewing the promise: Time to mend relationships in investment management will be available in June, please visit www.kpmg.com for copies.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Topics

Act now W The implications of Basel II revisions

Public confidence in banks has been badly damaged by the financial crisis. In its wake regulators across the world are working intensively to fashion a new framework for the financial services industry. The Financial Stability Forum is emphasizing the need for better risk and capital management. The Basel Committee is pressing ahead with revisions to the current Accord. Details are still under discussion. But as Thilo Kasprowicz and Klaus Ott claim, banks do not necessarily have the luxury of being able to wait until all the details are finalized.

hen the current version of the Basel II Accord on capital adequacy and supervisory arrangements for banks was finalized in 2006, it was clear that further updates would follow. Even though many banks would have preferred a ‘regulatory break’ for a few years, detailed work under the aegis of the Basel Committee for Banking Supervision has been proceeding since, at the same time as the financial crisis has taken hold. The crisis has given major new impetus to the Basel process. Much of the debate at the G20 London summit, and the principles captured in the final communiqué, are feeding directly into updating Basel II. Conversely, the Basel Committee had already formulated proposals which, in some respects anticipated the G20 recommendations.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Thilo Kasprowicz

Klaus Ott

Current proposals In January 2009, the Basel Committee published three discussion documents addressing critical areas where they believe the current framework needs to be strengthened:

Enhancements to the overall framework: these are aimed at strengthening risk capture in Pillar 1 (minimum capital requirements); improving corporate governance and risk management and their supervisory oversight (Pillar 2); and improving disclosure of financial exposures to enhance market discipline and allow third parties to develop better understanding of a bank’s overall risk profile (Pillar 3) Revisions to the market risk framework: the current framework fails to capture some key aspects of market risk and will be extended; in addition, stressed value-at-risk requirements will be imposed Incremental risk in the trading book: since the crisis began, a number of banks have suffered large losses from trading exposures, and the committee now proposes a supplementary incremental risk capital charge, based on estimates of potential losses Consultation on these proposals has now ended, and there are clear target dates for complete implementation of the final conclusions: December 2009 for the overall framework enhancements, December 2010 for the market risk and incremental trading risk proposals. Since the revised Accord can only take legal effect when it is implemented into individual national jurisdictions, it is clear that these implementation timetables are extremely challenging.

Similarly, many banks should wake up to the potential implications now. In view of the high political pressure to act on the lessons learned from the crisis, the European Union and others are already anticipating expected changes. They are issuing detailed directives and draft regulations to strengthen banking supervision and improve risk and capital management of banks even before December 2009 or 2010. The luxury of waiting until proposals are finalized and regulations drafted in detail before planning how to comply is simply not available. Most aspects of the revised framework are already clear in principle. Banks should be urgently working out how to respond. Strategies, methodology A number of the new proposals will involve banks in reconsidering strategic decisions. For example, certain trading book products will attract higher capital charges, and some banks may need to review whether or not to continue in a particular securitization markets, whether as originator or investor. Changes to capital definitions will mean banks will have to review the issuance of some capital instruments, for example hybrids. Proposals on concentration risk will mean that credit portfolios will need to be scrutinized critically. Credit risk management teams should re-think their approach to active portfolio management. Basel II will also involve changes to methodologies and valuations. Stress testing will almost certainly be imposed more widely, and potentially even applied to integrated underlying portfolios of securitizations. Liquidity regulations will involve the thorough identification of cash-flow positions for a wide range of products and the need for adequate processes for liquidity risk management. Furthermore, the calculation of risk-weighted assets for some products will change. Changes to disclosure, in particular for securitizations, trading book activities and the use of special purpose vehicles, are likely to accelerate the move to bring internal management reporting, external statutory and financial reporting according to IFRS into closer alignment: banks should be looking at consistent disclosure strategies, capital market communications and reporting policies.

Organization and IT These proposals will have implications for many aspects of a bank’s systems, processes and infrastructure. Some risk management and disclosure processes will need to be redesigned. Management information systems may have to be reconfigured to support new reporting procedures and facilitate enhanced communication with supervisory authorities. Banks should prepare for a much closer interaction with regulators, who will increasingly use their intervention to monitor business and risk strategies. Underpinning process changes will be requirements to reconfigure and enhance IT architectures and system functionality. Databases supporting cash flow information, portfolio composition, disclosure and risk management will almost certainly need to be upgraded. Issues of skills, resources, staffing and cooperation across departments are likely to arise, both as banks undertake the necessary change programs, and as they comply with the new regime on a continuing basis. Basel II has been a significant challenge for many banks to date. Even before the current framework has been fully implemented, new challenges are now apparent. It may be tempting to think that the proposed revisions to the framework are simply slight enhancements or variations. But the changes will impact even on banks using the less demanding Basel II standardized approaches. There is a lot to do and, as we have seen, the timetable is tight. Given the present political momentum for change, it is more likely that deadlines will be brought forward rather than be delayed. Analyzing the strategic impact of the new regulations and planning for implementation should not be delayed for further clarification.

For more information please contact: Thilo Kasprowicz Partner KPMG in Germany Tel: +49 69 9587 3198 e-Mail: [email protected] Klaus Ott Partner KPMG in Germany Tel: +49 69 9587 2684 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Canadian financial services

Quietly prospering

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Ann Davis

Largely away from the gaze of international commentators, financial services in Canada remain in robust health, and in certain cases are positively booming. A number of factors are responsible, including a generally conservative culture of excessive risk-avoidance, strong regulation, and a welcoming business environment. Ann Davis explains.

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cross the developed world, the financial crisis has seen banks collapsing, being bailed out by governments or being taken into public ownership. More than a trillion US dollars of value has been wiped out from bank balance sheets. However, many Canadian banks have proved much more resilient than those of any other major economy. Last November, Time magazine called Canada ‘the new gold standard in banking’1. The 2009 Global Competitiveness Report from the World Economic Forum ranked Canada No 1 for soundness of banks2. By any measure, Canada’s banking sector is one of the strongest – if not the strongest – in the world. How so? © 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Ten years ago, the Financial Times top-50 ranking of the world’s biggest banks was dominated by US and UK banks. No Canadian banks made the list. Today, all of the ‘Big 5’ Canadian banks are now in the top 505.

Canada’s banking sector embraces:

21 domestic banks.

55 foreign-owned subsidiaries and branches.

47 Trust companies.

Five major banks dominate Canada’s banking sector (see box), which in total embraces 21 domestic banks, 55 foreign-owned subsidiaries and branches and 47 Trust companies. The financial services sector as a whole has shown remarkably steady growth of about 3.5 percent per year over the last ten years, to reach a total turnover of C$80 billion3. Over the same period, the ‘Big 5’ has collectively doubled their market capitalization4. Ten years ago, the Financial Times top-50 ranking of the world’s biggest banks was dominated by US and UK banks. No Canadian banks made the list. Today, all of the ‘Big 5’ are now in the top 505. Royal Bank of Canada and TorontoDominion are among only seven global financial institutions to hold a triple-A credit rating from Moody’s. Regulation is part of the reason for the solid success of Canadian banking. Cultural attitudes are also crucial. In both of these respects, Canada has maintained a distinctive tradition, the roots of which extend deep into the early half of the last century. That regulatory framework, coupled with a conservative attitude to risk-taking, has helped to ensure a consistently prudent approach and a greater degree of openness and transparency than in many other systems. Another key feature is that mergers and acquisitions in the banking sector are constrained among the ‘Big 5’, which has limited the size of individual banks and avoided concentration of risk. Government policy encourages the establishment of new banks to promote competition. Large banks – those with

more than C$5 billion equity – must remain ‘widely held’. Bank mergers have been proposed as a route to greater international competitiveness, but have been vetoed at the political level. Limits on foreign ownership have been imposed and mergers between banks and insurance companies are not allowed. A further significant factor is that during the 1980s, the big banks bought most of the large independent investment dealers, thereby integrating them into the more prudential banking structure. These strengths have been consistently recognized by the International Monetary Fund. In its regular Financial System Stability Assessment in 2008, the IMF concluded6: The Canadian financial sector is among the world’s most highly developed The five large banking groups that form the core of the system are conservatively managed and highly profitable Stress tests suggest that the large Canadian banks are able to withstand a broad range of shocks Of course Canada’s banks have not been unaffected by the global crisis. Nevertheless, none have collapsed, none have needed government bailout and there has been no need for injections of government capital. There may have been an air of confidence in the comments by the governor of the Bank of Canada, Mark Carney, when he claimed in April 2009 that

