SEPTEMBER 2012

M A G A Z I N E

SEVENTH EDITION

Bringing back big bond business

Crouching Tigers,Hidden Lions

Chinese Currency Controls

FinanceLabsfavourite

YouTube films

London Study Trip 2012

14

24

28

8

and much more...

Welcome to this special edition of FinanceLab Magazine. This is-sue of FinanceLab Magazine is issued in connection with Fi-

nanceLab London Study Trip and written by Study Trip contestants.

We start of in the city of our destination, The City; as The 2012 Olympics has come to an end, the first article reveals that UK has more in common with ancient old Greece than just athletics and sports games, namely indebt-edness.

In an interview with Nick D’Onofrio, manag-ing partner at North Asset Management, the next article gives you key insights on how to make it in the asset management business. Furthermore, the article reveals how North Asset Management has profited from arbi-trage opportunities in the European market. Staying in Europe, the next article explores the tough environment for IPOs in Europe by analyzing the market conditions and evaluat-ing the performance of the most recent IPOs. While the market for IPOs is suffering, bond deals are flourishing; the next article explains how current macro environment has benefit-ted the bond market and brings an overview of recent debt issues. As is turns, the ma-

jority of firms who have issued bonds during the past two decades have used the funds to help finance acquisitions. Thus, the next article explores the M&A market in 2012.

As we take a look at the current macroeco-nomic environment, we take a further look at the US, as we argue that the economy is considerably better off than the indebted euro zone countries. Moving to emerging markets, we look at the Asian Tigers and the slowly, yet steadily, emerging African Lions. Looking further into the by far largest econo-my out of the Asian Tigers, China, we explore the currency control as we take a look at how the government of China has a strong grip around the renminbi.

Turning back to the western markets, we look at recent trends in sales and trading as we analyze the upside potential in equities from a recovery in Europe. Afterwards we take a look at Basel lll and analyze the implications of increased capital requirements. Lastly, we round up this issue of FinanceLab Magazine by moving onwards from public to private. Here, we look at the private equity market as we investigate how the private equity market has been affected by the current financial crisis.

EDITORSNOTE

2/42

ABOUTEDITORS

LAYOUT

CONTRIBUTORS

FinanceLab is a network and interest organisation aiming to improve financial competences among stu-dents through networking, education and hands-on experience.

FinanceLab is represented at several universites in Denmark such as Aarhus School of Business, Copen-hagen Business School, Aarhus University, Univer-sity of Copenhagen, Tech-nical University of Den-mark, Aalborg University and Niels Brock.

Visit FinanceLab.dk

Rune Randrup-ThomsenSarah Louise Hansen

Frederik Ploug Søgaard

Ole-Bjørn KolbækMerit Fatima von EitzenRasmus DitlevsenJon Rustemi KaznelsonJens Bech PetersenKasper Vinther OlesenTomas RosalesJohan Riis MadsenMikael Petersen

Mads Axel SchønbergKevin Hellegård NielsenMarie Leth ChristensenFabian BergJørgen Bråten NordbyFarina Ria NordamBastian AueKasper Olesen

From the Olympus to the UK

Nick D’Onofrio, North Asset Management

The five biggest IPOs in Europe in 2011 and the uncertainty

dominating the IPO market

Bringing Back Big Bond Business

M&A transactions in 2012

The Global Debt Crisis - Why America is different

Crouching Tigers, Hidden Lions

Chinese Currency Controls

Private equity take-overs

Trends in sales and trading

Basel III

CONTENT

PROOF READERNaja Hannibal Ottosen

3/42

This summer London is host-ing the Olympic Games. The Games, however, are not the only Greek influences hitting

the UK hard presently. The European debt crisis with Greece as its frontrun-ner is quickly catching up on the Brit-ish economy. June statistics show that financial stability is deteriorating in the UK, and British GDP is contracting. Will the Olympic Games help boost growth or will they only worsen government fi-nances? The fight to restore growth and decrease debt will continue long after the Olympic battles have ended.

Towards financial instabilityIn the Financial Stability Report from June 2012, the Bank of Eng-land writes “the outlook for financial stability has dete-riorated, particularly in light of heightened uncertainty about how, and when, euro-area risks will be resolved”. Major British banks do not have large exposures towards the weakest European sovereigns, but their exposures towards non-bank private sec-tor borrowers in many of these countries are significantly larger. While past efforts by UK banks to build

resilience, through higher capital levels and stronger funding structures, have provided some insulation from strains in the euro-area, progress in building capital is slowing and UK bank’s fund-ing costs remain high - partly due to

investors’ concerns about potential future losses. Es-timates from the Bank of England suggest conta-gion in Spain and Italy could cost UK banks up to GBP 100bn. While diver-sification generates

risk, diversification benefits ex ante. It also generates contagion ex post. Spe-cific UK banks that are most exposed

From the olympus to the uk

4/42

BY MARIE LETH CHRISTENSEN

“While the Olym-pic battles will end

mid-August this year, the fight to

restore growth and de-crease debt con-

tinues”

As London Bridge stood in all its pride and glory, few people realized that UK has adopted more than just a few cultural events and traditions from in-debted Greece.

REal GDP Growth

5/42

-8,0

-6,0

-4,0

-2,0

0,0

2,0

4,0

6,0

2007

Q3

2007

Q4

2008

Q1

2008

Q2

2008

Q3

2008

Q4

2009

Q1

2009

Q2

2009

Q3

2009

Q4

2010

Q1

2010

Q2

2010

Q3

2010

Q4

2011

Q1

2011

Q2

2011

Q3

2011

Q4

2012

Q1

2012

Q2

pct. Quarter on quarter

Quarter on same quarter one year ago

to the Euro-zone crisis include Barclays and the bailed-out Royal Bank of Scot-land according to a note published by Credit Suisse in June. In the event of the PIIGS (Portugal, Ireland, Italy, Greece and Spain) leaving the Eurozone, Bar-clays faces losses of GBP 30bn. and RBS of GBP 22 bn. according to the Credit Suisse note.

The gloomy economyAt the same time as threats of spreading contagion from Greece through Spain and Italy to the UK remain high, the British GDP is contracting. As London is celebrating at the Olym-pics open-ing ceremony, the economic outlook is gloomy. According to the Office for Na-tion-al Statistics, British GDP contract-ed by 0.7 percent in 2012 Q2. The drop of 0.7 per cent in the second quarter of 2012 is the third consecutive quarterly contraction in UK GDP. Total output has now declined by 1.4 per cent over the last three quarters in the UK.

All four of the main sectors in the UK economy have contracted between the first and second quarters, with con-

struction providing the largest negative contribution to growth. Causes of the drop in growth stem from many sourc-es, such as an extra public holiday to celebrate Queen Elizabeth’s Diamond Jubilee in June, as well as government spending costs and the euro-zone cri-sis.

Fighting the deficitWhile athletes are fighting each other in the Olympic arena, British Prime Minis-ter David Cameron is fighting to reduce the UK government’s deficit and im-prove its finances. Elimi-nating Britain’s structural budget deficit during the next five years in order to strengthen or main-tain investor confidence is a central po-litical goal for the government. However, the British economy is due some kind of boost over the coming months. Produc-tion looks set to rebound from the hit from the extra public holiday, and ticket sales and visitors’ spending during the Olympics may boost growth. Only time will tell whether the net effect of hosting the Olympics, will be positive or negative for the UK. The Olympic Games held in Athens in 2004 are generally consid-

ered a significantly contributing factor to the current Greek sover-eign debt cri-sis. At this backdrop it is worth ponder-ing whether the UK Olympics will prove a good investment in infrastructure or a contributing factor to worsening gov-ernment finances and further spur the downturn in the UK economy.

Challenges aheadClearly, challenges lie ahead. Most Western economies are struggling with high and increas-ing debt levels, Chi-na’s growth is stagnating India and Bra-zil have lost momentum and Rus-sia is overly dependent on high energy prices. Renowned economist Nouriel Roubini fears that because Western problems are due to insolvency, and not illiquid-ity, policy tools are rap-idly becoming ineffective and useless. Roubini’s views are supported by several leading econ-omists. Thus while the Olympic battles will end mid-August this year, the fight to restore growth and decrease debt continues.

6/42

This is the first installment in a series of articles based on in-terviews with successful mon-ey managers. In July 2012, we

talked to Nick D’Onofrio, managing partner at North Asset Management, in their offices in Knightsbridge, Lon-don.

In 2002 Mr. D’Onofrio and several col-leagues of his from Morgan Stanley in London decided to set out on their own. The decision to start a fund was moti-vated both by the attractive opportuni-ties they saw in the market at the time and by entrepreneurial drive. Over the decade that North has existed, its funds have received several awards for its impressive performance, including the 2011 EuroHedge Award in the Global Macro category and a Barron’s ranking of 32 out of the 100 best performing hedge funds in the world in the period from 2006 to 2009.

Intending to obtain information about the industry that would be interest-ing to students of finance, we talked to Mr. D’Onofrio about the investment approach of North Asset Management and about what it takes to work in a macro hedge fund.

The Investment ApproachThe company’s flagship macro fund, MaxQ, is focused on Europe and a few other countries. It primarily trades FX and interest rate derivatives on the short end of the yield curve. Specifically, the portfolio manager tries to identify mar-ket dislocations and future trend revers-als by assessing factors including fun-damentals, the extent to which they are priced into rates, and the feed through effects of public policy on inflation. The fund looks for such dislocations both between markets – such as FX vs. inter-est rates – and across markets – such as Czech interest rates vs. German in-terest rates.

An example of a recent trade men-tioned by Mr. D’Onofrio that profited from such dislocations was going long the spread between German and Czech rates, which had narrowed beyond what was justified by fundamentals and his-torical patterns. Another example was going long the spread between the pre-miums on Austrian CDS and Belgian CDS which, given the state of Belgian public finances and politics, should be wider than it was. The attractiveness of these trades was augmented by the asymmetry of their expected payoffs,

both having potentially a large upside without much downside risk.

When asked about what characteristics allow his fund to profit from such oppor-tunities, Mr. D’Onofrio mentioned size, focus, and ability to trade tactically. Of these, the advantages of moderate size are closely related to both focus and to the ability to trade tactically. It is difficult for the large funds and oth-er institutional investors to make mean-ingful profits from trades in small and illiquid markets. This, in turn, means that these markets are under-analyzed, leaving opportunities for focused funds, such as MaxQ. In order to benefit from this situation, the fund, of course, has to stay relatively small. It plans to do so by continuing its past practice of closing the fund to new investments whenever it approaches £1 billion.

Moderate size also allows the fund to move quickly in and out of positions. Recently, the fund has been positioned to benefit from a worsening of the Euro-pean crisis, but has managed to shield itself from the sharp reversals caused by policy initiatives by tactically modify-ing or reversing its exposure in expecta-tion of intervention.

Asset management interviews series

Interview: Nick D’onofrionorth asset management

By exploiting the dislocations both between mar-kets, North Asset Management profits from the ar-bitrage opportunities in the European market

By Bastian Aue & Kasper Olesen

What it takesThe rising profile of hedge funds over the last couple of decades has inspired an increasing interest in working in the industry among students, despite the career uncertainty involved. However, the competition for positions is in-tense, and it is not always clear what it takes to get hired. We asked Mr. D’Onofrio what he looks for when he is assessing a prospective employee. He responded by highlighting four traits that he looks for: a sincere interest in markets, an ability to think critically, a degree of humility, and solid quantita-tive skills.

