usis review march 2016
TRANSCRIPT
ReviewUSIS
UoSInvestment.com
• Syria - The prospect of peace?• Profit increases at British Gas• Sterling reacts to EU uncertainty• Derivatives - A portrait • The rise of the right• Tax avoidance? - Google it!• Trouble ahead for the global economy?
March 2016
Contents
Contents USIS Review March 2016
Editor’s Letter 3
Banking and Finance
- Sterling reacts to EU uncertainty 4
- Trouble Ahead for the World Economy 5
- Tax Avoidance? Google it! 6
Economics & Global Affairs
- Syria - The prospect of peace 8
Investments and Strategy
- Profit Increases at British Gas 10
- Derivatives 11
Politics
- The Rise of the Right 13
Interested in joining the USIS Review? 14
2
Our Partners
Editors, Contributors & Sources
A Word from the Editor
Welcome to the third 2016 edition of the USIS Review.
I must firstly extend a warm welcome to all our new writers and thank everyone who con-tributed to this issue for the time and effort they have put into producing such detailed and interesting articles.
The March edition of the USIS Review is brought to you by a range of students from a wide variety of degree backgrounds. The financial world does not exist in isolation from the world and geographical, political, and scientific developments frequently have a huge impact on the way that markets operate. We are proud of how the diversity of our writers al-lows us to fully engage with this complex interrelation of factors in order to create a review of the world of investment for students at the University of Sheffield.
This month our Banking and Finance team took a look at how Sterling is reacting to the uncertainty surrounding Brexit. They also analyse how a variety of trends are affecting the Global Economy and explore the structure that allows Google to avoid tax. The Economics and Global Affairs team have covered the narrative of the Syrian civil war, and the prospect of peace. The Investments and Strategy team discuss the financial health of British Gas and the impact that derivatives are having on the global economy. Finally, our Politics section discusses the recent growth of far right political groups in response to issues such as mi-gration.
We have also included some helpful information for readers who are interested in gaining writing experience as part of the Review towards the end of this issue.
Our special thanks go to Rothschild, the University of Sheffield Enterprise Zone and the Sheffield University Management School for their on-going support with this publication.
I very much hope you enjoy this edition of the USIS Review.
Simon Cummins Editor-in-Chief
3
Editor-in-Chief: Simon Cummins
Vice Editor: Adilah Hameed
Contributors: Nathan Allaby, Anton Balint, Simon Cummins, Daniel Graham, Adilah Hameed, Elizabeth Lanigan, Charlotte Ridley Sources: Bloomberg, Bloomberg Businessweek, Thomson Reuters, Financial Times, Economist, Investors Chronicle, Wall Street Journal, Investopedia, Mergermarket, Yahoo Finance, Company Press Releases & Company Annual Reports
USIS Review March 2016 Editor's Letter
Sterling reacts to EU uncertaintyBritish pound hits a seven year low
The pound has drastically dropped and has hit a remarkably low level against
the dollar for the first time in seven years. It is speculated that the cause is closely connected to the UK potential exit from the European Union, which
is set to be determined in June 2016 through a national referendum.
The sterling dropped as much as 2.4% at $1.4058, its lowest level since March
2009. The fluctuation comes closely after Boris Johnson, the current Mayor
of London, decided to go against Prime Minister David Cameron's proposed
campaign to leave the European Union.
Since the turn of the New Year, specu-lation over the whether the UK will exit
the EU has risen, made easier by the coining of the term: ‘Brexit’. Such spec-
ulation and uncertainty has already had negative results on the pound which has already been pushed down more
than 4% against the US dollar. Analysts say this may contribute directly to the
outcome of the vote this summer. Sam Hill, senior UK economist at RBC Cap-ital Markets said ‘today's weakness ap-
pears to reflect an increased probability of ‘Brexit’ after political reaction to the
new deal on EU membership was more split than the PM would have hoped’.
However, Kamal Ahmed, economics edi-tor for the BBC, highlights that there are other factors determining the slump. He
cites the recent strong run of the dollar against the euro and the Swiss franc
which show that it is not just the pound that is faltering. Ahmed clarifies that
this due to the Federal Reserve’s choice to raise interest rates in December 2015, not the prospect of "Brexit", and further suggests that it may occur again during
2016.