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Canada’s ‘Big 5’ Banks 9 Market Capitalization (Q3 2008)

Royal Bank of Canada:

C$45 billion Toronto-Dominion:

C$37 billion Bank of Nova Scotia:

C$30 billion Bank of Montreal:

C$17 billion Canadian Imperial Bank of Commerce:

C$18 billion ‘Our system is better’7. But who is to deny that it certainly seems to be? Complacency would obviously be a mistake. Although the Canadian financial system has weathered the storm better than other global financial institutions, the future remains unclear. Increased regulation will surely impact on all Canadian financial institutions, and Canadian banks will still need to work hard at remaining globally competitive. But it has shown itself to be an inherently stable system. Beyond this, Canada has shown that it’s a great place to do business for the wider financial services community. Toronto, in particular, has proved itself to be a natural magnet for financial services. Over 200,000 people are employed in the financial services sector in Toronto, including around

10,000 chartered accountants8. The city boasts the second largest CFA (chartered financial analyst) society in the world after New York. Toronto is also more affordable than many other major financial centers. All these factors have driven one of Canada’s most notable but little-appreciated, success stories: the growth of hedge fund administration in Toronto. Canada’s domestic hedge fund market is comparatively small – perhaps C$20-30 billion of assets under management. But the great untold story in the Canadian hedge fund sector is the movement of global hedge fund administrators to Toronto and other parts of Canada. There is likely well over a quarter of a trillion dollars of global hedge fund assets being administered in Canada. Toronto has always had a large domestic fund administration industry. But since the mid-1990s, hedge fund administrators such as Citco, Butterfield Fulcrum Group and SS&C Fund Services have been setting up offices in Toronto, Halifax and other parts of Canada, and existing traditional fund administrators such as State Street, Citibank and RBC Dexia have been expanding their services to hedge fund clients. Seven of the top 10 global hedge fund administrators now have offices in Toronto likely employing several thousand hedge fund administrators.

Toronto offers solutions to many of the issues facing administrators, through the key competitive attributes of quality and cost. Toronto has an excellent telecommunications infrastructure, the most fiber optic cable of any city in North America, the largest public transport system in North America after New York, and the fourth busiest airport in North America. It is only the 54th most expensive city globally, and Canada as a whole was ranked the most economical of the G7 nations by Competitive Alternatives, 2008 edition. Strong stable banks, a steadilygrowing financial services sector and a growing presence in niches such as fund administration – it is time for the rest of the developed world to take a closer look at the Canadian system.

For more information please contact: Ann Davis Partner KPMG in Canada Tel: +1 416 777 8587 e-Mail: [email protected]

1. ‘Why Canada’s Banks Don’t Need Help’, Time, November 2008. 2. The Global Competitiveness Report 2008-2009, World Economic Forum. 3. Banking and Financial Services: Prudence equals strength, Halcyon Business Publications, March 2009. 4. ‘Canadian Banks: A better system’, Financial Post, April 2009 5. Financial Times, March 23, 2009. www.ft.com. 6. Canada: Financial System Stability Assessment – Update, IMF, January 2008. 7. Remarks to the University of Alberta School of Business Edmonton, Alberta, March 30, 2009. 8. Hedge Fund Administration in Toronto, KPMG in Canada, December 2008. 9. Office of the Superintendent of Financial Institutions, 2009.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Managing risk and capital performance are significant challenges following the financial crisis, but insurance executives are still cautiously optimistic about their growth prospects over the next 12 months, says Frank Ellenbürger.

A glimmer of hope D

espite some recent well-publicized casualties, the insurance industry is weathering the current economic conditions better than banking. Mainstream business operations are holding up well. Problems have only arisen from exposures to risky financial instruments like credit default swaps (CDS) and collateralized debt obligations (CDO) or losses in investment portfolios. Profitability is more likely to have been impacted than underlying solvency. Currently troubled capital markets, falling ratings and plunging share prices have prompted many to rethink their risk and capital management strategies. With this in mind, KPMG International recently commissioned the Economist Intelligence Unit to survey insurance executives around the world to gain insight into their current perception of business prospects and risk priorities.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Frank Ellenbürger

Insurers cautiously optimistic about growth The research found many were anticipating that growth would improve over the next 12 months. Over half of the respondents thought prospects for both organic growth and growth by acquisition/take-over were positive. North Americans appeared most confident, which may reflect a perception that this region will rebound most quickly from the current economic slump. The less optimistic news is that the same executives said a continuing lack of confidence in the capital markets could stifle their recovery. Less than four in ten respondents said that they expected an improvement in their share price over the next year. Well-designed and actionable procedures for mitigating the risks that created so much recent instability will likely be key to restoring faith in the markets. Risk management is a significantly higher priority It is clear that concerns over the impact of the weakened economy, and particularly the capital markets, have prompted insurers to place significantly more emphasis on risk management and capital performance. At board level, the survey showed that the proportion of time spent on both risk management and capital management has increased substantially. Over 80 percent of board members are now spending at least 20 percent of their time on risk management issues. The survey also found that almost two-thirds of respondents have appointed board-level risk committees in addition to their longer-established audit committees. In terms of priorities, market risk and credit risk are top of the agenda.

Greater focus doesn’t equal more spending on risk Interestingly, a significant majority of respondents regard themselves as already good at managing risk activities. When asked to rate their effectiveness in 11 different categories of risk management, at least six in ten respondents believed themselves to be effective in each area. And despite devoting more time to risk from the board level downwards, not everyone was intending to spend more money on the risk function. Around half of the respondents expected to invest more. But this leaves a substantial proportion (47 percent) expecting to achieve stronger performance with the same resources in both risk and capital management as before, and no plans to increase training resources, recruiting or other investments in risk functions. Enough capital in the industry? Meanwhile, there is an apparent contradiction around responses heard on capital. Most respondents (85 percent) believe they are well-capitalized relative to their risks, and most believed that the industry as a whole has sufficient capital reserves. But more than half nonetheless believe they will need to strengthen their capital over the next 12 months, which is more in line with messages we are hearing from the marketplace. The survey continues over the summer and will track any shifts in attitude. Link to better valuation The impact of the current financial crisis on the insurance industry is clear in terms of lower valuation in the market. But insurers clearly feel a sense of optimism that they have seen the worst now, and have the attributes to prepare for a more favorable environment. If they can demonstrate excellence in managing risk, continue to be profitable, and communicate this achievement effectively, we may well see market confidence and valuations boosted in the year to come.