First, the prospective employee needs to be sincerely interested in fol-lowing and understanding markets and

current affairs. If this intellectual curios-ity is absent, it is unlikely that the can-didate will be able to acquire the neces-sary analytical depth needed to identify the market dislocations and trend re-versals that North Asset Management profits from.

Second, the candidate needs to be able to think critically. This encom-passes two related skills; 1) the ability to disentangle an overwhelming amount of information, cut through to the key is-sues, and infer a concise hypothesis, 2) the ability to question prevalent beliefs and hold unpopular opinions.

Third, a degree of humility is re-quired, in that one acknowledges if one’s analysis is incorrect when new evidence contradicts it. This kind of hu-

mility allows one to continuously ques-tion the validity of one’s inferences, thus reducing the likelihood of clinging too long to loss-making positions.

Fourth, the increasingly sophisti-cated methods and strategies employed by the hedge fund industry make quan-titative skills a big comparative advan-tage. It is possible to work in a hedge fund without a PhD in physics, but, as Mr. D’Onofrio says, “one has to be com-fortable with numbers and quantitative models.”

For more information about Nick D’Onofrio and North Asset Manage-ment see www.northasset.com

“...one has to be comfortable with

numbers and quanti-tative models”

Moderate size also allows the fund to move quickly

in and out of positions

7/42

Some of FinanceLabs favourite films on

If you find yourself laughing after watching these films, you’ve propably passed the

FinanceLab nerd test

Damn it Feels Good to be Banker

I want to be an investment banker

Bankers’ Song - We Didn’t See It Comin

Brokeback BankersBaby Got WACC

Rob Smallwood - The Banker’s Bonus Song

Every Breath Bernanke Takes

“Fear the Boom and Bust” a Hayek vs. Keynes Rap Anthem

8/42

INVESTMENT PANEL

1 2 3Write your IP application

Share your market views in the onlinecommunity

Be qualified as anInvestment Panelmember

HOW TO JOIN THE INVESTMENT PANEL:

PANEL WORK FLOW:

Send application to mail@financelab.dk

Source: Ernst & Young Global IPO Trends 2012

...and the uncertainty dominating the IPO market

By Rasmus Ditlevsen &Jon Rustemi Kaznelson

The 5 biggest IPO’s in Europe in 2011

10/42

Introduction

The European IPO market in 2011 was split into two distinct periods. The first two quarters of 2011 continued the positive

trend of 2010, whereas the last 2 quar-ters saw a dramatic decrease in global IPO activity, mainly due to the debt cri-

sis stretching throughout Europe. The amount of capital raised in 2011 fell 19% from USD 36.7b to USD 29.7b, however the numbers of deals actually saw an increase of 6% from 252 deals in 2010 to 266 in 2011. Even though these numbers might reveal a pan-Eu-ropean economy in trouble, much has improved since 2009 - capital raised increased at a tremendous 396% from

2009 to 2010 and numbers of deals rose 306%. The following will give a brief overview of the European IPO mar-ket as well as the largest recent IPOs in Europe.

The five biggest IPOs in Europe in 2011 (by capital raised) were all executed within the first half of 2011 reflecting the overall trend of the market.

Despite the economic conditions and the related uncertainty, some compa-nies found a good window to go through with the IPO. For instance, Glencore International PLC managed to raise USD 10bn in May making a dual list-ing on London and Hong Kong stock

exchanged, which is becoming more common as companies need to be flex-ible and keep an open mind towards funding.

The uncertainty that the debt crisis in Europe brings to the IPO activity is

clearly reflected in the VIX index below, or alternatively referred to as the “fear index” (see graph). When the VIX index is above 20% it becomes much harder to make a successful IPO due to the volatility in the market.

The IPO mar-ket is not all bad news; Glencore International PLC managed to raise USD 10bn in May making a dual list-ing on London and Hong Kong stock exchanges.

Euro debt crisis and volatile market is hampering the success and realization of one IPO after another.

By investing in the lumbering, deficit ridden, and low-growth giant you

would actually have avoided the huge drops in stock value

““

Source: Yahoo Finance

11/42

The five companies from the below table revealed that there was a possibility to find an appropriate window where they could go public. The VIX index clearly shows how different the 2 periods of 2011 were. Looking forward, the trend towards the end of the year is relatively positive, where the VIX index is showing signs of a down-turn in market volatility, to a more IPO friendly level.

The challenge of finding a window of IPO opportunitiesRetrospectively, the VIX index has been flirting with the 20% line through most of the first half of 2011. Given these cir-cumstances it might not come as a surprise that

2011 was the year where a new record was set, namely the one for most with-drawals or postponed IPOs. So what risk did these 5 companies face when they decided to go public? Increasing volatility and lower investor confidence

result in an increase in perceived risk. In the book-building phase this means the investors want to see a discount in the pricing, i.e. higher volatility implies a higher discount demanded. Using years of strategic thinking, optimization

“The pipeline of firms waiting to go public remains high. Both issu-ers and investors are being far more cautious, particularly in light of the difficult current market conditions. They are just waiting for the global market to stabilize and concerns over global growth to

dissipate before they decide to become active again.”

(Maria Pinelli, Global Strategic Growth Markets Leader at Ernst & Young)

-80%

-70%

-60%

-50%

-40%

-30%

-20%

-10%

0%

10%

20%

Glencore Bankia JSW SA Banca Civica

Nomos Bank

STOXX 600

Bloomberg European 500 index

Last  year's  stock  price  development  

Looking forwardIn the first few weeks of 2012, optimism returned for IPO prospects with the London IPO of Ruspetro and a spate of IPOs launching in the US, including the much-scrutinized Facebook IPO. This reflects some easing of the tough mar-ket conditions that plagued the end of 2011 and has been further boosted by the rally in stock market indices around the world in early 2012.Continued volatility is the theme for 2012, as Europe continuously tries to solve its debt problems. There is no

quick fix to the ever-growing debt crisis, which greatly impacts the IPO market. For Q1 2012 9 IPOs were withdrawn, demonstrating that the IPO market is still impacted by uncertainty in the global economy. The European IPO market suffered once again during Q2 2012 with a 68% decline to just USD 915m via 46 IPOs (only 2% of global capital raised this quarter) compared to USD 2.9bn raised via 39 deals in Q1 2012. The weakness of the IPO market reflects not only the tough market con-ditions but also the number of compa-nies that postponed their IPO plans by 6-12 months following the challenging market conditions in the second half of 2011.

Whilst we expect market volatility to continue into 2012, there will be pe-riods when market conditions will be favorable for IPOs. In this climate, companies will have to ensure that the groundwork is completed well in advance so they can be opportunistic should an IPO window open. Other les-sons learned in 2011 include the need for selling shareholders is to be realistic about company valuation and to ensure that the business is supported by a compelling equity story to attract poten-tial investors. Even with these lessons learned and great caution, the 5 biggest IPOs in Europe in 2011 showed how difficult the current environment is.

and efficiency improvement before the five companies went public ultimately needs to be reflected in their valua-tion. This requires flexibility and speed, which is the key to success. These tough circumstances have fostered a new approach towards IPOs; whereas before it was seen as a sign of weakness to be in the pipeline for several months without bringing the deal to the market – now its just good business.

The uncertainty that dominated the market activity hopefully returns to a steady state at some point. In order for

the market to return to a steady state, historical IPO cycles shows that it takes a few successful IPOs with solid returns after the listing to rebuild investor confi-dence. The general consensus in some parts of 2011 was leaning towards the perception that the IPO asset class was high risk relative to returns – where it should be a normal part of a diversified investors portfolio. If it takes a few suc-cessful deals to give the IPO market a much-needed push, how have these 5 companies performed (see graph)? Looking at the last 52 weeks, which gives fairly good indication of post

IPO performance, Glencore is down 13.17%, Bankia is down 67.65%, JSW SA is down 7.52%, Banca Civica is down 34.6% and Nomos Bank is down 5%. The STOXX Europe 600 price index – which represents large, mid and small companies across the European region – is up by 13.64% and the Bloomberg European 500 Index is likewise up by 12.39%. Even though there should be made no final conclusion on the basis of these numbers, they indicate that these IPOs did, so far at least, not break the IPO cycle.

“The five biggest IPOs in Europe in 2011 were all executed within the first half of 2011 reflecting

the overall trend of the market”

“Whereas before it was seen as a sign of weak-ness to be in the pipeline for several months with-out bringing the deal to the market – now its just

good business”

12/42

13/42

14/42

With a USD 9.8 billion debt is-sue in May, United Technologies Corporation (UTX) stressed the attractiveness of debt issuance

given current market conditions. The deal is the biggest bond deal since Pfizer’s (PFE) 2009 $13.5 billion bond deal and comes at a time when corporate bond volumes top.

The largest single deals in historyUTX, the maker of diverse products as Carrier air conditioners, Black Hawks, and Pratt & Whitney engines used the bond issuance to help finance its USD 16.5 billion acquisition of Goodrich Cor-poration, an aerospace manufacturer. With expected ratings of A2 by Moody’s and A by Standard & Poor’s (S&P), UTX sold bonds at record-low coupons, lur-ing bond buyers away from the turmoil in Europe. Investors happily greeted the new bond deal, and UTX garnered USD 38 billion of bids in the six-part USD 9.8 billion offering, making the UTX deal the most demanded corpo-rate bond deal in history. The six-part deal featured four fixed rate tranches consisting of USD 1 billion of three-year notes at a credit spread of 80 basis points, USD 1.5 billion of five-year notes at a spread of 105 basis points, USD

2.3 billion of ten-year notes at a spread of 135 basis points, and USD 3.5 bil-lion of thirty-year notes at a spread of 173 basis points over comparable ma-turity Treasury securities (see Figure 1). The company also sold two floating rate tranches with the eighteen month and three year tranches pricing at 27 and 50 basis points over the London inter-bank offered rate (LIBOR).

Acquisitions were similarly the driving force behind the largest ever U.S. bond deals, when the rival drug makers PFE and Swiss Roche Holding (RH) in 2009 acquired Wyeth (a USD 68 billion deal), a healthcare company, and Genentech (a USD 47 billion deal), a biotech corpo-ration, respectively. RH and PFE bonds obtained Aa1 and Aa2 ratings from Moody’s and AA- and AAA from S&P, respectively, placing them well above the UTX rating. Being the largest in his-tory the RH offering was a six-part deal with four fixed rate tranches amounting to enormous USD 12.25 billion. Matu-rities were similar to the UTX deal but credit spreads of 335 basis points over

Treasuries for the 3-year and 5-year notes, 345 basis points for the 10-year notes, and 365 basis points for the 30-year notes, were higher than today. In addition to this, Treasury rates are also lower now. RH also sold floating rate tranches with one year and two year tranches pricing at 100 and 200 basis points over the LIBOR. The five-part PFE is-sue offered three, six, ten and thirty years fixed-rate bonds with coupons ranging from 305 to 345 basis point more than comparable Treasuries, and two-year floating rate notes priced at 195 basis points over the three-month LIBOR.