The high level of confidence in the US economy, compared to the more
hesitant confidence attributed to the Eurozone emits, might go towards
explaining the drop in the pound. In the meanwhile, the Bank of England and
the European Central Bank are current-ly sending non-combative messages
regarding the rise of interest rates. Citi’s UK economist, Michael Saunders
suggests that the pound falling will have negative effects for Europe especially holiday destinations, which could be
damaging given Easter holidaymakers are searching for the best prices. US
bank Citi further predicts the uncertainty will continue to grow before the referendum date having estimated that the chances of Britain
leaving the European Union has risen from 20-30% to 30-40%. However, the reluctance
of businesses to leave the EU might prove to be a deciding factor in clearing up some
uncertainty; many of the FTSE 100 listed companies are said to be preparing to issue a
warning over the threats that may material-ize, should Britain leave the European Union. These threats will include job losses as well as
reduced direct foreign investment.
At this point the uncertainty and specula-tion looks set to continue over the next few
months, and the wait until 23rd June contin-ues.
Elizabeth Lanigan BA Business Management
Banking & Finance
England
USIS Review January 20164
companies have cut payrolls, others have slashed dividends, and around 40 shale oil companies in North America have declared bankruptcy.
Nevertheless, this declining global back-drop has meant that and central bank actions nurtured market expectations of further reductions in interest rates which have fuelled concerns over the banks prof-itability.
Central banks having been faced with tough economic decisions, leading some to introduce negative interest rates to boost their economic development. The objective of negative rates is to discourage institu-tions from storing cash in banks, which then leads to the cash being capitalised into alternative investments, which then stimulates growth and creates economic development.
Consequently, setting negative interest rates, previously a very rare practice, has become a common for more countries as many central banks search for alternatives to stimulate long-term growth, whilst jug-gling with the current tumble in oil prices. In January, the Bank of Japan, shocked markets with the introduction of negative interest rates. This occurred about their Eu-ropean Central Bank had stated that they
would review its current monetary policy stance, whilst the Federal Reserve issued a stress test guidance encouraging negative interest rates.
However, Mark Carney, Bank of England Governor, stated at a G20 meeting in Shanghai, while negative rates might be an attractive way for an individual coun-try to weaken their currency and boost exports, the global economy will suffer as a whole. This statement is contradicted by the most recent Riksbank monthly infla-tion report, which states that the Swedish government’s immense experiment with negative interest rates seems to working. Perhaps the effect of negative rates will have a much larger impact around the globe than previously thought.
The situation is worse than it was in 2007, and as William White, the Swiss-based chairman of the Organization for Eco-nomic Cooperation and Development’s policy review committee and former economic advisor at the Swiss-based Bank for International Settlements, told The Telegraph in Davos, “our macroeconomic ammunition to fight downturns is essen-tially all used up,”.
Adilah Hameed BA English and History
Global Trade
A bad outlook for the global economy?
5USIS Review March 2016 Banking & Finance
The global economy is facing an eco-nomic turmoil which is in part caused by governments around the world run-ning out of monetary policy solutions.
BIS chief Claudio Borio has stated that ‘in the recent quarter, we may have been witnessing the beginning of its resolution’ whilst further stating that ‘we may not be seeing isolated bolts from the blue, but the signs of a gather-ing storm that has been building for a long time’.
This storm is comprised of a combi-nation of tumbling stock markets, a rapid sink in oil prices, the collapsing of evolving market currencies, and the slow economic growth in China. The increased anxiety about global advancement has inevitably driven the price of oil and EME exchange rates low. Kenneth Rogoff, who is a senior fellow at the Council on Foreign Relations (CFR), warns of “a slowing Chinese economy, collapsing commod-ity prices, and the beginning of the U.S. Federal Reserve’s rate-hiking cycle”, as a evidence of the declining health of the global economy. Emerging economies like Brazil, South Africa, Thailand, and Turkey, rather than China, will be the real sources of concern in 2016, argues U.C. Berkeley’s Barry Eichengreen.
Global oil prices have decreased in the past 18 months and key benchmarks have begun trading below $30 a barrel, which is the lowest level in more than a decade. The Organisation of the Pe-troleum Exporting Countries (OPEC) has cut its forecasts for global oil-de-mand growth and the world economy, saying lower oil prices were offset by low consumer appetite. This will also impact developing countries such as Russia and Brazil. Traditional oil giants like Saudi Arabia and Gulf allies, on the other hand, will see their oil revenues fall by $300 billion in 2016. Major oil
A Summary of the New Report from the Bank of International Settlements.
Tax Avoidance – Google it!Google strikes a deal with the taxman
The UK public don’t have the luxury of nego-tiating with the taxman about how much tax
we should be paying. So why is Google able to strike a deal with the taxman?
