Sustainable Finance

IFC Leads Sustainable Investing in Emerging Markets

2010-04-26T05:40:00.001-07:00

Two recent announcements from IFC (the World Bank Group member dedicated to private sector development in emerging markets) demonstrate continuing leadership in emerging market sustainable investing.

The IFC's inaugural green bond, a $200 Million, four year, fixed rate issue scheduled to close on April 26, will reserve all proceeds for investment in climate friendly projects in developing markets. This is the first time IFC will dedicate bond funds to a specific pool of loans. The green feature makes the bonds attractive to a growing audience of institutions charged with finding socially and environmentally responsible investments. “The Green Bond is yet another example of how IFC is creating innovative financial products that offer both development impact and good return for investors”, said Nina Shapiro, IFC Vice President and Treasurer.

IFC has also published a brief on it's ongoing sustainable finance mission in preparation for the Spring Meetings – the annual review of the joint IMF-World Bank Development Committee and the IMF International Monetary and Financial Committee held April 24 and 25 in Washington, DC. The plan is not just to invest IFC funds wisely, but to build investment infrastructure in developing countries while using IFC's track record to encourage and enable sustainable investment by global capital markets in those developing countries.

Three IFC focal points seem particularly exciting for the sustainable investment community:

IFC is developing the necessary market infrastructure to support the growth of sustainable investment by funding the development of enhanced stock market indices, market research, and training; and by sharing IFC’s substantial experience in incorporating environmental and social issues when investing in emerging markets.
With assets of over $20 trillion and long-term investment time horizons, pension funds are a potentially important source of investment capital for the hundreds of millions needed to combat climate change. IFC is working with pension funds to develop new financial instruments to help tackle climate change.
Private Equity is an increasingly important source of capital for growing businesses in emerging economies. IFC is supporting private equity managers use of sustainability to identify new investment opportunities and drive improvement projects within their investments.

This work, along with projects like the Carbon Efficient Index, developed with S&P and Trucost and the Private Equity Toolkit, designed to bring a serious look at sustainability into private equity's investment decision process, show what IFC's mission is all about.

Photo credit: acameronhuff

Opportunities Inland: Growth for New Regions and Sectors in China

2010-04-19T01:39:00.000-07:00

If you are not investing in China, you are missing out. Although some businessmen have been deterred by the country’s lopsided export-driven growth engine, international investors are finding an array of potential growth drivers appealing. While financiers sit tight for the expected revaluation of the yuan, strategists claim that China’s future growth will come from many new sectors and geographical locations. Investment opportunities exist hundreds of miles west of Shanghai and Beijing, in China’s lesser populated inland provinces.

China’s smaller cities are still in the early stages of industrialization and urbanization, in a huge domestic market and plenty of room to grow internationally. These regions have great demand for better infrastructure as well as residential and commercial real estate to support that growth.

Earlier this year investors feared that China’s economy was overheating and Chinese stocks slipped. But buyers are returning and confidence is increasing due to structural adjustments by the Chinese government to curb unhealthy liquidity which causes bubbles. China’s central bank moved to raise the reserve requirement ratio and slow exorbitant loan growth by banks. Internationally these were seen as smart moves and responsible growth management. Now the perception has changed and equity performance is cathching up. The MSCI China Free Index rose 2.2% so far in 2010, and almost 4% in April alone.

The next question is where exactly to invest. Chinese banks are announcing great returns, lower provisions for risky assets and higher fee-based income. Many analysts believe that China’s financial sector is likely to be very profitable in 2010. Another rapidly growing sector is China’s clean-tech industry. The world power reportedly spent $35 billion on renewable energy in 2009, including an international push into wind turbines. China’s low costs and relatively advanced technologies make it a fierce competitor in energy alternatives.

As second and third tier cities continue to growth robustly, plenty of new support infrastructure will be needed. China has openly been buying up natural resources, commodities, cement, and metals which are inputs for further development of public transportation systems. China still does not have a national railway or highway system. Finally, consumer services and leisure are a safe bet for solid long-term growth. As China develops, wages are rising and people have more to spend on vacations and fancy restaurants. Luxury goods and services will be big business.

Keep an eye on China’s growth and don’t be afraid to approach the beast. There are plenty of opportunities and partnerships abound.

Photo Credit: Creative Commons

Gatekeepers – Halting Fraud, the Corporate Governance Breakdown

2010-04-19T01:15:00.000-07:00

When should accountants, lawyers, etc. be held liable in order to deter their client's fraud?

It's confession time. First, “corporate governance breakdown” is search engine optimizationese for something that's usually called “securities fraud”. I know, I know, this is like using faux pas as a synonym for bank robbery. And why is “corporate governance” a hotter search term than “securities fraud” at a time when the SEC suit against Goldman and the bankruptcy examiner's report on Lehman Bros have securities fraud in the headlines? Who knows, but, like the heart, Google wants what Google wants. Second, any good ideas in this column are stolen from Multiple Gatekeepers, by Andrew Tuch, which will appear in the Va. L. Rev. Multiple Gatekeepers (MG for short, I like my law review articles in British racing green) is 77 pages long, with extensive footnotes. Some of these footnotes cite the works of professors who (literally) put me to sleep in law school – not including the ubiquitous Prof. Coffee, who arrived at Columbia long after I left and now seems to be cited repeatedly in every article, including MG, that has anything to do with corporate governance – perhaps “Coffee” is an optimal search term. This column is going to run considerably less than 77 pages, so we promise much oversimplification (sorry Prof. Tuch), for which we will compensate with frequent, obscure references that may be recognizable to a fortunate few as attempts at humor.

MG is not written on a blank slate. Many trees have given their lives to the discussion of topics like: who are gatekeepers – professionals (accountants, lawyers, investment bankers) who “rent their reputation” to assure investors of the quality of information provided by a corporation issuing securities or engaging in some other transaction requiring approval; when should gatekeepers be liable for the client's fraud – always (strict liability), when they fail to exercise due care (fault based liability) or never (since the client perpetrating the fraud is inevitably broke when caught, this answer is beloved only by, well, gatekeepers); and which of these answers will best protect society from the client's potential fraud – a question answered, at least in part, by the application of optimal deterrence theory. Optimal deterrence theory may sound like a branch of calculus used to site missile silos during the cold war, but fear not. Based on the application in MG it seems to be fairly basic game theory requiring only simple arithmetic, an understanding of expected value and an assumption that each gatekeeper will act with omniscience to maximize its utility.

MG's principal contribution is to note that transactions involve more than one gatekeeper, that these gatekeepers have an interdependent capacity to deter fraud, and that once this interdependence is recognized, optimal deterrence theory points to a fault model of gatekeeper liability as most effective in deterring client fraud. This contradicts other observers, who have argued for a strict liability approach based on the application of optimal deterrence theory to each gatekeeper independently. MG then reviews the existing legal bases for gatekeeper liability, noting the existing system is generally fault based, but prescribing greater clarity. As an aside, the 33 Act seems to have anticipated optimal deterrence theory with some prescience, while aiding and abetting liability under Rule 10b-5 lacks predictability. MG also prescribes formal procedures to enhance cooperation and coordination among gatekeepers.

Kudos, Prof. Tuch. All the right answers, for some of the right reasons. The participation of multiple gatekeepers in securities issuances and other major corporate transactions is an unassailable fact. Their interdependent capacity to deter fraud is correctly judged by Prof. Tuch, but with the emphasis on capacity, not practice. Real life gatekeepers often seek to avert liability by narrowing and clarifying the scope of their engagement rather than rooting out client fraud. Understandable, given the history, training, professional rules, fear of liability and desire to maintain a cordial relationship with the client, who is, after all, paying the bill – understandable, but not optimal deterrence. The result is gaps between the coverage of the gatekeepers, gaps through which the client bent upon fraud may creep.

Although I enjoyed the section applying optimal deterrence theory (family and friends claim I watch Star Trek, The Next Generation, but there is no admissible evidence), I did not find it persuasive. The gatekeepers don't seem to have enough information on the cost of liability and deterrence to undertake the calculations called for by the theory. Even if they did, the gatekeepers are driven by history, personal obligation, client loyalty and other factors not fully accounted for in the theory's approach to maximizing utility. Despite this, the conclusions and prescriptions match my own intuition based on experience. Right now the gatekeepers know the cost of liability is huge, even if not readily measurable in advance. They recognize they are already spending, tons, on deterring client fraud. They recognize that the approach of retreating to a narrowed engagement is losing the liability war, and most of the liability battles. Even if the gatekeepers don't have enough data to play Prof. Tuch's optimal deterrence theory game, they can still recognize that it's time to overcome history and follow his prescriptions.

Photo Credit: Asakusa Temple Gatekeeper by Jim Epler

Emerging Markets Plugging In To Mother Earth

2010-04-12T01:03:00.000-07:00

Imagine you are living far, far off the grid, in an emerging market rural outpost, say 100 miles Northwest of Moroto, Uganda near......well, you are pretty sure there's an outside world. You'd like a radio, maybe even a cellphone. You'd like to see at night without lighting candles and filling your home, and your baby's lungs, with soot and other dangerous combustion reaction products. If only you had an extension cord 100 miles long or better yet, if only you could just plug in to the dirt floor of your own home.

