Thursday, July 29, 2010

MSCI job cuts – the shape of things to come?

With the recent wave of consolidation in the ESG research sector, news that MSCI will cut as many as 80 jobs as the index company combines its operations with research house RiskMetrics, doesn’t come as a big surprise. However, could this be the beginning of a troubling trend for social investors?

The consolidation merry-go-round started in 2009, when RiskMetrics acquired both Innovest and KLD Research & Analytics before RiskMetrics itself was scooped by MSCI earlier this year.

Closer to home, Toronto’s Jantzi Research teamed up with European research firm Sustainalytics in September 2009.

Earlier this month, The Corporate Library and GovernanceMetrics International (GMI) announced a merger. Analysts note that the two were perhaps the last, relatively large independent companies in the ESG research field.

Consolidation is a fact of life in the broader financial services industry, and it almost always comes with job cuts. Should we expect ESG research firms to act differently simply because they analyze companies based, at least partially, on the way they treat their employees? Probably not. It’s important to remember that ESG research is a business, like any other, and needs to be profitable to survive.

But there is a risk that this could become the old “Do as I say, not as I do” conundrum if ESG researchers violate their own policies for other companies in areas such as job security and employee rights. In a world where transparency and open dialogue are paramount, you not only have to do the right thing, but have to be seen as doing the right thing.

So, how many jobs cuts are acceptable in this new world of consolidation? And will it affect the quality of the research itself? Many SRI mutual fund companies rely on this kind of research, and they will soon have fewer choices. That doesn’t necessarily mean the quality of the product will suffer, but we’ve certainly seen examples in other industries where the big players feel free to bully their customers, simply because they know they can.

And then there’s the next generation of ESG and SRI financial analysts. Will they now be thinking twice about joining an industry dominated by a handful of large companies where job opportunities are limited?

Food for thought in the lazy days of summer. Comments are welcome.

Wednesday, July 14, 2010

The Big Short

Michael Lewis has an outstanding ability to take the complex and opaque world of the capital markets and translate it into an immensely readable story. He’s done it again in The Big Short, the story of how sub prime mortgages became A rated mortgage backed bonds, those bonds became Collateralized Debt Obligations, and from those CDOs were created synthetic CDOs. If you wanted to hedge your exposure to the CDOs, you bought credit default swaps on them. And when that towering pyramid collapsed…well, this is the story of the people who saw it coming and shorted the subprime mortgage market.

The Big Short follows several characters who watched as more and more mortgages were issued to people who clearly had a limited ability to repay them, the sub prime borrowers. And how these characters, some Wall Street insiders and some on the edges, realized that the opportunity in front of them, to bet against the sub prime gong show, would make them huge amounts of money.

Being the capital markets nerd that I am, this book was a page turner for me. I'll happily choose this stuff over John Grisham any day. As I read on though, in addition to wanting to see how it worked out for the protagonists, and Mr. Lewis does manage to create some suspense about that, two thought provoking themes emerged.

The first was how the ability to make big money and walk away drove Wall Street to create more and more arcane instruments that were increasingly divorced from their underlying collateral. Fees were booked as each deal was done, and the outrageous compensation was paid out almost immediately. These people had no incentive to think about what would happen to these vehicles 3 months down the road, let alone three years. One of the more innovative ideas around managing risks from financial derivatives is to make the creator of the product keep some percentage of it, say 30%, on their books. That would certainly have forced the investment banks to take a closer look at the CDOs they were selling.

The second is that even though those who shorted the sub prime market made a great deal of money, they didn’t rejoice. They were saddened by the moral failure of the people working in the capital markets. One of the characters we follow through the book, a hedge fund manager, says “I have a job to do. Make money for my clients. Period. But boy, it gets morbid when you start making investments that work out extra great if tragedy occurs.” This is Michael Lewis’s angle, and perhaps one of the reasons I enjoyed the book so much – that people who run money have a moral obligation to society - “the truly profane event (is) the growing misalignment of interests between the people who trafficked in financial risk and the wider culture.”

