Category: Uncategorized

A Risk-Based Brexit Solution

Why does trade matter? Trading takes place between two countries because both benefit by creating products where each has a comparative advantage and exchanging them rather than each country trying to produce everything itself. The fact that billions of pounds-worth of international trade takes place all around the world seems to provide conclusive evidence in support of this assertion. So yes, trade does matter, because in general it produces economic benefits and improves people’s lives.

Do trade agreements matter? Yes – the UK mainly exports relatively sophisticated products and services, and another country will unlikely permit UK exports to enter its borders if they do not meet minimum product quality and testing standards; or, if they were produced by infringing the intellectual property rights of one of its citizens or corporations. And the best way to ensure these requirements are met is to reach agreement at a governmental level over what they should look like.

If trade matters, and it is facilitated by trade agreements, why would the UK abandon the vast amount of work that has gone into facilitating trade with the EU in favour of starting again at the WTO level?

If trade matters, and it is facilitated by trade agreements, why would the UK abandon the vast amount of work that has gone into facilitating trade with the EU in favour of starting again at the WTO level? This is not a sensible option - indeed, one might say it is plain irrational.

It’s Not Just About Trade - Politics is Key

So, what is the best mechanism to achieve Brexit whilst facilitating UK-EU trade? Well, it is crucial to recognise that Brexit is not just about trade. There are political aspirations as well. These include: the desire to leave the EU; to place a limit on immigration from the EU; to remove the UK from the jurisdiction of the European Court of Justice; to create its own trade deals with non-EU countries and to avoid a breakup of the UK. However, there are also aspirations to minimise adverse effects on UK-EU cooperation in terms not just of trade, but also national security, immigration from non-EU countries, science and education.

And what is on the wish-list of the EU regarding Brexit? The desire to preserve the principles upon which the single market was founded – that full access depends on participants agreeing to the free movement of goods, services, capital and people across national boundaries. EU members also wish to discourage secessionist tendencies (which are on the rise) amongst its members, by demonstrating that Brexit will involve substantial “cost” to the UK. But they also share with the UK the desire to minimise adverse effects on UK-EU cooperation in terms of trade, security, immigration from non-EU countries, science and education.

Finding a Solution by Dealing with Uncertainty

Where are we so far? We have established the importance of continued high levels of UK-EU cooperation and trade, but identified many factors that seem to force the two sides apart. How can these tensions best be resolved? We argue the only way to do this is by minimising uncertainty. Why is this? Uncertainty is always bad, because policy-making and economic activity require the ability to make rational decisions in a complex world. More uncertainty leads to less decision-making and therefore political deadlock and less economic activity.

There are two dimensions to Brexit strategy uncertainty – the viability of the strategy (i.e. the degree to which it preserves the aims of both sides), and the time the strategy can reasonably be expected to take to implement (the longer the time, the greater the uncertainty).

Identifying precedents as the basis for an agreement represents a quantum leap towards minimizing both dimensions of uncertainty

When two parties come together with the basic desire to reach an agreement over something, but subject to the achievement of often conflicting aims, they look for precedents. They ask the question: “How have such agreements been achieved in the past, under similar circumstances?” Identifying precedents as the basis for an agreement represents a quantum leap towards minimizing both dimensions of uncertainty – they provide information about the detailed workings of a solution that support viability, and help to clarify where modification is required to suit each party’s actual aims, thereby helping identify a realistic timeline and road map for negotiations.

The Solution in Detail

We believe that Brexit can best be achieved by negotiating a comprehensive Association Agreement, which would define the UK’s entire relationship with the EU, including a free trade agreement, and incentivising UK companies to employ more domestic workers through a package of tax incentives.

The recently negotiated Association Agreement between the EU and the Ukraine serves as a possible precedent for Brexit and facilitates exit of the UK from the EU whilst permitting free movement of goods, services and capital between the two. Existing EU directives (which are implemented by national legislation and already part of UK law) would remain unchanged. Existing EU regulations (which are directly applicable to EU members without further supporting national legislation) will be repealed but mostly (because they are mainly product-specific technical standards) “cut and pasted” into UK law during the 2 year post-Article 50 period. The UK would develop a legal mechanism to define new UK laws and standards, both independently and in response to new EU directives and regulations, to balance the requirements for legal sovereignty with the need to retain access to the EU market.