Soon you will be doing exactly that. Lebone Solutions, a team of six MIT students, has developed a battery powered by microbes living in dirt which can operate for months, charging LED lights, radios and cell phones. The device costs less than $20. It harnesses the energy from metabolic reactions of soil dwelling bacteria, an energy source that has been recognized for years but not utilized in a practical way. Lebone Solutions member Presser Aiden predicts 1,000 households will be using one by this summer. Although the dirt battery will be welcome in many emerging market areas, it was designed with sub-Saharan Africa in mind a region where some of the Lebone Solution members (along with 500 million other people) have lived without power.

The dirt battery was hailed by Popular Mechanics as one of the ten most brilliant innovations of 2009 and named one of the winners in this year's MIT IDEAS competition. It's also featured in a cover story on public service at MIT in this month's Spectrum (an MIT newsletter). The Spectrum story made me feel much better about many years of contributions - contributions to a wealthy institution that didn't always seem like it should be high on the list of neediest candidates for my limited funds.

The Spectrum public service story also reminds me of two trends I've been noticing lately. The first is a greater emphasis on relatively low tech solutions to problems like malaria, rural power or clean water. Solutions that combine solid engineering and cultural analysis without spending a fortune on new frontiers of basic science or expensive equipment that many emerging market populations can't afford. The second trend is the rapid advance of microfinance, with organizations like Kiva leading the way and tools like securitization steering microfinance in the direction of a socially beneficial investment that can compete with other interest bearing options. These trends are a powerful combination that might lead to a real take-off for impoverished rural areas a lot faster than expected.

Photo Credit: AnnaleeBlysse

Servicing Debt While Seeking Economic Growth

2010-04-12T00:39:00.000-07:00

Across the world, governments are struggling with fiscal frugality. Government deficits are increasing at the same rate as during the second world war. The public debt is projected to rise to an estimated 110% of GDP by 2014, a rise of almost 40 percentage points from just 3 years ago. Without drastic changes by policy makers to curb and reallocate public spending, the financial trajectory for big powers looks bleak. But how can countries focus on economic growth while servicing their massive debts?

Some countries being forced to face their financial shortcomings before others. Portugal has plans to pay down its deficit from 9% to 3% over the next 3 years. Greece must cut its deficit from 12.7% of GDP in 2009 to3% by 2013. Britain’s upcoming election will be won based on economic growth and financial austerity. But the majority of the OECD members have no detailed strategy to service their debts while hitting their growth targets. The policy prescription they choose will have a huge impact on the stability and structure of their economy across all sectors.

Today’s deficits are leading to debt burdens that are simply unsustainable. A general rule of thumb regarding a reasonable level of public debt is 60% of GDP. That limit is outlined in the Maastrich Treaty, the guidelines for the euro. It is the figure that the IMF recommends as well. It asserts that the 35 percentage point raise in rich countries debt could raise borrowing costs by two percent. Sixty percent was also the average debt to GDP ratio among rich economies prior to the financial crisis.

If the world’s debt burdens are reduced to pre-crisis levels, the costs of the crisis will not be passed on to future generations. It would allow governments more fiscal leeway to deal with future recessions and would ensure that higher public debt does not hurt private investment, lowing future growth.

While reducing debt burdens to pre-crisis levels makes sense, it will not be easy. A recent report in the Economist suggests that governments will need to improve their budget balances by an average of 8% by 2020 in order to reduce their debt ratios to 60% by 2030. Each strategy to balance the budget has its own pros and cons. Raising taxes, for example, may hurt growth more than living with a higher debt ratio. Most economists agree that fiscal adjustments via spending cuts are more sustainable and growth friendly than those that rely on tax hikes. Cutting public-sector wages is more effective than cutting public investment. Some cuts, like slashing farm subsidies or raising pension ages, have multiple benefits. They promote growth both by improving public finances and by augmenting efficient allocation of resources. The taxes that hurt growth the least are those on consumption or immobile assets like property. With the current global warming and pollution problems, green taxes are also an effective mechanism that will clean our economies and our environment. Only time will tell if governments will be able to fend off political pressures and take action to pay down their debts.

Photo Credit: Creative Commons

Intel's Sustainability Charter – What Really Happened?

2010-04-07T04:42:00.000-07:00

Harrington Investments, Inc. a Napa, California-based socially responsible investment advisory firm wanted to establish a committee of the Intel Board of Directors that would be responsible for sustainability. To achieve this, Harrington intended to propose a by-law amendment for adoption by the Intel shareholders at the annual meeting, as it had in 2008.

Intel, like all big public companies, doesn't relish taking resolutions to the shareholders unless they are proposed by management. On the other hand, Intel is often recognized as an ES&G leader and seems to be proud of it – the Intel web site has extensive sections on social responsibility and environment. For Intel management, it was a Hobson's choice – look like you are saying no to sustainability, or endorse a by-law amendment that sets up a new committee with broad responsibility to pursue sustainability – an amendment that the Service Employees International union is endorsing as a means to address the problems of working families.

Instead of choosing, Intel found another path. On March 18, the Intel Board approved an amendment to the charter of the existing Corporate Governance and Nominating Committee to include the following:

“The Corporate Governance and Nominating Committee:

.......

Reviews and reports to the Board on a periodic basis with regards to matters of corporate responsibility and sustainability performance, including potential long and short term trends and impacts to our business of environmental, social and governance issues, including the company's public reporting on these topics.

......”

My speculation is that Harrington did not find this completely satisfactory. There is no committee dedicated to sustainability, and even the Governance and Nominating Committee has only the duty to report to the Board, not to strive for any particular goal or standard of sustainability achievement. Harrington's press release on the amendment notes that:

“Intel also had their outside legal counsel Gibson, Dunn & Crutcher LLP write a legal opinion specifically stating that pursuant to Delaware law, corporate responsibility and sustainability reporting based upon the committee's charter, was part of the fiduciary duty of company directors”

Intel's decision to seek the legal opinion may have been the final concession needed – Harrington did agree to withdraw the shareholder resolution proposing the by-law amendment and new committee.

Now that you have the facts, at least those that are publicly available, who won? Harrington is proclaiming the amendment to the committee charter and the legal opinion as a victory in its press release. Intel, a company that is normally not shy about trumpeting its ES&G achievements, is saying nothing. Intel has already been compiling annual CSR reports, but the formal involvement of the governance committee and its reports to the full board might add to the scope and rigor of Intel's efforts. Without seeing the text of the legal opinion it's hard to be sure, but based on the Harrington press release, the opinion may be circular - if the committee charter says it is to report to the board on sustainability matters then it is the fiduciary duty of the committee to so report – not exactly revolutionary. If the opinion stated that sustainability was more important than profitability it would be a hot potato (remember this is a public, for-profit corporation and the shareholders did not even get a vote on the sustainability amendment) but to opine that the directors can generate and consider reports on sustainability issues, issues which can and do effect profits, especially on a long term view, just does not seem like a stretch. So, Harrington gets something to crow about and Intel may actually get even more serious about its sustainability reporting – everybody wins, right?

Maybe. Intel dodged an unpleasant moment of conflict at its shareholders meeting, one that would surely have generated some negative publicity. In fact, Intel avoided going to the shareholders on this altogether. The Board can amend committee charters, and if the new language creates some unexpected problem, then the Board can further amend to fix it. Intel management can also stop worrying about a more broadly chartered sustainability committee like the one Harrington originally proposed, one that might add an extra dimension to future environmental or labor issues. Intel made some new reporting commitments, but only in an area where management was already a willing reporter. Harrington is issuing the press releases, but Intel management is silently smiling.

Photo Credit: xcaballe

Arrrgh! Pirate Finance – Emerging Market Success?

2010-04-05T01:49:00.000-07:00

The piracy finance model excerpted (with minor edits) below appeared in early March in a UN report, and has gained interest through more recent republications, first in UN Dispatch, then Alphaville. The model is fascinating – so is what it tells us about Somalia, an area that, right now, can only aspire to be an emerging market:

The success and expansion of pirate militias requires new organizational arrangements and practices. Although leadership of pirate networks remains anchored in Puntland and central Somalia, participation in maritime militias and investment in pirate operations is open to a broad cross-section of Somali society. The refined finance model guarantees every participant in the operation, if successful, a well-defined percentage or share of the ransom money.

A basic piracy operation requires a minimum eight to twelve militia prepared to stay at sea for extended periods of time, in the hopes of hijacking a passing vessel. Each team requires a minimum of two attack skiffs, weapons, equipment, provisions, fuel and preferably a supply boat. The costs of the operation are usually borne by investors, some of whom may also be pirates.

A would-be pirate should already possess a firearm. For this contribution, plus, his services, he receives a class A share. Pirates who provide a skiff or a heavier firearm, like an RPG or a general purpose machine gun, may be entitled to an additional A-share. The first pirate to board a vessel may also be entitled to an extra A-share.

At least 12 others are recruited as militiamen to provide protection on land if a ship is hijacked., In addition, each member of the pirate team may bring a partner or relative to be part of this land-based force. Militiamen must possess their own weapon. Each receives a ‘class B’ share — usually a fixed amount equivalent to approximately US$15,000.

