Sunday, December 28, 2008

Wikinomics in finance?

I quite enjoyed reading Wikinomics, although it took far too long. It's an interesting and engaging overview of the latest impacts that mass collaboration has on all sorts of business models. I was particularly surprised to see how many big names were already successfully active in that space. Which begs the question why, apparently, none of them are in the finance industry?

In essence, the Wikinomics principles consist in Being open, Peering, Sharing and Acting globally. Classifying these as principles implies that they are to be applied diligently and carefully as they might kill off any business model otherwise. 

Much of what being open, peering and sharing stands for appeared to be synonymous to me at first, so let me try to identify the differences. Transparency, or being open, could be seen as a catch-all term for peering and sharing. In the Wikinomics sense, it means to provide some sort of access to one's business model. Peering refers to a non-hierarchical production mode where control can only be exercised in a very limited way (for instance by providing a rule book and/or a platform). Sharing means that control over pieces of intellectual property is given up, implying that others can take advantage of it if they discover profitable ways to do so. Wikinomics impressively demonstrates the application of these principles in a number of industrial settings, mostly dealing with immaterial assets such as engineering knowledge, software, IP and other know-how. 

Those principles of wikinomics seem to be anathema to the domain of finance, though. Historically, this industry is rife with control, secrecy and exclusion. Is it inevitably so, though? I don't think so. It is probably inevitable when it comes to the client relationship (yes, the Swiss perspective) and the deployment of capital, which is exclusive by nature. Also, the characteristic of finance as a regulated industry will constrain the applicability of wikinomics as long as it is not embraced by the regulator

When it comes to all other aspects of know-how in finance (risk management, asset management, investment research etc), however, I see no reason why they could not be profitably opened up to wikinomics, especially when there is a premium on transparency in times of crisis. The Tapscotts themselves propose to apply wikinomics to risk management, but unfortunately, they stick rather close to the surface IMHO. It will be interesting to watch IBM Data Governance Council's initiative for XBRL in risk reporting. 

However, without regulatory leadership or at least explicit support, such initiatives are destined to fail or thrive only in un-regulated niches, which are likely to shrink going forward.  A pet project for Ms Schapiro? Here's to hope!

Saturday, December 27, 2008

Redefining Old

Nomura has an excellent piece of research out that goes well beyond what that genre usually entails in the brokerage space. The Business of Ageing is an extensive discussion of the key risk of the pensions industry that is longevity, its implications for the real economy, financial markets and the major industries. I particularly value the section about longevity with its discussion of the technophysio approach which, in combination with longevity convergence across countries, is posited as leading to rapid longevity growth. Where official UN projections arrive at an average life expectancy of ca 85 years in 2050, Nomura models predict ca 90 years. 

Redefining Old refers to another interesting aspect of the paper: Whereas a social security definition in terms of years lived will lead to an increasing share of the "old" cohort burdening social security, the authors argue that with increasing healthy life expectancy due to morbidity compression, it will be reasonable (i.e. necessary) to expect people to work (much) longer. The authors pinpoint that age at about 80, which would be suicidal for any politician to ask for. Note that this blog has argued for the same number before.

Virtually unseen in brokerage research is the extensive, up-to-date scientific apparatus provided. The label useful is fully deserved.

As a side comment: In spite of Switzerland's claim of having an exemplary retirement system that is the envy of the world, her only (and favourable) appearance in the paper is in a table about obesity ...

Thursday, December 11, 2008

XBRL final rule imminent

Well, we've got something wrong there, it seems. It wasn't the US SEC meeting deliberating on the final XBRL rule that was scheduled for 10 December, it was a Sunshine Notice to announce the SEC meeting of 17 December. But what's a week in the greater scheme of things ...

Speaking of which - it's interesting to note that one of the seven milestones on the road to IFRS adoption in the US is going to be improvement in the ability to use interactive data for IFRS reporting (p27 ff). Specifically, the SEC would look for a more detailed IFRS taxonomy in its 2011 review, presumably containing standard industry extensions. Thus, XBRL has just been hiked up to a critical priority in a strategic project.

Monday, December 08, 2008

Death and taxes ...

This is an excellent presentation by Governor Jens Thomsen of the National Bank of Denmark, on how to hedge and invest in an environment where average life expectancy rises by over 5 hours every day. He proposes that governments should issue more ultra-long term bonds to create a hedging substrate for that time horizon. 

What Thomsen does not address, however, is the challenge to such instruments arising from an investment environment with massively higher government debt, as it is foreseeable in many countries. The temptation to apply the inflation tax to reduce such debt may be overwhelming, which is why such ultra-long bonds should be issued with an inflation protection.

