Sunday, June 26, 2016

26/6/16: Black Swan ain't Brexit... but

There is a lot of froth in the media opinionating on Brexit vote. And there is a lot of nonsense.

One clearly cannot deal with all of it, so I am going to occasionally dip into the topic with some comments. These are not systemic in any way.

Let's take the myth of Brexit being a 'Black Swan'. This goes along the lines: lack of UK and European leaders' preparedness to the Brexit referendum outcome can be explained by the nature of the outcome being a 'Black Swan' event.

The theory of 'Black Swan' events was introduced by Nassin Taleb in his book “Black Swan
Theory”. There are three defining characteristics of such an event:

  1. The event can be explained ex post its occurrence as either predictable or expected;
  2. The event has an extremely large impact (cost or benefit); and
  3. The event (ex ante its occurrence) is unexpected or not probable.

Let's take a look at the Brexit vote in terms of the above three characteristics.

Analysis post-event shows that Brexit does indeed conform with point 1, but only partially. There is a lot of noise around various explanations for the vote being advanced, with analysis reaching across the following major arguments:

  • 'Dumb' or 'poor' or 'uneducated' or 'older' people voted for Brexit
  • People were swayed to vote for Brexit by manipulative populists (which is an iteration of the first bullet point)
  • People wanted to punish elites for (insert any reason here)
  • Protests vote (same as bullet point above)
  • People voted to 'regain their country from EU' 
  • Brits never liked being in the EU, and so on
The multiplicity of often overlapping reasons for Brexit vote outcome does imply significant complexity of causes and roots for voters preferences, but, in general, 'easy' explanations are being advanced in the wake of the vote. They are neither correct, nor wrong, which means that point 1 is neither violated nor confirmed: loads of explanations being given ex post, loads of predictions were issued ex ante.

The Brexit event is likely to have a significant impact. Short term impact is likely to be extremely large, albeit medium and longer term impacts are likely to be more modest. The reasons for this (not an exhaustive list) include: 
  • Likely overshooting in risk valuations in the short run;
  • Increased uncertainty in the short run that will be ameliorated by subsequent policy choices, actions and information flows; 
  • Starting of resolution process with the EU which is likely to be associated with more intransigence vis-a-vis the UK on the EU behalf at the start, gradually converging to more pragmatic and cooperative solutions over time (what we call moving along expectations curve); 
  • Pre-vote pricing in the markets that resulted in a rather significant over-pricing of the probability of 'Remain' vote, warranting a large correction to the downside post the vote (irrespective of which way the vote would have gone); 
  • Post-vote vacillations and debates in the UK as to the legal outrun of the vote; and 
  • The nature of the EU institutions and their extent in determining economic and social outcomes (the degree of integration that requires unwinding in the case of the Brexit)
These expected impacts were visible pre-vote and, in fact, have been severely overhyped in media and official analysis. Remember all the warnings of economic, social and political armageddon that the Leave vote was expected to generate. These were voiced in a number of speeches, articles, advertorials and campaigns by the Bremainers. 

So, per second point, the event was ex ante expected to generate huge impacts and these potential impacts were flagged well in advance of the vote.

The third ingredient for making of a 'Black Swan' is unpredictable (or low predictability) nature of the event. Here, the entire thesis of Brexit as a 'Black Swan' collapses. 

Let me start with an illustration: about 18 hours before the results were announced, I repeated my view (proven to be erroneous in the end) that 'Remain' will shade the vote by roughly 52% to 48%. As far as I am aware, no analyst or media outfit or /predictions market' (aka betting shop) put probability of 'Leave' at less than 30 percent. 

Now, 30 percent is not unpredictable / unexpected outcome. It is, instead, an unlikely, but possible, event. 

Let's do a mental exercise: you are offered by your stock broker an investment product that risks losing 30% of our pension money (say EUR100,000) with probability of 30%. Your expected loss is EUR9,000 is not a 'Black Swan' or an improbable high impact event, but instead a rather possible high impact event. Conditional (on loss materialising) impact here is, however, EUR30,000 loss. Now, consider a risk of losing 90% of your pension money with a probability of 10%. Your expected loss is the same, but low probability of a loss makes it a rather unexpected high impact event, as conditional impact of a loss here is EUR90,000 - three times the size of the conditional loss in the first case. 

The latter case is not Brexit, but is a Black Swan, the former case is Brexit-like and is not a Black Swan event. 