If a ship is successfully hijacked and brought to anchor, the pirates and the militiamen require food, drink, fresh clothes, cell phones, air time, etc. The captured crew must also be cared for. In most cases, these services are provided by one or more suppliers, who advance the costs in anticipation of reimbursement, with a significant margin of profit, when ransom is eventually paid.

When ransom is received, fixed costs are the first to be paid out. These are typically:

Reimbursement of supplier(s)
Financier(s) and/or investor(s): 30% of the ransom
Local elders: 5 to 10 %of the ransom (anchoring rights)
Class B shares (approx. $15,000 each): militiamen, interpreters etc.

The remaining sum - the profit,- is divided between class- A shareholders

Wow. The model has sophistication, with four classes of securities: 1) investors get a super share that splits 30% of the gross; 2) suppliers essentially get a subordinated preferred – payment is contingent on a successful hijack and ransom but return is a fixed percent of value supplied; 3) land based militia also get a lesser preferred, with a fixed sum contingent on success; 4) marine pirates get common.

The model assumes compliance with the deal terms by pirates, not generally known as a law abiding group. Is this driven by fear of retribution, the need to preserve reputation so that future missions can be staffed and financed or some other force, such as clan relationships? Really the model assumes more than just compliance. Since the supplier has limited upside, the supplier's investment probably makes sense only if the supplier can count on investing in multiple operations, with some chance to recover in the event the failure rate is high on the first few operations in which the supplier participates.

Finally, the model has some pieces missing. Who is the organizer and how are they compensated? Is it the primary investor? If so, does the lead get a share of that 30% that exceeds the pro rata share attributable to his investment?. Is the captain of the ship the organizer? If so, isn't this worth a couple of extra Class A shares? Who, in general, are the financiers? What percentage of Somalia's can afford to be venture capitalists?

In an emerging market with no consistently functioning educational or judicial systems, the pirates are pulling off some fairly sophisticated financing. Aside from how to be a pirate, what's the lesson? The pirate model probably tells us something about the capability and resiliency of the Somalians, if this lawless territory could somehow turn itself back into a nation and offer legitimate opportunities that would attract the same ingenuity. It may even tell us something about the prospects for investment and assistance for the Somali private sector from the outside world. Apparently, Somali's can run a business, but the outsider who is not viewed as part of the crew may end up walking the plank.

Photo credit: darkpatator

GAVI's Finance Model Strikes Vaccination Gold for Emerging Markets

2010-03-26T01:23:00.000-07:00

Imagine you are Rwanda's minister of health. You have a problem – actually many problems, but we'll start with one. Pneumococcal diseases kill 1.6 million people per year around the globe, nearly one million of them children under 5 years old, and nearly all of them in emerging markets like Rwanda. Why only in emerging markets? Because the diseases can be prevented with a vaccine, one that costs as much as $104 per dose in developed countries, $312 per patient since the vaccination protocol requires three doses. Your government, even with help from NGO's like UNICEF, can't afford to vaccinate even a tenth of Rwanda's population at these prices, but you are very tired of watching your children die.

The GAVI Alliance, a non-profit partnership of governments and NGOs, recently announced an agreement with Pfizer, Inc. and GlaxoSmithKline (GSK) that will go a long way to solving your problem. First, GAVI recognized that the patent protected price of $104/dose reflects the cost of R&D, testing and approvals, production facilities, marketing, etc. not to mention some profit, but that the actual marginal cost of producing one extra dose would be tiny, perhaps a few dollars per dose. The marginal cost of producing many extra doses, enough to make a real dent in the needs of emerging markets would still be relatively low (since it would not reflect sunken costs like R&D, testing and approval, marketing) but it would have to include the cost of expanded production capacity. Nonetheless, big pharma could sell at a huge discount to fully absorbed cost and still make a few bucks on a marginal cost basis, provided it could actually sell the extra volume to emerging markets at a deeply discounted price.

The problem? How could big pharma invest in expanded production capacity with no assurance that emerging markets would actually buy the extra vaccine output, even at steeply discounted prices? The GAVI Alliance solution – AMC. Old timers, push away those blurry notions of Ramblers and Mitt Romney's dad and think Advance Market Commitment. GAVI and the emerging market governments have committed to pay Pfizer and GSK for 30 million doses per year from each supplier for ten years, at a price of $7.00 per dose for the first 20% of the doses purchased and $3.50 per dose thereafter.

Nice work GAVI (and attaboy Pfizer and GSK too). Exactly who, to quote Butch Cassidy, are those guys? Launched in 2000, the GAVI Alliance is a global health partnership representing stakeholders in immunization from both private and public sectors: developing world and donor governments, private sector philanthropists such as the Bill & Melinda Gates Foundation, the financial community, developed and developing country vaccine manufacturers, research and technical institutes, civil society organizations and multilateral organizations like the World Health Organization (WHO), the United Nations Children's Fund (UNICEF) and the World Bank. The agreements with Pfizer and GSK are a culmination of the first AMC project, commenced in June 2009.

GAVI uses a second financial wrinkle, IFFIm, collecting binding governmental pledges from donor countries (G-7 types) and then borrowing against the pledges in capital markets to accelerate effective receipt of the pledged funds. Look for AMC and IFFIm to show up again, and again, possibly with an even more dramatic application. Some diseases, malaria for example (a primary focus for the Bill & Melinda Gates Foundation), present a more difficult variation on the Pneumococcal problem. The emerging markets offer a huge potential market for a vaccination that will prevent malaria, but instead of just adding production, big pharma needs to invent the drug, and it is reluctant to invest billions in anything where the potential customers are generally very poor. The potential market is so vast that a malaria cure could be profitable even at a low price per dose. An AMC arrangement might be enough to move a promising malaria vaccine research program into development and ultimately production,

Photo Credit: hdtpcar

Shop til you Drop: China’s Online Retailing Sector

2010-03-25T06:43:00.000-07:00

In the wake of a global recession, China’s online retailing market continues to grow at an increasingly rapid pace. The trading size of the online retail market rose to nearly $37 billion, sustaining high growth throughout a tough year. At the end of 2009, internet users in China totaled 384 million, with an annual growth rate of 29%. According to the China Network Information Center (CINIC), almost one in four of these netizens have shopped online. Although the market is still adjusting to new development strategies and marketing mechanisms, companies from across the globe are hoping to tap into this booming domestic market via the worldwide web.

While e-commerce has been present in China for the past decade, new players are jumping on the bandwagon in C2C, B2C, and B2B forms. Although C2C still accounts for the largest share of the online retail market, the B2C is the main driving force of e-commerce, with an 8.7% growth rate. This is partially because the foreign firms entering China via internet are having the most success using this model.

The key to sustainable B2C sales is not only customer base acquisition, but also the quality of the customer service a company offers in addition to logistics, payment and policies. In this huge domestic market reaching consumers in rural regions can create logistical nightmares. Further, the quantities of inventory needed on hand to satisfy the potential demand can be daunting. E-commerce experts suggest that companies entering the market should focus on premium products that are exclusive and unique, rather than competing with established brands. Chinese consumers are eager for exciting foreign products and have the disposable income to buy at premium prices.

Smartdirect.cn, China’s first online supermarket, offers Western and Chinese food and household items. The one-stop shop sets itself apart from similar online vendors that sell only their brand or separate sales and logistics, which is common in the Chinese market. Smartdirect sells a diverse range of products and provides accompanied services including orders receiving, logistics and distribution, settlement of payments and after-sales service. Easier said than done, the real value from this operation comes from lean supply chain logistics. But first China’s distribution channels need to mature to meet market demand.

Another challenge in this unique marketplace is the need for a safer and more efficient online payment system to handle credit-card transactions. Cash on delivery is still a common mechanism in online shopping. However with the rapid development of new technologies, online payment tools like Alipay and Paypal are improving quickly, reducing the risks of online shopping.

While there are still some obstacles, companies entering this market now have a better shot at fostering strategic alliances and improving distribution systems in addition to obtaining first mover brand loyalty. So what is your company waiting for?

Wachovia’s Dirty Money

2010-03-25T06:36:00.000-07:00

Is turning a blind eye to your customers’ illegal activities a crime? Apparently so. Wachovia entered a deferred prosecution agreement with federal authorities in Miami this week, agreeing to pay $160 million to settle claims that it willfully failed to establish an anti-money laundering program. The bank failed to effectively monitor for potential money-laundering activity on more than $420 billion in financial transactions with currency exchange houses, or “casas de cambio”, according to a news release by U.S. Attorney Jeffrey Sloman. An investigation into the transactions with CDC’s revealed that Wachovia knowingly failed to identify, detect and report suspicious transaction in third-party payments processor accounts. Not only were Wachovia’s actions irresponsible, but they were actively harmful, providing liquidity to drug cartels in Mexico.