A worldwide glance at the largest debt issues introduces three telecoms to the all-time high of bond deals (see Table 1). France Telekom (FTE) comes in sec-ond after RH with its USD 16.3 billion 2001 offering, Deutsche Telekom (DT) comes in third with its USD 14.5 billion 2000 offering, and the now bankrupt WorldCom (WC) is fifth in between PFE and UTX with its USD 11.9 billion 2001 deal.

Proceeds mainly helped alleviate the large debt loads many big telecoms had acquired. The refinancing was mostly due to several investments in expan-sion or modernization of the large carri-ers, such as the bidding on 3G network auctions for DT, and expanding/buying international networks for FTE. Over a period of just one year, the telecom companies each broke records for debt issuances at the time. It seemed inves-tors favored the debt, as all three com-panies were met by massive demand, with FTE being in highest demand.

Bringing Back Big Bond Business

Figure 1: 10 year nominal U.S. Treasury rate

BY KASPER OLESEN & TOMAS ROSALES

15/42

Company   Year   Size    

(USD  billion)  

Primary  Reason   Tran-­‐ches  

Rating  (Moody’s/S&P)  

Treasury  Spread  

(10  years  fixed)  

Roche   2009   16.5   Acquisition  (Genentech)   6   Aa1/AA-­‐   345  

France  Telekom   2001   16.3   Refinancing  (int.  network)   6   A3/A-­‐   285  

Deutsche  Telekom   2000   14.5   Refinancing  (3G  auctions)   8   Aa2/AA-­‐   -­‐  

Pfizer   2009   13.5   Acquisition  (Wyeth)   5   Aa2/AAA   325  

WorldCom   2001   11.9   Refinancing   3   A3/BBB+   255  

United  Technologies   2012   9.8   Acquisition  (Goodrich)   6   A2/A   135  

Kraft   2010   9.5   Acquisition  (Cadbury)   4   Baa2/BBB-­‐   188  

Ford   2001   9.4   Refinancing   5   A3/BBB+   300  

GlaxoSmithKline   2008   9.0   Share  repurchase   4   A1/A+   173  

General  Electric   2008   8.5   Refinancing   3   Aaa/AAA   200  

 

They got offers of about USD 25 billions for their original plan of selling 7-8 bil-lions, and as such doubled the scale of their issuance to the USD 16,3 billions. Favorable conditions bypassed high credit risk and skepticism towards the sector for all telecoms.

FTE, WC, and DT all offered short-term tranches of 2, 3 and 5-year maturities with coupons as different as the 5.5% floating rate of FTE, 125 basis points above the LIBOR, to DT’s of 7.7% on their dollar 5-year maturities. With the longer-term tranches of 10 and 30-year maturities, FT, DTE, and WC all indi-cated the credit risk of buying the debt. Coupons went as high as 8.3% for DT’s and WC’s 30-year maturities, 260 ba-

sis points over the 30-year comparable Treasury security. FTE similarly had a spread of 315 basis points over the 30-year Treasury.

Current market conditions favor debt issuanceWith treasury yields and central bank rates in free fall (even down to nega-tive digits for some!) current market conditions favor high-grade debt issu-ance. Alas, not surprisingly, corporate bond volumes were historically high in the first six months of 2012 with first-

quarter issuance the second highest on record. Companies are seen jumping into the market to get financing plans out of the way with low coupons, even though broader markets are shunning risk. Each maturity is at the low end of earlier pricing guidance, indicating strong demand. Investors appear with a robust demand though insurance com-panies and the like are discouraged from buying because of low yields. They could sit on their hands for a few weeks or months, waiting for yields to go back up. However for the historical records, UTX brought back big bond business.

Table 1: the largest bond deals in history. References: see below.

The low interest rate environment yields the perfect opportunity for com-panies to minimize their debt over-loads. An example hereof is Deutsche Telecom who issued 14.5 billion in bonds to refinance their debt.

With its 13.5 billion bonds issue Pfizer was behind one of the largest bond deals in the past few years. The capital raised was used to finance the acquisi-tion of Wyeth.

InfoLIBOR stands for London Interbank Offered Rate is the rate offered for a short-term loan between banks in London. The Danish counterpart is the CIBOR (Copenhagen Interbank Offered Rate), both common bench-marks for short-term borrowing.

Credit RatingsTop layers of Moody’s and S&P’s rat-ings systems (in descending order) are Aaa, Aa1, Aa2, Aa3, A1, A2, A3 and AAA, AA+, AA, AA-, A+, A, A-, respectively.

Dine with FinanceLab and major investment banks

Upgrade your resume with a Trading Diploma

Improve your analytical skills

Expand your network

Become a Reuters certified user

… Sounds appealing? Go to FinanceLab.dk and register!

Remember to follow us on Facebook.

CARE TO JOIN US?

16/42

JOIN US?

OPEN MEMBERS NIGHT Every 1st Thursday of the month

Børsbar

introduction to FinanceLab

Education

learn from older members

fun and networking

every season of the year

17/42

When exploring the most recent history of the larg-est M&A deals one theme keeps reappearing, phar-

maceuticals. The five largest deals in 2011 were all within life science and predominantly between pharmaceuti-cal manufacturers. Among them were some true mega-deals headed by Ex-press Scripts paying Medco share-holders USD 29 billion and Johnson & Johnson acquiring Synthes for more than USD 21 billion. In 2010 the 5 biggest deals were all health care related with the exception of one. The biggest was Sanofi-aventis taking over Genzyme in a deal valued at over USD 20 billion. In 2009 the picture was no different. Pfizer led the way with the astonishing USD 68 billion acquisition of Wyeth. Merck & Co and Schering-Plough followed with their USD 41 billion merger. No need to say that 2008 was the same with at least the five biggest deals all within health care. The trend is crystal clear ”if it’s big, it’s pharmaceuticals”.

Now, this was supposed to be an article on the biggest deals of 2012. So what has 2012 offered so far? In terms of deal size we are far from the level of the past years with few transactions in double digits billion USD. However, the trend of health care domination seems unim-paired. Again the top deals so far are all in the pharmaceutical sector, however UPS is expected to close its acquisition of Dutch based TNT, which will con-

stitute the highest val-ued deal of 2012 so far.

Within phar-maceuticals we have

seen an attempted hostile takeover of the American biotech company Illumina by the Swiss health care giant Roche. The initial offer from January of USD 5.7 billion representing a premium of 64% over Illumina’s market cap was turned down. Finally, in April USD 6.7 billion was offered and subsequently turned down. Roche decided to abandon the offer with the questionable reasoning

that they no longer believed in the tech-nological potential of Illumina. Roche has in the meantime been involved in the successful takeovers of Genentech and Ventana Medical Systems.

One big deal this year reached sign-ing in April. The American generic pharmaceutical manufacturer Watson Pharmaceuticals acquired its European competitor Actavis for an amount of USD 4.3 to USD 5.9 billion depending on the financial performance of Actavis. Watson has already been expanding by acquiring Australia-based Ascent Pharmahealth for USD 393 million in cash in January. Watson CEO Paul M. Brisaro commented on the strategic ra-tionale: “The acquisition of Actavis will create the third largest global gener-ics company, substantially completing Watson’s expansion as a leading global generics company. Actavis dramatically enhances our commercial position on a global basis and brings complementary products and capabilities in the United States”. It seems that economies of scale were major value drivers in this deal as it has been in many previous

By Johan Riis Madsen & Mikael Petersen

18/42

“The trend is crystal clear - if it’s big, it’s

pharmaceuticals”

in 2012M&Atransactions

““Economies of scale were major value drivers in this deal as it has been in many previous deals within the

sector”

19/42

deals within the sector. Watson has stated that it expects to save USD 300 million due to cost synergies in the next three years. The synergies are mainly expected in the areas of research & development, selling and general ex-penses.

Although the pharmaceutical in-dustry seems on the rise, the glo-bal M&A activity does not reveal this across the board. In fact, the market size has decreased by roughly 30% as compared to Q1 2011. The market suffered its fifth consecutive quarterly decline with only the European region showing quarterly increases. The U.S. market went down sharply to 54% compared to Q1 2011; (Energy, mining & utilities ac-counting for over a quarter of deal total amount in Q1 2012). The M&A index of the Centre for European Economic Research confirms the data as its indi-cator declined to the lowest level since August 2009. The reason for such weak performance is largely ascribed to the still unresolved European debt crisis and the associated uncertainty it brings to the markets with a potential conta-gion effect that could struck the world market. Nonetheless, M&A activity re-

veals a combined value of USD 415 bil-lon of announced deals in 2012. As of today, some of the expected deals are uncertain or pending, however, among them could likely be a giant transaction in the energy, mining & utilities sector with Glencore and Xstrata merging to-gether. The deal has a value of approxi-

mately USD 53 billion and would create one huge company with massive market power. Glencore aims to virtually control the entire value chain of the industry – ranging from extraction to transport and sale of the commodities. The combined future annual revenues are estimated to be around USD 210 billion.

Another such giant deal – and again in the energy, mining & utilities sector – is the acquisition of El Paso by American Kinder Morgan, which was completed in May for USD 37.4 billion. A key stra-tegic motive behind the deal was the

addition of 44,000 miles of natural gas pipelines from El Paso, as CEO Richard Kinder explained. His company thereby managed to grow to the fourth largest energy supplier in North America. Fur-thermore, the same sector records high value transactions with Sesa Goa taking over Indian Sterlite Industries for USD 10 billion and Apollo Global Manage-ment buying EP Energy Corporation, in a USD 7 billion deal.

It appears that not only the pharma-ceutical but also the commodity sectors escape the downward trend in M&A activity. Energy, Mining & Utilities make up 27.5% alone in global market share. Other prominent M&A cases in 2012 were seen in the Google Motorola deal and when Sumitomo Mitsui, Japans third largest bank, acquired RBS Avia-tion capital, an aircraft leasing company of the RBS group. Despite these and several smaller transactions, the overall market clearly shows that the commodi-ties and pharmaceutical sectors domi-nate current M&A activities.

Express-Scripts’ CEO, George Paz (right) and Medco’s CEO, David Snow in one of the largest M&A deals in the past few years

The five largest deals in 2011 were predominantly between pharmaceutical manufacturers

Another trend breaker in the M&A market was the energy, mining & utilities sector

20/42

THE global debt crisis:

Why America is different By Fabian Berg & Jørgen Bråten Nordby

LUCKY FOR THE US, THE STRONG DOLLAR IS OFFSETTING THE HEAVY DEBT BURDEN.

With an unemploy-ment rate stuck around 8.3% it

doesn’t seem as if Helicopter Ben can

stop worrying any time soon.

