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The Art of (non) Compliance- The Goldman Way!

“Those who fail to learn from the history are condemned to repeat it”. Going by the last week and the events hitherto, Churchill’s quote couldn’t have found a more deserving candidate.

Goldman Sachs- a torch bearer in the investment banking also holds the dubious distinction of often straying from the “ethical”, “legal” and “compliance” ethos of the financial world. These are the very values that espouse faith and confidence in stakeholders and investors as equal. For several years now, Goldman Sachs(hereafter,GS) has been accused of several misdeeds ranging from the role in 2007-08 financial crisis, involvement in European Debt Crisis, lopsided company culture and market manipulation.

On 22^nd October, GS admitted to its offence and agreed to pay nearly USD 3 billion in penalty for alleged bribery in 1MDB case. Overall, GS needs to shell out more than USD 5 billion for its sheer non compliance across Asia, Europe and America. If the quantum of penalty isn’t surprising, the manner in which the group operates is most certainly is! Why is it that a company almost always finds itself on the other side of the regulations? What makes the company which boasts of a vast talent of specialists indulge in unscrupulous activities? Whether, it’s the greed, winning-at-all-cost attitude, myopic vision or plain foolishness?

It has been a fairly simple playbook affair for GS. Indulge in “wrongful activities” make “quick profits” and when get caught “pay the fine”. And the cycle repeats! There’s no remorse. The involvement of GS in many of the major financial scandals in last one decade highlights the arrogance with which the firm has operated. The rules, regulations and guidelines at best serve as the mitigant but they are not a good deterrent. This is precisely the reason that just by paying a monetary fine (even the hefty ones) GS non compliance juggernaut rolls on.

It’s high time the regulators and the larger investor community must work in tandem to stem the rot. Shareholder activism must not be relegated to the textbooks and a handful few. With the advancements in technology, the sandbox approach to implement dynamic statutes must be encouraged.

With rising non compliance and legal costs, GS and its stakeholders have enough to ponder. Whether GS learns from the history or turns into one is for it to steer. But the consequences of non compliance can be unforgiving for a systemically important bank especially when an uncertain economic environment is looming large.

WHAT IF!?…THE COVID’19 NEVER HAPPENED.

The year 2020 began on a sombre note with the onset of Covid’19. To this day, it continues to rattle the day to day lives of every human being. Covid’19 is on its way to go down as one of the landmark episodes in the history of the mankind.The socio-economic and psychological impact of Covid’19 will certainly form the crux of many studies across disciplines.

A new “research”,especially on the economic literature emerges everyday to guide the policymakers for future course. And it makes little sense to perform the scenario analysis based on the “no Covid’19” or “pre Covid’19” world and predict the outcomes therein. How would the global economy had shaped up without the Covid’19? How would the companies have managed the supply chain ? How could the workplace dynamics have evolved? As absurd as it may sound, it would still be interesting to view the probable outcomes in the absence of a Covid’19 trigger.

GLOBAL ECONOMY:

According to IMF’s WEO, the world was expected to grow at 3.3 percent in 2020 and 3.4 percent in 2021. With “no Covid-19”, even at the worst case the world GDP would still hover between 2.5 percent and 2.8 percent. But this has changed drastically with Covid-19 as the forecasts are still uncertain about the possible impact in quantitative terms. While the global contraction is a given, the magnitude is still to be ascertained.

No-Covid’19 Outcome(probable): Expansion

Post-Covid’19 Outcome(almost certain): Contraction

SUPPLY CHAIN:

While the the over-reliance on specific hubs (read China) would have been business as usual, the Covid’19 world has laid bare the chinks the global supply chain. The companies are now actively looking to revamp their supply chain dynamics with some even contemplating to shift their businesses out and focus on clusters to hedge the emanating logistics risk.

No-Covid’19 Outcome(probable): Concentrated hubs

Post-Covid’19 Outcome(almost certain): Supply Chain Clusters

CENTRAL BANKING:

The central banks have acted like the true messiahs of the global economy in a Covid’19 world- a fact that was pretty uncommon and unheard of until last year. The central banks across the globe have done everything from slashing the interest rate to buying the corporate junk bonds in order to prop up their economies.

No-Covid’19 Outcome(probable): Conventional tools(mostly)

Post-Covid’19 Outcome(almost certain): Out of the box policies

INDUSTRIAL SECTOR:

The hospitality sector led by travel & tourism was one of the hot favourites in a “no Covid’19” world but has been battered severely. Similarly, the Bio-Tech and Pharma sector whose return was contingent upon the research and patents has found its support from the investors in developing the vaccine with relaxed approvals in trials.

No-Covid’19 Outcome(probable): Driven by geo-political and market factors

Post-Covid’19 Outcome(almost certain): May also be driven by health, safety and dynamism .