Besides the discussion of whether Brexit was a Black Swan event or not, however, the conditional loss (conditional on loss materialising) in the above examples shows that, however low the probability of a loss might be, once conditional loss becomes sizeable enough, the risk assessment and management of the event that can result in such a loss is required. In other words, whether or not Brexit was probable ex ante the vote (and it was quite probable), any risk management in preparation of the vote should have included full evaluation of responses to such a loss materialising. 

It is now painfully clear (see EU case here:, see Irish case here: that prudent risk management procedures were not followed by the EU and the Irish State. There is no serious contingency plan. No serious road map. No serious impact assessment. No serious readiness to deploy policy responses. No serious proposals for dealing with the vote outcome.

Even if Brexit vote was a Black Swan (although it was not), European institutions should have been prepared to face the aftermath of the vote. This is especially warranted, given the hysteria whipped up by the 'Remain' campaigners as to the potential fallouts from the 'Leave' vote prior to the referendum. In fact, the EU and national institutions should have been prepared even more so because of the severely disruptive nature of Black Swan events, not despite the event being (in their post-vote minds) a Black Swan.

Tuesday, June 21, 2016

21/6/16: Real Ireland and the New 'Fiscal Space'

My comment for the Sunday Business Post on the Summer Statement by the Irish Government, covering fiscal space for 2016-2021 is available here:

21/6/16: Some Painful Stats on Males 'Nonemployment'

Courtesy of @TheStalwart, a nice chart comparing levels of non-employment for prime-age males across a range of countries.

Couple of things jump at a glance:

  1. Ireland is firmly within the Souther European states group;
  2. Irish change between 1990 and 2014 is one of the smallest on record, suggesting absence from employment is a long-running problem for Ireland.
  3. In 1990, Ireland ranked at the top in the sample of countries in terms of the proportion of prime-age males not in employment (note, these exclude those in education and training). In 2014 it was fourth ranked, owing to a massive swing to the upside in the emasure in Greece, Spain and Italy.
  4. Countries normally associated with stable and healthy labour markets (e.g. Israel and Finland) are running high proportions of prime-age makes not in employment
  5. Notice Iceland's position (presumably no 1990 data is available) ranked 6th lowest percentage of prime-age males not in employment.
Quite interesting.

Monday, June 20, 2016

20/6/16: Aid:Tech in Techstars 2016

So it is now official: AID:tech ( is one of 11 companies selected for the Techstars 2016 programme:

AID:tech is the largest blockchain player in the market for providing payments facilitation, data collection and analytics; and assets / supply chain management company for international NGOs and State organisations providing aid and social welfare supports around the world. The company has fully-developed, field-tested suite of solutions allowing it to assist NGOs and governments in:

  • Reducing risk of fraud in international aid and social welfare payments by digitalising their payments processes;
  • Transmit a payment to the end recipient of aid, instantaneously verifying identity of the recipient, receipt of funds, and confirming the use of funds in the case of aid-related purchases
  • Substantially (by a factor of up to 3 times) reduce the cost currently charged by less secure platforms that generally offer lower degree of tractability of transactions.

Today there is a lack of transparency and accountability in the distribution of funds by NGO's and governments.

Of the $360bn transferred each year by NGO's, only $90bn is currently delivered via transparent systems and these systems are extremely expensive to administer. By utilising private blockchain technology, AID:tech enables all international aid to be accounted for, including the distribution of assets such as medicine, food and other essentials. The platform also offers add-ons such as smart contracts and instant micro-insurance, as well as advanced data analytics that help organisations to better plan and execute aid deliveries.

AID:tech is finalist in the Irish Times Innovation Awards ( and and is shortlisted for the ‘Best Humanitarian Tech Startup’ for The Europas European Tech Startup Awards

Disclosure: I am very proud of being involved with the company as an adviser and shareholder.

20/6/16: Creating Fiscal Space. Or Money Growing on Trees

You might excuse an average punter for thinking things are going the beleaguered Irish Health Services ways with some EUR500 ml added to the spending bin ( After all, even the good folks of The Times bought into the positive story.