According to court documents, Wachovia was aware, as early as 1996 and through 2004, that high risk drug money was being laundered through CDC’s in Mexico. Wachovia was also aware that other banks had stopped doing business with the CDC’s, however the bank continued to expand its business with the shady exchange houses and providing correspondent banking services to them, including wire transfers, bulk cash, pouch, and remote deposit capture services. In plain English, Wachovia allowed the CDC’s to wire drug money to recipients all over the world and physically transported large sums of money to the U.S. for deposit. These funds were used to purchase airplanes for narcotics trafficking, from which over 20,000 kilograms of cocaine were seized.

Other agencies involved in the case are the attorney general’s office, U.S. Drug Enforcement Administration, U.S. Department of Justice, Internal Revenue Service, Florida Controller’s Office and the Federal Financial Crimes Enforcement Network (FinCEN). While the federal indictment alleged that Wachovia violated the Bank Secrecy Act (BSA), criminal charges are being deferred as long as Wachovia continues to cooperate and implement remedial actions.

Sloman, called the bank’s actions “blatant disregard for our banking laws” by giving international cocaine cartels a virtual carte blanche to finance their operations. As Wachovia merges into Wells Fargo Bank later this month, they have to be wondering if this acquisition was worth the soiled name they are bringing to their business.

No More Free Lunch: Purchasing Directors in China Face Rising Prices

2010-03-22T02:40:00.000-07:00

The cost of doing business in China is rising. China has been the world’s factory and the anchor of the global disconnect between rising material prices and lower consumer prices. Now, factories in throughout China are being forced to raise the prices of exports as the costs of energy and raw materials soar in a fiercely competitive market. While China is still considered cheap by Western standards, suppliers are no longer eager to race to the bottom. They are investing in the capital and knowhow to improve their production and compete on a global scale. Purchasing directors able to adapt their sourcing strategies in this rapidly changing market will find that new advantages and rich opportunities await them.

Corporations that began outsourcing production to China in the early 1990’s have benefited from dramatically lower costs and thus high corporate profits. The challenge for medium and large multinationals in China these days will be to maintain consistent prices from reliable suppliers while continuing to cut costs and improve efficiency. While some companies contemplate moving inland, where labor costs are lower, or to other parts of Asia, such as Vietnam, India, or Bangladesh, many purchasing directors realize the advantages China has to offer. Rather than moving factories or massive supply chains, resulting in logistical nightmares and productivity losses, firms willing to invest in a competent procurement team and strategic sourcing processes will continue to dominate in this unique market.

So where does that leave companies just now starting to source from China? According to a recent survey by AT Kearny, over 70% of companies surveyed plan to procure from China by 2010, a 40% increase from just a decade ago. Yet many purchasing directors are not prepared to manage these sourcing efforts efficiently and cost effectively. They lack the experience on the ground to fully understand the intricacies and obstacles associated with emerging market procurement, especially in a market as cutthroat as China’s. Companies often underestimate the value of working with an expert who knows the territory, the costs and the players, inside and out. Beyond cultural and language obstacles, logistical issues like proximity and expertise come into play. Locating a reliable supplier is just a start. It takes a true professional with their finger on the pulse to ensure reasonable pricing and fair contracts in these dynamic market conditions.

While increasing costs have their downfalls, companies that procure strategically will maintain their low prices and benefit from better suppliers, standards, and quality. Don’t be left in the dust.

ARPA-E: VC, Angel Investor or All of the Above?

2010-03-15T05:26:00.000-07:00

ARPA – E, that's Advanced Research Projects Agency for Energy. It's like DARPA, but instead of creating the Internet, it fosters transformative energy technologies. It's like a VC or an angel investor, but with a half-open DOE checkbook instead of private capital. It's even a little like the old depression era CCC, spending government reconstruction money on projects that employ people, but in this case they employ a few scientists who will lead us, eventually, to a greener future filled with high tech jobs, secure energy sources and stabilized greenhouse gas levels. ARPA-E is prepared to get involved with transformative energy technology anywhere from the laboratory stage to the difficult juncture between development and early commercial application.

Enough with the alphabet soup. What's new with ARPA-E, how much funding does it have and how is it being spent? On March 2, 2010 ARPA-E announced its third funding opportunity, with $100 Million available to focus on grid-scale energy storage, electrical power technology, and building energy efficiency. This came relatively hard on the heels of ARPA-E's December 2009 news releases establishing a fellows program and announcing a second funding opportunity, also with $100 million available, to focus on electrofuels, carbon capture, and batteries for electrical energy storage in transportation. 37 projects have been selected for funding (at cost to ARPA-E varying from $500,000 to $10 Million each) as the result of the initial funding opportunity, a relatively open ended call for transformative energy related proposals. The selected projects are too diverse to summarize. The winners include a mix of universities and private companies, small and large.

Is ARPA-E an angel investor or a venture capitalist? Of course, it's the government and it's not investing for a financial return. The cost of funded projects is shared with the project proponents, and the percent ARPA-E contributes varies depending on several factors, particularly on the technology's stage of development. The closer the technology is to the basic research stage, the higher the percentage of the tab ARPA-E will pay. DOE does get some rights in intellectual property developed with its funds, although the ARPA-E structure allows the bulk of the IP value to remain with the project proponents. The low end of that $5000,000 to $10 Million per project does not sound like much, but remember, ARPA-E isn't covering the whole cost, and in some cases projects might be able to attract private capital well before the technology is commercialized. So, the angel or VC answer, is, (as always), all of the above, depending on the project.

ARPA-E is more than a source of capital. ARPA-E Director Arun Majumdar writes, “We are determined to attract the best and brightest minds to solving the energy problem”. Top engineers and scientists are serving as reviewers for project selection, but now ARPA-E is seeking program directors, to guide funded projects and identify new areas for breakthroughs. So ARPA-E, like a successful angel or VC, is providing guidance and connections, but the focus remains technical. ARPA-E's funding is a drop in the bucket compared to what other nations, particularly China, are spending on energy research, but innovation isn't all about money. With the right choices on projects and people, ARPA-E can be the catalyst for the next........you fill in the blank, think energy Internet.

Photo Credit: C-Ali

Entrepreneurs Believe in Angels

2010-03-15T05:06:00.000-07:00

As venture capitalists tighten their purse strings, entrepreneurs are seeking out angel investors for funding. Too many venture firms need to make large investments with huge payoffs on individual companies to keep their funds’ overall performance appear attractive. Over the last two decades, the number of venture funds has grown from 650 to over 1,600, with the average fund size ballooning from $53 million to $350 million. Since VCs are focusing on existing companies, and the limited partners are not giving them additional capital, deals that would have traditionally gone to VCs are flowing to angels. One VCs trash is another angel’s treasure.

Angel groups are made up of high-net-worth individual investors, generally based in San Francisco, Seattle, New England and Washington D.C. These loosely collaborative bodies are receiving far more funding requests from a higher caliber of start-ups while keeping prices low. By increasing their investments in companies that are in post-product and post-revenue, angels have significantly improved their risk profile. Groups like the Alliance of Angels, based in Seattle, and Hub Angels in Boston have seen a substantial increase in companies requesting funding from both coasts. And numerous angel groups have seen their membership double and triple in size.

The Angel Capital Association recently surveyed 150 angel group leaders and learned that nearly 60% of them said that the number of business plans they received and the quality of those opportunities was better or the same as in 2008. Those comments were based on improved economic conditions for angel investors, but all access to good companies. However, 16% of those surveyed said that the quantity and quality of investment opportunities was down, while the remainder felt increases in quality or number of opportunities, but not both.

Angel investing, which generally provides financing in smaller slices than venture capitalists would consider, has not been immune from the financial downturn. One report from the Center for Venture Research suggests that the average amount of money angels are investing per deal is dropping even as the number of deals trends upward. The fact that dollar allocation per angel is decreasing can be frustrating for entrepreneurs as well as investors. Competition for angel financing has intensified, driving companies to improve products, find compelling markets, form impressive management teams and propose attractive deal terms. While competition should be a good way to weed out the weaklings, it can be a mixed blessing. Some firms are seeing the quality of early stage deals declining because there are more bad deals made, increasing the odds that really good deals will slip through the cracks.

Photo Credit: Metropilot

Local Law Red Lights - What's SRI Now?

2010-03-09T04:02:00.000-08:00

Life is tricky for the international corporation and the socially responsible investor. Consider poor Google. First Google withdraws from a gazillion dollar potential market in China rather than accepting censorship (OK, it was a little more complicated than that). Now Google finds its Italian managers convicted of a crime for failing to prevent a posting on Google's subsidiary YouTube – thereby violating the privacy of an Italian autistic child who was tormented by bullies in the posted video. UBS wants to disclose customer information in the US (to settle some tax evasion problems it created for itself) but is told not to by a Swiss judge. Variations in law from one country to the next have long posed problems for business, lawmakers and socially responsible investors, but the increased scope of cross-national businesses that could call anywhere home and the fact that the Internet knows no borders seem to be revealing some new strains.