Over the past couple of years, the public have become increasing aware of large
international corporations such as Google, Amazon and Starbucks paying insignificant
levels of taxation despite benefitting from levels sales revenue which have reached into
the billions of pounds. Since this infor-mation came to light, and with a view to
recover tax monies owed to the public purse, there has been a campaign to bring these
mega-corporations to light and hold them accountable for their fair share of tax.
Following a multi-year ‘open audit’ by Her Majesty’s Revenue and Customs, the multi-national technology firm Google has agreed
a £130 million deal to pay taxes back dated from 2005 as well as changing the structure
of future taxation. This could be regarded as a significant victory for the current UK
Government as Google has previously paid £6 million in 2011 when sales were at £395
million and £20.4 million in 2013 when sales revenue reached £3.8 billion.
The Double Irish Arrangement
The double Irish arrangement is a tax avoid-ance strategy adopted by many multination-
al corporations which exploits a loophole in the definition of corporate residency
within different countries. For example, a US based company such as Google can
create an Irish subsidiary located in a tax
haven such Bermuda called ‘Google Ireland Holdings’ and an operating subsidiary located in Ireland called
‘Google Ireland’. According to US law, a company is determined a tax resident based on its place of incor-
poration, whereas Irish law states that tax residency is determined by
where a company is managed and controlled.
From the view of the US Gov-ernment, Google licences out its
intellectual property to Google Ireland Holdings who in turn then
sub-licence the intellectual property to Google Ireland, allowing Google
to sell its products outside the US whilst avoiding paying US corporate tax on profits generated outside the
US. From the view of the Irish Gov-
ernment, Google Ireland Holdings
and Google Ireland are regarded as two separate corporations. Therefore, revenue
generated from selling Google’s product in Europe by Google Ireland is transferred
back to Google Ireland Holdings in Ber-muda. Consequently, these payments can
be treated as royalty/trade costs (i.e fees for the use of the intellectual property),
thus minimising the amount of profit that is subject to the 12.5% corporation tax. In
this way Google Ireland Holdings can then receive the payments in a tax free environ-
ment.Dutch Sandwich
Despite the complex network, the Double Irish arrangement could still see Google Ireland’s profit subjected to withholding
taxes which is often the case for royalties. The addition of the Dutch Sandwich creates
a simple way of avoiding such withholding taxes and therefore furthering Googles tax
efficiency. The Dutch Sandwich is simply
6 USIS Review March 2016Banking and Finance
ECB
a stepping stone inserted between Google Ireland and Google Ireland Holdings. Again, intellectual prop-erty is sub-licensed out from Google Ireland Holdings but this time to the Dutch Company, Google Nether-lands which in turn is sublicensed out to Google Ireland. The transfer of royalties from Google Ireland to Google Netherlands is not subject to withholding taxes because EU law states that payments between EU resident companies are exempt from such taxes. Finally, Google Netherlands payments are made back to Google Ireland Hold-ings (in Bermuda) which are not subject to withholding taxes accord-ing to Dutch law. You can’t dispute that Google’s creativity extends to their efforts to become ‘tax efficient’.Where does the UK fit in?The role Google UK LTD is to sup-port Google Ireland via ‘the provi-sion of marketing services’ and does not sell any products to customers, according to Google themselves. Therefore, when a UK based com-pany purchases a search ad from Google, the money is sent to Goog-le Ireland, this is the case for any purchases made throughout Europe. In, 2012-2013, UK sales contributed to 11% of Googles worldwide busi-ness which is valued at $5billion but accounted for by Google Ireland. The purpose of the audit by HMRC on Googles accounts was to establish whether Google UK is actually con-ducting business in the form of sell-ing. As such, it can be speculated that Google UK LTD is acting as a front for its sister company in Ireland, therefore subjecting Google Ireland to declare its profits in the UK.The Deal Following this multi-year ‘open audit’ by HMRC, Google has agreed a £130 million deal to pay taxes back dated from 2005, based on the profits made by Google UK. More im-portantly, the deal includes restruc-
turing the system Google uses to pay its taxation in the future which will be based on sales activity to UK customers, rather than profit. This deal declared that HMRC have accepted that Google UK Ltd is merely providing support for the main European Operations office in Dublin, and that its complex arrange-ment of minimising UK taxation is legal. Is this good for the UK?Consider the fact that the complex structure Google adopts in order to avoid paying taxation in the UK has been deemed legal by HMRC. At first glance the deal seems positive, it’s the first major inroad the Government has made in tackling multinational corpora-tions tax avoidance strategies. The most significant aspect of the deal is the fact that taxation will now be based on UK sales of Google and not profit; bearing in mind that Googles UK sales revenue reaches into the billions, this could mean that Government will receive a fairer proportion of taxation. Is this bad for the UK?As stated above, at first glance the deal seems positive. However, Google has stated that the amount of taxation depends of the level of earnings gener-ated from UK based advertisers. This is a shrewd move by Google, as it is likely that UK based advertisers contribute a fraction of the total figure of UK sales revenue, therefore only partly reflecting
the earnings Google makes in the UK. Ad-ditionally, it has been reported that France have refused to strike a deal with Google over back taxes, and are seeking full repay-ment, reported to be around £1.3 billion, far greater than the amount Google paid to HMRC. Furthermore, the French Finance minister has attacked the deal between the UK Government and Google, mounting pressure on the EU commission to investi-gate the deal. It is probable that Google will try to negotiate with the French authorities in order not to pay the full sum. However, if France are successful in obtaining a figure anywhere near the £1.3 billion reported, it could be a huge blow to the current UK Government.
