Executive Magazine

Stage fright

by Executive Staff April 1, 2010

written by Executive Staff

The Oscar-winner question for the regional outlook on initial public offerings (IPOs) is not whether the Middle East and North African primary markets are stuck in a first quarter hurt locker, as much as whether the rest of 2010 will lift performances up and away or prompt regional investors to dispatch avatars to international markets.

The numbers for March IPOs and the entire first quarter are quickly told. Three offerings were open for subscription from March 22 to 28, all three for Saudi insurance companies, and the amount sought from subscribers equals to just more than $100 million. The three firms — Solidarity Saudi Takaful (seeking $59.2 million), Amana for Cooperative ($34.1 million), and Wataniya Cooperative Insurance ($8 million) — had, as Executive went to print, not released information on the demand commanded by their offerings in the first half of the subscription period.

Stumbling start

With neither IPO miracles nor rights issues having presented themselves in the MENA in recent weeks, the region’s total value of initiated and traded new share offerings in the first quarter of 2009 was a humble $178 million — 98 percent of which came from the Saudi listings of Herfy Food Services and Alsorayai Trading Industrial Group.

IPOs that closed in the first quarter but where the stocks have yet to commence trading are the $144 million issuance of real estate firm Mazaya Qatar, and an insurance issue in Tunisia by Assurances Salim, worth $7.1 million. Whereas Mazaya Qatar had difficulties achieving full coverage of the subscription offer, Assurances Salim reported very high demand at 28.5x subscription coverage.

For the first quarter of 2010, the count of newly listed companies on regional bourses is five — one Jordanian and four Saudi — and their price performances since flotation have ranged from 17 percent to 254 percent versus the issue prices, according to Zawya.

Jordanian transport company Ubuor Logistic Services, which had a small over-subscription, advanced 73 percent from the issue price in March trading, whereas Herfy and Alsorayai gained 15.2 percent and 17.4 percent, respectively, since their debuts in February.

Waiting at the red carpet

For April 2010, the only confirmed new subscription dates are for Tunis Re, from April 5 to 16, and for a Saudi appliances maker Al Hassan Ghazi Ibrahim Shaker Co at the end of the month. The Tunisian reinsurance firm will offer shares worth $9.9 million. It appears it won’t be until late May that regional primary markets will see their next exciting premiere, with the $272 million IPO of Saudi city creation firm, KEC Madinah.

With such pickings, investors with strong and urgent cash dispositions may have to look east, where Asian markets promise to drive the IPO production this year. The seasonal blockbuster opening on April 1 — more a heavyweight period drama than high-octane thriller — is the $11 billion IPO conversion of ageing Japanese life insurer Dai-Ichi, from a mutual insurance to a listed company.

Stage fright should not be the issue for Middle Eastern performers, after the corporate players had time to adapt to the rules of the securities game in several strong IPO years up until August 2008. However, market volatility and uncertainty over governance standards — the saga of lost hoards of gold at Damas jewelers has seen a new installment in March on Nasdaq Dubai — are among the reasons why resurgence of Oscar worthy IPO performances might hit the MENA bourses a season or two later than the occasional chief economist of a regional exchange would wish.

April 1, 2010 0 comments

Finance

Counting the cost of war

by Ahmed Moor April 1, 2010

written by Ahmed Moor

For as long as insurance has existed, companies, states and individuals have purchased policies to protect against war. Britain and France have long provided war insurance to companies, and America passed the War Risk Insurance Act in 1914 to provide marine insurance during World War I.

Unfortunately, war risk has not disappeared and new types of man-made risk have yielded the development of related insurance products, such as terrorism insurance.

The Middle East has long been prone to war and terrorism risk. As a consequence, the Arab War Risks Insurance Syndicate (AWRIS) was created in 1980 by a group of Middle Eastern insurance and reinsurance companies. The syndicate boasts a broad membership of 170 companies from 19 Arab countries; 21 board members hail from Lebanon alone. AWRIS collected a net premium of $21.7 million in 2008 and held $41.2 million in reserves in 2008. Total assets under management are approximately $1.22 billion. Providing war and terrorism risk coverage is difficult as the occurrence probabilities are difficult to predict, while the associated liabilities are generally enormous, which is why a syndicate or government-backed agency is usually required.

