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VOLUME IV: ISSUE VI

FEBRUARY 2014

THe STory of baSeL: TaKe THree

an overview of international regulators latest attempts at banking regulation


by William helmold
Following the global economics crisis of 2008, many
felt that stricter provisions for stability and regulations were
needed on the worlds financial institutions. From this international consensus for action, the third installment of the basel
accords, referred to as basel iii, was created and ultimately
ratified for implementation by the major economies of the
world. Currently, the united states and other ratifying countries are in the process of implementing basel iii, and are expected to reach full compliance by 2019.
the basel accords are recommendations for central
banks regarding regulations in the banking industry. the first

two editions of the basel accords were basel i and basel ii,
passed in 1998 and 2004 respectively. though largely surpassed and effectively superseded by basel iii, their approach,
or framework, for addressing banking stability is still promiemerging markets
turmoil
brendan Tsai
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basel three regulations


William Helmold
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INSIDE THIS ISSUE

nent in basel iii. they are created by the basel Committee on


banking supervision (bCbs) and date back to 1998 when
basel i was originally agreed upon. officially, the bCbs has
no direct legal authority in any particular country since it is an
international organization of central banks; however, in reality
it has significant influence over minimum banking regulations
because member organizations typically implement the
agreed-upon recommendations of the committee. one additional caveat surrounds the issue of enforcement. While signatory countries may pass the recommendations of the bCbs in
their own countries, the duty to enforce the passed laws also
falls on the respective countries. thus, the longevity of bCbs
recommendations is more a subject of political appetite than it
is of prudent regulatory oversight. Despite this, the bCbs is a
major coordinator of banking regulations among the top
economies of the world, and its basel accords play a vital role
in safeguarding the financial stability of the international
economy.
as a policy set, basel iii is unique from the various
national banking laws of the world because it focuses exclusively on the issue of banking institutions liquidity. basel iii
is especially targeted as a solution to the economic risks posed
by systematically important Financial institutions (institutions that the media commonly refer to as too big to fail),
though its provisions are often implemented for smaller banks
as well.
the major policy standard within the basel framework is the solvency ratio, calculated by dividing regulatory
capital by risk-Weighted assets (rWa). regulatory
capital consists of tier 1 Capital and tier 2 Capital. tier 1
Capital is core capital including equities and disclosed reStory continued on p. 3, see Basel
uproar in Denmark
Graham Jordan
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proFiting From
obamaCare
Kevin Lai
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february 2014

emerGinG marKeTS TroubLe--repeaT of 1998?


an analysis of the latest emerging markets turmoil
by brendan tsai
While recent signs of a bolstering u.s. economy
have encouraged the Feds recent decision to reduce its
monthly bond-purchasing program by another 10 billion,
the Feds decision may pose a serious problem to many
other countries in the global economy. specifically, recent turmoil in the emerging markets has fueled wider
concerns in the global markets, and has only been further
aggravated by slowing revenues from China and tighter
monetary policy in the u.s. in fact, the sharp selloff of
emerging market currencies over the past week have investors scrambling to withdraw their exposure at a record
pace according to barclays, investors are yanking
money out of equity funds specialized in this asset class
at the fastest pace since 2011.
Just how serious is this issue? benoit anne, global
head of emerging-market strategy at socit gnrale,
stated, global emerging markets are now trading in fullblown panic mode. moreover, according to epFr
global data, equity funds specialized in exposure to
emerging markets have returned $12.7 billion to investors
in the two weeks leading to January 29th, the largest twoweek outflow since the economic crisis of 2008. Furthermore, concerns about the fundamental policies and
economies of emerging markets have plummeted currency values, especially for countries heavily dependent
on commodities exports. Just last week, the peso plunged
by more than 15%, its largest drop in 12 years, and the
turkish lira tumbled to an all-time low of 2.27 per dollar
earlier in the month. in fact, some economists have
claimed that this years cash outflows from emerging
markets look eerily similar to those of 1997-1998, during
which multiple developing nations saw their economies
tank.
on a brighter note, however, most economists believe that this years selloff of emerging market currencies has not yet created a cause for panic. During
1997-1998, many developing nations borrowed heavily
on the dollar, making it very difficult to repay loans when
currencies dropped. Currently, however, reserves of foreign cash have grown by $7.7 trillion, according to tthe
economist. Furthermore, data from the international
monetary Fund (imF) show that account deficits are
smaller, foreign debt levels are lower, and exchange rates
are more flexible. a more flexible exchange rate regime
in emerging markets reduces the impact of disturbances
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generated from other countries, and gives authorities in