What does the future hold?There is no doubt that the tax deal between the UK Government and Google will remain at the forefront of global news whilst other countries pursue Google to pay back taxes. Consequently, the deal between Google and the UK Government might have an unwant-ed knock-on effect for other multinational corporations like Amazon and Starbucks. If the powerhouse of Google can be inves-tigated and compromised, this might leave other corporate giants vulnerable to public campaigns regarding their own questiona-ble tax arrangements.
Daniel Graham BA Economics
ECB
7USIS Review March 2016 Banking and Finance
evision network which was involved produc-ing and hosting a number of anti-government programs in a way that could not be censored by the Syrian state.
Another group of particular note is the Kurd-ish Peoples Protection Units. The Kurds are one of the largest cohesive ethnic groups in the world that do not have their own official country. However, in the regions of southeast-ern Turkey, western Iran, northern Iraq, and northern Syria, Kurdistan is a nation in all but name. Fiercely opposed by the governments of many of the internationally recognised countries that they inhabit, as they wish for independence, Kurdish forces are a significant force in the fight against Assad. In terms of international engagement, the Kurds receive air support from a broad coalition of western countries, including Canada, the UK, France, and the US. However, they are often the “mistaken” targets of air strikes from Turkish warplanes.
Attempts to resolve this conflict are as old as the conflict itself. In late 2011 the Arab League launched two different initiatives designed to bring representatives of the Government and Opposition to the negotiating table. These failed without any real progress. However, now in early 2016, almost five years after the con-flict began, progress is finally being made. This is the result of a series of conferences held in Geneva. The first of these was held on Saturday
30th June 2012 the first of what was to be three Geneva peace conferences was convened. Initiated by the UN Peace en-voy to Syria at the time, Kofi Annan, the negotiations included most of the UN security council. However, it failed to include representatives from the Syrian government or opposition groups.
Geneva II was held on 22nd January 2014 and succeeded in bringing togeth-er representatives from the opposition and Syrian government. However, no agreement could be reached regarding the future of Syria after the war ends. Consequently, the war continued.
The main objective of Geneva I, Geneva II (2014), and Geneva III (2016) was to create an agreed structure for the creation of a transitional government. Neither side could accept the other continuing to hold power in any form. The Syrian government maintained that a rebellion, no matter how pow-erful, is still merely a rebellion and has no legitimacy. In contrast, the opposi-tion essentially argued that the crimes committed by the Syrian government against their own people, both before and during the war, meant that any legitimacy that it may have once possessed was voided. The curious ele-ment is how the international commu-
nity has played a role in both continu-ing the conflict, with many countries giving military aid to their preferred victor, whilst publicly maintaining, in a variety of peace conferences, that peace needs to be achieved as soon as possible for the sake of the Syrian people.
On the 27th of February 2016 a ceasefire was finally announced after the US and Russia began to jointly pressure both conflicting groups to negotiate. This truce is being mon-itored by international observers. Unfortunately, as Karen DeYoung of the Washington Post described on the 2nd of March, a number of vio-lations to the terms of the ceasefire have already been reported. However, none of these violations have been formally recorded by either the US or Russia, who oversee the internation-al observing task force. One source reported that “The approach doesn't seem to be finding a violation - it's more in trying to dodge them”.
Perhaps if the illusion of peace can last it will lead to the emergence of peace.
Simon Cummins BA History and Philosophy
9Economics & Global AffairsUSIS Review March 2016Economics & Global Affairs USIS Review March 2016
Syria - The prospect of peace?
8
The land currently known as Syria has been a centre of civilisation for nearly
four thousand years. Its capital city, Da-mascus, can claim to be one of the oldest
continuously inhabited cities in the world. However, the roots of the modern
state are much younger. Today's Syria was formed after the collapse of the Ot-
toman Empire, at the end of WW1, when the country became a French “mandate”
or colony. Independence from France came on the 24th of October 1945 when
the latest descendent of this grand ancestry of states and empires became a founding member of the United Na-
tions.
