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CORONAVIRUS AND FINANCIAL MARKETS: UNCERTAINTIES AND LESSONS FROM AN UNPRECEDENTED CRISIS

Théo Dolle – ESCP Alumni – Commodities Derivatives Sales, BNP Paribas

Cécile Kharoubi – Professor of Finance, ESCP Business School

 

In the impact paper we wrote as part of the ESCP Business School’s “Managing a Post-Covid19 Era” series, we investigate the consequences of the Covid-19 crisis on financial markets, focusing on the wide divergence between equity and commodity markets, the risky involvement of non-professional investors, and the rehabilitation of the banking sector.

While the health crisis represented by the Coronavirus puts our globalized society in an unprecedented situation, it is also a great post-Subprime fire test for the financial markets. Following the crisis of 2007-2008, the financial markets were unanimously decried as the source of the financial crisis. The current crisis, which is primarily an economic crisis and whose source is totally exogenous to the functioning of the markets, nevertheless provides an opportunity to test their viability, efficiency and usefulness in a context of global crisis.

In order to draw lessons from this situation that markets have never seen before, it seems important to assess the extent to which markets represent a synthesis of available information, as Eugene Fama assumes in his theory of efficient markets. However, the opposing movements in equity and commodity markets suggest that financial markets, particularly equity markets, are currently out of touch with reality. Moreover, 12 years after the collapse of Lehman Brothers, the changing role of banks in the economy continues and could prove decisive in the context of a potential economic recovery and market stabilization.

 

The wide divergence of equity and commodity markets

The academic doxa still perceives financial markets as a synthetic representation of available information. However, in our world punctuated by an uninterrupted flow of often contradictory news, information is plural and already tends to threaten the informational efficiency conditional on the validity of orthodox financial theories. But what happens when financial markets offer us several distinct representations of reality? This is what the case of the divergence between equity and commodity markets shows us today. Indeed, while the equity markets, supported by the exceptional expansionary measures taken by central banks and states to reduce the economic impact of containment measures, have already rebounded close to their historical highs reached before the start of the health crisis, the commodity markets, particularly gas and oil, are still at the heart of a historical crisis whose repercussions threaten the future of the energy industry in the long term. This is evidenced by the prices of U.S. crude oil, whose major index, WTI (West Texas Intermediate), plunged into negative territory for the first time in history on April 20, dropping to a price of -40.32$/barrel. So how do you explain such a divergence? The major explanation lies in the fact that energy commodity markets, unlike equity markets, are always linked to the macroeconomic reality that drives the supply and demand dynamics on a daily basis. The price of WTI became negative for the first time on the eve of the expiry of the May contract. Traders who had to “roller” their futures position from May to June in order not to receive physical delivery were then faced with the scarcity of storage facilities and were therefore willing to pay to get rid of the oil they did not want (or could not) physically receive. It was therefore a reality on the ground that caught up with the oil market. If they are sustainable in the medium term, the historically low levels of energy indexes will lead to a profound rethinking of our global energy production model, while pushing traders and analysts in these markets to rethink their forecasting models in order to include scenarios never before imagined in concrete terms. However, this return to reality has not yet been experienced by the equity markets, which are still being boosted by the aggressive policies of central banks. The Financial Times even describes this divergence between the depressed economy and the rising equity market as “so extreme that it leaves analysts at a loss to explain*” This major dislocation shows that the different markets are offering distinct diagnoses in a new situation where uncertainty is the rule.

 

Banking sector: All is forgiven?

If there is one point on which this crisis is opposed to the crisis of 2008 it is on the role of banks. Indeed, if banks have been found guilty of the subprime crisis, they are now potentially supporting the economic recovery and hope to see their image improve in public opinion. Indeed, banks, through the granting of loans often guaranteed by the State in order to finance an economy in free fall, have the opportunity to partially restore their image. Moreover, when banks’ results are published, it is noted that the role of the market activities of these institutions paradoxically mitigates the impact of the health crisis on their results. Indeed, the rise in transaction volumes and the explosion in volatility on all financial markets has boosted the earnings of banks’ trading divisions. The example of Barclays, whose trading revenues, up 77% in the first quarter of 2020, have made it possible to increase provisions for credit losses, is particularly telling. We can therefore expect banks that still have significant market divisions to outperform those that have already relegated these activities to the retail sector. This trend is all the more paradoxical since most banks tend to focus their strategy on reducing trading activities, which were often decried after the subprime crisis and whose declining margins have squeezed earnings.