KPMG’s global risk and capital management insurance survey 2009 In April 2009, KPMG initiated a twopart research program to explore how the financial crisis is changing insurance industry attitudes to risk and capital management. We asked senior executives how they are responding to prevent further losses and position their businesses for growth in future. The initial report, capturing the thinking of 315 industry executives from 49 countries, was launched in early June 2009. Key findings in April 2009 – Over half see positive prospects for growth in the next 12 months – Managing risk is a much higher priority and two thirds of companies have appointed board level risk committees – At least 6 in 10 think they are already effective at managing risk across the board – Around half don’t intend to increase investment in managing risk – Top three activities where risk management plays an active role are new product development, strategy development and pricing Part two of the survey will track further changes in attitude and responses to risk management in the forthcoming months. Results are scheduled to be published in an in-depth briefing in November 2009. For more information or copies of the first report, please visit www.kpmg.com

For more information please contact: Frank Ellenbürger Partner, Global Sector Leader, Insurance KPMG in Germany Tel: +49 89 9282 1867 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Oliver Kirby-Johnson

Steve Blizzard

The financial crisis has had less impact on the payments business than on other parts of banking. However, a recent KPMG International survey does reveal some significant changes in emphasis. Investment projects face greater risks and tighter criteria for returns. There is a widespread fear of substantial increases in regulation, which is already affecting banks’ behavior and investment plans. Mobile payments continue to offer great opportunities – but only in certain regions. Oliver Kirby-Johnson and Steve Blizzard argue that distinctive and definitive business models will be key to future success.

Show me the money Insights into global payments

A

recent KPMG International survey of industry regulators, major banks and financial technology companies explores how changing economic conditions have affected the outlook for the global payments industry and the factors likely to drive change over the next five years1. Payment processing is a fundamental function for banks; as the cost of capital increases and returns elsewhere are constrained, banks will be looking to squeeze more out of payments and enhance returns from basic transaction processing. Many payment strategies are possible, but a clear customer focus and benefit are needed to succeed against the competition. Banks need to attract deposits in order to bolster their balance-sheets and liquidity ratios. To a customer, the bank relationship is not about balances, it is about how well and easy the bank makes or receives a timely, effective payment. Only a rich palette of payment types attracts high-quality deposits, while mass-market deposits must be served by the most efficient payment services possible in order to keep costs down. Achieving this is going to require innovative approaches to business models at the same time as regulatory constraints are tightening.

The focus of investment has moved sharply away from innovation, with small projects that will yield shortterm benefits gaining a high proportion of the attention and investment funds. Investment in payments Banks are continuing to invest significant sums in payments, but the vast majority of discretionary investment is aimed at increasing efficiency rather than introducing new products or services. The emphasis is on achieving efficiency through scale and by eliminating paper. Even small changes (such as eliminating nonstandard account numbers) have a high priority if they have a positive effect on efficiency. Shared services projects, previously abandoned, are being reconsidered, and many banks are reviewing carefully the markets they wish to serve, directly or indirectly. The focus of investment has moved sharply away from innovation, with small projects that will yield short-term benefits gaining a high proportion of the attention and investment funds.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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A rapidly-growing area of focus is intra-day and counterparty risk. The liquidity crisis which struck in 2008 brought home to many banks the fact that they did not understand in sufficient detail exactly what their position was at any particular point. When an institution fails, payments can seize up, and gains and losses can be frozen unpredictably. Increasingly, banks are realizing the need to invest in measuring intra-day risk across different channels and instruments. In a similar shift in emphasis, regulators are also realizing the need to control these risks, and will be imposing relevant requirements on banks. Nevertheless, some banks are holding back on investment because they fear that they could be swamped by regulatory changes in the coming year. Regulation and competition More regulation will inevitably lead to increased costs, but may bring few real benefits for customers. Many more services will be brought into the scope of regulated activities. Central banks will demand much more reporting of liquidity. Banks and their customers will have to provide more information on the other side of transactions, especially for securities and financial instruments. This will help to manage risk and identify illegal and shadow economy transactions, and should also help in the management of fraud and money-laundering. However this kind of reporting conflicts with the desire for privacy, and growing levels of conflict are likely between bank regulators on the one hand and competition authorities and privacy commissioners on the other. Mobile and contactless payments In emerging markets, especially, mobile payments are continuing to receive significant attention and investment support. In countries with poor fixed telecommunications infrastructure and low rates of access to banking services, mobile payments offer far more benefits to most people and small businesses than conventional payment types. Many people have access to a mobile phone. Mechanisms that allow them to pay bills, send money to family

or simply deposit a pay packet for safety offer huge benefits. Mobile payments may be the key to formalizing the market and offering banking services to large swathes of the population. Many mobile telephone companies (telcos) are keen to offer such services. Business models that allow cooperation between banks and telcos, with the telco managing the customer relationship but the bank managing the funds and risk, are gradually emerging. In several Asian countries (including China, Korea and Singapore) Government initiatives exist to promote e-payment and these are expected to lead to a rapid decline of other instruments. In cards, there is a move from ATM cards to scheme-based debit cards, and considerable interest in contactless and mobile payments; customers in this region have shown a remarkable willingness to embrace new instruments and payment structures. While conventional technology developments addressing contactless cards and Near-Field-Communications (NFC) devices are no longer seen as urgent in Europe or North America, there is likely to be continued growth in this area in South Asia. Payments in a new context Internally, some of the best opportunities come from bringing together common payment functions into a single, highefficiency and high-availability engine that serves multiple business areas. Convergence and standardization of payment classes still offers good returns in the medium to long term, particularly with the introduction of ISO 20022 and xml messaging. In many banks, there is still room to eliminate non-standard processes and paper, and to reduce repair costs for cross-border transactions, which will yield good returns in the shorter term. Payments remain one of the most profitable activities within the banking sector. Cash management and corporate treasury functions, once seen as boring and unworthy of senior management attention, are now among the most reliable revenue opportunities for banks. However, seizing the opportunities this offers requires a major shift in thinking for many senior executives.

About the report To find out more, or get copies of the report The beating heart of banking: Insights into global payments, please visit www.kpmg.com

Distinctive business models With this variety of emphases in different areas of the payments industry, the need for clear strategic focus has never been greater. It is no longer enough simply to seek to manage greater volumes with greater efficiency. Institutions need a more discriminating approach, and the development of a distinctive business model in which they can pursue competitive advantage. This may be in a particular client sector, or a specific currency or a leading technology. For example, national government payments offer bulk and scale in individual currencies; as we have seen, mobile payments offer similar large-scale entry opportunities in emerging markets. Those payment service providers that most successfully grasp the opportunities available will be those which pursue the most thoroughlyarticulated and distinctive business models – whichever sectors of the market they focus on.

