Foreign Exchange Regimes

Foreign Exchange Regimes

Currency Board or Central Banks

It is a monetary Authority that makes decisions on the valuation of a nation’s currency specifically whether to peg the exchange rate of a foreign currency to a local currency.

Features of a currency board

a.       It must have sufficient foreign currency reserves.

b.      The board maintains absolute and limited convertibility between its notes and coins and currency against which they are pegged.

c.       It only earns profits from interests on foreign reserves.

d.      It has no power to effect monetary policy and does not lend to the government.

e.      It does not act as a lender of last resort to commercial banks.

Government Intervention in the Forex Market

  Each country has a central bank that may intervene in foreign exchange market to control its currency value. The central bank attempts to control the money supply in the country.

Reasons for government intervention

a.       To stabilize fluctuations in exchange rates.

b.      To establish implicit exchange rate boundaries which allows the countries to move currency within certain bounds.

c.       To respond to temporary disturbances of excess currency demand and supply in the market.

d.      To improve the country’s trade deficits.

Types of Government Interventions

1.       Direct Intervention-The most common way of central banks’ intervention to affect the exchange rate is to enter the private currency market directly by buying and selling domestic currency. By doing this, central banks conduct two types of transactions:

Selling the domestic currency in exchange of foreign currency-This transaction will raise the supply of the dollar and increase the demand for the pound causing a reduction in the value of the dollar. The pound on the other hand appreciate in value. The central banks power to reduce the dollar’s value by direct intervention in the forex is virtually unlimited.

If the central bank wishes to raise the value of the dollar, it will need to buy dollars in exchange for pounds. The ability of the Central Bank to raise the value of the dollar through direct intervention is limited to stock of pounds available in the reserves.

2.       Direct intervention can be split into: sterilized intervention and non-sterilized intervention.

Sterilized intervention is a policy that attempts to influence the exchange rate without changing the monetary base. The aim is to change the exchange rate without affecting money supply with interest rates.

Non-sterilized intervention is a policy that alters the monetary base. The central bank intervene by increasing or decreasing the money supply. Money supply will increase with the attempt to weaken the home currency and decrease to strengthen the home currency. Authorities do this through purchase or sale of foreign bonds with the domestic currency. This process is referred to as Indirect intervention.

Regulation of Derivative Markets

Regulation of Derivative Markets

Over-The-Counter Derivatives markets operate at a lower degree of regulation and oversight as compared to the exchange traded derivatives markets. Up and until 2010, the OTC derivatives market in Kenya was unregulated. The transactions would be executed with only minimal oversight through laws that regulated the parties themselves but not the specific instruments. Following the financial crisis that begun in 2007, new regulations were set and the OTC markets became regulated but not to the extent of the exchange traded market.

Purpose of Regulation

1.       Market Integrity

To ensure that prices on the exchange properly reflect the demand and supply of the underlying asset market.

2.       Prudential regulation

Ensuring players in the market are financially sound and are able to market obligations.

3.       Business conduct

Protect consumers especially retail clients

4.       Business growth

By promoting innovation and allowing new markets to develop.

5.       Market stability

Criticism or Misuse of Derivatives

There are three principal arguments against derivatives

1.       It is seen as a form of gambling

Due to its speculative nature it is seen as a permitted or legalized form of gambling

2.       Destabilization of markets

Opponents of derivatives markets claim that the very benefits of derivative/low cost and low capital requirements results in an excessive amount of speculative trading that brings destability.

They argue that speculators use a large amount of leverage thereby subjecting themselves and their creditors to substantial risk if the market does not move in their direction.

3.       Complexity

Derivatives are seen a complex financial instruments that require a high level of understanding of mathematics thus making many distrust derivatives and the people who deal in them.

Recap

There are two general classes of derivatives: Forward Commitment Derivatives and the Contigent Claim

There are three types of forward commitments: forwards; futures and swaps. This type provides the parties the ability to lock in a price at which they will transact at a future date.

The contingent claim class includes options which are categorized into call and put options. This class provides the right to one party (holder) to buy or sell an underlying asset at a future date at a price fixed during the initiation of the contract.

Importance of Competition Policy in Reducing Poverty in Kenya

A.    INTRODUCTION

1.      Competition is pivotal to market operations and fosters innovations as well as growth and productivity which help in creating wealth and thereby reduce poverty. However, markets are not always efficient and uncompetitive markets are always those that matter most to the poor. This article outlines the direct and indirect as well as often complex connections between competition policy, competition, private sector development, poverty reduction and growth. The existence and linkages of these aspects in the developing or middle income world context is often under recognized.