In ancient times, when I was young, corporations doing business in more than one country knew each operation had to comply with local law, and they didn't think much beyond that. Suddenly, the SEC started using US accounting requirements to investigate US public companies that had paid bribes abroad and then failed to account for the bribes clearly and disclose them. The US Congress went a step further with the Foreign Corrupt Practices Act of 1977– it didn't matter if bribing public officials was an accepted way of life in Lower Slobovia, bribing a public official was illegal for the US public company (even if all the activity took place entirely in Lower Slobovia). Japan and most of Europe lacked similar laws. For some years US companies complained that this was a disadvantage in winning government contracts in emerging market nations, but the complaints drew little sympathy, and much of the world eventually adopted similar anti corruption laws with extraterritorial effect. FCPA enforcement is actually undergoing a revival right now.

Another 1977 Congressional action went beyond simple extraterritoriality to effectively supervene local law. The Anti-boycott law banned any form of complicity or cooperation in the boycott of Israel, even when refusal to comply would violate local law in some Middle Eastern countries. US companies effectively had to withdraw from certain markets unless they could find a way to sell that kept them completely insulated from any activity related to the boycott of Israel.

The world was just warming up. South African Apartheid triggered action by Congress (the Comprehensive Anti-Apartheid Act of 1986 banned new trade and investment), a call for boycott by the UN General Assembly and an unprecedented level of activity by investor groups.- all designed not just to supervene local law, but to overturn it.

All these older instances of government and investor social action around local law concerns had a common element – a response to a situation or activity that was widely perceived (at least at the time) as immoral. Some of todays local law issues seem a little more complicated. Consider China – censorship of political speech – bad. Attack on servers to find dissidents -worse. Here we have a good old fashioned evil activity – yet so far governments and investors don't seem to be lining up to protest. Part of this may be fear, China is a big enemy to make and a big market to lose. Part of it may be a philosophy of staying engaged with a country that sometimes seems to be moving in the right direction. Part of it may be timing, the censorship issue hasn't been in sharp focus for long – it may yet generate some serious heat from the SRI community or even a few governments.

What about the Italian YouTube situation?. Wherever you come out on this issue – and free transfer of information, decriminalizing activity that is a mere conduit for free information and other aspects of the YouTube side have merit - it's hard not to recognize that the Italians have a legitimate interest in protecting the privacy of Italians, especially autistic children - not exactly evil. Maybe Google can find a better way to screen YouTube postings for privacy violations, maybe it will have to pull YouTube out of Italy, maybe Italians will be so worried about losing YouTube they will change their law. In any case, you won't see Congress looking for ways to override Italian law and you won't see investors boycotting Italian stocks in Google's defense. Google is on its own.

Which brings us to the Swiss, noble defenders of bank secrecy. With Swiss Army knives opened wide, they hold their banks hostage to this policy – even when it may lead to a disastrous outcome on tax evasion charges in the US. Bank depositor privacy may not sound as good as privacy for autistic children, but it's probably not evil, especially when you consider the fact that the policy is supposed to have an exception where active tax evasion is involved. Once again, no legislature or investor group will ride to the rescue of UBS, they will just have to figure something out. The IRS will keep squeezing and the IRS will not really care about Swiss law applying to Swiss based accounts when US operations of a Swiss based bank have abetted tax evasion by US taxpayers.

For Google in Italy and UBS in America, it's back to the sixties. No matter how complicated it gets, multinationals still need to figure out how to comply with local law in every jurisdiction where they do business. Multinationals doing business in China may be headed for some South African style fireworks. First it was antifreeze in the toothpaste and lead in the toys, now its censorship and server attacks to preserve the status of the powerful. Who knows what's next, but running a capitalist economy with a dictatorship of the proletariat (as represented by party officials and friends, many of whom are getting rich) is like tectonic plates pushing against each other, sooner or later we will have an earthquake. Companies accepting censorship or otherwise accommodating Chinese laws that are 180 degrees away from rights Westerners perceive as fundamental may ultimately need need to do more than just comply with local law, they may need to placate active, socially responsible shareholders.

Photo Credit: Conner395

Breaking the Glass Ceiling: Women in the Workforce

2010-03-09T02:48:00.000-08:00

The economic empowerment of women over the past 50 years is an unparalleled revolution. It is a social change unlike any other in the number of people who have become independent and the lack of social friction that it has caused. Literally, millions of people who were once dependent on men have taken control of their financial situation without any major wars or violent confrontations. This massive transformation has modernized our economy and overhauled our social structure.

This progress varies across the globe. Women make up just about half the workforce in the United States (49.9% to be exact). Globally, the female unemployment rate is slightly higher for females (6.4% for females, 6.1% for males.) In Italy and Japan, employment rates for women are still around 20% lower for women than men. Women earn substantially less than men and are severaly under-represented in top management positions. Interestingly, throughout Africa unemployment rates for women are lower than those for men, but they also make up a larger percentage of the informal workforce through small entrepreneurial enterprises. These figures leave 77.8 million women who are actively seeking work. Does the increasing proportion of women in the labor force really mean that the gap between male and female participation is closing? And are the women looking for work finding it? In transition economies 91 women are economically active per 100 men, but in Latin America, the Middle East and North Africa that number drops to about 50 women per 100 men. Nonetheless, the growing proportion of of women in the labor force is one of the most striking labor market trends of our day.

At the end of her campaign to become America’s first female president in 2008, Hillary Clinton remarked that her 18m votes in the Democratic Party’s primaries represented 18m cracks in the glass ceiling. In the market for jobs rather than votes the ceiling is being cracked every day. Worldwide, women run some of the world’s best companies, such as PepsiCo, Archer Daniels Midland and W.L. Gore. They earn almost 60% of university degrees in America and Europe. Despite progressive politics and opportunities at the top, women still have a smaller likelihood of being in regular wage and salaried employment than men, even though the female share of contributing family workers exceeds the male rate in almost all economies where data is available.

Although the gender gap has not fully closed in any region, we are moving in the right direction. Women are economically independent and able to support their families better than ever before. As attitudes continue to open, women are rising to the challenge, educating themselves and taking advantage of resources available to them. Get it girls!!!

Citizens United Backlash – Congress and SRI take on the Supreme Court

2010-03-03T04:40:00.000-08:00

In Citizens United v FEC the Supreme Court decided that corporations are people too, or at least that domestic corporations can spend money on “electioneering communications” just like a natural person, because the corporation has a constitutionally protected right of free political speech. The decision generated massive and instant concern (frenzy?, panic??) in the media, but the sky has not yet fallen. In fact, the impact of Citizens United is likely overestimated, and there is even some chance that the Citizens United backlash will be more powerful than its direct effect (why isn't frontlash a word?). At the very least, the decision will spotlight on some issues of corporate social responsibility and socially responsible investing that will benefit from the attention.

Why won't Citizens United be a huge deal? First, corporations can still be subjected to any campaign contribution limits that apply to individuals, like the $2,400 per candidate per election limit on campaign contributions for Federal office. Remember, the Supreme Court didn't say that corporations had more rights than regular people. This one is not so important because, as in the actual Citizens United case, limits on campaign contributions don't stop spending on independent ads – the individual or the corporation can swiftboat one candidate, without contributing a penny to the opposing candidate, or even run an “independent”, but supportive, ad. Second, corporations already had plenty of ways to spend money on elections, lobbying and politics in general and corporations don't really love to spend money. To the extent that Citizens United affords an opportunity for more effective political spending, the corporate funds will shift away from lobbying and into more direct electioneering. Citizens United will not, in and of itself, greatly change the cost/benefit analysis that already went into corporate political spending, and therefor it won't greatly change the total amount of corporate political spending. Third, corporations are nervous about making stockholders and customers angry. We'll consider some more refined SRI aspects in a moment, but even the most irresponsible corporation will think twice before putting its name on a political attack ad if it has to deal with a broad segment of the population as customers and/or investors.

There's backlash brewing on at least two fronts. Because Citizens United is based on a constitutional right, Congress can't overrule it with legislation, but take a peak at the summary headings from Citizens United legislation introduced by Senator Schumer and Congressman Van Hollen:

PREVENT FOREIGN INFLUENCE IN U.S. ELECTIONS;
BAN PAY-TO-PLAY (includes ban on campaign expenditures by govt. contractors);
ENHANCE DISCLAIMERS TO IDENTIFY SPONSORS OF ADS;
ENHANCE REQUIREMENTS FOR DISCLOSURE OF POLITICAL EXPENDITURES (includes reqd. web site posting for each expenditure within 24 hours);
PROVIDE LOWEST UNIT RATE FOR CANDIDATES AND PARTIES;
PREVENT CORPORATIONS FROM COORDINATING THEIR ACTIVITIES WITH CANDIDATES AND PARTIES.

If passed, this would make it impossible for government contractors and uncomfortable for all public companies to take advantage of the new electioneering opportunity created by Citizens United. Some elements of this legislation would effect current political spends, not just the new areas of electioneering expenditure opened up by Citizens United. Even if it's tough to get anything passed now, things will change quickly if corporations go crazy with electioneering activity.

In addition to possible legislation, Citizens United is a wake up call on corporate governance issues that have long surrounded corporate political activity. An approval process in which the board of directors is required to provide detailed prior approval of political spending and political spending is disclosed in some detail have long been best practice. Citizens United is already getting shareholder groups excited again about political spending. On February 24 the Council of Institutional Investors and Center for Political Accountability announced a letter writing campaign to persuade the companies comprising the S&P 500 that Citizens United would create new pressures and risks, making disclosure and board approval even more important.