The carnage calculation

The below rationale and equation is taken from one insurance underwriter’s presentation to an industry group. It serves as a stark demonstration of the difficulties associated with developing a formula to price terrorism risk.
For each state “Q” of the Al-Qaeda terrorist network, there is a “Markov Feedback Policy“ involving “C,”a series of counter-terrorism actions. In a democracy with checks and balances on police and security services, these actions must be commensurate with the threat, i.e. dependent on Q, so C = C[Q].
Defining Qk to be the state at time k: the controlled Markov Chain model is
defined by the transition probability matrix T[i,j]: P {Qk+1 = i | Qk=j; C[Qk]}.

There are two primary types of insurance: property insurance and life insurance. At present, there is insurance available to protect both property and lives in the event of war or terrorism. In the Middle East, the AWRIS provides specialized war policies covering marine and aviation operations and property, sabotage and terrorism, personal accident (war-related), political risks and special risks.

Weighing up the risk

Property war insurance is primarily purchased by shipping companies and airlines. One type of insurance available is war liability, which covers people and goods in the craft. Another predominant type is hull insurance, which provides compensation for the craft based on its appraised value. Life war insurance is provided on an individual basis by a number of life insurance companies around the globe. The risk contracts can vary anywhere from one day to years depending on the period of an individual’s engagement in a war or terrorism prone area.

Pricing war risk insurance and reinsurance is dependent upon the ability of the insurer or reinsurer to accurately gauge the probability of an event. Historical experience can help insurance and reinsurance companies build realistic financial models for these risks. In the case of AWRIS, member companies cede risks and premiums to the syndicate whose rates are determined by a governing technical committee.

Importantly, the syndicate includes a provision for individual governments to subsidize the cost of coverage by paying a portion of insurance company premiums to the syndicate. The goal would be to reduce the cost of war risk and terrorism risk insurance to the end consumer.

Human conflict and conflict-generated losses are a fact of life. Because of the unpredictable nature of conflict, whether it be war or terrorism, this type of insurance will always be difficult to price. Furthermore, because of the high liability associated, many successful war and terrorism risk insurance and reinsurance schemes require government backing. It appears that the private market is still working to provide a solution independently of the public sector.

April 1, 2010 0 comments

Economics & Policy

A momentous task

by Sami Halabi April 1, 2010

written by Sami Halabi

Raya Hassan has been Lebanon’s Minister of Finance since the government was sworn in, in November 2009. Before becoming a minister, she worked in the office of the prime minister on both Paris II and Paris III donor conferences, and served as an advisor to the minister of economics and trade with the United Nations Development Program. As part of her ministerial duties she has been tasked with drafting a budget for a country that has been without one since 2005. On condition that figures relating to the budget would not be discussed, Hassan agreed to an exclusive interview with Executive to discuss issues related to the budget, the public debt and the finance ministry’s strategy going forward.

E The government’s debt strategy so far has been to trade short-term debt for long-term debt; this increases the debt service and moves the burden onto future generations, as well as exposing ourselves to currency fluctuations. Can you address these concerns?

When we are formulating our debt strategy we think of several factors. One is extending the maturity curve in order to smoothen [it]. Because we have maturities that go up and down, we try to smoothen it as much as possible so that we don’t have one big maturity of spending at a particular year and time; and we try to extend it as much as possible.

We extended for several reasons. While it’s true you pay more, you are getting a comfort zone. Plus, when we go abroad for Eurobond [subscription] we are able to get longer maturities for better prices than we can do here…there we issue at 10 and 15 [years]. We used to issue Eurobonds at 8, 9, 10 percent; now we have the luxury to refinance this debt at much lower coupons than we were able to five years ago. We want to make sure [the debt] is not only [held] purely by Lebanese banks, because this is too much exposure for them. It’s not a good thing for either of us.

E The decision to stop issuing treasury bills [TBs] was met by “anger and confusion,” to quote one banking executive, and has seemingly been overturned, since you will begin issuing again in April. This has sparked accusations that the finance ministry has caved under pressure from creditors. Can you respond to this claim and explain the strategy of halting and re-issuance of T-bills?

Frankly, I didn’t speak to any bank. It coincided with me on [a] Monday deciding on how much to take from the auction for the TBs. I told [my staff], ‘please get me how much is now in the treasury account.’ It turned out to be 6,500 [billion LL or $4.3 billion] on a net basis. I [then] said ‘I think we are going overboard with the surplus reserve that we want to have in terms of the treasury account. Therefore let’s maybe think about stopping the auction at least for a short period.’