20/42

21/42

It has been almost four years since the default of Lehman Brothers Sep 15, where the world experienced the peak of the biggest financial cri-

sis in modern history. The burst of the American housing bubble led to global economic and financial turmoil. What initially started with reckless lending policies in the market for personal and mortgage loans in the US eventually caused the huge securitized debt mar-kets to dry up with gigantic losses for private investors and banks. Four years later, this has developed into a debt problem at a country level with all eyes now turned towards Europe. The intro-duction of the EUR made it possible for countries such as Spain, Greece, Por-tugal and Italy to raise wages and costs while borrowing cheap money thanks to strong credit quality of countries such as Germany. Lately, the world has to a large extent only been focused around these countries and finding a solution to save the Euro zone and the rest of the world from a series of na-tional defaults. It almost seems like the world has forgotten the elephant in the room; the US has a larger debt burden than the euro zone countries combined and the budget deficit peaked in 2009 at 10.1% of GDP compared to 6.2% for the euro zone. So why are investors still under the impression that the U.S is in better shape than some of the largest economies in the Euro zone?

The Federal Reserve’s work towards US economy recoveryFrom an economic perspective there are good reasons to be worried, especially considering the lackluster recovery on the labor market. FED, unlike the ECB, has a dual target; to keep inflation close to 2% and to maximize employment. To lower borrowing costs for households and businesses and stimulate employ-ment growth, the FED has slashed the target rate to 0.0-0.25%, and pledged to keep rates exceptionally low until late 2014. This has not been enough. Fed has also been forced to use quantitative easing (QE). The first round, QE1 (Nov 2008-Mar 2010) focused on buying back mortgage backed securities (USD

1.25 trillion) and treasur-ies as well as debt issued by Freddie Mac and Fan-nie Mae (USD 300 billion).

Thereafter the Fed announced QE2 (Nov 2010-Jun 2011) where they bought USD 600 billions worth of long-term treasuries to further keep interest rates on long-term treasuries low. When economists started to worry about infla-tion the Fed responded by introducing Operation Twist in Sep 2011 and it was recently extended to the end of this

year. By selling short-term and buying long-term treasuries, this form of finan-cial intervention will not increase the Fed’s total assets.

Despite all unconventional methods from the Federal Reserve the real econ-omy has not yet responded as desired. They are still stuck at an unemploy-ment rate of 8.3%, where the observed decrease in the unemployment rate is largely due to a reduction of the labor force. If the labor force had been the same as pre the financial crisis, the un-employment rate would be as high as 11% clearly illustrating the lack of result from Fed’s unprecedented expansion-ary monetary policy. After all this argu-ing of the grim situation in the United States we still think it is in better shape than debt infested countries in Europe.

Why the US is differentThe US has one major advantage: the dollar! Even though the net result of the Euro crisis is unfortunate for the US economy, and the strong dollar weighs on exports, the current turmoil in the Euro area has further strengthened the Dollar’s position as a “safe haven”. The current economic environment has boosted demand for treasuries, as the USD (together with JPY) is the only cur-rency offering enough liquidity. Conse-quently, the US borrowing costs are at the lowest since the early 18th century

-12

-10

-8

-6

-4

-2

0

2

4

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

%

years

Budget deficit

US yearly deficit

Euro zone yearly deficit

“the debt burden in the US is to a much larger extent justified by the economic

cycle”

inve

*)The Euro Area yield is the aggregated Euro Zone and not the EFSF

22/42

meaning the US can refinance itself at a very low cost despite of its enormous debt burden. That is not the case for the highly debt burden euro zone countries such as Italy and Spain which current-ly have to settle with refinancing rates as high as 7%. Even considering euro zone aggregated the borrowing cost is higher than in the US as indicated by an EFSF 10y bond recently traded between 50-100bps above the US 10y Treasury yield.Regardless of the cheap refinancing a large fraction of international econo-mists have pointed out the fact that the debt is still building up, and even if they get cheap funding they must at some point start paying down on their debt. This is obviously a good point and some-thing US politicians need to take into

consideration. In the near term however there are very few expecting the faith in the dollar to disappear. The USD is still 62% of global FX reserves (excl. China)

according to the IMF’s latest data, an increase from 60% in 2010.

Another important point is the differ-ence between the demographic picture in the U.S and the Euro zone countries.

The median age in the US is 36.9 years, while the median age in Italy, Spain and Greece is 44.3, 41.5 and 42.2 respec-tively. According to macroeconomic

theory the average person will follow the same consumption and produc-tion pattern throughout his/her life.

Early in her life she will consume more than she produces, while in the intermediate part she will pro-duce more than she consumes before she retires and once again

consumes more than she produces. Accordingly, a country’s debt situation should to a large extent depend on the demographic distribution of the coun-try, because its inhabitants varies be-tween borrowing and saving for its soci-

ety, hence a large debt can be justified if a large share of the citizens are yet to enter the workforce. These people will transform from a cost into a value-cre-ating asset, which implies that they will create more than they produce in the foreseeable future. The current age dis-tribution in the U.S clearly shows that a large proportion of the population be-longs to this age group, hence the debt burden in the US is to a much larger extent justified by the economic cycle. The Euro zone countries on the other hand are at the stage in the economic cycle where they actually should save

money, because a large fraction of their inhabitants will soon disappear from the labor stock.

On top of arguments above, the US’ attempted economic recovery has ad-vanced further than that of the trouble-makers in the Euro zone. US GDP is in-creasing and even if the growth is rather slow, the country is gradually recover-ing. The private sector is also in a good position after reducing their debt level markedly from the peak. The money that has been, and still is, thrown into the US economy, can create the jobs

that will help the US take advantage of the growing labor force it will get during the next decade and that is an oppor-tunity none of the other indebted coun-tries have.

“US’ attempted economic recovery has advanced further than that of the

troublemakers in the Euro zone”

0,00

5,00

10,00

15,00

20,00

25,00

30,00

35,00

2009

M01

2009

M04

2009

M07

2009

M10

2010

M01

2010

M04

2010

M07

2010

M10

2011

M01

2011

M04

2011

M07

2011

M10

2012

M01

2012

M04

2012

M07

Euro Area

Germany

Ireland

Greece

Spain

Italy

Portugal

USA

inve

TO THOSE WHO DOUBT MY INTENTIONS

I WILL NOT FIGHT BACK

BUT I WILL RISE

I WILL CONQUER THE TOP

I WILL STAMP DOWN FINANCIAL CRISIS

I WILL REWRITE THE HISTORY ABOUT FINANCE PEOPLE

AND JUST BEFORE I SET OFF...

WE’LL MEET AT

INVESTMENT CAMP 2012

INVESTMENT CAMP 2012

23/42

The real economic factors still have to recoverIn conclusion, there are still some is-sues that need to be solved. The growth that is stimulated from monetary action and quantitative easing must exceed the inflation created by the printing of money and unemployment has to de-

crease drastically. If this fails, they can risk that the economic interventions push the U.S economy into an even deeper crisis. As a consumer driven economy, the puzzle is complicated; the high percentage of unemployment keeps the consumption low, while the consumption related industries cannot hire more workers before they experi-ence an increase in consumption. The recent boost in the oil and gas sector could be part of the solution, and help put off some of the pressure on the con-

sumer industry, but there is still a lot of ground to cover. In other words, the U.S economy is far from saved, but it still looks a lot brighter than Italy and Spain these days. The Fed still has time to provide monetary aid, and hopefully the economic recovery will occur before the financing cost skyrockets.

10 5 0 5 10 15

0-4 10-14 20-24 30-34 40-44 50-54 60-64 70-74 80-84 90-94 100+

Spain: Age distribution (%)

Female

Male

10 5 0 5 10

0-4 10-14 20-24 30-34 40-44 50-54 60-64 70-74 80-84 90-94 100+

USA: Age distribution (%)

Female

Male

Opening for registrations soon!

Asia and Africa in the struggle for profit generating equity investments in an uncertain economic climate - a compar-

ative macro-analysis with an overview of inherent risk and growth opportuni-ties.

The IC’s in BRIC’s and the rest of the tigersAn overarching ambiguity character-ises Asia, the region is composed of exceptionally diverse national econo-mies. The economy of Asia comprises more than 4.2 billion people (60% of the world population) living in 46 differ-ent states. Asia is the largest continent in the world by a considerable margin, and it is rich in natural resources, such as petroleum, rice, copper and silver. Manufacturing in Asia has traditionally been strongest in East and Southeast

Asia, particularly in the China, Taiwan, South Korea, Japan, India, the Philip-pines, and Singapore. Japan and South Korea continue to dominate in the area of multinational corporations, but in-creasingly the PRC and India are mak-ing significant inroads.

Asian domestic de-mand has generally remained strong dur-ing the turmoil in the advanced economies, buffering the impact of the weakening exter-nal environment. Ca-pacity deployment has remained high, and regional labour markets have been tight on the back of strong employment growth and steadily rising real wages. Domestic demand has benefited from the continued easing of macroeco-nomic policy across most of the region. Growth in the Asia region is expected to gain momentum over the course of 2012, and is currently projected at 6 and 6.5 percent in 2012 and 2013, re-

spectively. From August 2011 onward, global risk aversion surged in response to escalating turmoil in the euro area. In Asia this caused a large withdrawal of foreign equity investments, plunges in regional stock markets, share currency depreciations. So far capital flows to Asia have rebounded throughout 2012,

following the sharp en-trenchment in portfolio equity flow last year.

Strong economic and policy fundamentals have helped buffer most of the region’s

economies against the global financial crisis, by limiting adverse financial mar-ket spillovers and better tolerating the impact of deleveraging by European banks. However, growth in Asia slowed markedly in the last quarter of 2011, mainly due to the weak external de-mand. Export growth has lost momen-tum across the region, both for elec-tronics and non-electronic goods. The level of exports to the European Union

Emerging markets

Crouching Tigers,Hidden Lions BY MERIT VON EITZEN

& OLE-BJORN KOLBAEK

“With its heavy reliance on commodity

prices, the Lion might not continue

to roar”

24/42

“Business is on the rise in Africa and the early bird will catch the worm”

24/42

has fallen considerably below trend, while exports to the United States have recovered to their long-run trend after the global financial crisis. Meanwhile, the regions trade surplus continued to shrink in the last quarter of 2011. This development was highly influenced by China.

Another downside risk for Asia is re-newed escalation of the euro debt crisis. Although Asian economies on average rely less on euro area and UK banks than other regions, these banks nonetheless have a substantial pres-ence in several Asian economies. They are important sources of credit in two ways 1) direct lending, including in the area of trade finance, to private sector agents in the region, through cross-bor-der transactions and lending by local subsidiaries and branches; and 2) indi-rectly, through their role in the wholesale funding of regional banks, particularly in Hong Kong SAR, Korea, Singapore, and Taiwan Province of China.

While developments in the euro area continue to represent the most impor-tant source of risks for Asia, the region also faces two other risk factors. First is a hard landing in Mainland China. Even though a low probability event, a sharp correction in e.g. Chinas real estate market represents an important down-side risk. Moreover, although conserva-

tive mortgage loan-to-value ratios and healthy bank balance sheets might buff-er the banking system to some extent, the likely tightening of financial condi-tions and associated corporate sector distress would result in a signifi-cant slowdown of the Chinese economy. IMF estimates sug-gest that in this scenario, output in China could fall to as much as 4 percent below baseline after two years, with likely substantial trade and financial spill-overs to the region, especially Hong Kong SAR, Indone-sia, and Singapore. Second concern is booming commodity prices. A shock to commodity prices could create a diffi-cult trade-off between inflationary pres-sures and budgetary risks from energy and food subsidies. Overall, the region’s policymakers now face the difficult task of adjusting the amount of insurance needed to support stable, noninflation-ary growth.