2.      The Competition Authority of Kenya has a very important role to foster efficiency in the economy by ensuring enforcement and advocacy of competition law with the goal of reducing poverty and promoting economic efficiency as well as growth.

3.      While anti-competitive conduct by entities is a sign of weak competition, indecorous public policies and the power of vested interests to hinder necessary reforms may be considered important. A holistic approach is therefore important to identify where competition is weak and that is where departments like consumer protection and enforcement come in handy. Mergers and Acquisition and Buyer Power departments help identify gaps in the market that need to be addressed to regulate anti-competitive practices whether through complaints made to the authority by consumers or the authority conducts investigations ex proprio motu.

B.     COMPETITION POLICY AND GROWTH

4.      Competitive markets enable proper utilization of a nation’s resources in the production of goods and services. Evidence from theoretical and empirical research over the last few years shows that there are productive and efficiency gains which are derived from competition¹. Competition gives firms continuing motivations to make production and distribution efficient, adopt better technology as well as innovate. These sources of productivity improvement lead to growth and poverty reduction².

5.      The strength of competition is likely to affect the competitiveness of a country in terms of the country’s exports ability to compete globally and imports not destroying local products. A competitive environment in the domestic markets plays a very important role in international integration of industries. Intense fair competition is therefore a very important ingredient for high productivity. This is made possible by market-vigilant regulators.

6.      However, growth and lower prices alone do not always result into poverty eradication. Even in nations with growing economies and competitive markets for essential goods and services, the distribution of income may still result into some individuals living below the poverty line and in relative poverty. Therefore, other policies such as tax, trade and anti-corruption are critical in fighting poverty (OECD, 2013).

^7.                For more innovation see Cook et al (2007). P. 26 and P. 311

^8.                Innovation and competition are some of the strongest influencers of productivity as indicated in Dollar and Kraay (2001) in a World Bank report.

C.    COMPETITION POLICY AND POVERTY REDUCTION

9.      The poor interact with the economy in various ways. The state must take responsibility of assisting the markets function effectively for the poor so that they can have more choice and encourage innovation as well as provide goods and services at the least cost possible.

10.  The highest number of the poor is mostly farmers and small entrepreneurs. These groups are likely to benefit more if entry and exit barriers are minimized, if they can access quality inputs at fair prices and sell output on fair terms (OECD, 2013).

11.  Most of the poor individuals are the major recipients of government-funded services. Bid-rigging³ for government funded infrastructure and services is a common phenomenon and it reduces what the people can get from the budget allocation. For instance, instead five new hospitals only four are constructed. An appropriate competition policy seeks to address such gaps (OECD, 2008).

12.  Competition policy and law enforcement helps poor consumers and producers by breaking up cartels, exposing dominant firms that engage in anti-competitive practices and reducing barriers to entry and exit thereby enabling small firms survive in a market where they otherwise would not have survived. Additionally, entry helps the poor not only by putting pressure to reduce prices but also by creating more employment and business opportunities (OECD, 2013).

13.  It is therefore the recommendation of this paper that the authority should continue being vigilant in the Kenyan market and promote competition law enforcement and advocacy. This in turn leads to the ripple benefits of a better life for Wanjiku.

^3.  For more information on Kenya’s policy on collusive tendering/ bid-rigging visit https://www.cak.go.ke/images/docs/Restrictive-Trade-Practices-Guidelines.pdf

REFERENCES

Organization for Economic Co-Operation Development (OECD) (2013). Policy Roundtables: Competition and Poverty Reduction. Retrieved from https://www.oecd.org/daf/competition/competition-and-poverty-reduction2013.pdf

Organization for Economic Co-Operation Development (OECD) (2008). Why is competition important for growth and poverty reduction? VII Global forum on international investment. Retrieved from https://www.oecd.org/investment/globalforum/40315399.pdf

Cross-Border Cartel Enforcement in Africa

Cartelist Theories

From the undertaking’s perspective, businesses have an inducement to form cartels because coordinating their economic activities would yield greater profits than if they were acting independently. The general rationale for this assertion is based on the internalization of a negative externality. In competitive markets, businesses are only interested in how their reduction of output would benefit them, ignoring the positive effect that the reduction in output has on the profits of others through reduction of total market output and the consequent increase in prices. A cartel incorporates these effects by considering how change in output of each firm affects joint profits. Consequently, through reduction of total output below competitive levels, joint profits increase.