For more information please contact: Oliver Kirby-Johnson Partner Financial Services KPMG in the UK Tel: +44 20 7311 4005 e-Mail: [email protected] Steve Blizzard Director Financial Services KPMG in the UK Tel: +44 113 231 3737 e-Mail: [email protected]

1. The beating heart of banking: Insights into global payments, KPMG International, June 2009.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Addressing the trust gap Renewing confidence in the financial services industry

Freddie Hospedales

There are things that we take for granted. We trust and rely on what are ‘givens.’ We turn on a tap and, in most places, water comes out. We put money in a bank without question, and when we want it, it’s there. The conventional assumption is that the organization, and by association the people running it, can be relied upon. However, in the past 18 months this convention has been broken. Freddie Hospedales argues that rebuilding trust requires rebuilding brand identity in the widest sense.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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The Trust Gap The reputation and credibility of many financial institutions, and the people who work in them, have been significantly compromised. It is not just that the system we have assumed was safe has failed; trust in whatever comes next is lacking. In the US, a recent survey1 shows that only 19 percent of Americans now trust the financial system, and just 13 percent trust the stock market. In the UK, research by a large advertising agency has shown that 25 percent of the UK population has no trust in banks2. By contrast, trust in banks in several emerging economies has actually increased. While trust in banking has dropped by 33 percentage points in the United States, in China trust has risen from 72 percent to 84 percent, and in Brazil from 52 percent to 59 percent3. Part of the cure is recognizing the problem While the focus for many organizations over recent months has rightly been on liquidity, capital and risk management issues, the media have almost daily picked on the leadership of one financial institution or another, intimating bad management and greed as factors leading to the crisis. This impacts on trust in a number of ways. First, general public confidence is damaged. But the same is true of capital markets, whose confidence is fragile at best and which only need the slightest hint of bad news to send markets falling. This perhaps goes some way to explaining the increasing search for blame, particularly since September 2008: people not knowing what they are buying or selling; bonuses paid on short term risk and in failed companies; management not aware of systemic risk; regulators focused on capital not necessarily liquidity; politicians seeking national political gain ignoring the fact this is a global issue. The list of those attracting blame is long. For many, it is time to review or re-think all, or parts of, their business models and strategies.

The new stakeholder landscape In many countries, a new stakeholder landscape is evolving. It is important to changing perceptions that financial institutions understand this change, and do not assume that circumstances will ultimately go back to how they were. Traditionally, core stakeholders included investors, regulators, staff, customers and the media. This is still the case, but today, stakeholder groups should be reevaluated. Two examples illustrate this. A significant development in the past nine months has been the increase in government involvement in financial markets. While governments have always been significant stakeholders, their role as major shareholders or funders of financial institutions now gives them greater influence. The reaction to bonus payments by western governments is one obvious example. Another stakeholder group to be re-assessed is the media, particularly in view of their role at the height of the crisis, which some within the industry argue exacerbated market turmoil. Some financial journalists, who have spent years obtaining a living from the industry, were noteworthy in talking down the market rather than talking it up when it needed it. Clearly their role in the recovery is going to be important. Bridging the trust gap Some firms have put in place classic reputational risk management programs to monitor, measure and report on their reputation. This is a great way to prepare for and react to developments, whether operational or in the external environment. However, in the current climate the wider debate should focus on perceptions and positioning of the brand. Aspects of this have been overlooked or certainly under-valued by some in the past 18 months. In relation to brand perception, I am referring not just to the retail context of financial services as is easy to assume, but to the wider market including rating agencies, fund managers, wholesale banks and re-insurers. The modern brand is increasingly concerned with

19% of Americans trust the financial system, and…

13% trust the stock market.

25% of the UK population has no trust in banks.

While trust in banking in the United States dropped by

-33% …trust in banks in China rose by

+12% …and in Brazil by

+7%

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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In banking especially, the need to be seen as a ‘safe pair of hands’ will be one of the first priorities.

assembling and maintaining a mix of values both tangible and intangible. In simple terms for this article, we can look at a brand as comprising three core elements: what it does; the way it does that (its culture/personality); and the symbols associated with that organization, its logos, colors, imagery etc. Looking at what a company does, much has been written since the end of 2008 about how many banks need to review their business models, release non-core assets and revert to being traditional banks (narrow banking). In addition, the competitive landscape is changing. As trust in banks - places to keep our money safe, for companies to borrow funds from to develop and grow – has eroded, alternatives with names we trust more become more attractive. For example, in the UK some well known high street non-banking brands are looking at providing a wider range of offerings in the personal finance space. In investment management a number of boutique houses are setting up, for some, to move away from the damaged reputations of larger institutions.

Turning to the way a company does things, a number of changes should happen. The increased role of governments in the ownership of financial institutions will influence their future behavior. This also raises the influence of the general public’s perception of how financial services companies are seen to behave. Alistair Darling, UK Chancellor of the Exchequer, speaking before the Parliamentary expenses scandal in May, said ‘Banks need to demonstrate to the public that they’ve learned lessons from recent events,’ and continued, ‘but in order to rebuild public trust, we also need to reform banks’ culture’4. Looking ahead, managing reputational risks will be a basic requirement. But more widely, being clear ‘what you will be known for’ to various core stakeholders will be important in the new business environment after the crisis. In banking especially, the need to be seen as a ‘safe pair of hands’ will be one of the first priorities. However, regardless of which sector of financial services, restoring confidence requires

regaining trust. For many this will require reviewing the business strategy, the brand in its widest sense and how that is communicated in the new stakeholder landscape. Failure to do this may well mean that the long road to recovery will be longer than it need be.

For more information please contact: Freddie Hospedales Head of Marketing & Communications, Financial Services KPMG in the UK Tel: +44 20 7311 5264 e-Mail: [email protected]

1. The Chicago Booth/Kellogg School Financial Trust Index survey of more than 1,000 US households, conducted over two weeks in March 2009. The data was analyzed by two academics, Paola Sapienza of the Kellogg School of Management at Northwestern University and Luigi Zingales University of Chicago Booth School of Business. www.financialtrust index.org 2. The McCann Erickson’s latest Moodier Britain survey, 2008. Jeremy Lee, Marketing, November 25, 2008. 3. 10th edition of the annual Edelman Trust Barometer, January 27, 2009. www.edelman.co.uk 4. BBC News, www.bbc.co.uk, March 27, 2009.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Separating value Getting the most from your disposals

As many financial services organizations may be taking their first steps on the road to recovery, most analysts agree that there is likely to be a wave of complex disposals and separations across the industry. Smart sell-side separation planning could enhance your realized deal value by as much as 30 percent. Scott Marcello, Moh Sheikh, and Chris McGolpin discuss some of the common separation challenges and present their blueprint for a positive separation. © 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Identifying the hotspots Separation could be more complex and costly if your organization has:

Scott Marcello

Moh Sheikh

Ignore separation planning at your peril Following the turmoil in the financial services sector, a significant increase in the level of disposals and restructurings is expected. But in the rush to get the deal done, it can be easy to underestimate the complexity and financial impact of separating businesses – and that can have a serious negative impact on the deal value, success of the separation efforts and ongoing success of the retained business. When it comes to carving out part of the organization, many businesses lack a coherent grasp of how their people, processes, assets, contracts and technology are integrated around the world and across functions. Knowledge of these issues tends to be fragmented, with no infrastructure to develop an informed view. This can make separation very challenging and more importantly, failing to address this can increase complexity and destroy value. What can also be neglected is the emotional and political impact of separation on people. Managers and employees tend to separate behaviorally before the deal is done. It’s vital to deploy a process that aligns the interests of both the selling and separating entity, and fosters a collaborative rather than an adversarial approach to separation. Too often we see clients failing to do this.