In March 2011 the Syrian people erupt-ed in protests as part of a widespread
wave of dissent that spread across the Arab world, which came to be known as
the “Arab Spring”, that removed lead-ers from power in Libya, Egypt, and
Tunisia. These uprisings and protests were particularly significant because of
the central role played by social me-dia networks. Facebook, Twitter, and
YouTube became weapons for organi-sation and allowed activists to operate a decentralised structure that was capable
of sharing their revolutionary message and ideals with a unprecedented global audience. Revolution had been brought
into the 21st century.
In a number of cases, state violence and police crackdowns, that were intended
to quell the uprisings, were recorded using smart phones. These images only
fuelled further further protests. This article is primarily concerned with Syria because the severity and long lasting na-
ture of the popular dissent here stands out even in this context.
When protests erupted in Syria the government’s response was to send
in the army and crush resistance with force. This is most vividly captured by
the fact that the state laid siege to an entire town, called Jisr al-Shughour,
and caused almost 10,000 of their own citizens to flee to Turkey. Navi Pillay, the
U.N. High Commissioner for Human Rights, reported in December of 2011, a mere nine months after the protests
began, that the actions of the Syrian state had already led to the deaths of
over 5000 people, including at least 300 children. Today the figure is substan-
tially more. The man who ordered these crimes against humanity, Bashar
al-Assad, has occupied the official office of President of Syria, and the semi-un-
official role as dictator, since he was “elected” unopposed in 2000.
The defection of a sizeable portion of the Syrian army caused a situation of
Syria
severe unrest to morph into one of civil war. However, it is also clear that
the sectarian nature of the conflict is a major obstacle to peace. Although the
majority religion is Islam, government forces are primarily Alawite, a school
of Shia Islam, whilst the opposition are primarily Sunni Muslims. However, the groups themselves refuse to accept that
the conflict has any basis in religion and insist that the root problem lies in international interference. Although it seems difficult to totally disregard reli-
gion when considering why the conflict is so severe, it is undoubtedly true that
international intervention has led to the deaths of many Syrians.
From the early stages of the civil war the Syrian government received support
from Russia, Iran and Iraq. This took the form of military and economic assis-
tance. Various opposition movements also receive substantial support from
countries such as the US and Saudi Ara-bia. Some of the information released
by WikiLeaks, in the form of diplomatic cables between the State Department
and the US embassy in Damascus, show that the US was giving financial assis-
tance to groups that politically opposed the Syrian government until at least
September 2010. This included almost $6 million given to the “Barada” satellite tel-
An overview after five years of civil war
Energy
Profits increase at British Gas as pressure mountsHow the collapse in commodity prices is affecting the British energy sector.
Over the last 12 months the UK’s largest energy supplier British Gas has seen a growth in profits of 31%. Despite the fact that weather temperatures have not exceeded the usual average, there has been an increase of gas consumption in Britain by 5%. This is surprising as temperatures in 2014 were very mild.
The chief executive of Centrica (the parent company of British Gas), stressed that the rise in profits at British Gas was due to the wholesale costs decrease. These savings were naturally passed on to the consumer. The increase in profits were entirely to do with the global col-lapse in commodities prices rather than shifts in the weather or popular con-sumption trends. John Moylan’s analysis shows that the company’s profits were just returning back to normal levels, after having falling in the previous year due to the warmer weather.
E.ON, EDF, SSE, Scottish Power and Npower have already made gas price cuts. However, British Gas took un-til last week to announce that it was cutting gas prices by 5.1%. This makes them the last of the big six to make a reduction in gas prices. This is not the first time that energy suppliers have been slow to reduce prices when their costs fall. The UK Markets Authority is
currently conducting an investigation into the UK’s energy suppliers and initial estimates suggest that consumers overpaid as much as £1.2billion a year between 2009 and 2013.
Over the last past year British Gas has cut standard gas prices three times and customers may see a further reduction in gas prices this year if the wholesale prices remain low. However, wholesales cost of electricity only account for 40% of customers’ bills and other costs like government levies continue to increase. Energy companies with higher profits like British Gas are now under greater pressure.
The implications of the commodity slump are not limited to British Gas.
10
Centrica’s share price fell by 12% due to the dramatic decrease in global whole-sale gas prices. Centrica shares value is currently down by £2.4 billion for its oil and gas assets and power stations. No surprise British Gas revealed 500 job cuts within the energy efficiency business. However, this trend seems set to reverse as Centrica was one of the largest risers on the FSTE 100 in recent days, with shares closing up as much as 6.85%.