Unsatisfactory performance may also incentivize firms to collude. This mainly happens during hard economic times in an industry or in the entire economy which is mainly characterized by undesirable performance, high risk and uncertainties. This is reflected in price warfare and cut-throat competition. In such instances, collusion is used as a tool to ease competition pressures. However, these agreements kick out or minimize new entrants or products which could destabilize existing firms (Hüschelrath & Weigand, 2010).

Adding in to the profit maximization and tough times reasoning, which have been the major focus of academic research on the motivations to form cartels, an alternative approach to motivation for cartel formation is looking at the arguments presented by busted cartels. Albeit, it is fairly obvious that these arguments do not necessarily reflect the true motivation for cartel formation but might in fact have been developed ex post as a defense strategy in court. They however still have to make logical economic reasoning. The four commonly used arguments are: the industry cannot function with competition; quality and safety will decline without the cartel; the industry competes in service and quality; and the cartel is necessary to stop unconscionable or unfair competition. The one thing in common in these arguments is that competition is not working (according to the undertakings) and therefore acting in a coordinated manner could be beneficial to consumers (Hüschelrath & Weigand, 2010). A disarming counterargument against this preposition is that it is not upto the industry to determine whether competition is unworkable (World Bank, 1999). Practical experiences and economic research indicates that competition is socially desirable and it is up to competition regulators to decide whether some level of regulation is needed, for instance, to promote safety or make ineffective impacts of unfair competition.

Another challenge to cross-border cartel enforcement in Africa is jurisdictional conflict due to lack of uniform laws. The law to be applied in international anti-competitive conduct has been subject to debate since the 90s when the EU proposed for a universal competition regime but developing countries and the US opposed this and recommended bilateral cooperation based on non-bidding rules. Jurisdictional conflict in competition law in Africa mainly arises from application of domestic and regional law. The overall effect is a dual competition regime.

Ethics in International Business

Ethics can be defined as a branch of philosophy that entails systematizing, defending, and recommending concepts of right and wrong conduct. There are several ethical situations/ dilemmas experienced by MNCs in the course of international business. These include:

1. Marketing practices- some laws prohibit misrepresentations in adverts, for instance, the Competition Act no. 12 of 2010 Kenya.

2. Pricing discrimination- in some jurisdictions, it is strictly unlawful to charge different prices for similar products and services without justifiable course.

3. Poor labor practices and working conditions- some MNCs may employ low skills to pay low wages hence exploiting workers. This may be prohibited in some jurisdictions.

4. Corruption- in some countries it may be okay to offer bribes while in others it goes against the societal moral fabrics.

5. Environmental concerns- dumping and environmental degradation is strictly prohibited in most countries and there has been a clarion call by bodies by supranational bodies such as the UNEP to safeguard against the effects of climate change. Proper stewardship may help MNCs grow in this area.

6. Financial reporting- different jurisdictions have different requirements in reporting. It is in reporting that issues of tax declaration and falsification may arise. It is imperative that MNCs employ the best practices in this case.

7. Procurement practices- in certain jurisdictions, the procurement laws prohibit bid rigging, for instance, the Public Procurement Regulatory Act and the Competition Act no. 12 of 2010 Kenya.

8. Industrial espionage- spying on the competitor may be prohibited by the law.

How to adopt and retain ethical standards by MNCs

1. Set standards applied equally in all subsidiaries.

2. Regular training on the business ethics.

3. Follow the customs of a country and avoid engaging in what is morally acceptable.

4. Keep a unique set of ethics which have remedial measures in case of deviation.

Corporate governance

This is a system of processes, policies and rules that direct and control a company’s behavior.

Principles of good corporate governance

        i.            Ensure that the business is in a good legal standing

     ii.            Provide transparency in company’s decision making processes.

   iii.            Cooperation between management and board

   iv.            Prudence in strategy setting and decision making

      v.            Provide framework for action if there is a violation of the company’s code of ethics

   vi.            Ensure that the firm is geared towards long term value creation.

Main elements of good corporate governance

a)      Transparency

b)     Independent leadership

c)      Consensus building/ stakeholder relations

d)     Accountability

e)      Inclusion or corporate citizenship

f)       Adherence to the rule of law.