Friday, December 05, 2008

XBRL final rule imminent?

I've been looking for a confirmation of what David Blaszkowsky of the US SEC said during yesterday's XBRL conference here in Warsaw, namely that he'd been given clearance to announce a Commission meeting to be held on Wednesday, December 10, during which a final XBRL rule will be discussed and possibly approved - but I couldn't find anything, yet. So, there's something to look forward to next week ...

Tuesday, December 02, 2008

Accounting politics

On Saturday, Finanz und Wirtschaft has published an article of mine in which I discuss the background to the current tensions in accounting politics between the EU and the IASB. To the casual observer, this conflict may look like it is entirely related to the financial crisis, but it is more about the independence of the IASB than anything else. That's where the interest of every investor should come into the equation.

Tuesday, November 25, 2008

Highlights from XBRL conference

Highlights from the CFA Institute conference XBRL for Investment Professionals, held on 26 September in London, are now available as podcasts from the CFA Institute. They are available for free to CFA Institute Members, just login with your usual credentials.

P.S. They are not free to Members, just to conference participants ... sorry!

Sunday, November 23, 2008

IORPs up 46%

The number of cross-border IORPs active in the EEA has risen from 48 to 70 over a time period of 18 months, according to CEIOPS' 2008 Report on Market Developments. Cutoff dates were January 2007 and June 2008, respectively. The bulk of those cross-border plans is still focused on the country pair Ireland - UK, representing 50% of all plans, down from 60% on last count. Most of the activity happened in Austria, Belgium and Luxembourg. Removing the basis effect of plans that have been in operation prior to the implementation of the Pensions Directive, the growth in plan numbers increases to 244%.

While it's good to see some activity picking up, it's still too slow to constitute significant momentum, even if rebased.

Wednesday, November 19, 2008


Head over to the Data Interactive blog for an interview with me about XBRL from an investor's perspective - and don't forget to come back! 

Friday, October 31, 2008

Victims of the Crisis (I): XBRL?

This is the first installment in an loose series about victims of the current market crisis. We'll do a triage of the patient with a bit of a health check for cases of potential resilience. To be sure: we don't think the crisis is over ...

Just a few months ago, the XBRL bandwagon seemed unstoppable, set to take the world of financial reporting in a storm. Now,  we're not so sure. The all-important US SEC rule to make XBRL mandatory for US filers is overdue, and some doubt whether it will be coming forth at all, given the SEC's backlog of far more urgent things to do and only a few more weeks to go until the administration changes. 

On top of that, XBRL is increasingly seen to acquire a stigma of failure in the public eye because it is often identified as the hobby horse that detracted Chairman Cox from attending to his real job, for which he is under heavy fire. If that stigma persists, then Mr Cox' successor may be loathe to finish up, even if he were to share a similar level of enthusiasm for XBRL (which is a tall order). 

The user community is well known for suffering from ADD, so if the momentum of the move towards global XBRL disclosure is seen to be broken and availability of comprehensive XBRL coverage becomes a thing of the distant future, it will quickly loose what little interest it has had so far.

All that being said, the case for XBRL is as strong as ever. In fact, if accounting standards convergence is on the back-burner for the foreseeable future (more on that in a later installment), then a new use case for XBRL as a meta-standard for comparison and valuation purposes could emerge. 

Tuesday, October 28, 2008

Innovative ways of financing retirement

In this day and age where financial innovation is (wrongly!) blamed for the end of capitalism and the world as we know it lock, stock and barrel, the title of SwissRe's latest edition of Sigma is courageous. Nevertheless, it is a comprehensive assessment of the growing role that insurance will have to play in the provision of old age retirement funding, where insurance is to be understood in a functional rather than an institutional sense. 

An important section of the study is dedicated to managing retirement product risks. Longevity risk is identified as prominent among them, but its management is limited by the rather shallow depth and breadth of longevity risk markets. Notably absent from that section, however, are considerations on valuation techniques. If there is one thing that we can learn from the current crisis, then it is how crucially important it is to value & stress test innovative products properly over their entire life cycle.

Wednesday, October 22, 2008

XBRL for Investment Professionals

It's nearly a month that said conference took place in London, and I have yet to blog about it ... some of the reasons for that delay probably coïncide with the reasons why a relatively small group of less than fifty professionals came together for an event that has been organised by CFA Institute, EFFAS and the IASCF, namely current market dislocations. In the face of that, an infrastructure undertaking such as XBRL takes second place with many.

