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.