The rise of the Lion?!

Africa is a highly unstable continent. Political will, financial markets, growth rates, and democracy have been fluc-

tuating heavily. However, the last 10 years have shown a modification of this pattern with impres-sive growth led primarily by foreign direct invest-ment , . Chinese, Indian and Saudi firms have invested heavily in the continent, which has led to greatly improved infrastructure. The con-struction of roads is usu-ally the price big inves-

tors have to pay to get their investment through. The improved infrastructure eases business growth by providing means of export and access to wider markets. Especially agriculture is a field in which investment takes place on a remarkably large scale. In Ethiopia, an Indian company has bought a rural area at the size of southern Sweden . Com-pared to 10 years ago foreign aid has risen from $20b to $30b whereas FDI has increased by $35b from $20b to $55b. The peak of the inflow of capital was in 2008 where the continent saw an inflow of approximately $75b . The global economy has been slacking.

In the rise of The Lion, large-scale infrastructural projects are paving the way for economic growth

Global economic gloom has not altered the Asian consumerism and the shopping malls are still booming.

As the African economies are expanding, the agricultural sector is prospering in Africa.

25/42

“The region’s poli-cymakers now face the difficult task of

adjusting the amount of insurance needed to support stable,

noninflationary growth.”

Little to no growth has been the com-mon parameter of the western econo-mies, and the expectations to the BRIC countries are low. According to the IMF the economies of Africa are projected to have growth rates between 5%-10% . It is no wonder some African economies are referred to as lions – a clear refer-ence to the Asian Tigers, an expression created when they started developing 20-30 years ago . A major concern with the stability of the African growth rates, is how strongly correlated they are with the global commodities market, espe-cially oil and minerals . An example of this is Zambia where half the GDP de-rives from cobber.

Sub-Saharan Africa can be divided into three groups:

1. OEC – Oli Exporting Countries with an estimated growth rate of 7-8% despite unstable oil prices. These countries however are prone to high inflation and fluctuating fuel prices.

2. MIC – Middle Income Countries who have been hit heavily by the financial crisis and the following credit crunch since these economies are relatively closely linked to the western economies. The expected growth rates in this group are around 3-4%. Growth in this group is driven by consumption, and FDI in the minerals sector.

3. LIC – Low Income Countries have been excluded from the financial turmoil the last few years. They are all, except from Ethiopia, estimated to have growth rates of 6-7% in 2012 and 2013 . This cluster is particularly vulnerable to fluctuations on the global food market.

East African economies are relatively independent of commodity prices, and have proven able to generate growth without the presence of major reserves of natural resources. Africa is no longer dependent on the Western world to buy its goods. Over the last 20 years export to BRIC countries has risen from ap-

proximately 1% to about 20%, and it is expected that this figure will increase to 50% before 2030. The group of Afri-can countries with these characteristics consist of Kenya, Tanzania and Uganda in the east, and Côte d’Iviore, Ghana and Cameroun in the west. When it comes to production and the potential of local and regional sales a variety of economical factors come in to play. Naturally, private income must be on a level where consumers are able to con-sume goods and services, but still low enough to compete with Asian manu-facturing.

As an investor in Africa there is a range of challenges, namely the rule of law, protection of private property, and politi-cal/economical stability. Business is on the rise in Africa and the early bird will catch the worm. 34 out of 46 govern-ments have made it easier to start and run a business over the last year . The rise of democracy, less corruption, and a growing private sector has provided greater stability and growth, but African economies still struggle with compara-tively high corruption rates and lack of

In spite of promising growth prospects, the uncertainty in the commodity markets and the debts crisis in the euro zone might end up putting the Asian tigers to rest.

26/4226/42

responsible government. When mak-ing a strategic decision on whether to invest in the developing world a careful country-level analysis will be required. Political stability, an open economy, and a diversified private sector seem to minimize the influence of corrup-tion , . Naturally, an investor or provider of credit will be more willing to enter a project if the project is guaranteed rela-tive rule of law and clear protection of private property.

The lack of skilled labour is also a prob-lem, and the mortality rate and expect-ed longevity lessens the incentives to invest in human capital. Statistics from WHO suggests that longevity in the be-fore mentioned countries is rising at a dramatic rate. It has been estimated that the 1b African population will dou-ble over the next 40 years with the ma-jority of the population in the working age. It is imperative that the companies and governments are able to provide education and jobs or political instabil-ity could become an issue. Compared

with Europe and Asia where the median age is 40 and 30, respectively, in the median age in Africa is merely 20 years. This represents a huge potential for the continent and is quite similar to what happened in Asia 30 years ago. This situation paves the way for enormous productivity potential but also a boom in consumer demand. However, it also presents a risk: vast numbers of young adults seeking a future is like financial gearing in an LBO – it multiplies both good and bad performance!

The growth in Asia seems almost un-stoppable. India and China are moving in on the traditional tuft of tech savvy countries like Japan and South Korea. The new brands are spreading globally. Still production in South East Asia is hard to compete with, since labour cost and capital inputs are cheap. Given glo-bal demand does not suffer too grim a downfall – namely western demand – this should keep the money flowing with growth rates around 6.5%. On the risk side are European bank credit in the

region, the Chinese real estate market, and booming commodity prices. The path towards growth and stabil-ity that the African continent in large has endeavoured upon is still unclear in direction, and investments must be tracked carefully. With an expected growth spanning from 3 to 8 percent, an unexploited market, and booming consumer demand, opportunities exist. In this market the major risk factors are inflation, food prices, and the difficulty of handling corruption. With the popula-tion getting richer and endorsing tech-nologic advancements innovation is one side of the African medal – the other be-ing basics like agri-business, infrastruc-ture, food processing, and electricity. The lions are on the move and inves-tors hunting for long-term high returns should consider joining the pack.

27/42

These colourful notes does not merely reflect a mean for exchange of goods, but a complex currency of a country who has its mind set on

eating its cake and having it too.

China’s Exchange Rate and Capital Controls – a new era for the Renminbi!

28/42

China’s exchange rate and capital controls have without doubt been some of the the most heavily de-bated topics during the last dec-

ade. The topic was more or less omnipres-ent throughout the corporate, academic and political spheres – and with good rea-son! Given the country’s size, China’s poli-cies on exchange rate and capital controls have a major influence the global econo-my, capital markets as well as the ability of companies to hedge risk and move capital across borders.

In terms of currency controls, very few people will be surprised to learn that China indeed does keep a firm grip on currency flows in and out of the country. One cannot simply move money in and out of China; especially not when the transfer involves the Chinese national currency – the Ren-minbi (RMB). Similarly, the government has also put heavy restrictions on the cir-

culation of foreign currency within China. However, the severity of the capital con-trols is highly dependent on whether the currency flows are associated to the cur-rent or the capital account.

Current account? Capital account? Same same, but different…The obvious question is of course why it matters whether items are related to the current or the capital account.

Generally speaking, the current account is related to trade and in the case of China this includes items such as the sale of goods, provision of services, interest pay-ments and repatriation of dividends. As long as the activities are conducted in

Hong Kong Exchange Square is not only a financial nerve centre. It also

serves as a currency laboratory for Government of China.

28/42

By Jens Bech Petersen

29/42

compliance with Chinese law, neither foreign nor Chinese companies will face many difficulties in transferring money in and out of the country or exchanging RMB to foreign currency and vice ver-sa. For Chinese companies the receipt of foreign exchange can be retained or sold to financial institutions permitted to engage in such business, whereas for-eign companies may convert any RMB profits into foreign exchange through certification obtained from the State Administration of Foreign Exchange (SAFE).

Meanwhile, the foreign exchange con-trols on the capital account items are far stricter. In broad terms, any trans-action that aims at creating capital will be regarded as a capital account item. Examples of such items include equity investments, foreign direct investment (FDI), derivative deals and loans. For-eign companies can obtain approval for FDI through SAFE and thereby in-ject capital into their China entities, but the process is notoriously cumbersome and it normally takes two or three months before the capital can be put into use. The whole process only becomes more ardu-ous when the capital to be injected comes in form of RMB and may in fact ex-tend the total time frame by another month!

Regulations are similarly tough for Chinese citizens and companies that wish to move their capital out of China - not to mention if the capital is earmarked for investments in capital markets. In fact, neither for-eigners nor Mainland Chinese citizens can freely invest in each other’s capi-tal markets. Foreign investors seeking exposure to Mainland Chinese mar-kets can only succeed by applying for Foreign Qualified Institutional Investor (QFII) status, Renminbi Foreign Quali-fied Institutional Investor (RQFII) sta-tus or alternatively invest through enti-ties that already possess such permits. Mainland Chinese citizens will have to go through the Qualified Domestic Insti-tutional Investor (QDII) scheme.

Evidently, these restrictions pose some serious problems for foreign companies and investors alike. On one hand capi-tal movements relating to the capital ac-count have to be well planned so that

Mainland Chinese entities do not run out of cash, and on the other hand it is not straight forward to hedge the cur-rency risk. Similarly, investors face a tough challenge to gain direct exposure to the RMB or Chinese capital markets. While such problems can only truly be solved through a freely convertible RMB, the Chinese government has al-ready initiated measures that partly may solve the problem.

From Hong Kong with RMB!Due to its position as a global finan-cial center and strong legal framework, Hong Kong has time and again served as laboratory for China’s finance and currency policies. This was also the case in 2003 when the Chinese gov-ernment sought to develop an offshore RMB-market as part of the currency’s internationalization process.

RMB transactions began in 2004 with an arrange-ment that allowed Hong Kong banks to develop an offshore deposit market for RMB that allowed individu-als and companies to hold RMB in Hong Kong. Three years later the Chinese government took another major step in liberating its capital account when it

allowed companies to issue RMB de-nominated debt in Hong Kong – the so-called “Dim Sum bonds”. Although this marked a major step towards mak-ing the RMB convertible, it was still a very strenuous process to transfer the offshore RMB into Mainland China. In fact, due to the stringent capital con-trols, the Chinese government had developed two parallel markets for the RMB; the onshore CNY market and the offshore CNH market.

In this regard another milestone was achieved in 2009, when a pilot scheme was started to allow cross-border trade to be settled in RMB. Initially, this scheme only included Shanghai, Guangzhou, Shenzhen, Zhuhai and Dongguan in-side China and Hong Kong, Macau and the ASEAN countries abroad. However, the scheme was gradually expanded and in 2012 China allowed all of its

provinces to conduct cross-border trade in RMB with the rest of the world as long as the Chinese company had an approved import/export scope on its business license.

The RMB cross-border settlement scheme became complementary to the bilateral currency swaps that China has signed with selected partner coun-tries since December 2008. Essentially, these swap agreements allow foreign governments to offer local importers RMB financing when purchasing Chi-nese goods. Among the countries that already entered into these RMB swap agreements are Japan, Russia, Singa-pore, Australia, Hong Kong and Brazil. In combination the bilateral curren-cy swaps, the cross-border trading scheme and the offshore RMB-market has allowed companies to find support for a wide range of RMB related finan-cial services. In addition, Hong Kong’s offshore market also allows investors and financial institutions to gain expo-sure to RMB capital markets and finan-cial products.