Faced with the economic difficulties caused by the containment policies implemented by governments to contain the virus, banks then presented record provisions in their balance sheets to prepare for possible massive credit losses. The behaviour of central banks in the face of these uncertainties then presents a new paradox compared to the previous crisis. Indeed, some of them advise commercial banks not to be too conservative in their provisioning levels so as not to discourage lending to businesses and individuals in the context of the future economic recovery. This is the case of the Bank of England, which advised English banks not to be too cautious about provisions made in the first quarter of 2020. Central banks are therefore advising commercial banks to take more risk, while the latter are particularly cautious. The current health crisis has indeed pushed the banking industry into an unprecedented situation giving rise to particularly counter-intuitive paradoxes.

Although the crisis did not start in the financial markets, it will nevertheless have profound impacts that will affect the financial industry in the long term. There has been a dislocation of markets by asset class, and a rethinking of the role and model of banks. It is also likely that this crisis will have a lasting impact on the risk appetite of all investors, traders and banks.

 

Finance

ENLISTING TECHNOLOGY TO HELP FIGHT FINANCIAL CRIME

By Rachel Woolley, Director of Financial Crime Fenergo

 

Million-dollar properties, private jets and parties on luxury yachts with celebrity friends. Although it might sound like the plot for a new reality series, this is what corruption, illicit funds and political connections can buy at the expense of ordinary citizens.

Following an investigation by the International Consortium of Investigative Journalists (ICIJ)[1], thousands of leaked documents, known as the Luanda Leaks, suggest that the daughter of Angola’s former president, Isabel Dos Santos, acquired her enormous wealth through favourable access to lucrative deals. These activities were often to the detriment of Angola’s poorest citizens.

We’ve also started to see the application of unexplained wealth orders (UWO) in the UK, with the first UWO issued in 2018. The latest UWOs relate to the grandson of Kazakhstan’s former president, Nurali Aliyev[2], is currently being investigated by Britain’s National Crime Agency (NCA) to explain where he got the money to buy a £80 million house in one of London’s most expensive neighbourhoods. It is thought that the funds used to buy the property have criminal origins.

But these aren’t isolated stories. There have been countless examples in recent years of how corruption, fraud and political connections has resulted in billions of dollars being stolen worldwide in countries such as Brazil, Malaysia, Gabon, Russia and many more.

A recent report by Fenergo found that regulators have issued over $36 billion in AML/KYC and sanctions-related fines (and rising) since the financial crisis. This staggering number shows that related financial institutions had inadequate policy, processes, procedures and systems, in addition to poor governance and oversight in many cases.  Interestingly, a similar report found that the vast majority of these regulatory costs were associated with an AML/KYC-specific labour force.

Not surprisingly, the methods used to hide the illicit wealth are pretty similar; invoice fraud, suspicious transfers, offshore companies and complex ownership structures to disguise beneficial ownership of assets and property. Another commonality is the detrimental impact this has on some of the poorest citizens in these countries and the global economy.

But what can we learn from these scandals? And perhaps more importantly, what can be done?

For financial institutions, the importance of leveraging technology to unwrap complex hierarchies, related parties and identifying individuals with political connections cannot be understated. Understanding the ownership and control structure when onboarding entities is critical, along with robust screening practices to enable sufficient oversight of the relationship, accounts and transaction activity. Enhanced due diligence measures must be applied to politically exposed persons (PEPs), their immediate family members and known close associates. Relationship patterns are also significant, as the same service providers are often used, as was the case with Mossack Fonseca in the Panama Papers scandal.

It’s critical that financial institutions are vigilant in the detection and prevention of financial crime before it’s too late.  By automating KYC/AML compliance and leveraging rules-based technology, financial institutions can ensure that internal policies are fully in-line with constantly changing regulations across multiple jurisdictions.  However, human input will still be necessary when red flags are identified by the system.

 

Biography:

Rachel Woolley, Global AML Manager at Fenergo, has over 10 years’ experience in the Financial Services industry having worked primarily in the funds industry and retail banking. She has a strong background in regulatory compliance, particularly in the areas of anti-money laundering and counter terrorist financing (AML/CTF).

Rachel holds a BSc (Hons) Degree in Applied Accounting from the Oxford Brookes University and is an ACCA Affiliate. She currently holds three professional designations; Licentiate of the Association of Compliance: Officers in Ireland (LCOI), Certified Financial Crime Prevention Practitioner (CFCPP) and Certified Data Protection Officer (CDPO).