But, such a conjecture is wrong. What really is happening, thus? In simple terms, the Eurostat reclassification of the Government conversion of AIB preference shares into ordinary shares generates several implications:

  1. Preference shares represent a preferred (or senior) claim on AIB assets in the case of default or dilution compared to ordinary shares. That is the basics corporate finance and as such implies that State conversion of shares adds new risk to the State holdings, as well as reduces the value of that holding. It does create a marginal improvement in the AIB’s outlook for selling shares in the markets, however.
  2. The conversion also raises official State deficit and spending volume for 2015, which has no direct material impact on 2015 spending, except via two channels: Channel 1 is the impact that added spending has on future (2016) spending; and Channel 2 is the GDP effect - as AIB transaction added some EUR500 million to State official spending, that EUR500 million is now an addition to 2015 GDP.
  3. Because State spending for 2015 is now EUR500 million higher, and because our 2015 deficit was still below the approved (by the EU) target, the State is allowed - by the EU rules - to spend extra cash this year.
  4. Although Ireland has funds ‘available’ for such increased spending, the funding will come from borrowing. The reason for this is simple: Ireland is still running a general deficit. Not a general surplus. If the State were to spend EUR500 million of ‘added fiscal space’ on activities for which it is borrowing funds under pre-existent budgetary commitments, the deficit would have dropped - in 2016 - by, roughly, that amount. However, if Ireland were to spend it on a new spending line or to increase spending above previously planned, the funding will come via borrowing from some other activity, such as repaying Government debt.

In simple terms, there is no free lunch. Irish State does not have extra EUR500 million floating around that it did not have before. No matter what you classify things as, basic accounting means: unless you got paid by someone EUR500 million, you have to borrow EUR 500 million in order to spend it.

Simples. But not for Irish media that keeps confusing deficit financing via debt for resources.

Sunday, June 19, 2016

19/6/16: Irish Regulators: Betrayed or Betrayers?..

As I have noted here few weeks ago, Irish Financial Regulator, Central Bank of Ireland and other relevant players had full access to information regarding all contraventions by the Irish banks prior to the Global Financial Crisis. I testified on this matter in a court case in Ireland earlier this year.

Now, belatedly, years after the events took place, Irish media is waking up to the fact that our regulatory authorities have actively participated in creating the conditions that led to the crisis and that have cost lives of people, losses of pensions, savings, homes, health, marriages and so on. And yet, as ever, these regulators and supervisors of the Irish financial system:

  1. Remain outside the force of law and beyond the reach of civil lawsuits and damages awards; and
  2. Continue to present themselves as competent and able enforcers of regulation capable of preventing and rectifying any future banking crises.
You can read about the latest Irish media 'discoveries' - known previously to all who bothered to look into the system functioning:

And should you think anything has changed, why here is the so-called 'independent' and 'reformed' Irish Regulator - the Central Bank of Ireland - being silenced by the state organization, the Department of Finance, that is supposed to have no say (except in a consulting role) on regulation of the Irish Financial Services:

Please, note: the hedge funds, vulture funds, private equity firms and other shadow banking institutions today constitute a larger share of the financial services markets than traditional banks and lenders.  

Yep. Reforms, new values, vigilance, commitments... we all know they are real, meaningful and... ah, what the hell... it'll be Grand.

Saturday, June 18, 2016

18/6/16: Retail At Google Conference: June 2016

My slides from this week's presentation at Google Retail conference:

18/7/16: Gamed Financial Information and Regulation Misfires

A recent interview by the Insights by Stanford Business, titled “In Financial Disclosures, Not All Information Is Equal” (all references are supplied below and all emphasis in quotations is mine) touched upon a pivotal issue of quality of information available from public disclosures by listed companies - the very heart of the market fundamentals.

The interview is with Stanford professor of accounting Iván Marinovic, who states, in the words of the interviewer, that “financial statements are becoming less and less relevant compared to other sources of information, such as analysts and news outlets. ...there is a creeping trend in financial disclosures away from the reliance on verifiable assets and toward more intangible elements of a business’s operations.”

In simple terms, financial information is being gamed. It is being gamed by increasing concentration in disclosures on ‘soft’ information (information that cannot be verified) at the expense of hard information disclosures (information that can be verified). More parodoxically, increasing gaming of information is a result, in part, of increasing requirements to disclose hard information! Boom!

Let's elaborate.

In a recently published (see references below) paper, Marinovic and his co-author, Jeremy Bertomeu define ‘hard’ and ‘soft’ information slightly differently. “The coexistence of hard and soft information is a fundamental characteristic of the measurement process. A disclosure can be soft, in the form of a measure that “can easily be pushed in one direction or another”, or hard, having been subjected to a verification after which “it is difficult to disagree”."

For example, firms asset classes can range "from tangible assets to traded securities which are subject to a formal verification procedure. Forward-looking assets are more difficult to objectively verify and are typically regarded as being soft. For example, the value of many intangibles (e.g., goodwill, patents, and brands) may require unverifiable estimates of future risks.”