The Association Agreement will cover every aspect of the UK’s relationship with the EU by setting out all of the relevant EU directives and regulations which apply, in the following key areas:

  • Trade and trade-related matters, through the implementation of a “Deep and Comprehensive Free Trade Agreement” (DCFTA);
  • Economic and sector cooperation;
  • Financial cooperation, and
  • Institutional provisions

An immigration proposal that builds on the precedent set by agreement reached between the EU and Switzerland late last year is also realistic. Employers in certain areas of activity, professional groups and economic regions will have to notify vacancies to unemployment offices if unemployment is above average in these groups. These vacancies are available exclusively to the jobseekers that are registered at the unemployment offices for a certain period of time and the unemployment agency must provide the employer with details of potentially suitable candidates. Employers must consider these details and invite candidates to interviews.

We propose going beyond the Swiss model by including incentives which would enable employers to offset the cost of training, travel and accommodation against tax. So for example, a construction firm seeking 200 new staff for a 2 year project in Hertfordshire would be able to encourage workers from a relatively high unemployment area like the North-East of England by offering them a pay and compensation package including on-the-job training, the cost of rented accommodation, and weekly travel to and from home. The cost of this package would be claimed by the company against its taxable income.

Empowering Women In Family Businesses

That said, family businesses can be powerful enablers for women in what is still predominantly a man’s world. In the FTSE 100, there are more CEOs called John than there are females with that job title. And yet women such as Johanna Quandt and Susanne Klatten at BMW, Cristina Stenbeck at Kinnevik, Margarita Louis-Dreyfus at the Louis Dreyfus commodities business, Liliane Bettencourt of L’Oréal, Alice Walton at Walmart, and Abigail Johnson at the Fidelity fund management business have all taken on positions of power in their families’ businesses.

A caveat: those are all European and American examples. You might say that if it is hard for women to achieve power in secular, liberal societies which explicitly legislate for equality of the sexes, it must be nigh-on impossible in other parts of the world, particularly in “traditional” cultures or societies with deeply ingrained attitudes such as a belief in male supremacy.
That is the received wisdom, but the reality is more complex. For a start, as the “Johns vs women” example suggests, in so-called secular, liberal Western societies, there are still a lot more cultural and bureaucratic barriers to women’s progress than we are sometimes willing to acknowledge.

Traditional Culture

And the situation in traditional cultures is not as obviously anti-women as is often thought. In a family business, even if it is based in a traditional culture, female family members can have far more opportunities than they do in public companies in America or Britain. Family enterprises are often the predominant form of business organisation in traditional societies. And because the lines of command are shorter and ownership more concentrated in a family business, an enlightened patriarch can promote female family members much more effectively.

There are still a lot more cultural and bureaucratic barriers to women’s progress than we are sometimes willing to acknowledge

And yet it is obvious that in places like East Asia or the Middle East, where family enterprises dominate commercial activities, businesses are hardly awash with female family heads. Why? The obvious answer is that traditional cultures are the norm in these countries and the older generation is intransigently prejudiced against women. Again, the reality is more complex.
Even an enlightened patriarch can struggle to impose his will in a family that opposes him, or when other men find their power or worldview challenged and make life hard for him. But bravery and foresight have a subtle ally in the drive to promote women in traditional societies: internationalisation.

The Influence of Internationalisation

The positive effect of internationalisation typically begins when female family members are sent to study at universities or business schools overseas. After their studies end, they often get a job in a business with which the family has a relationship, such as an investment bank or law firm. After a relatively short time, they return to their home countries with the skills and experience to take on positions of considerable responsibility, despite their relatively young age. Going overseas can give a woman kudos that can’t be ignored.

Take the example of Lubna Olayan, who is CEO of her family’s conglomerate, which was founded by her father. She studied in the US, married an American, and is one of the most powerful women in the Gulf region. This is all down to the foresight and determination of her father to ensure that no barriers were high enough, and she was able to take a prominent role in the family business.

Very often new operations are established in countries where equal opportunities for women are set out in law, which helps to neutralise the power plays or strategic games that those with vested interests can employ at home

Another opportunity for the accelerated advancement of female family members arises when the business expands beyond its home country. Very often new operations are established in countries where equal opportunities for women are set out in law, which helps to neutralise the power plays or strategic games that those with vested interests can employ at home.

And the flexibility inherent in jurisdictions where Common Law (in which legal decisions depend on the circumstances of a particular case) applies, offers scope to facilitate the advancement of women’s rights to a greater extent than available where Civil Law (in which decisions are determined by fixed rules) or Canon law (where decisions are determined by fixed religious rules) apply. Once a company has needed to adopt this more flexible legal culture to be successful internationally, that culture tends to spread back to the home country.