emerging markets more independence with their monetary policy decisions. because these measures create a
sturdier defense to protect against rapidly devaluing currencies, some argue that , emerging market nations are
better able to adapt to changing market conditions, even
with slower Chinese growth and lower monetary stimulus
in the u.s. negatively impacting export revenues.
it becomes clear then that the issues surrounding
future improvement in emerging markets hinge on developments within these countries and beyond. For now, increasing focus will be placed on those countries in
particularly bad shape, namely turkey and argentina, and
their leaders push for economic reforms in response to
the latest tumble of their currencies. in fact, over the past
week, several emerging markets have increased their

benchmark lending rate as an effort to compensate investors for the perceived additional risk of emerging market economies. turkey increased its one-week lending
rate from 4.5% to 10%, while south africa increased its
own from 5% to 5.5%, the first rate increase in almost six
years, according to the Wall street Journal. the fullblown effects of these changes have yet to be seen, and
economists around the world will be sure to take note of
the potential effects these interest-rate hikes have on the
growth of emerging market economies. While the imF
continues to hold the belief that emerging market
economies are better able to withstand tighter financial
conditions, it looks as though this belief will be put to the
test, especially as the u.s. and other countries continue
their steady drawbacks in monetary stimulus.
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february 2014
Basel, story continued from p.1
serves and is perceived as being a banks most steadfast store
of value. tier 2 Capital is supplementary capital and is generally a catch all for capital that is disqualified from tier 1.
risk-Weighted assets represent a weighted sum by risk-tovalue of all the assets that a bank owns. assets that are considered riskier, such as residential mortgage backed securities
(rmbs), are assigned a larger haircut in the risk-weighting
calculation than assets that are comparatively safe, such as
municipal bonds. under basel iii, this ratio has been made
more rigorous in three ways. First, the actual ratio has been increased from 2% to at least 7%. second, the definition of regulatory capital has been narrowed, making the ratio more
difficult to fulfill. third, risk-weightings have been reassigned
to generally increase the value of rWa by an average of 23%,
thus increasing the required capital that a bank must hold.
aside from the solvency ratio, basel iii introduced
other important ratios. among them are the leverage ratio
(lr), liquidity Coverage ratio (lCr), and net stable Funding ratio (nsFr). the leverage ratio is a simple ratio of assets and commitments to regulatory capital. under basel iii,

Many of the worlds largest banks, at


whom this legislation is specifically targeted, have unified together to weaken,
delay, and deny many of the new initiatives in the latest round of reforms.
the leverage ratio is not to exceed 33. similarly, the leverage Coverage ratio dictates how many assets a bank must
hold relative to its total net cash outflow commitments over
the next 30 days. Finally, the net stable Funding ratio is the
ratio of long-term financial resources to long-term commitments, where long-term is defined as anything with a lifetime
of more than one year. this ratio is never to exceed one.
When determining the value of assets and liabilities, a risk-adjusted process is used to reflect the likelihood that the assets
value will be present in a turbulent market. as with rWa and
the solvency ratio, commitments to rmbss and general
Corporate loans receive less preferable treatment than the
likes of sovereign debt.
the introduction of basel iii has not been without
criticism. many of the worlds largest banks, at whom this
legislation is specifically targeted, have unified together to
weaken, delay, and deny many of the new initiatives in the latest round of reforms. the most commonly cited criticism by
the banking industry is that stricter regulations will make
lending harder, and thus will severely hamper future economic growth. a second commonly cited complaint regards
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the cost of compliance. as global financial institutions are
forced to comply with more and more regulations, the costs of
ensuring legality in everyday operations has increased at a
staggering pace, damaging not only profits but the possibility
of entry to the market by new firms. in a 2013 speech, goldman sachs Ceo lloyd blankfein portrayed this sentiment,
saying, For more than a decade, larger size and complexity
were viewed entirely as synergistic and virtuous. however,
basel iii introduces a series of capital surcharges associated
with size and complexity that will effectively raise the barriers
to entry in some businesses, and force some institutions to be
more disciplined about their resource allocation. this indicates that even as one of the worlds preeminent investment
banks, goldman sachs cannot avoid the negative economic
impacts of stricter regulation.
basel iii has also faced criticism from its proponents
at financial regulatory agencies, who from time-to-time feel
that the regulations do not go far enough to stabilize the banking sector. earlier this year, thomas hoenig, vice chairman of
the FDiC, argued that the us should move unilaterally on its
own if the banking lobby weakens basel iii. mr. hoenig
noted, the us has an opportunity to lead, lead to the top. all
the evidence shows this would lead to a stronger system.
there is no downside. this shows his opinion that only
through tougher regulation can economic disasters such as the
2008 Crisis be prevented, and that as a country and market
leader, it is the responsibility of the united states to lead efforts beyond the scope of the basel accords. in similar strains
of concern, others have argued that the basel iii regulations
need to move beyond the formal, banking sector, to the more
general financial services sector on account of the fact that
many traditional banking functions are increasingly being carried out by non-banking entities that are not currently subject
to rigorous regulation.
as basel iii becomes more fully implemented, the international financial sector should see some improvements in
stability. the higher reserve levels and their accompanying
stability, however, may come at a cost. it remains to be seen
whether critics in the banking lobby will be correct that the
latest basel iii regulations are too restrictive and will hamper
economic growth by making it harder for banks to extend
credit. on the other side of the coin, only time will be able to
tell whether or not the regulations go far enough to safeguard
the stability of the global financial system. Despite the claims
of either type of critic, it is likely that the basel iii regulations
will impact the financial system in unforeseen ways, especially as global markets evolve and change what metrics of financial health are relevant to regulators and investors alike.
the true effects of the basel accords will only be seen as they
are fully implemented.
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february 2014