The Citizens United backlash will dampen the effect of the decision itself and create a renewed focus on corporate electioneering and probably an even broader category of political expense,including lobbying. The backlash could go even farther. Is the issue for the SRI community just process? Consider Discloco, a company that has a great process to approve and disclose political expenditures, but uses the funds as follows: A) TV ad supporting a candidate who will vote against carbon cap legislation (because Discloco has old plants that are hard to retrofit); B) lobbying Congress for a loophole to be added to a new tax bill in conference, one that will benefit only the three companies in Discloco's industry; C) lobbying the administration to seek trade sanctions against foreign competition – the foreign competitors are actually selling goods at less than their true production cost thanks to government subsidies. Case A, and probably Case B, may give pause to anyone looking for socially responsible investments. Should corporations try to change the rules with political spending, or leave the rules to the voters, the ones who are actually people? Case C is a reminder, not all political expenditures are about changing the rules, sometimes it's about getting the system to work the way it is supposed to work. A total legislative ban on corporate political spending (if it was constitutionally possible), or a mutual fund using an absolute negative screen for any corporation that reports political spending, might be too simple to work. In any case, watch for that Citizens United backlash, and watch for it to generate a discussion on social responsibility that goes beyond approval and disclosure processes and takes on the substance of corporate political activity.

Photo Credit: Sam Ruaat

China’s Second Wind: Asian Superpower Embraces Alternative Energy

2010-03-03T04:23:00.000-08:00

China is no longer just a manufacturer of low cost widgets and knock-off designer bags. The Asian superpower has propelled itself into the clean energy market with a fervor, and is now the leading manufacturer of wind turbines, solar panels. China is poised and ready to expand into the construction of other energy infrastructure such as nuclear reactors and state of the art coal power plants. Chinese manufacturers benefit from three big advantages. The first is cheap labor. The second is a booming domestic market. Third, the Chinese government has made energy infrastructure its top priority (not be confused with making climate change a priority).

Just how cheap is Chinese labor? Reliable statistics on Chinese workers are hard to come by, making it difficult to analyze China’s competitive strength. The U.S. Bureau of Labor Statistics estimates that Chinese factory labor costs just 64 cents an hour (workers in the city make about $1.06 per hour while suburban and rural manufacturing workers earn roughly $.45 an hour). This includes wages, employer contributions for benefits and social insurance. Although wages have risen sharply over the past five years, they are nothing when compared with the average compensation of U.S. manufacturing workers at $21.11 per hour. Renewable energy industries in China are creating over 100,000 jobs per year, which need skilled and unskilled labor to keep its massive domestic economy chugging along at a smooth 8% growth rate.

China’s demand for electricity is rising 15% per year, and unlike more developed countries, China does not have excessive legacy infrastructure complicating its investment decisions. According to the International Energy Agency, China will need to add nearly nine times as much electricity generation capacity as the U.S., resulting in huge economies of scale and efficiencies from large production. U.S. companies often need to decide between buying renewable energy equipment or continuing to operate fossil-fuel power plants that have already been built and paid for. In China, power companies are buying new equipment anyways. Thus, alternative energy is particularly attractive and increasingly price competitive.

The Chinese government has put policies in place to steer loans toward renewable energy. Bank loans are available at interest rates as low as two percent, made financially feasible by China’s 40% savings rate and bolstered by further government incentives and taxes. All electricity users are charged a renewable energy fee. The fee increases residential electric bills by .25 to .4 percent and to .8 percent for industrial users. The fee revenue is transferred to companies that operate the electricity grid to pay the cost differential between renewable energy and coal-fired power.

China’s wind and solar industries are clearly making moves, but still need to grow structurally to create a cost-effective and sustainable energy system that will support its vast energy needs. Grid operators are not reimbursed for the cost of building power lines to wind turbines and other renewable energy producers, many of them in remote areas. Transmission losses are high for sending power over long distances to cities, and over 30% of China’s turbines are not yet connected to the national grid. Many of these wind turbines were built in the last year and construction has not caught up.

Is the RMB the Next World Currency?

2010-02-22T04:23:00.000-08:00

The U.S. dollar has faltered as the world’s stable currency during the recent financial crisis. Will China’s renminbi (meaning the people’s currency) step up to the plate? According to Geng Xiao, director of the Brooking-Tsinghau Center for Public Policy, we should not dump the dollar just yet. He asserts that China needs to take its currency through various structural reforms before it will be ready to carry the weight of the global economy. While the U.S. wants a quick adjustment to correct trade imbalances, it will take time to correct the internal subsidies and inefficiencies that have floated the yuan, distorting its value against the dollar.

There is no question that both powers want to improve imbalance between China’s surplus and the U.S. deficit. But rather than short-term exchange rate adjustments, the Chinese focus is on medium and long-term structural and institutional changes, which will not quickly correct the trade imbalance. China’s central bank needs to reform its pricing structure so that it is comparable to global pricing and compatible with productivity. For example, changing the exchange rate would not change inefficiencies in energy use, because people would still waste energy. But adjusting the pricing is a market based monetary mechanism that consumers and producers will both react to.

Although China hopes to create a stable, enduring currency in the future, the current exchange rate uncertainty has negative consequences now. Foreign investors look to invest in the RMB because they expect the RMB to appreciate, generating “hot money.” These capital flows also create bubbles in the property market and stock market. To correct distortions that attract unhealthy investment levels, China is taking on land reform, energy reform, state-owned-enterprise reform and social welfare to make its non-tradable sectors more comparable to the global pricing structure. Because China is still a developing country and still has low productivity compared to the U.S, so the two countries price structures will take time to converge.

In a recent interview with McKinsey & Co., Dr. Xiao argued that structural and institutional reforms, rather than exchange rate changes, are in America’s interest as well. During the recession, U.S. consumers were not consuming, even though the U.S. manufacturing sector largely targets the domestic market. So even if you change China’s exchange rate, the impact on the U.S. trade deficit will be minimal because the U.S. will buy from elsewhere. Going forward, he recommends that the U.S. produces for consumers in emerging markets – not just Chinese consumers in China – but also Chinese consumers who will go out and spend abroad.

So will the dominance of the dollar come to an end? If the Chinese economy and population continues to grow at a steady pace, it will easily become the largest world market. And if China can implement its reforms and create a modern market economy, the RMB will certainly secure its place as one of the important reserve currencies along with the dollar.

Photo Credit: David Dennis

Will The 400 Trigger Popular Revolt – Medieval Systemic Financial Risk in 2010

2010-02-22T02:22:00.000-08:00

America's Top 400 Households increase share of income while reducing tax rates. Who's getting mad and what will they do?

You've probably seen this chart recently - Maybe on Reuters or in Financial Risk monthly or on the back page of the Post the guy sitting across from you on the subway was reading. Maybe you always read all the IRS news releases or maybe you just found it in the dictionary, under “unsustainable?”. The table shows some interesting facts. Based on tax returns filed for years 1992-2007, America's top 400 households are reporting an ever increasing share of the nation's income and an ever falling effective tax rate, a combination sure to stir bile in the blogosphere. Given the current unemployment rate, that blogosphere bile might actually turn into mass populist outrage, a serfs storming the castle kind of phenomena, the sort of thing that can create financial risk, maybe even change, for a whole system.

What to do? For starters, douse your torch and lay down your pitchfork. We're not sure exactly which castle to storm The fab 400 has a lot of turnover. 72% made the list in only one year. Only one-fifth of one percent made the list all 16 years. Then think. What if you get to the castle and Bill Gates answers the door? Sure he had some sharp elbows when he was building Microsoft, but he created a lot of jobs, and now he's giving most of his fortune away, wisely. Suppose it's Warren Buffet, for years a voice of clarity in a world of double talk, now he's refilling Gate's philanthropic pockets faster than Bill can empty them. Now that you're a little calmer, I agree with you – the trends in this table seem to be headed for real problems, systemic political and financial risk, that we should do something about.

You can make the rich poorer, with income redistribution through taxes, but it's more fun to make the poor richer, so let's start there. When “rich” is the fab 400, there are an awful lot of “poor”. The number of high paying blue collar manufacturing jobs will never bounce back. It's not the economy, it's not even free trade (manufacturing jobs are declining in China) it's productivity. We manufacture more with less people, everywhere. Education is probably the single most important factor in upgrading the non-rich to higher paying jobs (or any job in the case of the unemployed). The easiest single fix might be to better align educational choices and job opportunities. Propaganda in elementary school never hurts. I'm working on a comic book about an heroic civil engineer and her faithful sidekick, a physician's assistant. Fear might also be a useful deterrent – every would-be English, History and Philosophy major could be required to sign an acknowledgment, “I understand the selection of this major will lead to chronic unemployment and I will ultimately have no choice but to go to law school or retrain as an elementary school teacher.”

