Currency Overlay

Currency overlay programs are committed to the management of current currency risk in a portfolio; currency exposures are looked upon as a distinct choice from the comprehensive asset distribution. The goal of currency overlay programs is to restrict losses and optimize gains that occur from currency risk.

In the context of the volatility of exchange rates, it is expected that investments in global equities are unpredictable. Currency risk can have an adverse effect on a portfolio that contains foreign denominated stock.

Investment in foreign denominated currency results in additional risk to portfolios. However, currency overlay programs can reduce the risks, while some result in profit opportunities.

The overlay programs are committed to the management of current currency risk in a portfolio. However, a currency overlay program is not a direct investment. It is a risk management program executed with derivatives that do not need an asset distribution.

Currency overlay can be passive/active. A passive overlay is not very complex. A comprehensive hedge of the currency exposure is established and efficiently transforms the complete foreign exchange exposure into the base currency. The emphasis of such a strategy is to remove the risk. This method does not look at supplementing additional return to the portfolio. By flattening out the peaks and valleys in asset values because of currency changes, a passive currency hedge removes all the risk due to exposure to foreign currency. It delivers improved stability to asset values.

A passive currency overlay is implemented utilizing basic derivatives, especially futures, forwards, and swaps. The advantages of passive currency management occur from the total effortlessness of the strategy.

A portfolio is safeguarded from any unfavorable fluctuations in foreign currency. This would enable the investor to assume more risk in other asset classes. The fees are also less since the strategy has been passive and depends on standardized derivative contracts. Though passive overlay programs are correct for certain clients, they are very basic in nature and structure.

Active overlay programs seek to decrease losses from foreign currency exposure.  For a normal currency overlay execution, an initial hedge ratio is established. The initial hedge ratio is identified on a portfolio specific basis by looking at factors like clients’ assets, liabilities and liquidity requirements. The part of the portfolio that is not hedged is then actively managed to create alpha by manipulating currency fluctuations.

Currency overlay programs could be of use to investors who are concerned about the currency risk that is a part of international investments. Passive and active programs are available to meet the objectives and risk tolerance of every specific plan. Before pursuing an overlay program, investors must prudently assess their overall asset allocation, future liquidity requirements, and investment policy guidelines to determine if an overlay program is appropriate.

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Mortgage Banking

In order to cater to the increasing needs for regulatory compliance, mortgage banks must adopt a wide-ranging method to compliance risk management (interfacing regulatory analysis, determining contesting regulations, incorporating operational process controls, managing data quality, and planning documents management).

Mortgage banking stakeholders comprehend the challenges, while adhering to transforming regulations and requirements from government regulators, government-sponsored enterprises (GSEs) and investors. Regulatory compliances impact the complete life cycle of originating and servicing a mortgage loan. The emphasis is on data quality related to decision-making, calculations, and analytics.

An organization cannot be looked upon as being compliant with a procedure unless it delivers proof of the functions, procedures and data represented by the rule. In order to prove “evidence of compliance”, an organization must record the connection between compliance rules, calculations conducted, and data derived.

There exist five critical components of managing a compliance program that delivers evidence needed to reduce compliance risk:

Regulatory Interpretation

Compliance is related to a comprehensive documentation of regulatory, investor, state and corporate needs. It is directly connected to the operational processes, data, and reports impacted by a distinct requirement. The process is handled by a team of stakeholders to bridge the gap between business and technology. The stakeholders collaborate with business, legal, IT and compliance personnel to interpret and record regulatory needs.

Regulatory Controls

It facilitates the interpretation of regulations being translated into related business processes. It needs a comprehensive process design, control, and management. Efficient process controls also need a robust elucidation of the process, an effective understanding of the key points of control and proper reporting that particularly addresses the key control points.

Exception Management

An effective process control and monitoring system would result in business process exceptions being reduced.

Data Integrity

 The effective execution of the previous three components would have a major impact on data quality. It is structured to facilitate the veracity and flexibility of data across the life cycle. The data quality is validated by the integrity of the source.

Event Data

 At the time of origination, servicing and default management, a loan transits via multiple stages and critical processing outcomes. It is vital for the data to be documented at the same time as the occurrence of the event to ensure compliance afterward. For instance, during the origination process, a distinct fee is modified in excess of an elucidated ceiling, the modified values along with the event are managed and used in compliance reporting.

Data Transfer

 Identify the perfect source system for specific elements and effectively transfer the data elements to a centralized repository. The lack of accuracy during the data transfer process is a vital reason for bad data quality. It needs inefficient initiatives to integrate the data later on.