Chris McGolpin

Good separation planning boosts buyer confidence and protects value In a market subject to aggressive ‘price chipping’ by purchasers, good planning focused on value and risk drivers is one of the best tools to make the most of value from disposals. Demonstrating a detailed understanding of what it will take to transition from an integrated to a separated state will enhance the vendor’s confidence in the carve-out financials and your ability to deliver the separation, giving potential purchasers less ground to discount their offer. In our firms’ recent experience, prompt and well structured separation planning can help enhance valuations by up to 30 percent. It also enables effective execution, mitigation of key issues and risks and maximizes the value of the remaining business. Building the separation blueprint Working with a number of financial services organizations KPMG firms’ professionals have found that one of the keys to effective separation is the creation of a detailed blueprint. It enables bidders to value the business and, putting it together helps the vendor and the separating business understand the nature of their future relationships. The blueprint should clearly articulate what the business operating model looks like today, when the deal is closed and at full separation.

– – – – – – – – –

Shared service centers Cross selling Shared sales forces Shared facilities / buildings Joint customers or intermediaries Group procurement contracts Single or shared brands Group policies and procedures Global systems / applications and data sources – Outsourced contracts / service model questions

Demonstrating a detailed understanding of what it will take to transition from an integrated to a separated state will enhance the vendor’s confidence in the carve-out financials and your ability to deliver the separation, giving potential purchasers less ground to discount their offer. A detailed implementation plan should also be in place. Key components of a separation blueprint should include:

1.

Confirm the separation principles – define and agree at executive level the core principles that will shape the scope and scale of separation. For example, do you migrate the standalone business to a new technology infrastructure at deal close, or will you ‘clone and go’ or will you carve-out the technology platform and transfer across? What basis will you use to decide which people go with the separating business? Issues like this will affect the scale of work involved in separating and enable timely and consistent decision making.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Topics

Selling a business or division may make strategic sense, but unless the separation challenges and the cost implications are understood, it can massively impact the sale value of the business.

2.

Prepare a ‘separation hotspot’ matrix to identify key operational touch points highlighting those that are materially significant and need to be addressed for deal close. Once interconnected parts of the business – like technology platforms, people and shared service centers – are identified, it is easier to break down potential issues according to their impact on people, processes, technology, contracts and assets and to quantify the cost impacts and separation challenges. Often there are between 200 and 300 separation hotspots identified between parent and separating entity, where management originally thought there were few. In our firms experience the top 20 ‘hotspot’ issues typically account for 80 percent of the separation costs, so it is imperative that these are identified and actioned early. Many organizations underestimate the challenge and workload involved in separation.

4.

Create a separation cost adjustment model to understand the cost implications of separation: what are the one-off costs of separation? What are the ongoing cost impacts of separation? This will allow sellers to strip out group allocated cost and direct costs and rebuild a bottom-up cost model for the separating entity. Plan well = increase the value Selling a business or division may make strategic sense, but unless the separation challenges and the cost implications are understood, it can massively impact the sale value of the business. It can also leave the operational team responsible for the separation with a major headache. One of the key lessons is to invest time and effort upfront to identify all the separation touch points and prioritize those where costs and risks will be material as this can potentially boost the sale price and mitigate the risk of damage to the parent business.

3.

Define detailed functional Service Delivery Models (SDM) – define how each function will operate at key stages over the transaction cycle (as-is, deal close and final separation) in terms of people, processes, assets, contracts and technology. Separated entities may well not be fully standalone at deal close, so vendors need to prepare a broad range of Transitional Services Agreements (TSAs) early to decide what is/is not offered and at what price to try to ensure operational integrity. A detailed set of functional SDMs will assist the identification and articulation of the required TSAs to support the standalone business.

For more information please contact: Scott Marcello Joint Regional Coordinating Partner, Financial Services, Americas region KPMG in the US Tel: +1 614 249 2366 e-Mail: [email protected] Moh Sheikh Associate Partner KPMG in the UK Tel: 44 20 7311 4492 e-Mail: [email protected] Chris McGolpin Associate Director KPMG in the UK Tel: +44 20 7311 1467 e-Mail: [email protected]

Learning from other industries The Jaguar Land Rover sale Ford manufactures and distributes cars in over 200 countries around the world. In separating it’s Jaguar and Land Rover businesses for sale, KPMG’s assistance helped to highlight over 350 separation issues that had to be addressed with the management teams. KPMG worked with Ford to help them develop a separation plan and a robust standalone business plan so that the separation issues were addressed and managed in such a way as to appreciably increase the value of the sale. Source: Getting under the bonnet: The Jaguar Land Rover sale, KPMG in the UK, March 2008.

In the real world Maximizing valuation is a key area of focus for Executives. Recent examples of businesses KPMG firms have worked with highlight how you can potentially improve purchaser’s valuations by challenging key management assumptions. Information technology function A carved-out business which was accountable for 25 percent of revenues, after our analysis, needed only half the number proportionally of IT staff expected, thus making significant savings. Value: +US$52 million to the overall valuation. Finance function An additional cost of US$8 million per annum was anticipated to replicate the function. However, after our analysis the lack of complexity of the separating business meant that cost was only US$2million. Value: +US$20million deal value.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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© 2009 KPMG International. KPMG International provides no client services and is a Swiss cooperative with which the independent member firms of the KPMG network are affiliated.

How do you cut costs without killing the business?

It’s not just about too little or too much. It’s about how and where to cut. Cut too close to the customer and you could lose them. Cut too much talent and you may not have a business to grow in the future. Cut knowledgeably, however, and sustained business performance can be achieved.

KPMG firms can help you do this. With accurate and insightful information on what’s driving which costs, we can help you cut waste without laying waste to the organization. We can help streamline and simplify the business, and help build a cost culture, from boardroom to washroom. In fact, help you prune so your business can blossom. To start, cut along to www.kpmg.com/ succeeding.

frontiers in finance – June 2009 | Topics

Adrian Harkin

Martin Blake

Mark Smith

Changing for the better Financial services organizations are spending billions of pounds every year on change initiatives, but many are unsatisfied with their results. Having recently benchmarked some 30 major financial services organizations across Europe and Asia Pacific, Adrian Harkin, Martin Blake and Mark Smith discuss how focusing on leadership and accountability for change could be the key to getting real value.

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ypically, financial services companies run anywhere from 5 – 50 concurrent major change programs in the course of a year: to embed new regulation, refresh IT platforms, integrate acquisitions, build new capability, enter new markets or restructure businesses. Following the credit crunch and global financial meltdown, change capability is needed more than ever. Change functions are now under even heavier pressure to correctly address the challenges of managing change. Challenges at their doorstep include adapting to new bank ownership structures, compliance with an anticipated deluge of tighter regulation and action on cost and capital effectiveness to inject liquidity back into the balance sheet.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Ninety percent of the organization may know something is wrong, but they don’t tell the people in charge – or even worse, they speak up but are not heard.