Nevertheless, participants tended to be quite happy with the conference and commented favourably on the quality of the audience as well. The relatively small size of the audience made it possible for the audience to interact with each other and to participate actively in the Q&A session, which is very helpful when you're the moderator ...

Here are the presentation slides. It's a pity that David McGraw's slides are not available, because his and Homi Byramji's presentations struck a strong chord with me. In David's case it was the breadth of the potential applicability within a leading institutional investor's processes, and the challenges that XBRL has to respond to (data governance!), whereas Homi was demonstrating clearly that, other than Encyclopedia Britannica, Thomson Reuters is not going to be asleep on the wheel in the face of the challenge to the middle man posed by XBRL. Personally, I am fairly confident now that XBRL is a sustaining innovation for information intermediaries. 

Shortly before the conference, Finanz und Wirtschaft published an XBRL update that I wrote. And there is one more update: XBRL CH is now officially a provisional Jurisdiction!

Deconstructing financial mythology

In its aptly numbered working paper 666, the Minneapolis Fed deconstructs (for the USA) what it claims to be the following four credit crisis myths from publicly available data up to 8 October 2008:
  1. Bank lending to non…nancial corporations and individuals has declined sharply.
  2. Interbank lending is essentially nonexistent.
  3. Commercial paper issuance by non-financial corporations has declined sharply and rates have risen to unprecedented levels.
  4. Banks play a large role in channeling funds from savers to borrowers.
There is not much reading to do as the authors rely on graphical evidence. (via MR)

P.S. And here's follow-up ... I'm sure there's more to come.

Tuesday, October 21, 2008

Confidence in accounts

Today's FT has an article referring to a letter that we've co-signed. The letter's signatories object to the ongoing political activism to relax accounting standards relating to the measurement of financial instruments. 

I am concerned that this is the most ill-conceived part of ongoing bail-out activities, which have started on a wrong footing and which threaten the long-term functioning of capital markets through political interventionism rather than a calm hand. Corporate accounting is aimed to reflect economic reality, and thus must not be subject to political fiat. The current thrust of activism aims to put the ostrich's head back in the sand. But guess what - it doesn't belong there! The consequence of such ill-advised changes would be that users of financial statements will loose confidence in corporate accounts, which is expressed directly in valuations. So, the effect will be contrary to intentions.

Sunday, October 19, 2008

Truth or dare?

EDHEC has made available an interesting survey of current European investment practices, comparing actual practice with recent state of the art in the investment literature. It's a feature of such a survey that practice cannot really look all that good since there will invariably be a time lag between conceptual groundworks and practical implementation. But it transpires from the results that practice does not seem to look to finance literature for competitive advantage by implementing the latest innovations, such as how to handle tail risk.

This conservative approach is probably due to a behavioural bias in the investment community to avoid the risk of being wrong and alone, and it is not likely to change anytime soon, what with the bad press that financial innovation has these days. But in true contrarian spirit, I'd like to point you to this insightful praise of financial innovation.

Consult the survey and compare it with your firm's practice for your own private game of truth or dare ...

Thursday, August 28, 2008

Evaluating short extension funds (130/30)

The current issue of the FAJ has a great piece about How variation in signal quality affects performance. On the face of it, the article deals with the generic perception that any relaxation of investment restrictions (read: long only) will invariably result in better performance. This is the selling proposition of currently fashionable 130/30 funds. But it doesn't - or only in the special case of an information coefficient which is stable over time. Managers with unstable ICs will see their performance deteriorate with increasing short positions. 

This approach delineates a way to help evaluating 130/30 funds which do not have a long enough track record in the product (i.e. the majority of vendors), but a more significant one in long only mandates. If that track record were to exhibit an unstable IC in long only portfolios already, then there might be a problem in the short extension.

Tuesday, August 26, 2008

Prediction markets

Let me be explicit from the start: I have a problem with the judgmental connotations of the term speculation. In my view, there is no meaningful distinction between investing and speculating. Investing as well as speculating is about the assumption of risk in return for the uncertain possibility of reward. There is only inappropriate investment or speculation, but not bad speculation per se. 

The cause for these rather philosophical considerations is my interest for prediction markets such as intrade, where you can effectively trade in all sorts of event probabilities. Literature has it that predictions produced using a bid/ask mechanism with real money will be of significantly better quality than survey forecasts for instance. Naturally, they cannot tell the future, but they will be more efficient at processing all currently available information than any one expert. Therefore, these markets serve two important purposes: If reasonably liquid, they offer high quality, quantified predictions of event probabilities of presidential elections or hurricane landfall severities, and they offer a hedging possibility, although the liquidity is definitely a limiting factor there at this point.