The problem is that ‘soft’ information is becoming the focus of corporate reporting because of coincident increase in hard information reporting. And worse, unmentioned in the article, that ‘soft’ information is now also a matter of corporate taxation systems (e.g. Ireland’s ‘Knowledge Development Box’ tax scheme). In other words, gamable metrics are now throughly polluting markets information flows, taxation mechanisms and policy making environment.

Per interview, there is a “tradeoff between reliability and the relevance of the information” that represents “a big dilemma among standard setters, who I think are feeling pressure to change the accounting system in a way that provides more information.”

Which, everyone thinks, is a good thing. But it may be exactly the opposite.

“One of the main results — and it’s a very intuitive one — shows that when markets don’t trust firms, we will tend to see a shift toward financial statements becoming harder and harder. [and] …a firm that proportionally provides more hard information is more likely to manipulate whatever soft information it does provide. In other words, you should be more wary about the soft information of a firm that is providing a lot of hard information.”

Again, best to look at the actual paper to gain better insight into what Marinovic is saying here.

Quoting from the paper: “...a manager who is more likely to misreport is more willing to verify and release hard information, even though issuing hard information reduces her ability to manipulate. To explain this key property of our model, we reiterate that not all information can be made hard. Hence, what managers lose in terms of discretion to over-report the verifiable information, they can gain in credibility for the remaining soft disclosure. Untruthful managers will tend to issue higher soft reports, naturally facing stronger market skepticism. We demonstrate that untruthful managers are always more willing to issue hard information, relative to truthful managers."

Key insight: "...situations in which managers release more hard information are also more likely to feature aggressive soft reports and have a greater likelihood of issuing overstatements.”

As the result, as noted in the interview, “…we should expect huge frauds, huge overstatements precisely in settings or markets where there is a lot of credibility. The markets believe the information because they perceive the environment as credible, which encourages more aggressive manipulations from dishonest managers who know they are trusted. In other words, there is a relationship between the frequency and magnitude of frauds, where a lower frequency should lead to a larger magnitude.”

In other words, when markets are complacent about information disclosed and/or markets have greater trust in the disclosures mandates (high regulation barrier), information can be of lower quality and/or risk of large fraud cases rises. While this is intuitive, the end game here is not as clear cut: heavily regulating information flows might be not necessarily a productive response because markets trust has a significant positive value.

Let’s dip into the original paper once again, for more exposition on this paradox: “We consider the consequence of reducing the amount of discretion in the reporting of any verifiable information. The mandatory disclosure of hard information has the unintended consequence of reducing information about the soft, unverifiable components of firm value. In other words, there is a trade-off between the quality of hard versus soft information. Regulation cannot increase the social provision of one without reducing the other.”

Now, take European banks (U.S. banks face much of the same). Under the unified supervision by the ECB within the European Banking Union framework, banks are required to report increasingly more and more hard information. In Bertomeu-Marinovic model this can result in reduced incidence of smaller fraud cases and increased frequency and magnitude of large fraud cases. Which will compound the systemic risks within the financial sector (small frauds are non-systemic; large ones are). The very disclosure requirement mechanism designed to reduce large fraud cases can mis-fire by producing more systemic cases.

In its core, Jeremy Bertomeu and Ivan Marinovic paper shows that “certain soft disclosures may contain as much information as hard disclosures, and we establish that: (a) exclusive reliance on soft disclosures tends to convey bad news, (b) credibility is greater when unfavorable information is reported and (c) misreporting is more likely when soft information is issued jointly with hard information. We also show that a soft report that is seemingly unbiased in expectation need not indicate truthful reporting.”

So here is a kicker: “We demonstrate that …the aggregation of hard with soft information will turn all information soft.” In other words, soft information tends to fully cancel out hard information, when both types of information are present in the same report.

Now, give this a thought: many sectors today (think ICT et al) are full of soft information reporting and soft metrics targeting. Which, in Bertomeu-Marinovic model renders all information, including hard corporate finance metrics, reported by these sectors effectively soft (non-verifiable). This, in turn, puts into question all pricing frameworks based on corporate finance information whenever they apply to these sectors and companies.

References for the above are:

The Interview with Marinovic can be read here:

Peer reviewed publication (gated version) of the paper is here:

Open source publication is here: Bertomeu, Jeremy and Marinovic, Ivan, A Theory of Hard and Soft Information (March 16, 2015). Accounting Review, Forthcoming; Rock Center for Corporate Governance at Stanford University Working Paper No. 194:

18/7/16: Euromoney on Brexit

My comment for Euromoney on the topic of Brexit impact on UK sovereign credit risks:

18/7/16: Stock Markets Crashes: 1955-2015

A good summary of all stock markets crashes since 1955 through 2015 via Goldman Sachs:

The caption to the chart says it all.