Failure is not an option. But many financial services organizations feel they are not getting the best value from their investment in change. Some point to initiatives which fail to produce expected levels of profit; others experience high levels of program failure. Only about a quarter to a third of change programs are regarded as strong successes. Change failures – the ‘elephant in the room’? Talking candidly to the teams involved in executing major change programs, we have found that disappointing performance is often acknowledged privately, but not addressed openly. Ninety percent of the organization may know something is wrong, but they don’t tell the people in charge – or even worse, they speak up but are not heard. Poor performance of change can also be a result of focusing the program to move too fast, or if it is managed by individuals who don’t fully understand the change management process. With spending on change in UK financial services organizations alone ranging from £5 billion – £7 billion annually, disappointing performance is silently draining billions of pounds from businesses at the most stressful time in the industry’s recent history. So what can be done? Getting leadership right is key to success From our benchmarking, we have identified a direct link between the value financial institutions gain from their spending on change and three key factors:

1 Treating leadership of change as a core organizational competence 2 Focusing on transparency and accountability 3 Driving capability deep into change functions

Leadership is identified as the first key to the successful implementation of change. Time and again, we see organizations struggling to optimize massive spending programs and failing, because there is no clear overall leader to drive and control the impact of change on the whole organization, to set priorities and allocate spending in a strategically balanced way. Responsibility is spread across divisions, accountability dissipates and conflicting priorities are never resolved. The result: poorly managed change that eats away productivity and wastes time and effort. So let’s be clear: the change function needs a single leader who ‘owns’ major change. This leader ensures the change portfolios align to the strategic priorities; ensure scare capital is allocated to the correct programs; moves people between programs as necessary to get results; and is accountable to the board for change results. The second key is a strong focus on transparency and accountability. Transparency means clear governance, reporting, information and communication, to ensure the whole organization understands what is happening and what results are required. Accountability means exceptional clarity on who is responsible for each part within a complex change program. Our benchmarking confirmed a basic human fact – people avoid accountability if they can. Nobody likes to be too pinned down. Leaders who emphasize clear negotiations on accountability and insist on transparency of information are more successful than those who do not. The third key is investing in capability. Capability means paying not just for systems and tools, but for good people and good quality learning as well. It is people – not organizations – that make change programs succeed or fail. Change is not a mechanical process which simply requires application of the

Key areas of focus Leadership Driving change strategy delivery, organizational behavior and change culture Transparency and Accountability Portfolio management, change governance, cost management and delivery of benefits Capability People/skills/capability, tools/method/process Source: KPMG International, May 2009.

latest tools and methodologies to succeed. But often organizations devote most of their money and time to technology and processes, and neglect or under-plan aspects like behavioral and cultural change. A significant investment in capability is required to enlist the support of the organization and guide it along the change journey. These ‘soft’ people issues can be the hardest to get right. The pace of change will continue to increase in the current climate, and so will the investment required. With clear leadership, a focus on accountability and transparency, and strengthened human capabilities, we should see more businesses achieving greater value from their investment in change.

For more information please contact: Adrian Harkin Partner KPMG in the UK Tel: +44 20 7311 6266 e-Mail: [email protected] Martin Blake Partner KPMG in Australia Tel: +61 2 9335 8316 e-Mail: [email protected] Mark Smith Partner KPMG in Canada Tel: +1 416 777 3395 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Topics

Vincent Heymans

Richard Pettifer

Getting ahead UCITS IV: Putting the potential into action

The European Union’s (EU) directive, Undertakings for Collective Investment in Transferable Securities (UCITS) – a framework for the regulation of mutual funds in the EU – has been undergoing a makeover. The changes, known as UCITS IV, come into effect in just two years. So, preparing now for what will likely be sweeping changes, is paramount for firms keen to benefit from the efficiencies available.

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he global financial crisis and its wider economic repercussions have had a severe impact on the sector, with total assets in UCITS funds falling 22 percent (or e1.77 trillion) last year, while net outflows from UCITS hit e335 billion1. The situation has since brightened somewhat, with the European Fund and Asset Management Association (EFAMA) recording net inflows of e30 billion into UCITS in the first two months of 2009. Nevertheless, question marks remain over the viability of many of the funds still in existence in today’s highly fragmented European funds market. With this as background the changes come at a crucial time.

The six major amendments it introduces – the so-called ‘Efficiency Package’ – have been widely applauded by the industry as a valuable toolkit that can enhance the effectiveness of the UCITS framework, and will offer significant efficiencies to fund organizations operating within it. The regulatory changes that make up the package will create significant opportunities for investment management firms to: i. Cut the number of management companies operating across Europe by leveraging the Management Company Passporting scheme, and hence reduce costs and capital requirements ii. Concentrate assets in their best performing funds and so improve returns iii. Decrease total expense ratios through a centralization of the middle-office and administration services iv. Reassess the fund administrators and custodians they use to service the funds v. Reduce time-to-market and administration costs for funds sold cross-border

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Figure 1

Plan of campaign framework 1. Understand and document the ‘as-is’ 2. Undertake the market analysis 3. Develop the hypothesis for the ‘to-be’ 4. Design the operating model 5. Challenge, validate and approve

Planning for Action With UCITS IV slated to come into force in July 2011, planning and developing clear and strong product strategies now will enable firms to get a headstart in the greater flexibility the new directive will give. Firms should plan now those fund ranges they expect to close, so that they can start to be wound down making eventual closure easier. Similarly, new fund launches can be restricted to those fund ranges which will have a long term strategic future. By doing this, firms can plan in advance those areas they expect to close, funds to consider winding down and possibly avoiding launching, making the eventual implementation of UCITS IV easier. Critical to this strategy will be an understanding of how to leverage the triumvirate of measures being introduced: the framework for crossborder mergers, master-feeder structures, and the Management Company Passport. A successful product strategy though, will depend on the idiosyncrasies of each fund promoter’s business model and the product range they currently offer, and as such must be forged on a case-by-case basis. Following the herd will no longer be the best solution (see figure 2). For example, while the provisions on cross-border mergers pave the way for consolidation, depending on the countries involved, tax liabilities may arise and will need to be taken into account. Taxation considerations fall outside the UCITS remit and so vary substantially from country to country. The impact of this on firms will vary according to strategy developed.

The location freedom offered by the Management Company Passport raises similar considerations. For instance, some firms that have their investment management and product development functions in one of the larger countries such as the UK, may opt to centralize the management company function there as well. Others may prefer Luxembourg or Ireland, because of lower tax rates and fund center status, or one of the Eastern European countries given their lower cost bases. But then there is the question of where to domicile the master fund. For instance, to date Luxembourg has been the customary jurisdiction for retail funds, not least because of the brand recognition Luxembourg UCITS have achieved around the world. And postUCITS IV these traditional fund centres are likely to retain an advantage as domiciles of choice, given their wide range of tried and tested fund servicing structures. Tax Uncertainties The area of greatest uncertainty surrounding the UCITS IV provisions and their potential benefits will not be addressed at all in the current process – the tax implications that surround the Management Company Passport, cross-border mergers and the establishment of master-feeder structures2. Depending on the rules of each jurisdiction, cross-border mergers may trigger tax charges, including capital gains tax and stamp duty, even though investors do not realize their investments at the time a merger occurs. In addition, there will be cases where investors could face higher tax rates following a merger than if they had remained invested in the original fund, these issues need to be identified and addressed early. Resolving this across the different countries in the EU will require a separate UCITS tax directive. That though, is years away. An approach KPMG firms have found helpful with clients to develop strategies is shown in figure 1. The option of waiting for total clarity on UCITS IV to be implemented may not bring the best success in the medium to long term. For those acting now to navigate the complexities, the rewards should be worth the effort.