It is very timely that the CFA Institute has just published the results of its last Monthly Question survey about prediction markets. 65% of respondents think that such markets offer valuable information, and a majority of 54% think that they are fit for investment purposes (mostly hedging).

Tuesday, August 12, 2008

Challenges in Quantitative Management

At last, I got round to finishing Challenges in Quantitative Equity Management, a freely available CFA Institute Research Foundation monograph by Fabozzi, Focardi and Jonas. The book is based on surveys and conversations with practitioners of quant management, capturing the collapse in industry outperformance following the summer of 2007. I was particularly interested to find out whether there would be any attention paid to XBRL, which I suspect should be quite relevant to quant management, but it wasn't even mentioned throughout the book. That's not to say it is considered to be irrelevant: Too many people using similar models and the same data was considered to be one of the major challenges to the quant approach going forward. 

Nevertheless, it is a worth while read for a number of thoughts and discussions, such as the distinction between quantitative and judgmental investment processes, the style correlation of quant management (which tend to be value-driven), the negative correlation between fund capacity and alpha-generation and, last but not least, the adaptive markets hypothesis as opposed to the efficient markets hypothesis. 

Wednesday, July 23, 2008

Swiss management of longevity

Influential Swiss newspaper NZZ has a good article (in German) about how Swiss Pensionskassen manage their longevity risks, i.e. not very much. The article claims that due to the usage of backward looking mortality tables, the longevity of members is systematically underestimated in a world of continuously rising longevity. Unfortunately the article does not take into consideration the experience in more advanced countries such as the UK. This is a valid issue which receives too little attention because of a rigid regulatory environment in Switzerland where many important parameters are politically determined with little consideration to factual developments.

Tuesday, July 15, 2008

A Plunge Protection Team?

While certainly no friend of conspiracy theories, I feel distinctly uncomfortable reading this well documented piece by a reputable source about the US government's alleged involvement in undercover equity market manipulation, a.k.a market stabilisation, in the name of national security (via naked capitalism). 

Monday, July 14, 2008

The fair value mindset

I like what the Chief Accountant of Xerox is reported to have said at the recent SEC round table on fair value reporting - but probably not in the way he would like me to. In essence, he says that fair valuing financial assets/liabilities is ok, whereas for operational items of non-financial firms it is not as it introduces volatility beyond the firm's control - they are used to mixed attribute accounting. And "managers will have to train themselves to think like market participants rather than operations experts". 

There is a lot to discuss there - but I'll try and make it short. Even operations experts should eventually think like market participants because economically, they need to take into account opportunity costs of their operational decisions, not least because their successor (average tenure, anyone?) or their boss might think like market participants ... Externally induced volatility is not a problem if it is real (and not an accounting artefact introduced by mixed attribute accounting), because it can be filtered, and users build confidence when they see it. Operational performance still remains visible. They like mixed attribute accounts? How dare they perform even the most basic arithmetic operations on numbers that do not have the same measurement attribute? Because it has been done for a long time and they are used to doing it does not make it any more sensible. So yes, I am in favour of full fair value, because financial reporting is made for users, not for managers. But I agree, there are some transition issues.

Tuesday, July 01, 2008

CEIOPS State of Pensions Report

CEIOPS' Report on financial conditions and financial stability in the European Insurance and Occupational pension fund sectors has a good section (starting p. 22) about recent developments in the European pension funds market, giving insights into last year's changes in a number of countries and a statistical overview, based on Eurostat.

Monday, June 30, 2008

CFA Institute Code for Pensions

The CFA Institute has published a Code of Conduct for Members of a Pension Scheme Governing Body. The Code is intended to guide the behaviour of individuals sitting on governing bodies of pension schemes worldwide (ASIP has contributed, among others), which is why its principles are worded rather generically (see IPE story). Go to the comments section for more detailed explanation.

I find Fi360's Periodic Table of Standards of Excellence to provide a great complementary overview of best practice.

Optimised reporting with XBRL

Together with Denis Füglistaler of Infinys, I wrote an article (abstract - in German) for IRZ. Thankfully, the editor has dedicated a friendly editorial to our article.

Sunday, June 29, 2008

The nemesis of pensions?

Is this man the nemesis of funded retirement systems? At any rate, Aubrey de Grey's work on life extension by regarding ageing as a curable disease gains increasing attention and traction, as witnessed by a veritable burst of recent media coverage such as Wired's. If his claim that life expectancy of about 120 years may be achievable to currently living generations, this would indeed pose a major challenge to retirement systems which rely on predictable mortality tables that shift slowly. Hence this space is certainly worth while watching for black swan risks.

