CFA Institute

Market Integrity Insights

So You Want to Invest in Facebook Do You? Good Luck with That

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· Boards of Directors, Corporate Governance, Equity Investments
Facebook

Every couple of years, an IPO comes around (this time Facebook) that the financial media proclaims the zeitgeist of the day and most exciting thing investors have seen and ever will see — at least since the last one a few years ago (Google).

Facebook is indeed a phenomenon, with about 12 to13 percent of the world’s population currently using the social networking site in some capacity (over 900 million users out of a world population of just over 7 billion). Of those users, more than half are active on Facebook every day. Such a statistic is incredibly impressive and mania inducing.

What does all this mean for the IPO? Read more →

Financial (Dis)Integration in Europe

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· EMEA, European Commission, Sovereign Debt, Systemic Risk
EU-Parliament

On 3 May, the meeting of the European Central Bank (ECB) in Barcelona prompted the deployment of more than 8,000 policemen to contain protests from Spanish citizens angered by the economic crisis — including unprecedentedly high unemployment rates that skyrocketed to 24.1 percent in March and drastic austerity measures.

A couple of days before, the ECB had published its annual report on Financial Integration in Europe. The report shows that the financial crisis raging for more than four years now has had a significant impact on the “Single Market” as envisioned by Europe‘s intellectual fathers. This is the first setback of the financial integration ofEurope, which accelerated in the 1990s and got an additional boost from the introduction of a single currency in 1999. Read more →

JPMorgan’s Derivatives Blow-up May Benefit Taxpayers

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· Derivatives, Standards, Ethics & Regulations (SER), Systemic Risk, U.S. Regulatory Reform
JPMorgan

It was bound to happen, a bank getting caught red-handed trading derivatives like it was a reunion of 2007 risk traders. But that it was JPMorgan Chase that found itself under the bare light bulb of significant “risk-on” derivatives losses is a true surprise.

Luminary Chairman and CEO Jamie Dimon did his best to navigate the controversy as an honest mistake: “Admit it, fix it, and move on — it is part of the normal process of hedging firm risks.”

He was no doubt hoping that would be the end of it. Yet, more than a few will want to know how “hedging” losses can wipe out 1 percent of this firm’s capital in a few short weeks and erase $11 billion in market cap in minutes. Not very reassuring when one considers that JPM and many banking firms of lesser reputation are putting taxpayer dollars at risk every day. Read more →

From Hedge Fund Guidance to New Handbook, Major Developments for the GIPS Standards

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· Alternative Investments, Global Investment Performance Standards (GIPS®)
Cindy Kent

A positive outcome from the recent economic turmoil is that investors are learning more about investment returns, risk, different investment strategies, and the methodologies employed by asset management firms to obtain their reported performance results. Understanding the composition and variability of performance returns is an integral part of investing. The Global Investment Performance Standards (GIPS®) offer benefits to investors by providing a universal set of guidelines so they can make better, more informed investment decisions — and directly compare performance results that have been produced in a consistent fashion and format between firms around the globe.

Investment firms that comply with the GIPS standards have a competitive edge: their commitment to ethics and the credibility of the firm. They recognize the value of complying with global, voluntary ethical standards that put the interests of their clients and potential clients first. The longstanding self-regulatory nature of the GIPS standards is based on a fundamental commitment to ethics and integrity — helping regulators exercise their responsibilities of ensuring full disclosure, fair representation, and transparency within financial markets. Read more →

Has Financial Innovation Hurt or Helped Market Integrity?

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· Systemic Risk
Francesco-Guerrera

Innovation has been a mixed bag for investors, according to an expert panel convened at the 65th CFA Institute Annual Conference in Chicago. While markets have become more efficient in many respects, with trading intermediaries whittled down and automated, threats to market integrity remain, including a reliance on leverage to squeeze profit margins from new banking business models and continued opacity in the darker shadows of the marketplace.

Francesco Guerrera of the Wall Street Journal moderated the panel, which included Bill Hambrecht, CEO of W.R. Hambrecht and Co; Duncan Niederauer, CEO of NYSE/Euronext; and Harold Bradley, chief investment officer of the Ewing Marion Kaufmann Foundation. Taken together, the panel represented perspectives of the triumvirate of sell side, buy side, and exchanges that make the capital markets work.