Figure 2

The UCITS IV ‘Efficiency Package’ Undertakings for Collective Investment in Transferable Securities (UCITS) are regulated investment funds domiciled within the EU and capable of being sold across boarders. First introduced in 1985, the aim of UCITS was to integrate the EU market for investment funds by offering greater investment opportunities to investors, as well as greater business opportunities to the asset management industry. Since then UCITS have become a world-renowned brand, enjoying considerable success not only in Europe, but in markets in Asia, the Middle East and Latin America. UCITS IV, which is due to come into effect in July 2011, introduces six headline changes to the regime: i. A full Management Company Passport, allowing a UCITS to be managed by a management company authorised in another member state ii. Establishment of a framework for fund mergers – no rules exist at EU level in this area at present iii. A new framework for masterfeeder structures – again, no rules for such structures exist at present at EU level iv. Replacing the Simplified Prospectus with a Key Investor Information document v. A new regulator-to-regulator notification procedure to speed up the cross-border funds distribution process vi. Improved supervisory cooperation mechanisms

For more information please contact: Vincent Heymans Partner KPMG in Luxembourg Tel: +352 22 5151 7917 e-Mail: [email protected] Richard Pettifer Director KPMG in the UK Tel: +44 20 7311 5749 e-Mail: [email protected]

1. The European Fund and Asset Management Association (EFAMA) pointed out in its report, Trends in the European Fund Industry in 2008. 2. For a fuller discussion on this topic please see article ‘Tax obstacles to the success of UCITS IV’ – included in the latest edition of frontiers in tax, KPMG International, June 2009.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Topics

Order returns... An economic overview

Jeremy Anderson

The current outlook is the most stable we have seen for many months – the results of the stress tests in the US banking system seem manageable, government interventions in Western Europe are helping to stabilize the banking system and, in Asia, the most stressed geographies seem to be getting the support they need, says Jeremy Anderson.

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Topics | frontiers in finance – June 2009

Despite the immediate and pressing impact of these challenges, we need to begin thinking about the future.

A

s we talk to senior bankers and regulators there is a common view that a semblance of order and predictability has returned to the markets. Perhaps, most importantly, there is now time to take more considered and collaborative decisions about what to do to re-build for the future. The increasing confidence and potential optimism this brings are fundamental to making progress, though we should be careful not to assume that the next few years will be easy. Many commercial and retail bankers remain very concerned about the likely scale of credit losses and provisions, with many expecting 2010 to be worse than 2009. Commercial real estate lending could create headaches for banks in many parts of the world as rents, yields and the value of property weakens. There is much ‘unwinding’ of government intervention to be done over the next few years as debt issuance guarantees are removed, government shareholdings in banks are sold, and toxic assets in bad banks and government insurance schemes are wound down in an orderly manner. The wall of regulatory change hitting the industry is likely to not only bring additional rules, but will also challenge the viability of some existing business units as capital and liquidity requirements become more onerous. It remains to be seen whether national territorial regulatory approaches will prevail, reducing the efficiency of capital and funding for global banks, or whether global regulatory collaboration can produce a simpler and less costly regulatory and reporting environment.

But, despite the immediate and pressing impact of these challenges, we need to begin thinking about the future. The global economy needs an efficient and effective global banking system to transfer risk, provide credit and support global trade. This has been a facilitator and engine of global growth over recent decades, growth that has lifted many people out of poverty. We need the industry to be restored to full operation as soon as possible to help create wealth in both the developed and the developing economies. The banking industry has re-invented itself many times before and there should be no reason why it cannot do so again. The same issues face the investment, savings and pensions industry. In those countries where public and private sector debt has soared, the responsibility for long term savings and pensions is going to have to pass back to the individual, leading to higher savings rates. There will be a great need for secure, stable and cost effective frameworks for people to build their wealth, whether for retirement or for a ‘rainy day’. While there has been widespread discussion of the rational issues which face us we should not forget to address the emotional aspects and, in particular, the ‘war for talent’. To put the industry

back on its feet the brightest and best people in the industry should be retained, as well as attracting new talent. Now we are asking many of our people to work harder than ever before while at the same time reducing compensation and rewards. Although the days of significant bonuses for ‘Day 1 Profit & Loss’ may have gone, we should be seeking to convince people that, as the industry rebuilds sustainable and predictable profit streams, it will again become a stimulating and rewarding career path for high caliber people. Finally, we should not lose sight of the opportunities which still present themselves. Although many countries have suffered, and will suffer difficult economic conditions for some time, many areas of the world are less touched by the global crisis and still have healthy funding sources and growth in their economies. For those banks which have strong balance sheets, and are unencumbered by government or regulatory restrictions, there has never been a better opportunity to acquire assets at a reasonable price. The banking ‘world order’ may not change dramatically, but looking back in 10 years time we may well see that the winners are institutions that have managed to emerge most quickly from the current turmoil and capture those opportunities which present themselves.

Many areas of the world are less touched by the global crisis and still have healthy funding sources and growth in their economies.

For more information please contact: Jeremy Anderson Regional Coordinating Partner, Financial Services, EMA region KPMG in the UK Tel: +44 20 7311 5800 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Series

A brighter future?

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Series | frontiers in finance – June 2009

Emerging markets: India India

Abizer Diwanji

For much of the past decade, the Indian economy has been booming. But while India has not been as severely hit by the credit crunch as many other countries, it does now face serious economic difficulties. Lack of credit and liquidity in the market is causing severe problems. And companies’ reliance on Foreign Currency Convertible Bonds has stored up an imminent crisis in the corporate sector. Abizer Diwanji argues that one of the keys to unlocking recovery will be government funding of infrastructure development and making the corporate bond markets in India more attractive to investors. © 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | Series

8-9% average growth of India’s economy per annum since 2002.

-50% The drop in India’s stock market during the crisis.

6% forecast growth of India’s economy in 2009-10.

US$500bn The amount estimated by the government that needs to be invested up to 2012 to improve the country’s basic infrastructure.

S

ince the millennium, India has been seen as one of the key growth countries among the developing nations – the third part of the BRIC (Brazil, Russia, India, China) quartet, whose dynamic new economies were set to challenge the developed world over the coming decades. From 2002, India’s economy has grown by an average of eight to nine percent per annum. The financial system has been progressively liberalized, and the country has been increasingly integrated into the world economy. During this time, the stock market boomed, corporate profits multiplied and foreign direct investment soared. Demand for the rupee drove up the exchange rate. Many politicians and business leaders grew accustomed to continuous growth and rising prosperity, and looked to them to steadily alleviate the continuing problems of inadequate infrastructure and rural poverty. Despite the boom, India is still far from becoming a modern advanced economy. The financial sector remains comparatively over-regulated. Securitization is limited. There is a very small and illiquid corporate debt market. Banks have historically been generally wary of excessive credit risk. Regulations that require Indian Banks to hold government bonds have meant that while bank balance sheets have been strong, this has not translated into commercial lending: by comparison with banks in Europe and the US, with typical loan-deposit ratios of 100 percent, Indian banks have

had ratios of 45–48 percent. Half of depositors’ cash has been locked up in government bonds. In some respects, these characteristics have helped to shelter the Indian economy from the worst of the global crisis. With little exposure to complex structured products, the financial sector has been shielded from the Collateralized Debt Obligation (CDO) subprime disaster. There is a much smaller toxic asset problem. Nevertheless, the country is far from immune to the crisis. So far in crisis, the stock market has fallen by 50 percent, and the rupee has fallen significantly against other major currencies, mainly as cash has flowed out of the Indian equity markets to fund losses in home countries. Other aspects of the Indian financial market have led to further challenges, in particular the limited market for corporate debt. Because companies in a rapidly-growing economy could not borrow easily at home to finance expansion, they relied increasingly on foreign capital and on equity issuance. A lot of ‘hot’ money flowed into the Indian stock market; private equity became a major source of funding outside of stock markets. A particularly notable feature was the development of Foreign Currency Convertible Bonds (FCCBs) as a vehicle to attract overseas funds. As the name suggests, these are debt instruments denominated in a non-rupee currency which also give the investor an option to convert the debt into equity at a future date at a significant premium to prices on the date of issue. Companies

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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Series | frontiers in finance – June 2009