18/6/16: Brexit, U.S. Elections & State of Discontent

My interview with ItalVideoNews’ Concetto La Malfa about Brexit and the US Elections:

Friday, June 17, 2016

17/6/16: Credit markets on the ropes?

In their research note, titled aptly “Credit Metrics Bode 1ll”, Moody’s Analytics produced a rather strong warning to the corporate credit markets, a warning that investors should not ignore.

Per Moody’s: “The current business cycle upturn is in its latter stage, aggregate measures of corporate credit quality suggest. The outlook for the credit cycle is likely to deteriorate, barring improved showings by cash flows and profits, where enhanced prospects for the latter two metrics depend largely on a sufficient rejuvenation of business sales.”

In other words, unless corporate performance trends break to the upside, credit markets will push into a recessionary territory.

Recessions materialized within 12 months of the year-long ratio of internal funds to corporate debt descending to 19.1% i n Ql -2008, Ql-2000, and Q4-1989. As derived from the Federal Reserve's Financial Accounts of the United States, or the Flow of Funds, the moving year long ratio of internal funds to corporate debt for US non-financial corporations has eased from Q2-2011's current cycle high of 25.4% to the 19.1% of Ql-2016.

Moody’s illustrate:

Now, observe the ratio over the current cycle: the peak around the end of 2011-start of 2012 has now been fully and firmly exhausted. Current ratios sit dangerously at 4Q 2007 and close to 1-3 quarters distance from each previous recession troughs.

The safety cushion available to the U.S. corporates when it comes to avoiding a profit recession is thin. Per Moody’s: “The prospective slide by the ratio of internal funds to corporate debt underscores how very critical rejuvenations of profits and cash flows are to the outlooks for business activity and credit quality. Getting profits up to a speed that will keep the US safely distanced from a recession has been rendered more difficult by the current pace of employment costs."

Here’s the problem. Employment costs can be cut back to improve profitability in a normal cycle. The bigger the cut back, the more cushion it provides. But in the current cycle, employment costs are subdued (do notice that this environment - of slower wages and costs inflation - is the same as in 2004-2007 period). Which means two things:

  1. U.S. corporates have little room to cut employment costs except by a massive wave of layoffs (which can trigger a recession on its own); and
  2. U.S. corporates have already front-loaded most of the risk onto employment costs during the Great Recession. Which means any new adjustment is going to be even more painful as it will come against already severe cuts inherited from the Great Recession and only partially corrected for during the relatively weak costs recovery period since then. 

Moody’s are pretty somber on the prospect: "As inferred from the historical record, restoring profits through reduced labor costs is all but impossible without the pain of a recessionary surge in layoffs. Thus, barring a recession, employment costs should continue to expand by at least 5% annually."

That’s the proverbial the rock and the hard place, between which the credit markets are wedged, as evidenced by the recent dynamics for both Corporate Gross Value Added (the GDP contribution from the corporate sector) and the nominal GDP:

Again, the two lines show steady downward trend in corporate performance (Corporate GVA) and slight downward trend in nominal GDP. In terms of previous recessions, sharp acceleration in both trends since the end of 4Q 2014 is now long enough and strong enough to put the U.S. onto recessionary alert.

Per Moody’s: "As of early June, the Blue Chip consensus projected a 3.2% annual rise by 2016's nominal GDP that, …signals a less than 3% increase by corporate gross value added. [This]... implies a drop by 2016's profits from current production that is considerably deeper than the - 2.5% dip predicted by early June's consensus. Moreover, as inferred from the consensus forecast of a 4.4% increase by 2017's nominal GDP, net revenue growth may not be rapid enough to stabilize profits until the second-half of 2017, which may prove to be too late for the purpose of avoid ing a cyclical downturn."

In other words, there is a storm brewing in the U.S. economy and the credit markets are exhibiting stress consistent with normal pre-recessionary risks. Which is, of course, somewhat ironic, given that debt issuance is still booming, both in the USD and Euro (a new market of choice for a number of U.S. companies issuance in response to the ECB corporate debt purchasing programme):

Just as the corporate credit quality is deteriorating rapidly:

You really can’t make this up: the debt cornucopia is rolling on just as the debt market is flashing red.