I picked up the phone and called the [central bank] governor and decided, with him — meaning he did not say, ‘No don’t do it,’ he said, ‘Fine, if you exit from the market maybe I will try to go in myself with very short CDs [certificates of deposit] issuance and let’s do it.’ Before I sent the letter specifying exactly how long I was going to be out of the market, it just happened, probably from a procedural point of view, that he issued a statement which went out to Reuters that said: ‘The Ministry of Finance is going out of the market indefinitely.’ That was not the case. I said that we will make sure that we go out for a short period and I sent, subsequently, a letter that said we were going to go out for one month.

I could have stayed [in the market]. That was another option; but then I could not take anything at all. I had to weigh my options: either let the auction happen and not take anything, which would have signaled a bad thing, or say that we were not going to do an auction for one month, knowing that, if there was going to be any need by the market, the central bank could come in and [supply] it.

It’s good to have a reserve, obviously, and the approach I am adopting is to have in my treasury account, three months worth of future maturities, whether Eurobonds or T-bills. The 6,500 billion [Lebanese lira] was beyond that, so I said, ‘let’s not go overboard with this because this costs money as well.’

Having this buffer has its price but we would rather have the buffer, rather than not having it at all and finding ourselves in any kind of situation [where] we are not able to honor our debt obligations. But once it went over the threshold we had [set] for ourselves, we said let’s not increase it.

E You said previously you were going to decrease it to a figure of 4800 billion LL.

Something to that measure.

E Many economists say that, considering this surplus comes from debt, which keeps the level of total stock of public debt higher, this is not congruent with Ministry of Finance’s and the Prime Minister’s stated principle that “we don’t want to increase the debt.” How does it make economic sense to horde borrowed money to pay back interest on debt?

Look, it’s not additional debt. This is pre-funding; I am not borrowing. At the end of the year, I will not be borrowing more as a result of this approach. I’m just borrowing sooner. I’m rolling over sooner. I am borrowing so I can meet my dues. I was going to do it anyway. I am not increasing my debt, I am just rolling over an existing debt to refinance the existing debt, but I am doing it sooner than the maturity. So it’s not increasing debt.

I have to increase debt because I have a deficit. At the end of the year [I] will have to borrow more. As long as there is a deficit, the stock of debt will increase, but this particular measure is pre-funding. You need to use it anyway. You need to go out of the market and refinance but you do it three months in advance rather than doing it at the date of maturity, because you want to make sure that in this volatile environment, you don’t run out of cash to pay whatever maturity might come.

E Do you have a projection plan under the current public debt strategy to begin paying off the principal on the public debt any time soon?

Maybe [we can] if we switch some of the project financing support that we got under Paris III. We have around $800 million [pledged] from the French, from the Americans, from the World Bank; [but] these are all linked to conditions. Plus, if we go ahead with privatization, the proceeds will go toward reducing our debt stock.

We are also betting on growth, which should be the anchor of any debt reduction strategy. Growth raises additional revenues and hopefully goes toward reducing the primary surplus and eating out of our debt stock. It has to be a multi-faceted approach.

E One of the biggest costs we have is Électricité du Liban (EDL) fuel costs. Currently this is financed through letters of credit, but do you have a fuel cost hedging strategy to predict fuel costs?

No, frankly we have not done it. It could be something that needs to be explored but today you have structural problems that you need to address irrespective of hedging against an increase in fuel prices. We don’t even have cost recovery; we are not at this stage. Therefore, EDL itself needs to be corporatized according to the law. There should be, eventually, the unbundling of the sector.

You need to tackle the generation [which] is a problem by itself. And, you need to tackle the distribution end, plus you need to reduce all your technical and non-technical losses. There is a whole restructuring [process] that needs to be done on EDL. One of [the elements] is to at least achieve a full cost recovery of the electricity and therefore we need to review the tariff structure. The tariff structure now is low by any international standards. It does not cover primary costs, let alone losses.

When I see my budget, in terms of the primary expenditures, its one-third salaries, one-third servicing, and one-third EDL. So there is not much you can do if you don’t solve the debt problem and you don’t solve your electricity problem — you cannot release the additional funds that you need for the government to really spend on the areas that you need to spend on like health, security and education. The structure of our budget is so rigid that there is very little room for improvement at this point.