The Reserve Bank of India has taken a series of steps to try to free up the market and inject liquidity. But although banks now have greater liquidity, this is not necessarily finding its way to private industry.

got cheaper funding with lower dilution as conversion was considered inevitable given the consistent rise in stock prices. FCCBs were attractive to investors as equity conversions offered higher returns than conventional debt. Further, there was always a redemption option with back interest if the conversion option was not exercised. However, all these attractions assumed that stock prices would continue to rise and that FCCBs would be converted to equity. The collapse in the stock markets has scuppered this, destroying the value of conversion. Instead, issuing companies are faced with the prospect of paying interest on these bonds along with redemption of principal when they mature. Since some estimates suggest that Indian companies have issued up to US$20 billion of FCCBs over recent years, with none of the corporates planning cash flows for redemption, this could lead to increased defaults in coming years. As the crisis has taken hold, profits have evaporated; many exporters have been hit; industrial sectors such as automotive, cement and real estate are

suffering from significant contraction in demand. The already tight credit market is being further starved as many banks become even more reluctant to lend. The Reserve Bank of India has taken a series of steps to try to free up the market and inject liquidity. But although banks now have greater liquidity, this is not necessarily finding its way to private industry. One major route to getting the economy moving again could be government investment in infrastructure development. Years of low investment have left India with crumbling roads and transport infrastructure and inadequate public utilities. The government has previously estimated that US$500 billion needs to be invested up to 2012 to improve the country’s basic infrastructure. Originally, it was hoped that foreign capital would contribute a substantial tranche of this. Now, this is unlikely. However, direct funding is not an option given a high fiscal deficit. The Government should seek to provide appropriate guarantees to cover the credit risk of large infrastructure projects. Banks would then be

incentivized to fund infrastructure demand. Core infrastructure funding could also help develop demand in commodities and ancillary infrastructure related services. A demand push in industry would ensure banks start lending to corporates again. This should restart the cash flow cycle. Finding a way out of this infrastructure investment trap will be a key priority for the new Indian government. But if it can be achieved, the benefits in stimulating the economy across all sectors could be immense. It is not as if the economy is in the doldrums: forecast growth of 6 percent in 2009–10 compares handsomely with the position in many western countries. Once the current cycle turns upwards to greater easing of credit and liquidity, there is every chance that this particular BRIC economy will boom once more.

For more information please contact: Abizer Diwanji Executive Director KPMG in India Tel: +91 22 3983 5301 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 | insights

insights New KPMG Thought Leadership frontiers in tax, June 2009. The third edition of frontiers in tax is designed to interest, challenge and stimulate tax professionals. This is a sister publication to frontiers in finance – and as the name implies, it focuses specifically on the tax issues facing the global financial services executive. In this edition KPMG colleagues discuss the tax implications of the current climate on transfer pricing, new regulations, influence on savings and opportunities in M&A. 2009 Global Fund and Fund Management Survey. This year’s survey is being released at a time of great turmoil and uncertainty in the industry. Covering taxation, accounting and regulation this annual Survey is a broad ranging, authoritative point of reference for financial services companies, marketing investment around the world. 2009 Global Hedge Fund Survey. The financial services industry is in one of the most challenging periods in history, and in previous year’s has experienced substantial growth but now faces an uncertain future. Effective strategies are critical to the success of a Hedge Fund Manager – now in its third year this Survey focuses exclusively on Hedge Funds, covering 25 countries. KPMG member firms provide a wide-ranging offering of studies, analyses and insights on the Financial Services industry. For more information please go to http://www.kpmg.com/Global/IssuesAndInsights

The beating heart of banking: Insights into global payments, June 2009. In the current environment, payments have proven to be a stable revenue base for banks, but the industry is still facing wide-spread development and change. KPMG International investigates the trends, regional variations, investment opportunities and insights in the global payments industry gained through our member firms’ experience and in-depth interviews with clients from banks, infrastructure organizations, regulators and industry groups. A glimmer of hope: Risk and capital management in insurance, June 2009. This initial survey report is the first of a two-part series produced by KPMG International in cooperation with the Economist Intelligence Unit. It examines how the financial crisis is changing the attitude of the global insurance industry to risk and capital management, highlighting some key issues including preventing further losses and positioning their businesses for future growth. The survey’s findings reflect the sentiment of the 315 senior insurance executives across 49 countries who answered the survey. Renewing the promise: Time to mend relationships in investment management, June 2009. With continued upheaval in 2009, KPMG aims to address the question of ‘Where to next?’ for investment managers in this report. Conducted in partnership with Datamontior it is based on a survey of 288 respondents globally with a further 22 in-depth phone interviews. Results include a number of interesting ‘disconnects’ between perceptions of investment managers and investors on the industry.

frontiers in finance editorial team Editor: Alison Halsey Editorial: Amber Stewart, Monica Eyers Production: Shofna Uddin, Nina Muelders

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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insights | frontiers in finance – June 2009

global financial services leadership team

Brendan Nelson Vice Chairman, KPMG in the UK Global Chairman, Financial Services Tel: +44 20 7311 6157 e-Mail: [email protected]

Jim Liddy Joint Regional Coordinating Partner Financial Services Americas region KPMG in the US Tel: +1 212 909 5583 e-Mail: [email protected]

Scott Marcello Joint Regional Coordinating Partner Financial Services Americas region KPMG in the US Tel: +1 614 249 2366 e-Mail: [email protected]

K T Kim Joint Regional Coordinating Partner Financial Services Aspac region KPMG in Korea Tel: +82 2 2112 0400 e-Mail: [email protected]

Chee Meng Yap Joint Regional Coordinating Partner Financial Services Aspac region KPMG in Singapore Tel: +65 6213 2888 e-Mail: [email protected]

Jeremy Anderson Regional Coordinating Partner Financial Services EMA region KPMG in the UK Tel: +44 20 7311 5800 e-Mail: [email protected]

Wm. David Seymour Global Sector Leader, Investment Management KPMG in the US Tel: +1 212 872 5988 e-Mail: [email protected]

David Sayer Global Sector Leader, Retail Banking KPMG in the UK Tel: +44 20 7311 5404 e-Mail: [email protected]

Frank Ellenbürger Global Sector Leader, Insurance KPMG in Germany Tel: +49 89 9282 1867 e-Mail: [email protected]

Gottfried Wohlmannstetter Global Head of Audit Financial Services KPMG in Germany Tel: +49 69 9587 2141 e-Mail: [email protected]

Jörg Hashagen Global Head of Advisory Financial Services KPMG in Germany Tel: +49 69 9587 2787 e-Mail: [email protected]

Adrian Curtis Global Executive Financial Services KPMG in the UK Tel: +44 20 7694 2275 e-Mail: [email protected]

Freddie Hospedales Head of Marketing & Communications Financial Services KPMG in the UK Tel: +44 20 7311 5264 e-Mail: [email protected]

© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved.

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frontiers in finance – June 2009 |

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Back issues are available to download from: www.kpmg.com/frontiersinfinance The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation. The views and opinions expressed herein are those of the authors and interviewees and do not necessarily represent the views and opinions of KPMG International or KPMG member firms.

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© 2009 KPMG International. KPMG International is a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. All rights reserved. Printed in the UK. KPMG and the KPMG logo are registered trademarks of KPMG International, a Swiss cooperative. Produced by KPMG’s Global Financial Services Practice in the UK. Designed by Mytton Williams Publication name: Frontiers in Finance Publication no: 906006 Publication date: June 2009 Printed on recycled material