Now, let's talk redistribution. You will soon be hearing a lot about VAT as the solution to our fiscal crisis, so let me get that first VAT joke out there right now. What's VAT? A sales tax that comes with its own bureaucracy. That's right, you don't see it as a sales tax (because through a series of collections and partial refunds VAT is handled in stages as goods are produced), but VAT has the economic impact of a sales tax. No sales tax will make a dent on the fab 400, they just don't spend a large enough percentage of their income. In fact, any new VAT or sales tax will exacerbate the trends that are already in the chart. That's right, VAT, like any sales tax, is regressive. At this point in history the VAT might actually be a financial risk in its own right.

Forget VAT and try two old things to turn those effective tax rate trends around. First, WAIT. 2007 was a very good year for capital gains. 2008 and 2009, not so much. The rich thrive on capital gains and our fab 400 had lots of them in 2007. Both the percent of total income and the effective tax rate trends might reverse, or at least decelerate, once the 2008 and 2009 data is available. Second, once we're confident we aren't facing a double dip recession, raise the capital gains tax, by a moderate amount and the top tier marginal income tax rate, by a moderate amount.

Photo Credit: FaceMePLS

Google, Rio Tinto and the rule of law in China - Emerging Market Red Light

2010-02-16T04:31:00.000-08:00

What happens when Communist party insiders control your competitor, your supplier, your customer and the legal system set up to resolve your disputes?

Recent headlines have highlighted China's alleged cyberattack on Google and China's indictment of four employees of Rio Tinto, one of the world's largest mining companies, for accepting bribes and stealing trade secrets. Both cases should remind investors that there is more to emerging markets than growth. The cyberattack came as Google struggled with censorship and accessibility issues in China while competing with a Chinese imitator. It led to Google's withdrawal of censored search service in China. Rio Tinto was involved in heated negotiations to supply iron ore to Chinese steel companies, at prices Chinese officials considered unfair. The Google and Rio Tinto incidents are not directly connected, but they raise some common questions on the sustainability of foreign investment in China and, in very broad terms, the sustainability of any large system that combines a market economy with political control by a privileged group not subject to democratic selection. Just how committed to the rule of law is China, how nervous should companies (and their shareholders) with extensive business in China be about this issue and what should they do about it.

From the outside (and Justmeans Sustainable Finance is looking forward to an inside view on China from Johanna Hoopes) some broad trends seem reasonably clear. First, the shift towards a market economy combined with the retention of strict political control by the Communist party is allowing party officials and business owners with close ties to the party to build personal wealth through control of assets, information and access that once belonged to the state. It's a less flamboyant version of the plutocrat creation decade in Russia, but with no pretense of democracy. Second, although China honors the rule of law in theory (both historically and currently the Chinese legal system is quite interesting and in many ways advanced), in practice Communist Party leaders will still control the outcome of any dispute that threatens a significant interest of the party. Sometimes the party considers the pocketbooks of its officials and their friends to be a significant interest of the party. Ouch, that's right, once in a while your Chinese competition might make the rules and own the referee. Rio Tinto officials are professing innocence in response to the recent indictments, but don't bet on the Chinese courts to agree. The issue is not unique to China or communism, many emerging market countries, especially those run by an unelected elite, have revealed some cracks when a growing economy creates friction the legal system can't handle.

Non-Chinese businesses recognize the issue, but they are desperate to get involved, and stay involved, with a market that will be the world's largest. Often they count on close relationships with Chinese stakeholders (sometimes co-owners, but also key employees, consultants, suppliers or customers) to keep them on the party's good side. As a safety measure, they can limit exposure of intellectual property in China and minimize non-removable investments like bricks and mortar construction on Chinese soil. Few will take a Chinese problem head on, with open defiance. Google's technical and financial might, and the moral courage its management eventually showed on censorship, are a combination we won't see often.

What should a business, an investor, or anyone else do to foster the rule of law in China? Probably start by recognizing that lectures will be counterproductive and Western democracies don't have an ideal record on this issue. Even in the US Federal system, where I believe the vast majority of judges are competent and honest, money is an extraordinary advantage, especially if you consider rule making (and the expensive lobbying that surrounds legislation and regulation) as part of the system. Then maybe give some credit to the companies that are willing to take a stand, even when it costs them. Attaboy Sergei. If you're an investor, look at China as more than just a rosy opportunity, what would happen if that hot stock you are considering suddenly found itself on the wrong side of a dispute with a company in China that was seriously connected to the party. Would the same thing happen even if the “dispute” was just a pretext for the competitor to gain at the expense of your suddenly not so hot stock? Finally, if you are doing business in or with China, then, with patience and diplomacy, whine about rule of law whenever you can, especially on Chinese web sites. China's leaders aren't democratic, but they monitor public opinion, especially on the Inter net. Each time concern about how the rules are made and enforced forecloses or modifies your opportunities in China, let your Chinese stakeholders know directly. In the long run, a judicial system that values the rule of law over party connections is important to the Chinese, not just the foreign investor.

Photo Credit: srqpix

Chase Gives Back Through Social Networking Sites

2010-02-16T03:46:00.000-08:00

Chase is exploring a new type of charitable giving. The company is harnessing the power of social networking to give individuals and communities a say in corporate philanthropy. The program provides over 500,000 local organizations with a national platform to attract donors, promote their missions, and gain visibility with 300 million Facebook users. Simply by friend-ing Chase Community Giving, then voting for a winner, Facebook users can take a stake in which local charities matter most to communities and expand their impact even further.

The grassroots campaign donates $1 million to the organization with the most votes, $100,000 to the top five runners up, and $25,000 to one hundred finalists, which in most cases is the largest single donation in the charities’ histories. These charities span 31 states, providing services such as supporting families and children battling diseases, providing help for the homeless, protecting the environment, helping veterans and their families, and aiding challenged communities in the U.S. and worldwide. To be eligible, the charities had to be registered as a 501 (c)(3) non-profit, have operating expenses of $10 million or less, and have missions consistent with Chase’s social responsibility guidelines.

Voters selected the winner of this year’s contest, Invisible Children, a San Diego based charity that works through U.S. high school and college student volunteers to advocate for kidnapped children in Central Africa who are forced to serve as soldiers in the civil war in Uganda. The organization, which received 123,990 votes in the final round, will use the funding to build school and microeconomic empowerment program as well as raise awareness in North America.

Chase has received a ton of feedback from Community Giving Fans on what causes they support and what issues they care about. Getting customers and stakeholders to tell you what they want is goal numero uno marketing. And Chase has accomplished that goal, not just by asking, but by involving stakeholders in the decision making process. Facebook execs are also happy to see their social network harnessed for this philanthropic cause. Sheryl Sandberg, COO of Facebook said “Chase’s creative approach puts the power of corporate giving directly in the hands of Facebook users.”

One of the benefits of crowdsourced philanthropy is that letting the masses decide where the money should go is more transparent and less biased than other forms of philanthropy But letting voters take matters into their own hands also has its own obstacles. In the final hours of the contest, one organization received an influx of votes from newly created profiles on Facebook. Although it didn’t change the final outcome, monitoring these online giving mechanisms to ensure a fair playing field for all participants will be crucial. Stakeholders must trust that their vote matters and is counted accordingly in order to buy into using technology to support corporate philanthropy.

Financing Water for All

2010-02-09T23:53:00.000-08:00

There are glaring global inequalities in the supply of water infrastructure and services. In 2000, an estimated 1.1 billion people lacked access to a safe water supply, and 2.4 billion to proper sanitation. The UN Millennium Development Goals set a target of halving by 2015 the number of people who lack access to safe water. To even take a stab at tackling this lofty goal, collaboration across all sectors will be required at a global level. In the past, players have shifted responsibility to each other. This problem can only be solved if all parties accept the need to change their approach. These parties include governments at national, regional, and local levels, NGOs, communities, public utilities, companies, multilateral lenders, and civil society to name a few.

According to a report by the World Water Council, financing flows need to at least double before we can even think about providing a sustainable water supply to the masses that lack it. These will have to come from all sectors: financial markets, water authorities through tariffs, from multilateral finance institutions, from governments and from public development aid in the form of grants.

There is a general consensus that inherent problems to the water sector arise from weaknesses in governance. Sector institutions are badly in need of reform if they are to aptly utilize new funding. Governments must also prioritize water. Because the water sector tends to be decentralized, policies and action plans must be implemented at community and regional levels, as well as bolstered on national and international scales. To ensure sustainable cost recovery from the generation of interal funds, a stable framework for future revenue transfers will be essential as well.

On the private side, international loans and equity investment in water have been declining. Banks and companies are aware of the risk-reward scenarios associated with water and the market for water infrastructure development remains illiquid in many economies. The sovereign risk on projects, including foreign exchange risk, is a major disincentive that must be addressed if water projects in emerging markets are to attract international loans and equity. Local businesses are crucial if water services are to be improved. These enterprises need the resources, innovation and training to do so. Service NGOs may be useful for support in these cases. Export credit agencies should also be urged to set targets for their water sector business to lengthen the maturities for water loans and to increase the proportion available for local costs.

Both public and private water providers should be able to borrow more of their capital locally, reducing the foreign exchange risk. Government and central banks should encourage the growth of local capital markets and attract more local savings from pension funds, mutual funds, and other institutional investors into efficient local channels. To support these efforts, multilateral financial insitutions must also make greater use of guarantees and other instruments to encourage more long-term local lending and shore up resources in local currency markets. Only if these steps are done collaboratively, may we actually make visible progress toward securing water access for all.