The increase in profits from the big six has led to added pressure to cut energy bills to fall in line with wholesale prices. Especially, after campaign group, Fuel Poverty Action released figures showing British Gas was profiteering in a year when there was an increase of winter deaths. More generally, the report implies the company could have reduced dual fuel bill by almost £100 per year. The cam-paign group blamed the government for not intervening when the big six focused on increasing profits, whilst citizens died.
Others critics argue only small saving were made due to the collapse in the global price of oil and gas. Conn, chief executive of British Gas’ emphasised the company delivered the diminishing com-modity prices to customers.
Charlotte Ridley BA Business Management
USIS Review March 2016Investments & Strategy 11
The 2002 Berkshire letter to its shareholders, authored by Warren Buffet and Charles Munger once famously stated that derivatives are 'financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal’. Unfortunately, they were right, as derivatives played a cru-cial role in the 2007-2009 financial meltdown. Remember the housing bubble that burst in the United States of America? Derivatives magnified the impact of the US housing collapse on the financial services industry. However, what are these financial products that are still some of the most contro-versial on the market and how are they used by investors and traders?
The Derivative Contract
The term ‘derivative’ is a generic umbrella for a diverse spectrum of financial products. A generic definition would be – a derivative is a security (a contract essentially) with a price that depends on or derived from one or more under-lying assets. Also, there are several types of derivatives that are most used in the financial markets, with options and futures being
Derivatives: A portrait A danger to the global finance system?
the most well-known. The fundamental difference between the two lies in the contractual feature of derivatives. Options are financial instruments that represent a contract which offers the buyer the right, but not the obligation, to buy or sell a cer-tain asset at an agreed price at a specific date or during a specified period of time. On the other hand, a Future is a contract that places an obligation on the buyer to purchase a certain asset (or on the seller to sell a certain asset) at an agreed (predeter-mined) future price and date. Please note two things before moving on to their use.
Firstly, the derivatives are the rights conveyed by the contracts – in the case of an obligation, the derivative is the right to have an option to buy or sell the asset at an agreed price for a certain period or on a specific date and in the case of the fu-ture, the derivative is the obligation to buy or sell an asset at a predetermined future date and price. The rights and obligations given by these contracts is what you buy or sell when you are trading derivatives, be it on a stock exchange or over-the-counter.
Secondly, derivatives are a category of securities and not a specific kind. There-fore, there are several different types of derivatives that are used for a wide range of purposes, from hedging or insuring
against systemic risk to increasing a position in a trade. In addition to the above mentioned ones, other important derivatives include forward contracts (which are only traded over-the-counter and not on a stock exchange), swap agreements (contracts between two parties agreeing to trade loan terms, such as switch-ing from a variable interest rate loan to a fixed interest loan) and the recently-made-famous, MBS (mortgage-backed security) – the ‘weapon of mass destruction’ that triggered the finan-cial slaughter of 2007 - a type of asset-backed security that is secured by a mortgage or a pool (collection) of mortgages.
The ‘hard work’ of DerivativesAbove we have read a brief introduction to what derivatives are in their essence. This section will look to offer an overview of what are their most common uses and what risks they present to financial markets.
Derivatives can be traded on or off an exchange. For example, they can be Exchange-Traded Derivatives (ETDs), which are, according to a JP Morgan 2013 Guide, ‘standardised contract traded on a recognized exchange’. Moreover, the contract terms of ETDs are non-negotiable and their prices are publically available. On the other end of the spectrum you have Over-the-Counter Derivatives (OTCs), which according to the same JP Morgan 2013 Guide, are ‘bespoke contracts traded off-exchange with specific terms and conditions determined and agreed by the buyer and the seller’.
It is well known amongst the financial servic-es industry that derivatives are used to hedge against systemic market risk which includes
USIS Review March 2016 Investments & Strategy
Financial Instruments
Financial Instruments
market volatility. As the New Zea-land Bankers Association explains, derivatives help corporations to manage risk and to protect them against the volatility of financial markets. One of the most common uses for these securities is to hedge against foreign currency fluctu-ations. For example, futures and forwards are particularly useful to agree an exchange rate in advance which reduces the exposure to cur-rency depreciation or strengthening, especially for companies heavily dependable on importing raw mate-rials from these economies.