Thursday, June 19, 2008

XBRL for Investment Professionals

The CFA Institute, EFFAS and the IASC Foundation are hosting the first XBRL conference for Investment Professionals in London on 26 September 2008. Thanks to the recent rule proposals of the US SEC applicable to corporate filers and mutual funds, there should be a lot of interest in that topic. Registration is now open!

Thursday, May 22, 2008

XBRL in Plain English

A nicely done video on the benefits of XBRL - but it may promise a bit more than accounting standards can deliver. Worth watching nonetheless!

Sunday, May 18, 2008

Failed Pensions Directive?

The Pensions Directive has failed and should be replaced by a new version as quickly as possible, according to a panel discussion reported by IPE last week. The reasoning is that at this point, there are only five new cross border pension schemes in operation.

While I agree that the market response to the new opportunities offered by the Pensions Directive has been slow to date, talk of a "new" pensions directive is counter-productive in my view. The retirement industry has an unusually long time horizon, it is therefore not prone to hasty moves, especially not in the presence of regulatory uncertainty. As the CEIOPS Initial review of key aspects of the implementation of the IORP directive showed in April, there are important aspects that require legislative attention, thus the transposition of the pioneering project that is the Pensions Directive, while formally finished, is not complete. 

The Pensions Directive can be improved, but improvements should be approached in a gradual manner, as it is highly unlikely that IORP II could bring pan-European harmonisation of retirement systems. Hence impediments to cross-border schemes, such as taxation issues, need to be removed one by one. The attractiveness of cross-border schemes should be increased by expanding the scope of the Directive's applicability. Surprisingly, this is not part of CEIOPS' conclusions, but as described earlier, an important segment of several Central & Eastern European countries' mandatory occupational retirement schemes lies outside of the Directive's scope. This unfortunate omission is due to the fact that these countries did have no part in the preparation of the Directive prior to their accession to the EU. 

Saturday, May 17, 2008

nomos vs. thesis

High quality private banking investment commentators with an independent mind are few and far between. The most prominent instance in the Swiss market is Konrad Hummler, partner of Wegelin & Co. His monthly investment commentary is well considered, independent and often controversial - and available in English. The current May issue deals with the moral hazard of banking supervision in its current zero failure mode. Recommended reading.

Wednesday, May 14, 2008

XBRL becomes mandatory in US

According to this story, the long awaited US SEC decision has finally materialised today: XBRL disclosures are to become mandatory in the US for firms with a market capitalisation larger than USD 5 bio from the closing of the current fiscal year. All other firms will have to follow suit by 2010 (first XBRL filings). Non-US domiciled firms listed on US markets and reporting using IFRS will have to start disclosing in XBRL starting 2011. This is quite an ambitious time frame, indeed, but we don't complain as the use of interactive data by investors can only take off once the data is actually available.

Update: Here is the official press release.

Monday, May 12, 2008

Financial anti-matter

The recent paper "Is Managed Futures an Asset Class? The Search for the Beta of Commodity Futures" approaches this extraordinarily timely question from an unusual angle: practice. The fashionable economics ingredients promise to make it no less appealing: behavioural finance, disequilibrium and reflexivity theory. The authors question some of the most basic assumptions of the commodities futures markets and propose a hedging response model that distinguishes between four different market scenarios which may result in markedly different systematic roll returns. While the predictive value of this model is not immediately obvious, its ex post explanatory power is quite impressive. Most surprisingly, it is a good read, too. Here is their answer to the question: 
Answering our own question is managed futures is an asset class? It is anything, but ... If anything, it is the "anti-asset class". It is an observable materialization of behavioral finance, where risk, return, leverage and skill operate un-tethered from the anchor of an accurate representation of beta. In other words, it defies rational expectations equilibrium, the efficient market hypothesis and allied models—the CAPM, arbitrage pricing theory or otherwise—to single-handedly isolate a persistent source of return without that source eventually slipping away. (...) Unbeknownst to modern finance, the commodity futures markets may be the shoals against which rational expectations equilibrium, the "de facto ruling paradigm of financial economics," is eventually shipwrecked.

In view of this and particularly this, it may perhaps be time to indeed revisit one's CF long exposure, which has been entered into on the possibly naive assumption that the futures markets are tightly monitored net zero sum games that have no impact on the spot markets. 