Unpaid Internships: The New Sweatshop? (and we are not talking emerging markets)

2010-02-05T11:42:00.000-08:00

Sweatshop paints an ugly picture, so let's start with what we are not writing about – an airless room in an emerging market country filled with seamstresses making subsistence wages, or less. We are not writing about students who are working for college credit (and in many cases wages too) as interns in a supervised educational program, like the co-op program pioneered by Northeastern University. We are talking about an office in a fun, creative glamorous business like publishing, entertainment or fashion; an office in a city like New York, San Francisco or Boston - in other words, the kind of office in which a lot of college students and recent grads would like to work so much that they are willing to work for free.

Consider a basic point, – employers don't get an exemption from minimum wage laws just by calling an employee an intern. Federal law does include a minimum wage exception for trainees and The US Dept. of Labor uses a six part test to distinguish between trainees and employees.

Most of today's expanding crop of unpaid internships fail at least one of the six tests – because the interns are regularly doing actual work, and a lot of it, for the benefit of the employer, not primarily learning. If you have any doubt about this, check the job boards for internships in any creative field. The skills required to even land one of these internships qualify the intern to handle a lot more than closely supervised photocopying. While the larger companies and NGOs, the ones that actually check with a lawyer once in a while, are often careful, the entrepreneurs sometimes go to town with an office full of unpaid interns who produce much of the regular work, maybe not all that different, in theory, from that emerging market sweatshop.

So what. Illegal doesn't always equal immoral or unsustainable. The interns are bright people who generally understand what they are getting. The on-the job-learning and the credential building are real, even if the hope of a paid position down the line might be exaggerated at times. Many of the employers are start-ups working on a shoe string who could not hire a single extra paid employee at minimum wage if they had to scrap the unpaid internships. Some employers might not even have a sustainable business without free intern labor. The basic theory of supply and demand suggests that any minimum wage retards job creation at the entry level and the Chicago School economists regularly advise emerging market countries against adopting minimum wages. Maybe slack minimum wage law enforcement during a recession is better than the kind of vigorous enforcement that would send these interns home to sit on the couch and drive their parents crazy.

Or maybe not; slack minimum wage law enforcement has some problems. First, some employers could and would create minimum wage jobs if they could not get free labor from interns. Second, only the reasonably well off interns can count on family support while they work for free. As the unpaid internship becomes a prerequisite to a creative career, doors close for the less fortunate. In an extreme case, companies have been known to auction unpaid internships off to the highest bidder with proceeds going to charity. Third, and most problematic, the unpaid internship seems to be spreading – presenting a slippery slope for minimum wage enforcement just in time for the Winter Olympics. The unpaid Summer internship morphed into the just graduated four or six or twelve month internship. The use of free labor also seem to be creeping out from the creative businesses. (Although we can stop banker bashing for one column. Investment banks still pay their interns more than minimum wage -before you ask, the banking interns do not make millions). Will the tide of unpaid internships ebb when the recession ends, or is this trend here to stay unless law enforcement tightens up?

If slack enforcement still sounds good to you, consider – wouldn't it be better to change the minimum wage law to something you would want to enforce? Maybe create some additional minimum wage exceptions for low revenue employers in creative fields who would clearly hire no one if they lost their unpaid interns? Possibly limit the number of free interns in relation to the size of the employer to make sure there were enough trainers to actually teach the trainees, not just exploit them. Maybe even limit hours for unpaid interns to part-time, so the intern who can't afford not to work can hold down a paying job too. What would you do: Abolish the minimum wage altogether; Enforce the minimum wage and effectively abolish the unpaid internship that produces serious work product for the employer; or, Change minimum wage laws to accommodate more legally unpaid interns, while addressing some of the problems this creates. Let me know, here or at Justmeans.

Socially Responsible Investing Run Amuck?

2010-02-01T12:29:00.000-08:00

Growing concerns about climate change and financial accountability have contributed to the rise of social investing. There are so many funds appealing to social investors, choosing a portfolio based on financial, environmental, and social returns can be daunting. These days funds range from corporate governance based, environmentally specific, social awareness and religion-themed funds.

Something for everyone may be an understatement. New faith-based exchange-traded funds (ETFs), managed by FaithShares Trust, cater to various Christian beliefs. The Trust uses statements by each church group’s national body, such as the U.S. Conference of Catholic Bishops, to define its investing approach. FaithShares Lutheran Fund avoid spirits producers, the Methodist Fund allows companies with less than 10% in alcohol-related revenue, and the Christian Values Fund abstains from any company that produces a caffeinated or alcoholic substance. The Catholic Fund takes a case-by-case approach. Similar to other socially responsible funds, FaithShares takes hundreds of stocks and weeds out the ones that don’t fit its parameters. The differences can become a bit obscure.

Environmentally focused funds have garnered more interest. Popular offerings include solar and wind specific portfolios such as PowerShares WilderHill Clean Energy Portfolio and First Trust Global Wind Energy. But risk-averse investors beware; this field is extremely dynamic with rapidly developing technologies and players. Broader-values based ETFs may be a safer bet. The iShares FTSE KLD Select Social Index Fund has a strong volume of stocks and outperformed the Dow Jones Industrial Average in 2009. KLD is typical of larger socially responsible funds in that it invests in similar holdings in the S&P 500, so its performance is characteristically more congruent with the main stream. However KLD’s services are far from free. And while these funds may perform better, they include stocks like XTO Energy (Calvert Social Investment Balanced Fund) and BP (Wells Fargo Advantage Social Sustainability Fund) and so may not agree with truly green advocates.

Despite all their popularity, the effectiveness of these funds as an investment or moral vehicle remains debatable. Fees for socially conscious funds are often higher than similar funds. Although many of these funds act like index funds, in some cases you are paying a high cost premium to support your cause. Newer and narrower funds may lack historical performance data and hold fewer asset options. Further, some funds stretch the definition of “socially responsible” to include high performing large caps or high growth stocks.

So how to choose an SRI fund that suits your portfolio? Do your homework, thoroughly, on the firm, the fees, and the returns. And make sure the funds do theirs. Most reputable SRI funds have a transparent methodology and criteria by which they choose the assets under their management. They also share clear metrics on the historic performance of each fund. For those who’ve thrown in the morality towel, there’s always the Vice Fund. Its biggest holdings include tobacco, spirits, and defense contractors. Although cleverly named, its performance has suffered and assets under management have declined in the past few years. Go figure.

Steve Jobs Makes How Much? When Raising Capital, Make a Bad Deal for a Good Cause

2010-02-01T06:21:00.000-08:00

Sometimes a bad deal can make sustainable finance sense in the long run, or even the short.

Steve Jobs has been working very hard for a guy who makes a dollar a year, flogging the I-pad, shrugging off the tampon jokes, convincing the analysts he's not dead yet. Why not take a real salary? When Ben & Jerry's was raising capital, it sold stock only to Vermonters. Wouldn't the price have been higher with a whole nation full of potential buyers? When Google went public with a computerized auction it certainly got the best price from the participants (who writes an algorithm better than Sergei?) but how many would-be buyers were not participating because they weren't familiar with the process?

They had their reasons. That dollar a year salary is part of the Mac mystique, and Mr. Jobs already owns enough Apple stock so that the compensation he forgoes is returned many times over when the enhanced Apple brand is reflected in a higher stock price. Ben & Jerry's has branded its Vermont hippy image, and what says hippy better than screw Wall Street, when I'm raising capital I'm selling to my neighbors. Take that Haagen-Daz. Google too, built it's master of tech brand at the expense of Wall Street tradition.

Prof. Victor Fleischer included these cases in a rigorous and insightful look at deals that seem to accept less than optimal results for the sake of building a brand long term. Brand building works for me, but in these particular cases the actual short term sacrifice might have been fairly limited. An odd deal is a gimmick, a special event that creates its own publicity and enthusiasm. A thousand really excited Vermonters may have allowed the underwriters to set Ben & Jerry's stock price up almost as high as a nation full of profit maximizing bargain hunters. When Google was raising capital, it's computerized auction probably did chase some buyers away, but how many first time buyers jumped in because something different was happening? Mr. Job's foregone compensation might be returned as stock appreciation, even in the short run. In other words, if the “bad” deal is interesting and well publicized, maybe we can use it to build that brand long term with out much short term pain.

Why doesn't this happen more often? Did Lloyd Blankfein really need to take Goldman through a public mea culpa, or did he just need to take a dollar a year? If I'm Tesla Motors, struggling with the fact that my electric cars will cost an awful lot to make until I can move to high volume production, what should I do? Build five hundred cars on spec, then auction them off? That's a start, but let's make it a little more interesting. Paint all the cars a special, unique shade of green. Open the auction only to bidders who are members in good standing of an environmental organization. Now you are really generating (sorry, couldn't resist) some publicity and those special green cars might even become the kind of status symbol that produces fevered bidding.

What are your ideas for a “bad” deal that doesn't really hurt because it creates short term buzz and builds a brand long term?

Comment here or visit the sustainable financing editorial section at Justmeans.