[1]https://www.bbc.co.uk/news/world-africa-51218501

[2] https://www.theguardian.com/uk-news/2020/mar/10/uk-issues-unexplained-wealth-order-over-kazakhstan-familys-house

 

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Business

CONSUMERS ARE READY FOR BIOMETRIC PAYMENT CARDS

Lina Andolf-Orup, Head of Marketing at Fingerprints

 

We’ve come a long way in the evolution of digital payments. Magnetic stripe cards, chip & PIN and contactless technology have all played a role in dethroning cash as ‘king of payments’, with many countries well on their way to becoming cashless economies. As with all tech innovation, though, consumer readiness is always the deciding factor in the crowning of new payments royalty.

Now there’s a new technology on the block, ready to help contactless offer even more value: the biometric payment card. In recent years, biometric payment cards have been steadily gathering momentum, currently being trialled by over 20 banks across the world, with the first commercial launch announced last year. A mass-market roll-out is imminent.

But with all the noise from the payments world, it’s important to answer the de facto question that’s key to any technology’s success: are consumers ready?

 

Lina Andolf-Orup

Contactless is (almost) king

Contactless has achieved great success globally, and are now seeing a steep increase across the world.

In addition to consumers being frustrated with having to remember a plethora of PINs and passwords, the current pandemic has also brought to light the unhygienic nature of cash and PIN-enabled payments. Now more than ever, consumers are eager to use a secure, convenient, and hygienic payment method. And contactless almost fits the bill.

Although consumers want to use their contactless card more often, security worries, payment experience frustrations, and the limiting payment cap are all preventing the card from reaching its full potential usage.

The missing link

This is where biometrics comes into play: the missing element that can take contactless into the era of worriless and limitless payments, and provide consumers an experience they expect in the 21st century. With consumers clear about what they want, let’s take a look at what’s top of their checklist and how biometrics can fill in the gaps to realize their ideal payment experience.

 

  1. Smarter, safer contactless. Just for you.

Security is a primary concern for consumers when it comes to contactless, with 38% of consumers citing security as the main reason they are hesitant to use the payment method. For older generations, this number rises to almost 50%.Yet with hygiene concerns at an all-time high, many consumers aren’t eager to use PIN-pads to secure their payments either. By moving the authentication onto the card itself, biometrics secure payments in a way that allows consumers to never touch a PIN pad again.

With the rise of data privacy concerns, consumers can rest assured that their biometric data never leaves the card and won’t be shared with third parties or cloud-based databases. Everything remains securely stored on the payment card itself.

 

  1. Let’s talk about UX

Although every generation is keen to use contactless more, millennials are especially eager to take greater advantage of this convenient payment method. 87% of millennials that own a contactless card use it regularly and three quarters are set to use it more often.

Biometrics bring additional trust to contactless payments, while keeping the same level of convenience, allowing consumers to make a secure payment in less than a second. And with a unified experience so you know what to expect every time you pay; not PIN code sometime, contactless another time, it always works the same no matter where you are in the world.

Because a biometric payment card does not need to be charged – it’s powered from the payment terminal in the same way traditional contactless is – there is nothing standing in the way of efficiency-loving consumers embracing this technology.

 

  1. Contactless made limitless

To offset the lack of PIN security, traditional contactless payments are capped. In light of the current hygiene concerns, countries around the world have already raised contactless payment caps in a bid to reduce PIN entry and cash use. But without any additional strong authentication, the limit has not been lifted completely anywhere to date. This is not only frustrating consumers, but our recent research found this was the primary frustration banks felt regarding contactless.

With the touch of a finger, biometrics brings the robust security needed to remove contactless payment limits altogether. Across contactless cards, mobile, wearables – and even future payment options – biometrics can provide a strong and seamless authentication solution to however we choose to pay or whatever contactless form or shape. Limitless payments with a harmonized UX, wherever consumers are, however much they spend, and wherever they pay: the perfect companion in the age of convenience.

 

  1. Tech nation

A less pressing, although by no means trivial matter, is that consumers are simply ready for something new. Over a third of consumers want to use more modern and personal payment cards, and biometrics sits alongside metal cards, tailored designs and other innovations to do just that. Not to mention that the standard contactless card, the last great innovation in card payments, is now over a decade old!

Featuring the latest fingerprint sensors and an advanced algorithm with AI, biometric payment cards not only meet the criteria for a modern and next-generation payment card but offer the most personal touch imaginable. Your fingerprint.

 

  1. Ready to roll…

We’ve arrived at a crucial point in the evolution of payments. With the technology tested and accredited in line with the rigorous standards of the payments ecosystem, the mass market adoption of this technology is just around the corner. But most importantly, consumers have never been more ready to embrace limitless and worriless contactless.

 

 

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