Sunday, May 11, 2008

Analysis of competing hypotheses

The US Central Intelligence Agency's reputation for analytical accuracy may have been tarnished lately, but nevertheless it can provide useful generic tools for analysis under uncertainty. The chapter on Analysis of Competing Hypotheses from the publication Psychology of Intelligence Analysis is such a case in point: it describes in some detail the procedure how to arrive at the most likely hypothesis by way of analysing competing hypothesis, knowing that - against intuition - the hypothesis with the least evidence against it is often the best guess. The rigour of this approach may be excruciating, but it is also the most promising in my view.

Friday, May 09, 2008

Finance 2.0

I've had the great pleasure and privilege of presenting the CFA Institute Comprehensive Business Reporting Modell as well as its position on XBRL to the 17th XBRL Conference in Eindhoven. Needless to say that this was also a great opportunity to share & discuss some thoughts about the future path of financial research with participants. 

The slides of my presentation are available here, but I'm already in the process of reworking them, taking on board new ideas from the peer discussions. My thinking goes along the lines that XBRL will be a disruptive force in finance eventually, but not in the immediate future as data intermediaries are well positioned to leverage their incumbent interfaces with the cheaper and faster fundamental information. For them, XBRL will be sustaining - for a while. That also means that most professional investors - at least those on the sell side - will not care much about XBRL since they are receiving the goods indirectly via improved third party providers. Disruption will come to them by other means, however ... I am looking forward to this conference in the fall, which should firmly establish the debate among investment professionals.

Sunday, April 13, 2008

No benefits to CFOs?

We've been talking about XBRL scepticism earlier, concluding that the instances referred to were not to be taken overly seriously.

This story (again!) is different, though, even though it has its shortcomings. Where it is probably spot-on is in the statement that preparers presently have little to no benefits from the implementation of XBRL as there are no tested ERP applications that truly integrate XBRL at this point. So all (complex) XBRL preparation will be done in a bolt-on fashion.

This is probably true for the time being, until the SAPs and Oracles of this world actually integrate XBRL GL into their products fully. On the other hand, the integrated approach of XBRL adoption is usually referred to as the most expensive one, thus the intermediate bolt-on solution will result in little additional expenditures.

The story gets much more disputable where it goes into the benefits for analysts. It quotes the FEI as poking holes in the other purported benefits of XBRL by insinuating that "The organization predicts XBRL could instead lead to analysts receiving excess information." This is an undue truncation of an admittedly complex, yet valid point made in the FEI's comment letter:
We believe we may be creating a situation where preparers will be providing more information than the analysts want (versus key information/data), later than when they need it (to update their models), thereby missing the real window of opportunity which is likely when a company releases its earnings for the quarter. Strategically, the long-term direction of this project needs to be determined and communicated − is it to upgrade the manner is which data is filed with the SEC or is it to provide (key) information to investors and analysts for their use?

Thursday, April 03, 2008

Pensions Directive Review

As a precursor to the EU Commission review expected later this year, CEIOPS has published its own Initial review of key aspects of the implementation of the IORP directive. The main conclusions (from the press release) are:
  • there is considerable diversity in the way some key aspects of the IORP Directive have been interpreted and implemented;
  • there is little evidence of major issues arising from these differences;
  • given early days and limited experience of the Directive's implementation in some areas, it would be premature to recommend changes to the Directive.

  • More to follow ...

    Wednesday, April 02, 2008

    Pensions webcast

    In yet another effort to increase its accessibility, the IASB makes its first ever recorded webcast about its recent pensions DP available to the public on its pensions project site. The webcast had about 120 participants and the included Q&A session was rather good.

    I think that the IASB ought to add public webcasts to its ongoing projects due process. The ease of (global) participation and dialogue would enhance the reach of the IASB's due process to a new group of users (of financial statements) which was hitherto unreachable due to lack of time and attention.

    Monday, March 31, 2008

    Reducing Complexity

    The IASB has made its discussion paper Reducing Complexity in Reporting Financial Instruments publicly available now. As complexity is a charge often raised against current accountancy trends by people who are either not aware of or uncomfortable with the more conceptual approach towards accounting used by the IASB, it would be interesting to observe the conclusions drawn in that paper. To make a long story short, I am quite happy with the outcome, namely that the DP accepts that fair value "seems" to be the only measure that is appropriate for all types of financial instruments, then going on to list no less than 24 different measurement methods for financial instruments (table 1). Some random thoughts in that context.
    Complexity is bad. That seems to be the tenet of the proponents of reducing it. I tend to disagree, however. In line with Einstein's razor, there is a place for complexity in financial reporting where it faithfully represents economic reality. Complex economic reality necessitates an adequate level of complexity in its description, lest it over-simplifies. Where, however, complexity is merely a consequence of accounting artefacts, it may safely be dispensed with.
    Fair value vilified. It is interesting to observe how some people try to make a case against fair value from the current financial market crisis, even though it is quite obvious that this is a clear case of trying to kill the messenger. This position is particularly difficult to understand coming from people with a background in engineering or science. There, it's evident that two variables can only be combined if they have the same unit of measurement: you cannot add metres and kilograms. In accounting, though, that seems to work just fine - it's currency units, after all. Or is it? Notionally, it certainly is, but I'd challenge anyone out there that a $'s worth of an asset measured at cost is very different from the same $ measured at, say, fair value. In short, the unity of measurement is an illusion under the mixed attribute model.