Challenges to corporate governance

a.      Political interference

b.      Lack of transparency

c.       Bureaucracy

d.     Lack of independent leadership

e.      Conflict of interest

f.        Lack of clear policies

g.      Lack of accountability

h.      Lack of diversity

Banking Regulations

Bank regulation is a form of government regulation which subjects banks to certain requirements, restrictions and guidelines, designed to create market transparency between banking institutions and the individuals and corporations with whom they conduct business, among other things. As regulation focusing on key actors in the financial markets, it forms one of the three components of financial law, the other two being case law and self-regulating market practices.

Bank regulation was solidified by the Bank of International Settlements’ Basel Committee on Banking Supervision through the Basel Accords. Basel Accords are an official treaty among representative central banks and regulatory authorities on regulation of banks. Their main is to enhance financial stability by improving supervisory role of the banking sector worldwide. The Accords are classified into Basel I, II, and III.

Basel I focuses on the capital adequacy of financial institutions to improve stability. It also defines banks capital ratio and sets standards for solvency monitoring and reporting. This accord categorizes assets of financial into five risk categories, i.e.0%, 10%, 20%, 50% and 100%.

The Shortcomings of this Accord include:

i. Categorization of credit risk was very generic as the risk was simply assigned to one of the 5 categories;

ii. A static measure of 8% for the multinational banks did not consider the changing nature of the default risk of financial institutions;

iii. The maturity of credit exposure was not considered and duration of credit instruments was not accounted for;

iv. There was no differentiation of counterparty risk for different kinds of borrowers; and

v. Did not provide any relaxation for diversification of portfolio.

Basel II revised the capital framework and focused on:

i. minimum capital requirements which categorizes the requirements into tier i and ii;

ii. Supervisory review- deals with risks such as systematic, liquidity and legal; and

iii. Market discipline- disclose on risks exposure and capital adequacy.

Basel III was developed after the 2008 financial crisis with the main pillars being:

i. Banks should have a minimum capital requirement;

ii. leverage and liquidity- an upper limit of 3% was introduced for the leverage ratio;

iii. counter cyclical measures- banks can set aside additional capital during times credit expansion and relax capital requirements during contractions;

iv. Bucketing system- banks are grouped together and assigned to the buckets according to their size, complexity and importance to the overall economy.

In summary the 3 accords can be broken down as shown in the table below according to the risk addressed and tools used.

	Risks	Tools
Basel I	Credit risk Market risk	Capital Adequacy Ratio (CAR)
Basel II	Credit risk Market risk Operational risk	CAR Supervisory review Market discipline
Basel III	Credit risk Market risk Operational risk Countercyclical risk Liquidity risk	CAR Supervisory review Market discipline Liquidity coverage ratio Counter cycle buffer Leverage ratio

    

Relative Value Methodologies

Relative value refers to the ranking of fixed income investments by sectors, structures, issues and issuers in terms of their expected performance during some future period of time.

Relative value analysis refers to the methodologies used to generate such rankings of expected returns.

There is a positive relationship between liquidity and bond prices, i.e. As liquidity decreases, the investors are willing to pay less (implying increasing yields) and as liquidity increases, the investors are willing to pay more (decreasing yields).

Rationale for secondary bond trades

i. credit upside trades- occur most often at the juncture of the highest speculative rating and the lowest investment rating.

ii. Credit-defense trades- managers reduce exposure to sectors where they expect a credit downgrade.

iii. New issues swaps- Managers tend to prefer new issues especially on the run Treasuries since they are perceived to have superior liquidity.

iv. Sector-rotation trades- Allows movement from sectors that are expected to underperform and into one that is expected to outperform on a total return basis.

v. Yield curve adjustment trades- attempts to align the portfolios duration with anticipated changes/shifts in the yield curve.

vi. Structure trades- swap into structures that will have strong performance given an expected movement in volatility and yield curve shape.

vii. Cashflow reinvestment trades-if the interest rates are expected to rise, buy short duration bonds and sell long duration bonds. If interest rates are expected to fall, buy long-duration bonds and sell short duration bonds.

Assessing Relative Value Methodologies

a) Nominal spread- is the yield difference between corporate and government bonds of similar maturity. It is currently the basic unit of both price and relative value analysis for most of the global corporate bond market.

b) Option-adjusted spread- is the effective spread for the class after removing any embedded options.