Besides a US Dollar settled non-de-liverable CNY forward market, Hong Kong also offers deliverable USD-CNH forwards, swaps and foreign exchange options. The interest rate risk can be managed through CNH interest rate swaps or alternatively through cross-currency swaps that under normal cir-cumstances provide higher liquidity. Hypothetically, this means that compa-nies and institutions with access to both Mainland Chinese and the Hong Kong capital markets potentially may benefit from the interest differentials. Moreover, outside of Mainland China, the CNH can actually be traded with very few re-strictions.

So, doesn’t this imply that the RMB is almost freely convertible? And how about risk management? Aren’t com-panies perfectly capable of hedging their RMB currency exposure? If the two markets could be treated as one, it would imply the existing of an arbitrage opportunity that could dictate the law of one price. But the CNY and CNH often do not trade at the same rates! So what is missing…?

“Investors face a tough challenge to

gain direct ex-posure to the RMB or Chi-nese capital markets.”

By Jens Bech Petersen

30/42

The Great (Capital Control) Wall of ChinaAgain the issue relates back to China’s stringent capital controls. Even though the divergence between the CNY and CHN will be limited by companies and financial institutions, as these have a natural incentive to buy RMB in the cheapest market and sell them in the priciest. However, since transactions only can be conducted on the back-ground of approved corporate activity, there is no clean-cut arbitrage relation between the two markets.

Thus, as long as the cross-border arbi-trage can be based on current account items such as trade and profit repatria-tion, companies and institutions can with relative ease move RMB across the Chinese border and potentially take ad-vantage of the spread between the two markets. Nevertheless, the cross-bor-der arbitrage becomes rather difficult to implement when a transaction relates to China’s capital account. As already

mentioned, under normal circumstanc-es it takes two or three months for a foreign company to inject new capital into a Mainland China entity and the process may potentially be extended by another month when the capital to be injected comes in the form of offshore RMB. Likewise, investors have to un-dergo a similarly cumbersome process when funds are transferred through the QFII and RQFII schemes.

When China regained control over Hong Kong back in 1997, it implemented a “one country, two systems” policy to allow Hong Kong to function as gate-way to the outside world. Similarly the Chinese government seems to be im-plementing a “one currency, two mar-kets” approach for the RMB. But why does it have to be so complicated? Why bother to establish offshore RMB hubs? Wouldn’t it be more feasible simply to remove the capital controls? The an-swer to these questions can be traced back to what economists have dubbed “The Impossible Trinity”.

Two’s Company, Three’s a CrowdIdeally, a country’s central bank would like to be able to (1) fix a country’s ex-change rate, (2) allow a free capital flow and (3) lead an independent monetary policy. However, in praxis this is hardly possible and the central bank will have to forfeit one of these three items. While countries such as the United Kingdom and United States of America largely have relinquished their exchange rate controls to maintain free movement of capital and an autonomous monetary policy, the Chinese government has chosen to sacrifice the free cross-bor-der flow of capital to retain control over its exchange rate and money supply.The impossible trinity also highlights the connection between China’s recent moves to lessen capital controls while expanding the daily trading band of the RMB. China may be at a point where it needs to ease its capital control in order to facilitate a more efficient dis-tribution of capital. A prime example in this regard is the country’s overheated real estate market, where considerable

“Allowing Chinese com-panies and individuals to invest more freely abroad could not only help China to deflate some of its domestic asset bubbles, but

could also deliver some of the much needed

capital for struggling western economies like the ones of Europe.“

0

50

100

150

200

250

300

350

400

jan/04 maj/05 okt/06 feb/08 jul/09 nov/10 apr/12 aug/13

Billi

on

US

Do

llars

Value of China's Outbound FDI

Figure 1: Value of the People’s Republic of China’s Outbound Foreign Di-rect Investment stock

amounts of Chinese investors have put their savings due to the lack of a feasi-ble alternative. Allowing Chinese compa-nies and individuals to invest more freely abroad could not only help China to de-flate some of its domestic asset bubbles, but could also deliver some of the much needed capital for struggling western economies like the ones of Europe. 2.200

2.400

2.600

2.800

3.000

3.200

3.400

Jan/1

0

Mar/1

0

May/

10

Jul/1

0

Sep/1

0

Nov/10

Jan/1

1

Mar/1

1

May/

11

Jul/1

1

Sep/1

1

Nov/11

Jan/1

2

Mar/1

2

May/

12

Billi

on

US

Do

llars

China's Foreign Exchange Reserves

Figure 2: Foreign Exchange Reserves of the People’s Republic of China

30/42

31/42

6,26

6,28

6,30

6,32

6,34

6,36

6,38

6,40

Jan/12 Feb/12 Mar/12 Apr/12 May/12 Jun/12 Jul/12

CN

Y p

er U

S D

olla

r

USD/CNY Exchange Rate in 2012

It requires a whole lot more than the ability to count when trying to convert

your currency into RMB.

Furthermore, if Chinese investors and enter-prises were less constrained with regards to outbound investments, the People’s Bank of China – China’s central bank – would be less dependent on buying US government bonds and could thereby more easily diversify its holdings into other asset classes.

In fact, this process may already have begun, as China’s stock of outbound invest-ments continues to increase (see figure 1) while its foreign exchange reserves slowly are starting to decline (see figure 2). This development has so far been accompanied by two percent depreciation of the USD/RMB exchange rate since the beginning of May 2012 (see figure 3). In addition, the second quarter of 2012 marked China’s first quarterly Balance of Payments deficit since 2000, which in praxis means that more money is leaving the country than entering (see figure 4).

Figure 3: Development of the 2012-exchange rate between the US Dollar and Renminbi

-50

0

50

100

150

200

250

1998  Q1  

1998  Q3  

1999  Q1  

1999  Q3  

2000  Q1  

2000  Q3  

2001  Q1  

2001  Q3  

2002  Q1  

2002  Q3  

2003  Q1  

2003  Q3  

2004  Q1  

2004  Q3  

2005  Q1  

2005  Q3  

2006  Q1  

2006  Q3  

2007  Q1  

2007  Q3  

2008  Q1  

2008  Q3  

2009  Q1  

2009  Q3  

2010  Q1  

2010  Q3  

2011  Q1  

2011  Q3  

2012  Q1  

China's  Balance  of  Payments  

Capital & financial account balance

current account balance

Overall Balance

Figure 4: Balance of Payments for the People’s Republic of China

While the process of liberating the country’s capital account has been rather slow, it seems imminent that cap-

ital flows in and out of China will be less constrained in the near future. Looser capital controls and a less constricted RMB exchange rate may in fact not only

turn into a win-win situation for China, but also for the global community as a whole.

32/42

The purpose of this article is to look at possible future trends in trading, with a main focus on the European area. The

possible trends will be based on a sce-nario, which will be further elaborated later in the article. Based on the sce-nario we will emphasize assets, areas and sectors that look interesting given the scenario is going to unfold. The beginning of 2012 was good for in-vestor’s, especially investors long in eq-uities. The Stoxx 600 index tracking Eu-ropean stocks was up by app. 11 % on its top on the 16th of March. But since then all increases were rolled back and the Stoxx 600 index was at its lowest point this year down by app. 4 % year to date at the 4th of June. The major factor for these declines is the current debt crisis in Europe. Its causing nerv-ous markets, which to some extend has an effect on all asset classes. Investors are leaving risky assets – like equities and high yield bonds – to seeks towards safe heavens. Currently, the American dollar is the most attractive and it has increased significantly during the last months, but also government bonds in Germany and Denmark has interest. The question is “What’s going to hap-pen now?”

A pessimistic scenar-io could be financial stress in a larger extend than seen so far. This could lead to another recession, which will have a large impact on especially the Europe-an economies. A more positive scenario is that European leaders will succeed to encapsulate the ongoing debt crisis and thereby calm the finan-cial markets; this could lead to an eas-ing in banks credit standards, which will help start a recovery. There are factors pointing towards both scenarios, but the scenario that will be used in the rest of this article is leaning towards a posi-tive future and will be further explained below.

The scenario is built upon certain posi-tive factors to take place. First it is vital for the Euro area that the current debt crisis is being contained and controlled to avoid it wreaking more havoc on the Euro currency and the Euro collabora-tion. One way to do this is to give the ESM more money, now they got the mandate which gives even more reason to raise capacity and the ECB should be given a reason to provide more support i.e. unleash QE. Second, the financial

markets have to regain trust in the Euro area, thereby fueling the very empty “Euro-tank” to-wards a recovery (albeit it might be a slow one, it is a recovery). For the Euro area to attract investors it probably needs support from US, China and EM so

that exports to these areas will increase. This will not only increase the confi-dence in the Euro area but also help to start the recovery. There is off course several risk factors combined with this scenario, which is more likely to happen on mid- to long-term than on short- to mid-term.

With the positive scenario in mind, the current market would seem to be at an attractive level to buy more risky assets such as stocks, corporate bonds and covered bonds in the financial sector. Nonetheless, this article will focus on stocks.

As previously stated, the stock rally in the first two months of 2012 was rolled back at the end of the second quarter. Compared to the past 5 years, the Stoxx 600 Index is still down with roughly 35 %, while the S&P 500 in the same pe-

“The European stocks gener-

ally took a heavy beating from the market during the

debt crisis”

Although the European stock market got a good head start in the first six months of 2012, the investor sentiment has gone gloomy.

Trends in sales

and tradingBy Mads Axel Schønberg & Kevin Hellegård Nielsen

33/42

-0,7

-0,6

-0,5

-0,4

-0,3

-0,2

-0,1

0

0,1

Today

29-A

pr-201

2

05-F

eb-201

2

13-N

ov-20

11

21-A

ug-201

1

29-M

ay-20

11

06-M

ar-201

1

12-D

ec-201

0

19-S

ep-201

0

27-J

un-201

0

04-A

pr-201

0

10-J

an-201

0

18-O

ct-200

9

26-J

ul-200

9

03-M

ay-20

09

08-F

eb-200

9

16-N

ov-20

08

24-A

ug-200

8

01-J

un-200

8

09-M

ar-200

8

16-D

ec-200

7

23-S

ep-200

7

Stoxx 600 S&P 500

riod is down with merely roughly 12 %. In addition, the EUR-USD currency-pair has moved in favor of the dollar-native investor thus giving those investors an extra possible upside to an invest-ment in European assets. Based on the above, the more risky European as-sets could be a favorable long position to investors. This is especially because stocks at the moment are highly cor-related with macro economic factors, causing healthy, well-functioning com-panies to get dragged down along with the rest of the market, and therefore they become relatively cheaper.