    Saturday, March 29, 2008

    Multilocal pensions?

    While not at all intended for that particular function, the McKinsey Quarterly Managing Cross-border Functions is a useful stimulus to consider the different organisational options in setting up a pan-European pensions operation. Clearly, the regulatory context may play a more prominent role than in many other industries, but this is not a qualitative differentiator.

    Wednesday, March 26, 2008

    Counterparty risk in credit markets

    As pension funds increasingly seek to efficiently manage their balance sheets, they invariably come to rely on OTC derivatives, by way of which they become exposed to counterparty risk. On 20 February, thus shortly before 16 March which saw the US Fed-assisted emergency neutralisation of Bear Stearns counterparty risk, Barclays Capital issued a research note that assessed the transmission vectors and systemic fallout of a major counterparty's default. The knock-on effects due to immediate re-pricing of credit risk would amount to an estimated USD 36 - 47 bio for an imputed outstanding notional of USD 2'000 bio. Bear Stearns' notional was well over six times that number.

    Monday, March 24, 2008

    The (Mis)Behaviour of Markets

    Benoit Mandelbrot's The (Mis)behavior of Markets: A Fractal View of Risk, Ruin and Reward (2004) is quite an intriguing read during these days of murderous market volatility. The list of his Ten Heresies in Finance goes a long way in giving a hint of his thinking, which is centred around his claim that the use of normal distributions in financial market modelling is a capital mistake:
  • Markets are turbulent.
  • Markets are very, very risky - more risky than standard theories imagine.
  • Market timing matters greatly - big gains and losses concentrate into small packages of time.
  • Prices often leap, not glide. That adds to the risk.
  • In markets, time is flexible.
  • Markets in all places and ages work alike.
  • Markets are inherently uncertain, and bubbles are inevitable.
  • Markets are deceptive.
  • Forecasting prices may be perilous, but you can estimate the odds of future volatility.
  • In financial markets, the idea of Value has limited value.
  • Don't miss!

    On Thursday, 27 March the IASB is going to release its long expected discussion paper on post employment benefits. Don't miss IASB member Steven Cooper's live web presentation introducing the discussion paper from 1200h to 1230h (UTC). You can register for the event here.

    It may be interesting to compare the IASB's position to the previously released paper of the UK ASB on the same topic. My guess is that the ASB's position will prove to be more aggressive, especially with regards to the highly controversial use of risk free interest rates to discount pension plan liabilities.

    Wednesday, January 30, 2008

    Oil money

    The McKinsey Quarterly has a great piece on The new role of oil wealth in the world economy. For me, this raises two broad issues. The first one is a continuation of the closing concern of the piece, namely the question whether higher oil prices can be good for the world economy. I think on a macro-level, this is possible. As long as the majority of the oil revenue is re-funnelled into the financial markets (i.e. is not being spent for consumption), it is tantamount to (forced) higher savings by net oil consumers with - admittedly - an ownership transfer of those savings to oil producers. So, oil producing countries build capital in lieu of the US citizen. 

    Secondly, Sovereign Wealth Funds (SWF). These vehicles have captured a lot of attention lately. Unjustly so, in my view. The operational question is: What is the difference between SWF and regular institutional investors of the same size? Allegedly, the SWF is sovereign, i.e. it is controlled by (typically foreign) politicians who cannot be trusted to have commercial interests only. This argument is moot for two reasons: 1) regular institutional investors (especially, but not exclusively of foreign origin) may not only be motivated by strictly commercial reasons either, and - 2) if a controlling investor in a country's strategic asset abuses her property rights, the country of residence can, as a rule, limit that investor's property right, which is a function of the country's legal framework. Such ad hoc interventions are much preferable to introducing permanent limits on the free flow of capital, which invariably will create costly distortions.