As we say, it is all too easy to see the problem of how to empower women, whatever the culture, as one that can only be dealt with through legislation. And the existence of an enlightened patriarchy is often a pre-condition to overcome prejudice against women assuming business power in traditional societies.
But internationalisation, both in education and business expansion, is the real catalyst for the empowerment of women in family enterprises.

Lone-Wolf To Collective Decision-Making

And yet there is some truth in that image of the lone wolf leader. When a business is small, an individual can probably run it effectively. When it grows, the habit is hard to kick. Even if they are not larger-than-life dictators, people who founded and grew successful businesses have a kind of natural authority. Without them, the business would not exist. That gives them kudos. Many encourage it, to varying extents.

Whatever the extent of the founder’s power, there comes a time when it would be better if he or she encouraged a more collaborative decision-making process. There is good evidence that decisions made by a well-trained, diverse group are often better than those made by individuals. For example see “An Organization-Wide Approach to Good Decision Making”, Harvard Business Review, May 27, 2015.

Also, inevitably there comes a time when founders start to find it more difficult to do what they once did single-handedly, either because they are getting old, or the business has grown too complex. Furthermore, as time moves on more family members might have a stake in the continued success of the enterprise, and reasonably feel that they ought to be involved in setting its direction.

Unsurprisingly, this can be a hard sell to someone who is used to exercising power. Their inclination can be to say “I have been successful so far, and if it ain’t broke, don’t fix it”.

As time moves on more family members might have a stake in the continued success of the enterprise, and reasonably feel that they ought to be involved in setting its direction

They might point out that it is more efficient for them to make decisions alone, and argue that their instincts are behind the past success of the business. They can say that committees put a strait jacket around decision-making.

Those arguments can be hard to counter - especially face-to-face. But the reasons to make the switch from sole leader to group decision-making are compelling. The process of making that change can be one of the hardest, most fraught that a family business ever makes. So how can it be managed?

No to Yes-Men

This transition raises many challenges. One is that it can only work if principals genuinely accept that they need to give up their power. If not, then they will just pay lip-service to democracy and the result is a decision-making group of yes-men and women, who in fact defer to the old leader. Worse still they can so easily believe themselves and the business to be invulnerable inside their self-made cocoon.

How do you avoid that? The first step is for the current leader, and others, to candidly describe the current situation and understand its shortcomings. Then they need to work out what they want the new situation to look like. This involves a careful mapping out of the structures the new situation will have: Do you need sub-committees? Do you need a board or a family council? Or both? And who gets to sit on them? Who decides that?

There must also be agreement about the process by which decisions will be made. There is no point simply having a discussion, after which an individual or clique impose their will on others. Equally, saying that consensus is required before any action is implemented might guarantee inaction. These issues require careful planning.

And then interpersonal issues also have to be addressed. How free will the members of the new group really be to speak their mind? They need a sense of empowerment, and conviction that their views will actually be heard and considered. There is no place for so-called “Mind Guards” who justify screening and censoring the ideas of fellow group members on spurious grounds of loyalty and tradition.

The worst thing that can happen to a family business is that family members wake up one day to find a power vacuum at the top of the organisation

The individuals who become members of the group will need to be trained in good decision-making techniques. They should be able to recognise when expert opinion is needed. They should be aware of their own biases and understand how their own methods of gathering or processing information might skew their decisions. They need to be able to give and take criticism in the right spirit, namely that the overall aim is to help the entire family. The new body also needs to be aware of, and guard against, Groupthink, which can be corrosive, even catastrophic.

Vitally, everybody in the group needs to be committed to the process in good faith; collaboration will not work if some are sceptical, want to build their own power-base or are dishonest. It has to be based on - for want of a better word - love.

The Leadership Paradox

Another huge issue is leadership. Even a democratic system works best when there is a leader who can ultimately make hard decisions if there is no consensus or time is of the essence. The old leader will probably not be the right person to head up the new regime, though. The old family head might be a powerful, alpha-type character, while what is needed as the business evolves is someone who is skilled in getting the best of out the decision-making group.

That said, identifying a leader can be a key catalyst that helps the founder let go. Someone who has been a successful leader, albeit a benign one, might be deeply sceptical about group decision-making. And he will only feel comfortable giving up his position when he can see a new leader who will step into his shoes by sharing his work ethic and values. For the transition to work, the old leader has to go willingly. Paradoxically, to move away from one-man leadership, a new leader is needed.