Other common uses include hedg-ing against interest rates, usually through swap agreements which exchange loan terms between the parties and to account for commod-ity price changes, mostly through futures if you are a seller or options if you are a buyer. Therefore, it can be argued that derivatives assist with the better management of cash flows and their existence is justifiable by their role in mitigating the impact of market volatility on the capital invested in business operations. However, are the risks outweighing the benefits?
The complex jargon aside, derivatives are a formal way of simple bets on fu-ture events. Various sources, includ-ing the well-known Investopedia.com, list the risks associated with de-rivatives to be: market risk (as in the risk associate with any investment, i.e. the chance you accept and take that you can lose money), counter-party risk (the risk of one party of a derivative contract defaulting on the contractual terms), liquidity risk and interconnection risk (the risks pre-sented by the systems of connection between derivatives instruments and dealer). I am not referring to these risks because they are noisy consid-erations that distract us from the real issue: the risk derivatives pose to the fabric of financial markets. In other words, we need to answer one ques-tion only: are these instruments a danger for the function and purpose
of financial markets?
Are derivatives that dangerous?
My answer is yes. Derivatives are a danger to the very fabric of financial systems across the world. Here is why: going back to Warren Buffett’s reasons for calling derivatives ‘weapons of mass destruction’, we can see that these secu-rities involve parties exchanging money at some future date, with the amount of that money to be determined by the value (defined as the market price) of an asset plus many more factors such as interest rates, stock prices and currency values. For example, if you are either long or short on a FTSE 100 futures contract, you gain or lose depending on how the market fluctuates. The market fluctuates irrationally in short-term – therefore, the likelihood of you losing money is unknown. Moreover, because derivatives have different time lengths, with some running as long as 20 years, you are taking a leap of faith – the risk you are taking is not rational, it might make mathematical sense but not com-mon sense for no formula can gauge the future which is the result of collective human action.
The above was a simple, very simple, example of a derivative. However, take into account two things: firstly, most derivatives are much more complex
and secondly, the all market actors that use derivatives have the same goal: not to lose money.
Sounds crazy?
That is because it is – they all expect to have their money protected by using the same tools and dealing in the same way with the same environment! Also, just to give you a tinny flavour of how complex some deriva-tives can be, let’s look at the notorious MBSs.
These were pools of mortgages that includ-ed anything from AAA to toxic mortgages. However, because they contained thousands of such loans, the rating agencies deemed them diversified enough to rate the entire pool with AAA! Therefore, not only that the MBS was priced based on thousands of other products but they were valued so high based on mindless assumptions such as the con-tinuous (apparently towards infinite) of the US real estate market. When the borrowers started defaulting on these loans, the entire MBS market collapsed like a domino and the financial slaughtered that nearly wiped financial systems was triggered in early 2007. Complexity is the enemy of profit making and capital allocation. That is why derivatives are dangerous.
Anton Balint LLB Law
12 Investments & Strategy USIS Review March 2016
US Politics
13
in migrants has led to the menacing prospect of unemployment for locals, whilst a study by
Oxford University’s Migration Observatory reported that each 1% increase in the share of migrants in the UK-born working age population leads to a 0.6% decline in the wages of the 5% lowest paid workers, and to an increase in the wages of higher paid workers. Thus, it is apparent that migration leaves the poorer sections of society worse off, whilst the rich become richer. Therefore, this could explain the paradox of the working class leaning away from the more lib-eral approach towards migration from the left. Media company Vocativ also produced an interesting study looking at the increase in social media support for right wing parties in Europe during the height of the crisis. As a result, the impacts of the migration crisis provides some compelling evidence for the rise of right-wing populism across Europe.
In a sentence, the European debt crisis arose because several Eurozone mem-ber states (Cyprus, Greece, Ireland, Portugal and Spain) failed to repay their government debt. However, in addition to this, the economic sanctions against Russia enforced by the US and EU after the Crimea incident, also significantly
The gradual rise of right wing parties has been an interesting concept to look at. As 67% is led by a right wing party, does pose a stark contrast to the political environment in Europe in the late 1990s. But why the sudden desire for a more conservative nationalist society, greater capitalism and social stratification? Why are the obvious beneficiaries of left wing politics deciding to sway their vote towarxads right wing parties like UKIP? This can be answered and explained by two main factors: the migration crisis and eco-nomic turmoil in Europe. However, the concept of increased individualisation is also a convincing argument for the rising popularity of the right.