Especially equities would be a preferable asset class to invest in, since it is gen-erally outperforming other asset classes in a recovering or growing economy. Also the European stocks generally took a heavy beating from the market dur-ing the debt crisis, though bank stocks probably were hit the most. Hence, the stocks of the Euro area might be at fa-

vorable to pick up at the current level. Though investors should be cautious when buying individual stocks or sec-tors, while not all have managed equally well on their way through the crisis. In-vestors should look to companies which have a fundamental healthy base of op-erations and have taken the necessary means to slim and trim the company enough to endure the crisis but still have retained the ability to keep pace or more with a recovery. Given the re-covery in the scenario expected to be at a slower pace, investors should be ex-pecting longer-term investments which emphasizes that the fundamentals are ought to be solid. In addition, these companies and sectors should prefer-able have product or service prices varying with the inflation beside being of a more durable or necessity based, which would strengthen the longer term investment. It is still important to stress that diversification is still important both cross assets classes, sectors and geo-

graphic locations.

In the light of the debt crisis investors would also want to take the debt of the company into account. It is vital to look for companies who hasn’t indebted it-self to survive the crisis but have kept a level in accordance to pre-crisis levels or to engage in sound investments.

There are off course several risk fac-tors associated with the scenario stated above. First of all its based on a believe in European politicians being both will-ing and able to encapsulate the debt crisis and solve the problems accom-panying the crisis. Furthermore, cur-rent macro numbers shows a slowdown in the American recovery and Chinese growth. With this being said, the Euro-pean area still looks interesting in the long run, both because a lot of healthy companies has been dragged down by factors that may not be relevant for the company.

The outlook depends heavily on whether Christine Legarde and the rest of the Troika are able to solve the current debt issue in the euro zone.

BASel III

34/42

Higher Common Equity Capital Requirement of Basel III and its impact on the Commercial Banks’ capital structure and

Risk Taking – Author Farina Ria NordamCapital Regulation, according to PwC’s Annual Global CEO Survey, is the most important factor influencing changes in financial institutions. Moreover, it is the second largest threat after economic uncertainty. Capital Regulation has long been discussed among regulators, ex-perts, scholars and financial practition-ers. Basel II’ excessive and more de-tailed regulation RWAs, for example, has been claimed to be one of the sources of recent financial crisis. Basel II has also been criticized for requiring banks to increase their capital, when risks rise. Consequently, this might cause them to decrease lending precisely when capi-

tal is scarce, potentially aggravating a financial crisis (pro-cyclicality effect of the accord). It is due to the fact that the judgements of PD tend to underesti-mate risks in good times and overesti-mate them in bad times. Thus, one of the main issues in the banking sector is “how much and what kind of bank regulation is optimal?”.

Basel Accords’ Capital Ratio The Basel Accords, “Cooke Ratios”, that tend to maintain enough capital to absorb losses without causing systemic problems and to create an equal play-ing field internationally, has undergode some improvement under Basel I II, 2.5 – and recently III – to find the “optimal

capital regulation ratio”. As a reaction to recent financial crisis, BIS increases a combination of higher minimum tier 1 capital requirement (common equity), a broader ratio of RWA, and adds lev-erage and liquidity standards through Basel III proposal.

Understanding the importance of hold-ing Minimum Regulatory Capital Re-quirement (MRCR), Nordam and Kon-tic (2011) calculated and illustrated the MRCR of the US Commercial Banks (with around 6453 institutions data pooled from FDIC) from period 1992 to 2011 (quarterly based) . They found evidence that MRCR held by the com-mercial banks in US are in excess of the minimum capital requirement of 8%. This is particularly evident among com-mercial banks with assets less than 100 M USD. This evidence supports some

Source : Basel III No Achilles’ spear

By Farina Ria Nordam

35/42

experts’ argument that “economic capi-tal” is more important than the regula-tory capital in running the business.

Impact of Higher Com-mon Equity Ratio on the Commercial Banks’ Capital Structure and Risk TakingThe finding on MRCR leads to the fol-lowing part of analysis of how the im-plementations of higher common equity ratio from 2% to 7%. (incl. capital con-servation buffer) will affect the Com-mercial Banks’ Capital Structure and Risk Taking”.

In the discussion of Optimal Capital Structure, Modigliani-Miller theorem is one of the core theories in modern cor-porate finance optimal capital structure theories. The theory was introduced with the assumptions that organizations are in a perfect capital markets with perfect information where there are no taxes, transactions and bankruptcy costs and individuals can borrow at same interest rate as organizations.

The capital structure of financial in-stitutions is determined mostly by the same departure point from the fric-tionless world of M&M that determine the capital structure of any other kind firm facing market imperfections, i.e. taxes, expected cost of financial dis-tress, transaction costs and signalling behaviour and agency problems arising from asymmetric information between shareholders and creditors and be-tween owners and managers. However, banks differ from other ordinary firms in two important aspects that affect their capital structures. Firstly, the presence of the regulatory safety net (i.e. deposit insurance) that protects the safety and soundness of banks is likely to lower bank capital. Harding et al, Merton (1977) shows that banks have an in-centive to decrease capital-to-asset ratios and to increase assets risk. As a result the risk of default is increased and wealth from the deposit insurance system is extracted. Nordam and Kontic (2011) also found evidence that bank’s high leverage level is motivated by the tax-shield inherited in debt. Secondly, the regulatory capital requirements raise the capital of some banks.

Thus, the main topic to be discussed in this article is the impact of the higher common equity requirement on the commercial banks’ capital structure and risk taking. The major concern on the regulatory attempts to raise bank capital ratio is that: “it will drive banks to seek out more risky investment” The criticism can for instance be de-ducted from William McDonaugh vice chairman of First National Bank of Chi-cago who says that:

“... the proposal could lead banks to take on riskier business to com-pensate for the lower returns they would almost assuredly get by having to maintain more capital”.

In line with this quotation Nordam and Kontic (2011) also find evidence that higher CAR and ROE are not positive-ly correlated with the earnings of US commercial banks with assets less than 100 M USD. Meanwhile, a contradict-ing result was found among the US commercial banks with assets more than 1 B USD . This finding has been supported by experts, e.g. Koehn and Santomero (1980), Keeton (1988) and Kim and Santomero(1988). Using utility maximization models they show that an increase in the required equity-to-asset ratio might either increase or decrease the portfolio risk chosen by a bank. If equity is relatively expensive, risk-averse bank owners may choose to in-crease its exposure to risky assets (with higher expected return) to gain a higher return on its free capital. Alternatively, the bank will liquidate its risky invest-ments and move to safer investments, thereby decreasing the expected return on the overall investments.

In contrast, a recent article by Keeley and Furlong, shows that the previous studies using such a framework are internally inconsistent and the models cannot be used to support the conclu-sion that “higher bank capital ratio can lead to great risk-taking” . Through the state-preference model used by Keeley and Furlong (1989), they analyze how the portfolio and leverage decision of an insured bank that maximizes its current value (the market value of its equity). The same result is found by Nordam and Kontic (2011) in observing the quarterly data from the US Commer-cial Banks from 1990s to 2011. In the project, they found evidence that higher

CAR will make the banks decrease their risk taking.

The problem with maximizing share-holder value in a bank is that commer-cial banks’ have illiquid assets that are strongly correlated and pro-cyclical with the economy. As a result, a small de-crease in asset value can erode share-holders equity in a highly leveraged commercial bank. Compared to a rela-tive to a highly leveraged commercial bank, shareholders of a bank with strict capital requirements will have a higher return on equity in “bad times”, while a lower return on equity in “good times”. However, this signifies that commercial banks have to own more of the down-side risk, as commercial banks have to reduce the risk of default by creating cushions at its own expense. This cre-ates an incentive for commercial banks – especially the ones that are “too big to fail” – to increase their leverage – and consequently, rely on explicit and/or im-plicit government guarantees to protect them from the downside risk – rather than acquire equity. As a result, com-mercial banks may be more willing to satisfy higher required return on equity than the following downside risk with more equity.

Understanding the commercial bank’s shareholders and its manager’s strong incentive to prefer high leverage due to the higher ROE, regulators increase capital requirements to diminish the consequences and social costs with a high dividend payout, debt overhang and moral hazard problem. As a result, one can argue that an increase in capital requirements has the potential to make the commercial banks’ less pro-cyclical and more efficient in downturns.

Hence, the impact of the application of Basel III higher capital requirement will affect US banks and European peers differently (JP Morgan, 2010). It is pre-sumed that European Banks are less capitalized and there will be larger need for them to transform current assets into both longer term maturities and of higher quality. Furthermore, higher capital requirements have also been criticized for intensifying pro-cyclicality problem within the economy by forcing the commercial banks to reduce their balance sheets (i.e. deleveraging) in order to comply with the new capital regulations.

“Private equity take-overs”A new normal in the Private Equity industry?

In a recent case the group chairman of HSBC BANK Douglas Flint criticized Basel III and its increase in capital re-quirements. He argued that 1% in-crease in capital requirements would diminish the banks’ lending capacity with approximately 100 billion pounds . This statement was further embraced by the chief executive of Barclays bank who argued that even the current capi-tal requirement level at 10% is too high and should be decreased in order to in-crease lending capacity.

In conclusion, Higher Capital Requirement of Basel III proposes by Basel Committee should be understood as the “good intention” of the regulatory agency to limit the risk exposure of the government and taxpayers that stand behind it. However, in order to reach the goal of financial regulation a symbi-otic co-operation with financial institu-tions like moral hazard on the “safety-net” provided by the regulators should be diminished. Although higher capital requirement intended to create a stable and reliable financial system, regulators will continue to face difficulties regulat-ing the more complex and intertwined financial system. Even though the Com-mon Equity Ratio has doubled in its ratio

from 2% to 4.5% (see diagram), some experts argued that it ought to be in-creased proportionally higher to be able to absorb alike recent losses. It is also important to bear in mind that upon the implementation of the Basel III, debt will remain the major funding source for commercial banks. Consequently, the government should start to think how to deal with “too big to fail” financial insti-tutions so that they are not become “too big to regulate” institutions.

In general the writer agrees with other scholars that more common equity is a competent tool to overcome the recent solvency and liquidity crisis, undervalu-ation of new equity financing and will be the first step in striving for an optimal capital structure of the economy. How-ever the writer believes that to make the proposal effective, the whole financial system needs to be reformed. So that the new Basel Accord implementa-tion purpose to decrease risk taking (to avoid systemic risk) and create a sound and reliable financial system can be achieved. Earlier government subsidies by rewarding debt financing i.e. through tax benefit and deposit insurance (and penalizing equity financing) had bene-fited managers and existing sharehold-ers. Such subsidies should be reduced

if equity capital requirement is to be fur-ther increased.

However higher capital requirement implementation should also take into consideration “the opportunity cost” of lending declining or asset liquidation as the most frequent steps taken by the banks increasing their reserves. It is due to the fact recent financial crisis have made investment and risk taking within banking industry to diminish. Ad-ditionally even though Basel III has tried to deal with this pro-cyclical problem of the regulation through i.e. Credit Valu-ation Adjustment (CVA), Conservation Buffer and/or Countercyclical Capital Buffer, regulators still need to realize the complicated application of these tools especially in identifying the state of business/economic cycle and conse-quently point of enactment.

At this level of analysis the writer will rest the “ex-post” impact of the Basel III Accord of higher capital requirement (common equity) on the commercial banks’ capital structure and risk taking to other students or scholars to elabo-rate upon its implementation in the near future.