    Monday, January 21, 2008

    New pensions accounting to raise volatility reports Georgia Tech Financial Analysis Lab's research on The Effects of Enacted and Proposed Pension Accounting Changes On Leverage, Profitability and Earnings Volatility, in which researchers simulate the impact of probably forthcoming accounting for pensions changes in the US on the DJIA components' income statement, extrapolating FAS 158 numbers to be run through the income statement. Unsurprisingly, they find a huge impact on the volatility of reported earnings, among other items and ratios. In the 2002-2006 period, volatility effectively doubles. 

    As FAS 158 is likely to inform the ongoing work on the revision of IAS 19, this kind of research is valuable for European users, too because it allows us to get used to different accounting treatments resulting from fair value accounting. It is important to keep in mind that these accounting rule changes will bring reported numbers much closer to economic reality than current accounting treatment ever can. If this increasing transparency leads to more sustainable risk management policies in enterprise sponsored retirement plans, then so much the better. Users of financial statements will be able to adapt their interpretations of the numbers in any case. 

    Sunday, January 20, 2008

    Assurance cost and disclosure neutrality

    Here is the cross-post of a short entry that I wrote for the Data Interactive Blog.

    Skepticism about XBRL seems to abound lately, although most of it is easily soothed. One issue stands out that may raise the hackles of preparers particularly: If XBRL were to have the same costs as Sarbanes-Oxley Section 404 implementation because of independent assurance, as one Reuters story suggests, that would be a big No-No indeed.

    However, looking at the Committee’s draft memo (page 75 and after), such dramatic headlines need to be taken with a ton of salt. Substantive assurance costs (if any) are likely to arise only if the production of XBRL formatted data were implemented in the least competent way imaginable, i.e., by means of what might be described as a parallel XBRL track of accounting. To assume that this is the default practice would not exactly reflect high expectations with regards to the professional competence of finance departments.

    One of the basic tenets of XBRL disclosure is that it is in fact disclosure neutral, i.e., the numbers displayed in an XBRL instance document are identical to what is reported on (electronic) paper. For as long as XBRL filing is not the exclusively permitted way of filing, assurance of disclosure neutrality probably satisfies the needs of most users of financial statements. In a reasonably well structured accounting & auditing cycle, such assurance should come cheaply.

    Tuesday, January 08, 2008

    XBRL Skeptics (sic) Abound?

    In evaluating the viability of any innovation, it is crucial to keep an open mind (some call it paranoia) about its limitations and critical issues. From that point of view,'s piece about XBRL sceptics is comforting reading. The doubts offered there are really quite immaterial: The luddite accountant's view that financial analysis is an art rather than a science, for the exercise of which he needs the entire statement is answered crisply: you can have that, too. The reason why XBRL will hardly take off without regulation is easy to explain: It will only become really useful once all preparers issue their information in that standard, and that will not happen spontaneously. Without it being useful, preparers have an easy case to make against going to the effort. Classic chicken and egg. The other points raised are transient in nature. 

    What I am more concerned about is the need for a consistent evolution of XBRL taxonomies within a coherent architecture, and the restrained use of X, i.e. eXtensibility, by preparers, lest XBRL documents become too complex to be useful. That is where scepticism is appropriate and healthy - but whether it is justified we will only be able to see further down the road.

    Sunday, January 06, 2008

    Longevity concerns

    The Economist brings us up to scratch on Abolishing Ageing, highlighting those areas of medicine which directly address ageing itself. For obvious reasons, this is an area of science that the retirement industry needs to watch closely, even though the current trend towards widespread obesity would not suggest that the most immediately promising approach of caloric restriction could win a popularity contest. But it could, once the side effects of caloric restriction (i.e. near starvation) are removed. Even so, the UK industry prepares for even higher longevity - some mortality tables expecting the average 65-year-old to live to 100 and beyond by 2050. 

    It is therefore apprpriate that the finance industry provides tradable longevity indices, such as Goldman Sachs' QxX family, or JPMorgan's Lifemetrics toolkit. Credit Suisse's Longevity Index does not appear to be directly accessible on the web. 

    Wednesday, January 02, 2008

    The future of public pensions

    Richard Ennis' article in the current issue of the Financial Analysts Journal may be aimed at the ailment of US public pensions,  but its tenets are equally applicable to European (including Swiss) public pension plans as well. A key issue is that of valuation, where current actuarial valuations are traditionally predominant under the pretext of perennial solvency of the state sponsor. Ennis convincingly demonstrates that the "issues are the value of the obligation, the cost to extinguish it, and on whom the burden of that cost falls. In a word, the concern is accountability." From a Public Choice perspective, his tenets are unlikely to be put into action just now, unfortunately. The increasing gulf between public and private pensions will have to get wider before this can be addressed fundamentally.