WORKPLACE:

The concept of work from home(WFH) has become a new norm in Covid’19 world. The idea which was experimented-with a little and had been championed by few have suddenly become an overnight sensation. The companies are increasingly looking to make their staff work remotely and cutting costs on expensive real estate. The use of virtual meeting tools have made the collaboration between the teams have eliminated the need for physical discussions.

No-Covid’19 Outcome(probable): Physical workplace being central

Post- Covid’19 Outcome (almost certain): Virtual workplace

EMERGING FRONTIERS:

The Covid’19 has certainly fast tracked the arrivals of new frontiers with technology at its forefront. The automation will become a mainstay to replace redundancy and acute demand for more advanced human skills will only see a growth. The scenario which otherwise was still few years away will become a reality atleast in the medium term.

No-Covid’19 Outcome(probable): Slow pace of adapting improvements

Post- Covid’19 Outcome (almost certain): Nimble innovations

The world during Covid’19 has definitely changed.The chaos it has brought, the opportunities it has presented and the outcomes it delivered can only be quantified as we move along. Until then, the expected outcome is as good as the individual analysis based on the theory available.

DIGITAL YUAN-CHALLENGING DOLLAR’S HEGEMONY?

China’s Central Bank has recently launched an homegrown digital currency as part of its effort to boost up electronic payments system. This also means that China has become the first major superpower to boast of its own digital currency.

According to People’s Bank of China, the intention of digital currency is to limit the cash in circulation with an aim to reign in money laundering and promote digital payments.The trials of digital currency have been introduced as part of pilot project across four cities-Shenzhen, Suzhou, Chengdu and Xiong’an.

The digital currency will have features similar to a “mined” cryptocurrency that uses blockchain technology with distributed ledger . But as the regular blockchain uses decentralized system with anonymity, the digital yuan will be circulated through legal banking channels. The details regarding users privacy remain unclear.

With its research in the area for more than five years and subsequent launch, the digital currency may serve as a key element in establishing what we can term as ‘Chinese might’. A dominant force in global politics and economy, China’s emergence as a leader in global crytpocurrency was but inevitable. The digital currency can be seen as a concerted measure to shore up its efforts to promote Chinese Renminbi(RMB) as an alternative especially to the US Dollar. This can be understood from the following: Firstly, introduction of Chinese Renminbi under IMF’s Special Drawing Rights(SDR) in 2016 alongside US Dollar, Euro,British Pound and Yen. Secondly, use of global financial centres like Taiwan, Hong Kong and Singapore in internationalisation of RMB. As a result of which more and more global indices like MSCI,FTSE have begun to include Chinese bonds and equities. Thirdly, introduction of CIPS(cross border interbank payments system) as an alternative to SWIFT in offering RMB based clearing and settlement services. And finally, the introduction of sovereign digital currency called digital yuan.

As the global economy reels with Covid-19 and a recession as its aftermath, the digital currency move by China can also be seen as a masterstroke in promoting technology as the major enabler in the global financial system. Where does that leave the West and the US? Is it the beginning of an end of USD hegemony? How will the US respond to the challenge?Will there be a Bretton Woods moment in the digital financial system?

As the world stares into uncertainty ,China with the first mover advantage is clearly far ahead than any of its global peers. The Dragon is surely breathing fire.

Recession’20- Is recovery in sight amidst Covid19 ?

The spread of COVID-19 has been unabating so far having accounted for nearly 300K deaths and infecting several millions . If the data sources are to be believed , no other nation with a notable exception of China,Japan and South Korea is able to “fend off” the virus,yet. With no vaccine or cure readily available, the policy makers across the globe are actively looking to lift the lockdowns and encourage “economic activities” with “great degree of uncertainty and fear”.

The new motto: Learn to live with the virus- serves as a perfect prelude to kickstart the economy. The world is facing its worst recession since the Great Depression of 1930s and the governments and policy makers are reeling under pressure to restore the economic normalcy.

Will the recession last for several years or be a quick turnaround? Can the world expect more shocks ? Is there a ‘new normal’ in place? What could be the mode of recovery? Will it be a V shaped or “Swoosh” shaped recovery? As the economies reopen, the answer to these questions would be more clear. Though the early signs of recovery from China pose a little encouraging if not an optimistic picture.

Let’s try to find out the “best possible” recovery method that can be attributed to the global economy amidst COVID19:

V Shaped Recovery: V-Shaped recovery involves a sharp decline in metrics followed by a sharp rebound to the pre-recession levels. With mostly every industry being battered, a V-shaped recovery can be ruled out in the short term.

2. U- Shaped Recovery: U-shaped is defined by a longer trough. This can last several quarters before the green shoots emerge. The recovery is rather undefined than compared to sharp rebound in V shaped recovery.

3. W-Shaped Recovery: W-shaped recovery is characterized by a period of extreme volatility. It can be best summarized as recession-recovery-recession.