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Moody’s Downgrades The UK’s Credit Rating

The prominent global credit rating agency, Moody’s has cut the UK’s credit rating outlook to “negative” after the nation voted to leave the EU. The outcome is expected to herald an extended period of concern.

The rating agency said the result of the referendum would have significant negative inferences for the nation’s medium-term growth position. It also reduced the UK’s long-term issuer and debt ratings to “negative” from “stable”.

The agency stated that the negative impact from lesser economic growth would offset the fiscal savings from the UK since the nation need not contribute to the EU budget in the future. It added that the nation had one of the biggest budget deficits among developed nations.

Experts believe that in the long term the UK’s credit rating may have an impact on the nation’s households.

Traditionally, the borrowing rate of the government is the standard for the other interest rates pertaining to the economy to be established.

Usually, a lower rating would typically match to higher borrowing costs. Under such a scenario, the impact would be felt by various sections in the longer term – the government, firms, and households.

The financial assessment came after the historic referendum in the UK on June 23rd, 2016. In essence, credit rating agencies, rate a nation on the basis of its economic strength.

More precisely, they rate governments, large firms on how likely they would pay back their debt. In other words, the greater a credit rating, the less expensive it is for a nation to borrow money in the global markets.

Therefore, theoretically, when a government wishes to secure money, a high credit rating would indicate a lower interest rate (and vice versa).

Globally, there are three key rating agencies – Moody’s, S&P and Fitch. S&P and Fitch have not yet issued a statement on the UK post-referendum.

Credit rating agencies also provide every nation a precise credit rating score. With regard to Moody’s and the UK, presently it scores the UK at “Aa1”.

In Moody’s rating scale, it is the second highest rating. It indicates “high grade”, under “AAA” which is “prime”.

By altering its position to “negative”, Moody’s has cautioned that the UK’s “Aa1” rating could be at risk of being reduced.

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Mobile Voice Recording in Financial Sector

In the financial sector, managing compliance is a critical yet progressively intricate challenge. Until recently, compliance needs for mobile communications were not subject to regulatory scrutiny in financial firms.

However, in 2011, the Financial Conduct Authority (FCA) eliminated the recording exemption for mobile phones and regulated that all mobile communications directly connecting to a financial trade should be recorded.

It was followed by the Dodd-Frank Wall Street Reform in the US, which makes it mandatory for telephone trades to be recorded, including those on mobile devices for financial firms trading in the US.

The MiFID II EU legislation would be implemented in January 2018. This would launch the most stringent mobile voice recording (MVR) regulations. It would result in substantially spreading regulatory needs within the UK.

All the market players involved in the advice chain for a planned trade should record all their mobile communications and maintain the data over a five-year period.

According to research conducted by Ovum (an independent analyst and consultancy firm), two-thirds of the firms required to record mobile communications have not yet complied.

It could be possible that several firms still have not accepted MVR because of misunderstandings about complex or expensive executions.

Again, some firms may have experienced MVR solutions before and could have had a negative experience, such as call degradation.

Moreover, there would be those waiting for MiFID II to take effect in January 2018, not understanding that if they have to renew their current mobile phone contracts at present, they could end up terminating those agreements and face expensive penalties for doing so.

If the appropriate solution is executed, MVR could ensure FCA compliance without disturbing productivity. Conversations would have to be recorded on a mobile device. There would not be any requirement for any special software, call forwarding or local applications.

The most optimal MVR solutions are one that records calls in line, at a network level. This facilitates compatibility with any mobile device, prevents the user from evading the solution and has no impact on IT needs for installation and maintenance.

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Brexit Could Lead to A Global Recession

A verdict by the UK to leave the EU would mostly trigger a massive sell-off in the pound, a sharp reduction in household income and a global recession, according to several experts. Analysts believe that the decision by the UK would have far-reaching consequences.

It would also have an instant and dramatic effect on global markets, investment, prices and employment.

According to George Soros (business magnate, investor), “Too many believe that a vote to leave the EU will have no effect on their personal financial position. This is wishful thinking.”

If there is a crash in real estate prices and unemployment after Brexit, as is likely, it would not be possible for a monetary policy to stimulate the economy and counter the resulting loss of demand.

As per assessments by various authorities, including the Bank of England and the International Monetary Fund, the average income loss per household because of a decreasing British currency would be around £3,000 to £5,000 yearly ($4,400 to $7,335).

Experts who monitor currency fluctuations predict that a Brexit could result in a 15 to 20% drop in the currency.

In 1992, the British currency had dropped, but it assisted the nation in the long-term by reducing the interest rates and boosting economic growth.