The new process needs to be clear not just for the family, but also to customers and other stakeholders. They might be nervous about the old family head stepping down or moving on and it is important to explain the new order to them. Again, a new standard-bearer can help reassure them.

Often families overlook something else important: giving the old leader a job and a credible purpose. One reason they can refuse to stand down is that they don’t want to become inactive. Giving them a meaningful role - looking after long-established relationships with key clients, for example - can ease things.

The worst thing that can happen to a family business is that family members wake up one day to find a power vacuum at the top of the organisation. The only solution is to start planning early. All too often families focus on the new family head, but it is just as important that they also think about transitioning from one style of leadership to another, acquiring and employing the key skills of group decision-making as they do so.

Families should plan to move away from lone wolf leadership to collaborative decision-making as early as possible, and do it in a careful, structured - and loving - way.

ESG As An Integral Part Of Your Wealth

Since the Paris Agreement was signed, over 400 businesses and major institutional investors have signed the Paris Pledge for Action which makes a commitment to “reduce greenhouse gas emissions to a safe level” without waiting for the Agreement to come into force in 2020. The Paris Agreement was a defining moment in the history of ESG, and may turn out to be the single most important catalyst for making firms and investors think not just about financial results, but also environmental (“E”), social (“S”) and governance (“G”) issues.

ESG has been gaining traction for a long time. Until now the starkest example, perhaps, was when the Rockefeller Foundation announced that it was divesting from fossil fuel stocks last year. That a family whose fortune came from oil was going green was a powerful indicator that ESG had become an essential component of decision-making for major investors.

All of this comes as no surprise to us. One of our core principles at Termes has always been that clients should only ever invest in something when they have a high conviction that it is right for them. ESG considerations are a part of that, and always have been. To us, that has always seemed entirely natural.

We just think you probably want to know whether the firms you invest in use child labour or pollute the environment, and to be sure that the company doesn’t systematically exclude women or ethnic minorities from their management, or don’t pay their taxes and so on.

You probably want to know whether the firms you invest in use child labour or pollute the environment, and to be sure that the company doesn’t systematically exclude women or ethnic minorities from their management, or don’t pay their taxes and so on

We believe that these factors are as important in guiding your investment decisions as more traditional financial measures such as dividend yield and price to earnings ratio. None of this seems radical or even controversial to us. You don’t have to be flying a flag for ethical investing to care about ESG.

Three Changes

Investors have always thought about these questions; in a sense, only the label “ESG” is new, having come to prominence over the past ten years or so. That said, three large-scale changes have made ESG considerations more central to investors in recent years.

One is that investors have far more information about ESG now than they ever used to. In the past companies only ever reported financial information, but over the past 10-20 years firms have increasingly started releasing ESG information too.

According to recent research of 4,609 companies, each with a market cap of over $2bn, 60% disclose their payroll expenses and 40% their energy emissions, although fewer publicise their water usage and the amount of waste they produce. These numbers should be higher, but this is a huge improvement on knowing nothing, and disclosure is improving year by year. And as well as self-reporting, there are numerous bodies which monitor businesses’ ESG behaviour, such as EIRIS (the Ethical Investment Research and Information Service).

These days investors have the power to make informed choices about aspects of companies that they previously didn’t, and they obviously want to use information to make the choices that are right for them.

Sustainability indicator reporting by the 4,609 largest companies, 2008-12

Source: Bloomberg, Corporate Knights Capital, “Measuring Sustainability
Disclosure: Ranking the World’s Stock Exchanges”

The second reason ESG is higher up the agenda is that globalisation has made these issues more pressing. As recently as 20 years ago the emerging markets were dominated by closed economies and business-unfriendly dictatorships, but many are now opening up to foreign investment and trade.

As a result big companies are exposed to business practices that might not be acceptable to investors. Offshoring means that supply chains are longer and often more opaque, opening them up to risks. So, even firms that used to be seen as solid-gold companies with impeccable reputations such as IBM, GE or Boeing are now prone to all sorts of ESG risks.

A third reason stems from the changing nature of the media, which means that citizens can blow the whistle and publish information about poor business practices. In the past you had to wait until the Guardian or the New York Times found out about that you were dumping waste in rivers.

These days anybody can upload the proof to YouTube and if it goes viral it can destroy your reputation - and share price - overnight. This is perhaps the starkest way in which behaving well can affect the bottom line, and shows that behaving well is not just right, but prudent too.

Risky Returns?