This is an excellent book about risk and reward, clear and understandable, with themes that figures prominently in the hearts and minds of the SRI community.

Friday, July 9, 2010

Risk and Reward - executives, shareholders, society

"Two years on from the global financial crisis, these tough new rules on bonuses will transform the bonus culture and end incentives for excessive risk-taking. A high-risk and short-term bonus culture wrought havoc with the global economy and taxpayers paid the price. Since banks have failed to reform we are now doing the job for them", said British MEP Arlene McCarthy (S&D).

The European Parliament passed new rules Wednesday capping cash bonuses and requiring 40 to 60% of any bonus to be deferred for at least 3 years. For those of us who saw as a silver lining in the sub prime mortgage debacle the ability to address problems in the financial services industry, this is a welcome effort.

The EU’s bank capital rules will now cover executive compensation. In addition there will be stricter capital rules on bank trading activities. According to the EU ‘Studies show that the rules are expected to lead to banks having to hold three to four times more capital against their trading risk than they do at present.’ The proposed senate legislation implementing the Volker rule addresses similar issues, limiting proprietary trading and investment activities at US banks.

Ideally, this is just the beginning. It is not only the interests of shareholders that should be protected, but the interests of all stakeholders. In an analysis of alignment of interest between executives and shareholders, Thomas F.Cooley writing in Forbes concludes ‘But it is also important to understand what (the charts) don't tell us. They say nothing about the appropriateness of the levels of compensation in any of the sectors, or disparities between the largest players and smaller companies. Further, these charts don't say anything about the alignment of managers' and shareholders' interests with those of society or taxpayers.

The latter is a particularly troublesome issue when we are talking about banking and finance. At the heart of the anger about bankers pay is the very legitimate concern that the bankers and their shareholders and debt holders benefit from a subsidy paid for by taxpayers--the subsidy that is implied by the notion that they are too big to fail. That subsidy empowers them to take bigger risks and earn bigger returns for themselves and their shareholders with all of the down side risk born by Main Street. That is the real outrage.’

Wednesday, July 7, 2010

CPPIB invests $250 million in oil sands company

The Canada Pension Plan Investment Board has purchased a 17% equity stake in Alberta’s Laricina Energy in a deal worth $250 million.

Laricina is a privately-held, Calgary-based company concentrating on the oil sands areas of western Canada.

“The investment is a very important endorsement for Laricina and we are excited CPPIB has shown confidence in Laricina’s management team and development strategy,” said Glen Schmidt, President and CEO of Laricina. “This is a strong testament to Laricina’s growth potential and continued progress towards building a leading in situ oil sands company.”

“Laricina has an experienced and proven management team and has strong growth potential from its world class resource base,” added AndrĂ© Bourbonnais, Senior Vice-President, Private Investments, CPPIB. “We are pleased to be making an investment that we believe will deliver attractive returns over the long term.”

In a press release, Laricina stated that “Alberta’s oil sands will continue to play an important role in the global energy mix for the foreseeable future and are vitally important to the Canadian economy, Canadian jobs and energy security. The oil sands industry as a whole is making dramatic progress in environmental management by developing practical technologies and the application of best practice.”

However, the Laricina deal is bound to be controversial, considering the CPPIB uses public dollars, in the form of funds not needed by the Canada Pension Plan to pay current benefits, for its investments. Industry news website Responsible Investor notes that earlier this year, the CPPIB opted not to support shareholder resolutions seeking environmental reports from BP and Shell on their oil sands projects. “It will come as a snub to campaigners who have urged large Canadian public pension plans to be more visible in addressing the whole tar sands issue,” Responsible Investor added.

The CPPIB is a signatory to the UN Principles for Responsible Investment and adopted its own responsible investing policy in 2005. At March 31, 2010, the CPP fund totalled $127.6 billion of which $22.8 billion was invested in private investments.