However, a devaluation would not be good for the economy this time because of three main reasons:

• The Bank of England cannot reduce rates from the existing low levels compatible with the strength of banks in the UK.
• The UK has a huge current account deficit and most probably would not witness another cash inflow.
• The loss of currency value would not assist exports because of uncertainty in trading environments that would be triggered due to the Brexit.

A Brexit would result in a Black Friday for the financial markets. There are huge amounts of short positions against the pound. They would moderate any currency decline post-Brexit.

At present, speculators would be waiting to exploit any opportunity. It would seriously impact the economic well-being of most people.

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The IMF Provides a Poverty Warning to The US

The International Monetary Fund issued a warning to the US with regard to poverty and increasing inequality in the nation on June 22nd, 2016. The two issues could impact its economic growth.

The IMF reduced its prospect for the US economic development this year to 2.2% compared to 2.4% estimated at the start of the year.

It mentioned the influence of moderate overall global growth, the reduction in the energy sector because of low oil prices, and a slowdown in domestic consumer expenditure.

Overall, the US economy is in good shape, rising strongly compared to other important developed nations, with unemployment at almost a nine-year low and inflation in control.

The biggest economy in the world has constantly proven its resilience in the face of market volatility, a bolstering dollar, and restrained global demand.

However, it recognized distinct trends that it said would gradually block avenues for future growth if not addressed at the earliest, especially an extremely high-level of poverty for a developed economy and growing inequality.

The IMF alleged a combination of several factors – the ageing of the US population, an increase in the no of people moving into retirement, decrease in productivity, and lack of investment present a new challenge to the US economy.

The IMF said, the progress of inequality and continuation of high poverty would aggravate those trends.

It further observed that 46.7 million people in the US are living in poverty. The share of the working class of all income in the nation has dropped by five percent in 15 years. The size of the middle class is the smallest in the last 30 years.

The divergence in the distribution of income has effectually cut consumer demand by 3.5 percent since 1999. The trend would impair both probable and actual growth.

According to IMF Managing Director Christine Lagarde, “Not only does poverty create significant social strains, it also eats into labor force participation, and undermines the ability to invest in education and improve health outcomes.”

The US must increase expenditure on education and infrastructure, and provide support to the economically weaker sections of the society (taxation reforms, improved social programs, a higher minimum wage) to reverse the trends.

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The Debt Fueled Global Growth

Bank for International Settlements (BIS) is an organization, which is usually referred to as the central bank of central banks. It has said that the boom-and-bust cycles that have impacted the international economy must come to an end.

The organization is urging policymakers to expeditiously modify existing policy. The international economy cannot afford to depend on the debt-fueled growth model that has resulted in the existing scenario.

At present, the debt levels are extremely high, while the productivity growth is very low. Against this background, the scope for policy changes is too narrow. The most evident sign of this issue is interest rates. They continue to be persistently and extremely low.

After the financial meltdown globally in 2008, and the sovereign debt crisis in the EU, central banks from across the globe implemented several measures.

Many institutions have launched bond-buying programs and reduced benchmark rates. This is to ensure that lending is increased. Certain central banks have also pushed interest rates below zero with a negative rate effectually charging banks who maintain cash at a central bank.

Several prominent central banks – The European Central Bank (ECB), the Danish National Bank (DNB), the Swedish Riksbank, and the Swiss National Bank (SNB) have forced critical short-term policy rates below zero.

This has curbed bond yields in broader asset markets. Markets experts estimate that nearly $8 trillion in sovereign debt was trading at negative yields at the end of May 2016.

The BIS believes that this monetary policy has been overburdened for a very long period. There is an urgent need for fiscal and structural policy changes. However, policymakers must avoid any shortcuts.

The measures must be long-term in nature. The BIS has urged for the completion of banking rules on capital buffers to assist during a crisis. The tax code can also be used to limit the bias of debt over equity or decrease the impact of financial cycles.

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Regulating Payday Lending

The federal government in the US is developing pioneering rules focused on the short-term, small-sum credit called as payday lending.

Though it appears to be an excellent idea, the plan proposed by the Consumer Financial Protection Bureau is not the method to do it.

Payday lenders provide service to individuals with poor credit who require cash quickly. Lenders normally deliver two-week loans. They are usually a few hundred dollars for a 15% fee and almost 400% annualized.

The terms may appear to be very outrageous, but they would definitely make sense for individuals who need money for minor tasks and do not have any other option to secure money.

However, there are certain conditions associated with these loans. The loans have to be repaid quickly. Since they are not repaid quickly most often, lenders exploit the situation.

Repaying the loan slowly is not encouraged. Normally, borrowers are asked to either repay completely on the due date or extend the total amount of added cost.