This all sounds very nice, the cynic might say - but doesn’t investing in companies with high ESG scores hit your returns? After all, you are reducing the number of companies you can choose from, aren’t you? We just don’t buy that argument. (The chart below shows that, at least for big companies, having good ESG scores makes almost no difference to share price performance.)

Source: MSCI

Okay, if you decided to exclude huge swathes of investable companies - ones with less than 50% female board members, for example - then your portfolio’s performance would probably suffer. But most people wouldn’t do anything so radical.

And yes, there might be a hit to returns if you reallocated all your assets to companies with high ESG scores overnight. But why would you do that? The move can be gradual. Why wouldn’t you want to travel in that direction?

If your aim is to construct a portfolio that tracks a market’s performance with similar volatility, then there is no reason you couldn’t do that and incorporate ESG principles into your investment choices.

There is just no reason that thinking about ESG means you have to abandon classic portfolio construction principles such as diversification, getting the right liquidity and maturity profile, ensuring the title to the asset and so on. ESG is just part and parcel of the decision about whether to make an investment.

The way we see it is that, whilst your investments can certainly cause you sleepless nights, this should not be because you didn’t expend every effort to ensure you understood the attendant risks, both financial and ESG-related. Everybody agrees that your portfolio should fit your financial risk profile. We say that you’ll sleep better if it fits your ESG risk profile too

And if the rest of the world is starting to agree, we can only say: what took you so long?

Cloud Computing For Family Enterprises

Cloud computing is a term that is widely used in today’s technology discussions yet the fundamental principle of the term has been around for as long as the last 15 years. Cloud computing in essence is controlling a remote resource, either owned or not owned by you (Private Cloud / Public Cloud) from a local device (Laptop / Tablet / PC / etc). Early webmail providers such as Hotmail and AOL were delivering email as a service back in the 90’s and one could argue that search engines essentially provide a cloud based research service, even the mainframe computing model bears a striking resemblance to the cloud computing model so why is it such a hot topic right now?

The focus has shifted to using thin client devices on the user end and increased server horsepower in the computer room as that would “reduce support costs” and provide “a greater ROI

Understandably, IT vendors will extoll the virtues of one computing methodology until the market stagnates at which point they will switch to another methodology if this boosts their business. This was evident in the move from mainframe computing to PC computing when we were told that it makes more sense to have the processing power on the user end and not in the computer room. Then, a few years later the focus shifted to using thin client devices on the user end and increased server horsepower in the computer room as that would “reduce support costs” and provide “a greater ROI”.

The networks of today are phenomenally more capable than they were in the past meaning that business transactions can traverse the world in microseconds, video conferences can be conducted globally with sub second latency and IT administrators can manage a server in Siberia from a sunny beach in the Mediterranean. When you have that level of connectivity why not offload some of your storage needs to a datacentre in the Arctic Circle that uses Mother Nature to keep its temperature down or to outsource your web hosting needs to a company that handles the majority of the world’s internet traffic. These providers are experts in their field with the kind of technical human resources you will only find in a place that provides those levels of precision engineering and technical challenges.

We believe that with the right governance and due diligence the cloud can be used as an excellent tool allowing for more agile and productive business processes

While both of these are valid points of view, the challenge for today’s Family Office or Family owned businesses is to understand the risks and rewards associated with Cloud Computing. First and foremost, the question of “Where is my data physically being stored?” is an important one. Consider the following example.

London based Family A have entered into a transaction with Bank B. Bank B utilises a cloud based email provider for all of their email communications. Bank B also uses a cloud provider for their long-term data storage and for their data backups they contract with a 3rd party provider on the sub-continent. In this example Family A’s data is potentially exposed to multiple people in multiple organizations across multiple geographies. In fact in many cases cloud providers will not tell you where your data is physically stored for “security reasons”. We know that at times this leads to costly and embarrassing confusion over data protection and related legal issues.

This is not to say that cloud computing is to be completely avoided. We at Termes believe that with the right governance and due diligence the cloud can be used as an excellent tool allowing for more agile and productive business processes. We believe there is a balance to be struck between on-premises and cloud based solutions which will deliver the right level of service your business demands. There are key questions to be asked when selecting a cloud provider such as:

  • What kind of authentication is necessary for a privileged user?
  • Who can access or even see my data?
  • Where is it physically stored?
  • Are private keys shared among tenants if a data encryption is used?

The Termes Partnership’s track record of working with Family Offices and Family run businesses is your assurance that these and many more questions are answered and the right technical, cost effective and ethical solution is designed, implemented and supported.