4. L Shaped Recovery: The slow rate of growth and persistent unemployment are the hallmarks of a L-shaped recovery. The economy may never be restored to its pre-recession level.

5. Swoosh Shaped Recovery: The recovery best resembles the Nike logo and is characterized by longer duration of economic growth. It’s longer than the V-shaped recovery and slower than a U shaped one.

The massive impact of Covid-19 on sectors like hospitality,airlines and real estate and its cascading effect on many others severely dims the prospect of a V-shaped recovery. As the virus lingers on and the new social distancing norms take effect, the economic recovery might be a painful one atleast in the short to medium run. In these uncertain times one cannot rule out a U or a Swoosh shaped recovery. Or a new lexicon be added to the economic dictionary?BEHOLD!

HACIENDA HEDGE

DEFINITION:

Hacienda Hedge is the world’s largest sovereign oil hedge. Deriving name from its Finance Ministry, Mexico places options bet on the future direction of oil prices. As a private placement(OTC), the deal doesn’t divulge on potentially market disrupting details such as numbers of barrels hedged, the cost of arranging the private options to sell at a fixed future price, and the months in which the future sales are price guaranteed. The only known is the “Price”.

HISTORICAL BACKGROUND:

Despite falling oil production,Mexico’s oil hedge has real economic significance. Its oil revenues still generate over 1/10th of its export earnings. Mexico first hedged oil in 1990, after Iraq’s invasion of Kuwait . The then prices soared from a low of $15.06 to $41.15 in a matter of months. The Mexicans greatly benefited. But the experience from the Asian Crisis of late 1990s caught Mexico unaware and bought Hacienda Hedge into a formal yet ‘secretive’ strategy. As per the reports, the strategy has formally come into force in 2005 and has been a regular feature ever since. The oil hedge on an average covered between 200 million and 300 million barrels.

PRESENT DAY:

While the oil crash in April’20 riled global markets and resulted in setback for many oil economies, Hacienda Hedge proved to be a great boon for Mexico’s finances. The put option of $1 billion with a strike price of $49 a barrel has significantly propelled the nation’s finances and the estimated figure is not too difficult to guess.

BAGEHOT’S DICTUM

DEFINITION:

Coined after the financial essayist Walter Bagehot,Bagehot Dictum states that in times of financial crisis, the central banks should lend early and ‘without limits’ to solvent firms at a ‘higher interest rate’ with ‘good collateral’.

CONTEXT:

The economic havoc created by Covid-19 in the world is increasingly putting more pressure on the global central banks to adopt uncoventional policies to combat the financial crisis. Specifically, lending only to the solvent firms against the collateral and charging a penalty rate not only promotes the efficient allocation of resources but also limits the moral hazard arising out distortionary market practices. The Bagehot’s Dictum, in principle, certainly serve the central banks to limit the adverse effects on economic activities and promote employment.

PAYCHECK PROTECTION PROGRAM:

The Paycheck Protection Program offers a modern version of Bagehot’s Dictum. Under, the CARES Act(2020) passed by the US Congress, Paycheck Protection Program for Small Business Administration intends to provide upto eight weeks of payroll and other costs for the businesses to remain viable.

CONCLUSION:

Even after being in existence for nearly 150 years, the relevance of Bagehot’s Dictum couldn’t have been more pronounced. It continues to guide the modern central banking to this day and more so under exceptional circumstances.

Policy Rates-Cut.Raise.Hold.

HEADLINE:

The Reserve Bank of India in its Third Bi-monthly Monetary Policy Statement for 2019-20 on Aug 07, 2019 announced a rate cut of 35 basis points(0.35%).

Federal Reserve on Jul 31,2019 lowered interest rates by 25 basis points(0.25%)

DISSECTION:

The two headlines above indicate that there has been a rate cut by the respective central banks of India and US. So, what is a rate cut? What role does it play in a country’s economy? The rates- policy rate or interest rate is a monetary policy tool mostly under the authority of a country’s central bank either through legal backing or mandate. A policy rate determines the availability and cost of money and credit in the financial system. The various forms of policy rate include Repo (repurchase) rate, Reverse Repo, Marginal Standing Facility Rate and Reserve Ratios(Cash Reserve and Statutory Liquidity). These policy rates assist in a country’s economy to contract or expand. For instance, a cut in the interest rate boosts economic activity through fostering credit expansion. While a rise in interest rate is commonly aimed at curbing inflation, currency depreciation and excessive credit growth.Finally, the central banks may choose to maintain the status quo by keeping the rates unchanged(hold).

NOTABLE PHRASES:

A monetary policymaker can be perceived as Hawk or Dove depending on the policy rate. A hawkish policy primarily favors high interest rate to arrest inflation while a dovish policy involves low interest rates to boost economic growth.