Several borrowers extend the repayment and they pay much more in interest and fees than they had borrowed initially. This could result in severe financial distress for the borrowers. This type of dealings accounts for a huge portion of payday lender’s revenues.

The challenge before regulators is to restrict this greedy lending without completely ending a useful service.

Certain states such as Colorado have implemented a rule providing borrowers a minimum of six months to repay the loan’s principal and covering total charges. Since then, interest rates have reduced, payments have become very inexpensive, and the service has remained broadly available.

The CFPB does not have the power to cap finance charges just like Colorado did, but it could implement something similar such as establishing a ceiling of gross income, for e.g., 5 percent, below which it would believe loan payments to be reasonable.

This would be a simple method since payday lenders naturally need a pay stub or other proof of income. This could attract normal banks into the small sum lending business, assisting to reduce annualized interest rates even further.

However, the CFPB has planned a very complicated method (lenders would have to conduct multiple checks in the borrower’s capability to repay), which would definitely slow down the process and increase the cost. Traditional banks would not want to enter the sector. Lenders would be in a position to accumulate more fees throughout the life of a short-term loan.

Hence, it would be prudent on the part of the CFPB to implement the model that has been tested in Colorado. Borrowers must find out the terms before agreeing to any payday loan.

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Quant Funds Can Assist in Diversifying the Portfolio

Technology has become central to the human society. It is also impacting the investment pattern. Quant funds use algorithmic, or algo-trading (systems make buy/sell decisions based on a predetermined formula after wide-ranging data analysis).

The process consists of using advanced statistical models on the basis of several specifications – price change, capacity, revenues, and financial ratios.

Quant funds usually follow a data-driven method. Usually, a specific model automatically identifies stocks on the basis of different data inputs that could or could not include fundamental data.

Similar to equity funds, quant funds have variations like large-cap and mid-cap. They are popular among portfolio managers.

Quant funds provide exceptional results if there is a very large liquid market, especially for long-only quantitative investing.

Some analysts believe a system cannot replace human capability, while quant fund managers feel that the model does consist of human intelligence and the use of algorithms simply removes human error in the investment process.

Quant funds screen all firms which are in line with their standards and identify the sectors & stocks that are performing well. This removes the fund manager’s authority to select a stock. The system would choose the stock only if it is in line with the standards that are incorporated into the fund’s model.

Quant funds may not recognize the impact of unknown changes since they are based on several assumptions. Hence, if a stock does not adhere to any historical pattern, there are possibilities that the model would not be able to forecast its movement.

Again, a quant fund would not buy even a good stock if trading volumes are insufficient. Returns from quant funds differ broadly. Hence, investors should analyze a funds’ previous record.

Globally, quant funds have a history of providing downside safeguard, but failing to match the returns from regular funds. These funds are appropriate for conservative investors.

A well-managed quant fund would have lesser volatility. Investors must look at volatility and then select. In conclusion, quant funds are a method to diversify the portfolio and not a replacement for regular funds.

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Gold Surges Post Brexit

Gold rose as much as 8% (the highest in over two years) on June 24th, 2016 after the UK provided a shock vote to exit the EU.

The investors were found rushing for protection in bullion and other assets perceived as lower risk. They were purchasing gold as an insurance asset, a hedge against tail risks and increases in volatility.

The anxiety in the market is expected to remain in place this week until the market comprehends the next political moves.

In sterling standings, gold delivered double-digit percentage increases to top 1,000 pounds an ounce for the first time in over three years.

The rate for spot gold peaked at $1,358.20 per ounce. The US gold futures for August delivery moved up by $59.30 to settle at $1,322.40. Shares of gold mining firms also moved higher.

Brexit is extremely beneficial to gold since, in an overall risk-off mode, it’s a logical safe haven for all investors.

Post-Brexit, market experts believe that there is a greater probability that the $1,350-1,360 per ounce level could be breached.

Gold dealers in the UK reported rising demand for coins and bars among retail investors, while stocks were rangebound.

Global stocks headed for one the substantial crashes on record as the vote triggered 8 percent falls for Europe’s biggest exchanges and the greatest drop for sterling.

The sterling was under pressure because of worries among the investors that the Brexit vote would result in similar movements in other European nations.

The Fed was expected to reduce interest rates to help protect the economy from any global fallout. Gold would be supported by the change in the stance to easier monetary policy.

Gold has become very attractive post-Brexit because the interest rates globally have been pushed lower.

At present, deflation is a bigger threat than inflation. Investors would not want to invest in a government bond with a negative interest rate.

The demand for gold always moves up when there are negative interest rates. Again from a political perspective, Brexit could trigger other nations to leave the EU. These uncertainties would contribute to the rise in demand for gold in the future.

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