uproar in DenmarK

goldman sachs role in Dong energy


by graham Jordan
if you thought the end of occupy Wall street was the
last time you would hear goldman sachs referred to as a giant
Vampire squid, you were wrong. last week, demonstrators in
Copenhagen once again took to the street with pictures of a vampire squid as they protested against goldman sachs.
this drama started in october of 2013 when Dong energy finalized a deal for new funding. Dong energy is a utility
corporation, previously owned by the Danish government. it is
one of the largest operators of wind farms in the world. For the
past couple of years, however, Dong energy has been struggling
to avoid bankruptcy as it deals with decreasing demand for electricity in addition to a high debt load and deteriorating margins.
While Dong energy originally planned on going public
to raise fresh capital, the financial crisis of 2008 made this unfeasible. as a result, Dong energy began to look for funding from
private investors. this process ended in october when goldman
sachs, along with two Danish pension funds, invested $2 billion.
When the Danish parliament approved the deal on January 30th
protests erupted, and there is still a general distrust of goldman
sachs amongst the Danish people. this distrust is based on three
facts.
First, some argue that a Danish pension fund, pensionDanmark, offered a better deal to the Danish government than
goldman. With this knowledge, it is a possibility that goldman
was chosen as a primary investor as a result of a backroom deal.
at face value, the offer from pensionDanmark values Dong energy about 40% higher than the offer from goldman, at $8.4 billion instead of $5.9 billion. however, people closer to the deal
maintain that this higher valuation came with additional stipulations and was less of an equity injection than a loan. unfortunately, more specific details are unavailable on the competing
offer. still, the price that goldman isying is around 0.8 times the
book value of Dong energy. this isnt cheap for a floundering
and highly uncertain utility.
second, through the deal, goldman will become the sole
new investor with veto power in major executive decisions.
goldman also, along with the other new investors, maintains the
option to sell back its stake to the Danish government if there is
not an ipo by 2017. this is an in-the-money put for goldman
which guarantees it at least a 3% minimum annual rate of return.
normally, investors would have to pay for this but, in this case,
goldman acquired it for free because of the uncertainty of Dong
energy. many Danish citizens deem these realities unfair and believe that the government is providing undeserved protection for
goldman.
third, the vehicle that goldman is using to invest in
Dong energy is based in luxembourg and owned by groups in

the Cayman islands and Delaware. each of these locations is


seen as a tax haven and this has created additional ire against
goldman. goldman responded to these attacks by stating that, it
would not be normal practice to set up a vehicle in Denmark
and that it will continue to comply with all applicable tax laws.
While its not news that many in the public still have
distaste for goldman sachs and finance in general, the strength
of the reaction against the deal was unexpected. a Danish official is quoted as saying, We understand that nearly everybody
hates goldman sachs but you cant do business and say: you
have the best offer but you cant win. officials in the Danish
government as well as representatives from goldman sachs
maintain that the transaction was conducted at arms length and
that goldman provided the most competitive offer to Dong energy.
regardless, the political fallout for helle thorningschmidt, the current prime minister of Denmark, has been intense. much of the population in Denmark still sees goldman
sachs as the cause of the 2008 financial crisis and, as such, there