36/42

The days where a well-struc-tured leveraged buyout (LBO) could generate returns in the triple digits might remain a

thing of the past as the private equity industry today is struggling with in-creasing takeover premiums and tight credit markets.

Up until 2007, the Private Equity in-dustry was associated with gigantic transactions of tens of billions and ex-traordinary returns. Today the story has changed. Following the financial cri-sis and the problems in the euro zone the capital markets have dried up and

LBOs have become more expensive. As such both the number and size of private equity takeovers have declined dramatically the last couple of years. Today, there are far fewer ‘quick wins’ in the industry as compared to 10-20 years ago. The generation of returns has increasingly become a function of the ability of the fund and company management to excel operationally and not a question of financial restructuring or buying cheap and selling dear. For instance, the Boston Consulting Group (2012) has estimated that in order to generate an IRR of 25% in the current market conditions, portfolio companies

must deliver an annual growth in EBIT-DA of 11%. This tougher environment is reflected in the relative amount of which the private equity industry accounts for global takeover volume. In the first half of 2007 the private equity industry ac-counted for 18%. Since then takeover volume has been slashed to a mere level of 7% last year. Consequently, as fewer deals are carried out and the competition for attractive takeover tar-gets has increased. At the end of 2011, PE funds held roughly USD 900 billion in non-invested equity. Not only do PE funds hold a lot of dry powder they also face stern competition from strategic

By Mads Ingeman Pedersen & Ragnar Stoknes Hafting

“With such a high stake the necessity of this investment turning out profit-

able is critical to the performance of Black-

stone’s portfolio”

37/42

buyers with excessive cash levels on their balance sheet looking for acquisi-tive growth opportunities. As a result of fewer attractive investment opportuni-ties and increased competition, the big-gest players are forced into the middle market, thereby pushing out many of the small and medium firms. Secondly, exits have become increasingly difficult due to the market turmoil. An example of this is a decline in number of IPOs, which in USA has dropped from an average of 311 per year during 1980-2000 compared with 120 per year dur-ing 2001-2009. On top of this, investors show bad appetite for new stocks. This has increased the risk for the mega funds as public offerings are often re-garded as the traditional exit strategy for their investments.

Summing up, the private equity in-dustry is today not flush with as many ‘quick wins’ as was the case 10-20 years ago and the generation of excess returns nowadays involves operational excellence to a far greater extent than before. Nevertheless, despite the chal-lenges that the industry is facing it is still an attractive place to invest as the toughened environment effectively has created a shake-out of less-performing funds.

Case study: Blackstone’s 2007 takeover of Hilton Worldwide

As mentioned above, the private eq-uity industry has taken a radical turn in the post-crisis era. This is reflected in both the number and the deal size of the PE takeovers after 2007. Look-ing closer at the 15 all time largest PE deals, interestingly, 13 of them are clustered in 2006-2007 according to BusinessInsider. Interesting is number

9 on the list, namely the USD 26 bil-lion public-to-private buyout of Hilton Hotels by Blackstone in October 2007. This transaction effectively made Black-stone the majority owner of Hilton’s glo-bal operations spanning nearly 3,500 hotels totaling over 575,000 rooms across 79 countries today. As for the deal details, the enterprise valuation of USD 26 billion equates to roughly 14.5 times EBITDA at the time. Further, the acquisition was financed with USD 20 billion of bank debt necessitating an in-vestment of USD 6 billion by Blackstone - by far their largest equity investment at the time. With such a high stake the necessity of this in-vestment turning out profitable is critical to the performance of Blackstone’s port-folio. This had the financial crisis hit Blackstone espe-cially hard as Hilton experienced a 30% fall in EBITDA when the economy turned south. According to The Deal Pipeline, a magazine covering the deal sphere in private equity and M&A, this made Blackstone’s billion dollar equity invest-ment plunge by 70%. As such, was it not for the fact that Blackstone had negotiated an attractive loan-package with the USD 20 billion being bor-rowed covenant-free; Hilton Worldwide could very likely have been seized by its lenders at this point. Nevertheless, the company’s management has along with Blackstone created somewhat of a strategic turnaround both financially and operationally. Firstly, Blackstone has restructured Hilton’s balance sheet with a restructuring of the original USD 20 billion debt load in order to meet in-

terest payments. This restructuring had creditors slash their claims by roughly USD 4 billion, while Blackstone con-tributed USD 800 million of new equity to buy back debt at a discount. This helped strengthen Hilton’s cash flows in a time when the hotel industry ex-perienced a general decline. Accord-ing to some analysts, Blackstone could have been forced to sell Hilton assets to cover its roughly USD 900 million in in-terest payments (The Wall Street Jour-nal, 2008). Secondly, at the time of the acquisition, Chris Nassetta was as the CEO given considerable trust in deliver-ing on a number of key strategic initia-

tives among them reanimat-ing and knitting together a fragmented, rather sleepy organization; of acceler-ating growth, particularly overseas; and of bolster-ing the profitability across Hilton Worldwide’s range of hotel brands. According to The Deal Pipeline, this re-turned the company’s 2011 EBITDA to its 2008, all-time high, level (The Deal Pipe-line, 2011).

As the typical life of a PE-investment is often projected to 5-6 years and the Hilton investment will pass the 5-year mark next month, it will be interesting to see whether Blackstone will press the IPO-button later this year or wait for more favorable market conditions. Something however might suggest that market conditions are not that gloomy at the moment: Their closest American competitors, Marriott and Starwood, trade at 13.9x and 13.8x respectively – close to the 14.5x EBITDA multiple at which Blackstone acquired initially.

“Not only do PE funds hold a lot of

dry powder they also face stern competi-tion from strategic buyers with exces-sive cash levels on

their balance sheet”

At a mere USD 26 billion The Blackstone Group acquired Hilton, an international hospitality group, in October 2007.

Equity investing, CFDs, Forex (FX) Overview, FX Calcula-

tions, 3- Way orders, Trading Tactics, Trading Guide, Com-modities Overview, Technical

Analysis etc.

Place trades in real mar-ket conditions, while we coach you through the

whole process.

Mini exam & trading competition

TRADING DIPLOMA COURSE

You will acquire the skills to trade Forex confidentlyLearn to trade stocks & CFD’s and profit in an up or down marketImproved trading techniques to increase your earningsLearn to read and interpret live charts using a variety of technical analysis toolsLearn our exclusive filtering system to find high probability trades

THEORY PRACTICE TESTING

Providing you with the basics of trading

“Taking the course definitely played a big role in getting a student job in SaxoBank”

Nidhi Gandhoke, CBS

RECOMMENDED

BY

TOP RECRUITERS

The winners ticket to the next

Nordic Trading Competition

38/42

The winners ticket to the next

Nordic Trading Competition

FOTO CASPER BALSLEV

04 - 05BØRSMÆGLER FOR ÉN DAG

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±ET MAGASIN FRA FINANSFORBUNDET

NR. 29. DECEMBER 2010

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±UDGIVER FINANSFORBUNDET,

APPLEBYS PLADS 5, 1411 KØBENHAVN K

ANSV. REDAKTØR LOTTE USTRUP CHRISTENSEN

REDAKTIONSLEDER CARSTEN JØRGENSEN (DJ)

BILLEDREDAKTØR CARSTEN RASMUSSEN (DJ)

JOURNALISTER BERIT VILLADSEN, JENS SILLESEN,

SAJEEV SHANKAR OG SABINA FURBO

DESIGN NR2154

TRYK DATAGRAF

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±OPLAG 13.000

ISSN 1604-0619

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±GODE IDÉER, RIS, ROS OG SKØRE INDSLAG SENDES TIL

CJO@FINANSFORBUNDET.DK

SÆLGES OGSÅ I ABONNEMENT

125 KR. PR. ÅR (FIRE NUMRE)

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±BON ER ET MAGASIN FRA FINANSFORBUNDET. DET

UDKOMMER FIRE GANGE OM ÅRET OG SENDES TIL

ALLE MEDLEMMER UNDER 35 ÅR. ANDRE VIL KUNNE

FINDE DET I KANTINEN, I CIRKULATIONSMAPPEN,

PÅ TOILETTET, I SKRALDESPANDEN ELLER HOS

TILLIDSMANDEN.

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±FORSIDEFOTO JAKOB MARK

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

39/42

Nordic Trading competition

AF SAJEEV SHANKAR / FOTO CASPER BALSLEV

Computerne er klar og parate. Det samme er de 15 deltagere, der har kvalificeret sig til tur-neringen Nordic Trading Competition. Fordelt på fem hold skal deltagerne se, hvem der i løbet af dagen kan få 100 millioner virtuelle kroner til at yngle mest. Bag konkurrencen står Financelab, der er en studenterorganisa-tion, som er bygget op omkring medlemmer-nes fælles interesse for at handle med aktier. Deltagerne i konkurrencen er dog ikke medlemmer af foreningen, men derimod studerende fra CBS. Fire en halv times aktie-handel skal nu afgøre, hvem der har bedst styr på dagens kursudvikling. Frederik Ploug

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±±

Søgaard er formand for Financelab og er en af initiativtagerne til konkurrencen. Han byder velkommen til deltagerne og giver dem en kort ”market briefing”. Det vil sige en oriente-ring om begivenheder, der kan få betydning for udviklingen på dagens marked. ”Konkurrencen er dog bevidst lagt på en dag uden de helt store begivenheder i finans-markedet. Det er gjort, så det er de deltagere, der er bedst til at bruge de analytiske redska-ber, der vinder”, fortæller Frederik. ”Release the bulls” råber han ud til for-samlingen. Konkurrencen er nu i gang. Delta-gerne i dag har alle deltaget i de tradingkur-

ser, der blev holdt i foråret. Vinderne ved hver af disse kurser er de 15, der er her i dag, og de er dermed de bedste af de 200 oprindelige deltagere. Skal finde de bedste af de bedste”Today is about finding the very best of the best”, som Wayne Walker siger. Han er under-viser på trading-kurserne og har flere års erfa-ring med aktiemarkedet efter at have arbejdet som trader tidligere i sin karriere. Han har store forventninger til deltagernes kunnen, og sammen med sin kollega Ole Quistgaard er han dommer ved konkurrencen

BØRSMÆGLER FOR ÉN DAG

PARTNER BENEFITS

Visuals (projector, roll ups, print, info screens) More than 5000 viewers pr. dayFinanceLab events and member meetings Between 50-400 studentsCBS.dk and CBS Observer Reaching 20,000 students

in the right placeat the right time

...Facebook page More than 2100 followersFinanceLab Magazine More than 1000 readersMember database More than 1200 members

Copenhagen Business School

University of Copenhagen

Visuals (projector, roll ups, print, info screens) More than 5000 viewers pr. dayEvents Between 50-400 students

Web page Reaching 1000 economy studentsPrint and visuals More than 1000 viewers

finance student employer branding

Get broad exposure at top universities all over Denmark

Take part in career and employer branding events

Get in touch with the Danish finance student community

Aarhus School of Business & University of Aarhus

Our channels are continuosly growing across the academic world.

40/42

finance student employer branding

YOUR ADHERE

41/42