The Lebanese financial sector has long been dominated by commercial banks, which have grown significantly in the post-war period. Indeed, customer deposits have increased threefold since 1995 to reach the $60 billion mark by the end of the first quarter of 2005. However, this phenomenal growth was more or less cancelled out by the banks and other financial institutions, struggling to allocate their deposit funding efficiently. They have scarcely invested their deposits into the domestic economy, opting instead to support the government’s financing plans by subscribing to government Treasury Bills and other types of fixed income securities. These have given high yields, but also contributed to killing off the domestic capital markets and the creation of alternative investment vehicles such as funds, that would allow investors to achieve substantially greater returns on their savings than they could individually.
Funds are essential for any national economy as they can:
* Achieve superior rates of return to investors through capital gain and profits.
* Help Lebanese companies in their growth and development plans.
* Trigger much needed privatization in Lebanon.
* Facilitate the numerous family succession issues (which are numerous in a country dominated by family ownership).
* Attract qualified individuals and entrepreneurs by providing them with the necessary seed capital, financial expertise and know-how.
* Create new jobs.
* Help the development of the capital and financial markets in Lebanon.
* Facilitate the repatriation of part of the Arab wealth that is being withdrawn from major markets such as the US and Europe after 9-11.
* Encourage wealthy Arab and Lebanese individuals and investors to invest in high value-added projects in the country and the region.
The creation of funds has been very slow in Lebanon, despite some early attempts in the mid- to late-1990s with Lebanon Holdings, the abortive private equity fund established in the mid-1990s by Lebanon Invest, and the Middle East Capital Group. Banks and other financial institutions did not encourage the placement of savings in places other than deposits or real estate and only a few Lebanese understood the efficiency of funds in channeling savings towards the economy, including the real estate sector. What is ironic is that today only banks are capable of raising the required amounts of money that can build up one or more funds. Lebanese banks have developed significant relationship networks throughout the Arab region, as well as domestically, in order to boost the fund management industry significantly, and there is no reason why Beirut cannot be transformed into a regional center for funds.
For the moment there is no real Arab center for fund management, with the slight exception of Dubai and Bahrain, which have just started to look into this activity, given the return home of significant Gulf investments in the US and Europe, rumored to be in the region of $300 billion. But none of these Gulf centers such as Bahrain and Dubai have focused solely on fund management, seeking instead to become global financial and commercial centers.
Becoming a hub for funds
Beirut can become the Edinburgh of the Middle East (Edinburgh, together with the main Swiss cities, Paris and London, has long been regarded as one of the main centers for European fund management). It has all the ingredients: its banks and their impressive fund-raising capabilities, the know-how of its expatriates and local specialists (some of the best fund managers in Europe and the US of Arab origin are Lebanese), and its unique East-West culture. The local infrastructure in Beirut, particularly in the Solidere area, and the proximity to Europe are also propitious factors for the development of the fund management industry in Lebanon (although the rapid introduction of broadband internet has now become a dire necessity).
Funds would also be considered to be the key for the development and diversification of revenues for local banks. Indeed, most banks in Lebanon are working hard to diversify revenues by opening branches or going into joint ventures with local partners in other Arab countries, as well as by developing particular banking products and activities such as retail and treasury management. By focusing on the development of fund management activities, Lebanese banks would be emulating the Swiss private banks model, which consists of having relatively small balance sheets but very large off-balance sheet assets, which come in the form of funds. A Swiss-model-type banking sector would facilitate the diversification of revenues and, more importantly, would strengthen the recurrence of the income stream over a long period of time. With the Basel II capital regulations to be applied in Lebanon starting in 2008, and which require banks to have healthy and recurrent revenues in order to increase capital organically (through the injection of profits into capital), the timing of the development of the fund management industry cannot be more appropriate.
In addition to contributing to a greater diversification of commercial banking activities and revenues, funds are regarded to be instrumental in the development of investment banking activities. Indeed, investment banks have not developed in a similar vein to commercial banks since the establishment of the first Lebanese investment bank more than a decade ago. The Lebanese market is too small and overwhelmingly dominated by a restricted number of business families, which make investment banking deals very difficult to come by, while encouragement from the government to develop the investment banking industry has not been efficient or loud enough. By launching funds of appreciable sizes (a fund would make sense starting from US$40 million to $50 million), the Lebanese commercial banks would be developing their own investment banking divisions (or subsidiaries) in the most efficient way, as the funds would inevitably feed in a continuous manner into the investment banking division with a diversified panoply of deals.
Importance of good management
Private equity and venture capital funds cannot be managed passively. They need full involvement on the part of fund managers. Active involvement is the only way of ensuring that value is created, corporate governance is improved, and investment banking deals are created, to the ultimate benefit of both the fund’s parallel investment banking division and the invested-in firm. For example, some companies may need an increase in capital in order to be healthier and more valuable in the medium to long-term, and would hence need the investment banking division of their banker to carry out a share issue for them. Another example would be a company needing, as part of its value creation strategy, to carry out a management buy-out, which can only be arranged and executed, via the fund, by an experienced investment banking division.
Weighing up the benefits
Funds should be regarded as a valuable tool in the development of an economy. The fund industry must be developed and diversified to include funds that are profit-oriented, developmental, social, or even a mixture of all. The domestic market could also benefit from a large number of funds, launched by many banks almost simultaneously. A market full of funds would accelerate the development of capital markets, create liquidity for securities (as there would be more than a handful of buyers and sellers of company shares) and quicken economic growth.
Of course, no matter what the specificities and investment policies of the funds are, it is crucial that those funds be managed with rigor and diligence. Some essential ingredients for good fund management include having high standards of integrity, acting with “due skill, care and diligence,” having high standards of market conduct, knowing one’s customer and his requirements, being transparent at all times and avoiding conflicts of interest with and amongst clients. Failure to meet such basic requirements could ultimately turn the many positive advantages of funds into a national nightmare.