is a significant amount of anger remaining towards the investment bank. before the Dong energy fallout, helle thorningschmidt led a minority coalition in Denmark that consisted of
three parties. amidst resentment over the goldman sachs investment deal, however, one of the three parties left her coalition.
this left her with only 61 out of 179 seats in the Danish parliament.
goldman is also concerned over potential fallout in its
other investment vehicles. although goldman never committed
any ethical or legal violations in the Dong energy deal, it was
surprised by how intensely the Danish people protested the deal.
goldman is now contemplating how it should continue with
other investments it has in Denmark. this includes its investment in an outsourcing company iss.
Currently, the deal between Dong energy and goldman
is on track to be finalized in mid-February. the recent uproar,
however, has left both thorning-schmidt and goldman with a
fair amount of negative publicity to deal with.
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february 2014

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profiTinG from CHanGinG inCenTive


a look into obamacare
by kevin lai
in early 2013, the onset of obamacare created a
chill in some parts of the economy. large health care
companies, including insurance companies and hospital
chains, invested significant resources into preparing for
millions of new customers. regardless of what people
thought of obamacare politically, the law was going to
make many people very rich. the affordable Care act
was not simply a law that mandated insurance for the
uninsured. rather, it would directly impact the core business model of medicine.
underpinning the motivation for the affordable
Care act were rapidly climbing medical costs that have
outpaced inflation for decades. in fact, the Congressional

budget office indicated that these costs are expected to


double their current levels by 2038 and are by far the
largest contributor to the united states long-term deficit.
thus, the goal of the health care reform was both to increase coverage and to reduce the growth in health
spending. the existing system, built around a fee-forservice model, had paid medical practitioners and hospitals based on the volume of procedures carried out. thus,
providers would bill an insurer medicare, medicaid, or
private company for every service. Consequently, patients throughout the us underwent redundant procedures due to often incompatible medical-records systems
between hospitals. the affordable Care act sought to
pivot towards a value-based-model that fosters increased competition between healthcare providers and
drive competition based on price and quality. the new incentive structure motivates providers to become more
cost conscious and supports the transition with nearly $1
trillion in support from medicare and medicaid.
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the real incentive paradox manifests during postacute care for over a third of patients who receive surgery or other treatments after they are discharged. While
the best option is often home health care, where patients
recover in a comfortable environment away from the risk
of hospital-acquired infections (hais), this is an inconvenient option for healthcare providers. providers instead
often approach post-acute care with expensive rehabilitation facilities and standardized 21-day timeframes, which
is a large overestimate of what the patient actually needs.
While providers benefit, insurers end up footing increased bills. With an increasing number of patients covered, companies like navihealth have been able to profit
by providing post-acute home health care and splitting
savings with insurers.
among the best ways to profit on obamacare is to
investigate the following:
hospital stocks: utilization rates increase and uncollected receivables go down as a result of an increase in
the pool of paying patients. since hospitals are required
by law to serve both insured and uninsured patients who
show up at the er, many hospitals formerly were not
able to collect as much as 30% of their billings.
testing laboratories: obamacare is positive for testing companies such as Quest Diagnostics (nYse:DgX)
and laboratory Corp. of america (nYse:lh) as more
insured patients are able to pay for diagnostic tests.
medical Device manufacturers: Companies such as
medtronic (nYse:mDt), stryker (nYse:sYk), and st.
Jude medical (nYse:stJ) may be hurt as obamacare
levies increased taxes on sales of these devices. as companies are projected to increasingly compete on price, investors expect consolidation and increased price
competition in this space, giving rise to potential short
plays.
insurance Firms: mega-insurers such as unitedhealth group inc.s shares were up by more than 22%
over the past year after the rollout of obamacare. similarly, Wellpoint inc., which operates under blue Cross
blue shield in 14 states, has risen over 37% this past
year.
as healthcare becomes more capitalistic under the
affordable Care act, firms that can leverage the changing incentive structures to their favor will become leaders
in this new landscape.
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