Read more on the Annual Conference blog →

Investment Company Accounting: FASB, IASB Proposals Step in the Right Direction, but …

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· Fair Value, FASB, Financial Statement Analysis, IASB
Mohini Singh, ACA

The Financial Accounting Standards Board’s (FASB’s) longstanding guidance on investment company accounting has acknowledged that investment companies are “special” in that investors in these entities bear all the upside and downside risk of the underlying investments made by the investment company and therefore such investors need to directly see the change in fair value of their underlying investments. The FASB guidance set forth certain criteria that needed to be met to qualify as an investment company. If an entity met such criteria, it was exempt from consolidating its controlled investments. Instead the entity reported its investments at fair value through the income statement.

The International Accounting Standards Board (IASB), meanwhile, has not historically had any such guidance in place. However, the IASB recently issued an Exposure Draft that proposes to exempt “investment entities” (note the difference in FASB and IASB parlance) from consolidating their investments. Read more →

The Value of Hedge Funds: Simon Lack, KPMG/AIMA Report Form Different Conclusions

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· Alternative Investments, Asset Manager Code of Professional Conduct, EMEA, Global Investment Performance Standards (GIPS®)
Rhodri Preece, CFA

According to new research sponsored by KPMG and the Alternative Investment Management Association (AIMA), hedge funds are one of the top-performing asset classes over the past two decades. The report, The value of the hedge fund industry to investors, markets, and the broader economy , prepared by the Centre for Hedge Fund Research at London’s Imperial College, finds that hedge funds outperformed traditional asset classes over the period 1994 to 2011, and did so with low levels of volatility, even through turbulent times.

Looking at the numbers, the research shows that hedge funds achieved an average return of 9.07 percent over the review period, after fees, compared with 7.27 percent for commodities, 7.18 percent for stocks, and 6.25 percent for bonds. The research also finds that hedge funds’ ability to deliver superior performance is not associated with significant risk taking: their returns are associated with lower volatility and lower value-at-risk than stocks or commodities. Read more →

Investor Ire over Executive Pay Rises

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· Boards of Directors, Corporate Governance, Executive Compensation, Standards, Ethics & Regulations (SER), U.S. SEC
Matt Orsagh, CFA, CIPM

It was only a matter of time. As we get deeper into proxy season (a preponderance of companies hold their proxy votes in the spring — yes it’s different in Australia, but we’ll get to that so be patient), it was inevitable that the number of contentious annual “say-on-pay” votes would rise. In the slow, sometimes halting recovery from the financial crisis — that now includes a double-dip recession in the U.K. — investors are showing little patience for executive pay packages that don’t appear to link pay for performance.

The say-on-pay vote has proven an elegant compromise addressing the issue of investor frustration over executive pay plans that don’t appear to hold executives accountable for long-term performance. Increasingly, investors are using a “no” vote as a cudgel to beat compensation committees back into line when investors perceive disconnects between pay and performance that are inadequately addressed by the company. Read more →

Big Troubles in Eurozone: Debt Starts with “D” and That Rhymes with “Flee”

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· Sovereign Debt, Systemic Risk
European Union flag

I hadn’t been paying particularly close attention to more than high-level issues related to the euro crisis of late. That was until a couple of articles caught my eye on the capital flows between member states and the headaches and fissures they are creating within the Eurozone.

To give an update to others who may have had a similarly high-level interest in this ongoing crisis, I have collected an anthology of different media articles from recent weeks. The best summary is here in a blog post from Andrew Stuttaford at National Review Online who tracks the story across Europe, beginning with this article by Nick Malkoutzis in the Greek publication, ekathimerini.com. Malkoutzis explains how the system works and, in the process, gives a good primer on the latest in Euro acronyms, starting with LTRO (longer-term refinancing operations); ELA (emergency liquidity assistance); and Target2 (a central payment system). Read more →

Chesapeake Energy: Investors Fume over Pattern of Poor Corporate Governance

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· Boards of Directors, Corporate Governance, Executive Compensation
Chesapeake Stock

We have been watching the Chesapeake Energy Corp. situation with interest ever since it was widely publicized that the company’s CEO, Aubrey McClendon, (he also was chairman until earlier this week), had borrowed as much as $1.1 billion in the last three years against his ownership stakes in Chesapeake oil and gas wells, according to a Reuters report. Under the terms of this “Founder Well Participation Program,” McClendon was allowed to own up to 2.5 percent of wells the company drilled, as long as he paid development costs proportionate to his stake.

Now, you may say, “No big deal, such extra participation in the wells aligns his interests with those of shareholders.” That’s really beside the point — as we learned in every financial crisis in recorded history, it’s the inability to service debt that gets you when the market turns. Read more →