The overarching cause of the rise of right-wing populism is the recent migration crisis beginning at the start of 2015. A culmination of the Syrian Civil War, discrimination in the Bal-kans, those fleeing from violence and war in parts of South Asia and certain African countries, has meant that the number of refugees seeking asylum in Europe has increased dramatically. The number of displaced people reached 60 million at the end of 2014, the highest level since World War Two. As a result of this, many feel that their indigenous culture is threatened by the expanding diaspora created. Moreover, the surge
damaged economies in Europe. This was because Russia is Europe’s third largest trading partner, with Die Welt (German Newspaper) reporting that sanctions on Russia alone could eventually cost Europe £82 billion and up to 2 million jobs. Both these factors subsequently led to a whole host of labour market problems, causing extremely high levels of unemployment, reaching 27% in both Spain and Greece.
Due to this, people’s vote is driven by fear, often longing for economic stability above all other factors, and this is seen to be bet-ter provided by more right leaning parties. Looking back in history can also help us to see this trend. For example, Hitler gained the majority of his support by appealing to the 6 million unemployed Germans in 1932 with the promise of jobs and national security. Thus, the combination of econom-ic insecurity and the influx of migrants created a perfect political environment for right-wing parties to thrive.
Individualism is the social theory that fa-vours freedom of action for individuals over collective or state control. The term was first coined in the 19th century generally showing us that it is a relatively modern phenomenon. The concept has arguably developed in popularity significantly over time, shown by the growth of capitalism and the freedom of expression. Moreover, the decline of trade unions and the fact that the number of self-employed people in the EU is at a 40 year high also supports this theory. This links into the waning popularity of the left, as their ideology is more focused on collectivism through state intervention and the spread of wealth, which goes against the movement of indi-vidualism.
This leads us to wonder which, out of the three, has been the real reason for the rise of the right wing.
Nathan Allaby BA Business Management
The rise of the rightIs the rise of the right wing party a result of individualization?
USIS Review March 2016 Politics
Advertisement
Interested in joining the USIS Review?A brief introduction to the University of Sheffield Investment Society Review. and the opportunities available.
Background
The USIS Review is the University of Sheffield Investment Society’s monthly, student-run financial publication.
Our writers engage in a diverse range of topics which cover breaking news and developments in Banking and Finance, Investments and Strategy, Technology and Economics and Global Affairs.
The Review has changed immseurably since I started writing in my second year. Under Matthew Smith, my predecessor as Editor-In-Chief, we have added new sections, gained sponsorship, and broad-ened the diversity of our writing popula-tion.
The review now has a huge range of sec-tions dealing with every aspect of the businesss and investment world. Our contributors study a diverse range of degrees from Engineering to Medicine, Economics to Politics and History to Management, so we have no specific re-quirements or prerequisites.
If you are able to keep to deadlines and can work effectively, both independent-ly and as part of a team, then you are cordially invited to contribute your own unique articles to our publication.
What can we offer?
A developed interest in business and fi-nance is a prerequisite for an enormous number of careers. Making the transi-tion from reader to writer will allow you to develop your skills and knowledge, whilst gaining tangible evidence that can set you apart from the crowd. On this
note, I would like to thank the University of Sheffield Management School and the Rothschild Group, whose sponsorship enables us to print hard copies.
In addition, answering "Commercial Awareness" questions is made easier when you wrote an article looking at the Brexit debate or the implications of po-litical stability for the Brazillian economy last month. Over time this develops into a broad understanding of the trends and developments across a wide number of industries and markets.
We have also have the opportuntiy to in-verview a number of guest lecturers at the University. This is an ideal opportu-nity to engage and network with estab-lished professionals in a variety of fields.
Opportunities
Producting this review every month is a team effort. We are looking to recrtu-
it a number of Depuuty Editors to help lead this effort. The role involves overseeing the articles in a single section, such as Banking and Finance. You would primarily act as a copy-editor, but also provide advice and sup-port to the writers in your section.
If you are interested in contributing, or would like further information, please don’t hesitate to contact us using the following email address:
You can Like us on Facebook (USIS Review) as well as on Twitter (@USISReview) for reg-ular updates on the publication and the op-portunities available.
Simon Cummins History and Philosophy
14
USIS Review
USISReview
USIS Review March 2016 Banking & Finance USIS Review March 2016
ReviewUSIS
Editor-in-ChiefSimon Cummins
Vice EditorAdilah Hameed
Contributors
Nathan Alaby | Anton Balint | Simon Cummins
Daniel Graham | Adilah Hameed
Elizabeth Lanigan | Charlotte Ridley
Copyright © 2016 The University of Sheffield Investment Society
Any unauthorised reprint or use of this material is prohibited. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including
photocopying, recording, or by any information storage and retrieval system without express written permission from the publisher. All opinions expressed within are those of the respective contributor and do not represent the views of The University of Sheffield Investment Society, the USIS Review or
our Partners.