E Do you think that all the other ministers understand this rigidity when you have conversations in the cabinet sessions?

We are trying to explain to them if possible. Some people don’t have this macro [economic] view of the inter-linkages between the different elements of the budget. We are trying to make the case that we are not happy with any VAT [value added tax] increases. God willing, we will not reach VAT increases.

But the situation that we are in right now necessitates that any increase in expenditures will have to be matched by an increase in revenue. Otherwise, if that does not happen we will accumulate a primary deficit. If we accumulate a primary deficit, our debt will start increasing at an increasing rate and we are back to square zero; pre-Paris II.

It’s a no brainer. We are not fans of any additional taxes, but if we are going to have to really address the structural problems and we don’t want to go to concessional funding [soft loans] or the private sector, then the only way is to try to raise additional revenues.

E Many entities have been off-budget line items in the past, such as the capital spending for the Council for the South and the Displaced fund, and capital spending is still not included for other entities such as the Council for Development and Reconstruction (CDR). As such, some economists have stated that up to 20 percent of spending goes to these non-budget line items, which are outside of the budget and only annexed later. Are these items and those like them going to be included in the next budget since it is, after all, public spending?

Yes, you are going to see them, definitely. You are going to see the actual expenditures and at the same time you are going to see them within the budget. You cannot incorporate all of these extra budgetary [items] that we call “treasury expenses” within the budget structure because, for example, for the treasury advances you don’t know it in advance. You cannot predict it, so you put it as an allocation within the budget. But in the budget book we are going to list them. We are going to say, ‘these are the budget allocations and these are the treasury expenditures’ and its going to be very transparent. The intention is at no point in time to say we have expenses that we don’t want to show. On the contrary, I want to show the bigger picture of how much our expenditures are.

E Do you agree that these entities constitute around 20 percent of spending?

It might be even more.

E Why are items like The Regie [Libanaise de Tabacs et Tombacs] and Ogero’s lump sum payments not broken down to in the budget proposals of years past?

These are the annexed budgets and these are also within the budget. The Minister of Telecom for instance, says he wants a certain amount of investment, gives us his budget and says, ‘I will transfer whatever surplus I have. After I let out my expenditure and I collect whatever revenues, I will send you the surplus that I have in my budget.’ All the annexed budgets are like this [including] the national lottery. They are given a budget and any surplus is transferred.

E So there is no key performance indicator (KPI) based criteria you use with these entities to ascertain their budgets then?

No. But this is what we are trying to do through the performance-based budget, which has already started in the Ministry of Education. This should pave the way for eventually using KPIs and performance indicators to start assessing the efficiency and effectiveness of all of these expenditures. This is part of the reform processes.

E A lot of the money due to the government, in the form of our direct taxes from the National Social Security Fund, municipality tax and income tax, is being evaded and double book-keeping is rampant, causing much waste of government revenue. Since taxes make up the bulk of government revenue, what has been done to curb this problem and are there any tangible results?

We are not involved with the municipality tax or the NSSF. Income tax is another story as is the VAT. You also have property taxes and things of the sort. I have to admit that there is evasion, everybody knows that. The banks pay 40 percent of total income taxes, so it’s concentrated.

E And they only constitute around 20,000 workers?

No, here I am talking about corporate [income tax]. Small grocery shops, the self-employed, doctors’ offices and things of the sort [evade taxes]. But there has been a lot of improvement. If you study the trend of the revenues you can see — other than the growth factor — that collection has been improving every year.

Obviously, there is still a lot to be done. How to do it? We are now trying to implement a twinning arrangement called a risk compliance audit. Rather than the inspector wanting to study every file and every company — which throughout his entire life he will never be able to do — we are saying that we can set up certain risk criteria and based upon this, we will study this group of people every year. It will not be done to all [companies]. As a result, based on that criteria, [we will study] the most important portfolios that poses a risk of evasion.

E The Central Bank is, by definition, the “lender of last resort” and it now holds around 15 percent of the public debt. Usually this is explained by saying that the Banque du Liban (BDL) is practicing its monetary policy. Can you explain why this amount has become so substantial if this is the case, and why aren’t they taking measures to decrease the burden on the government?

They should. Eventually, the BDL holdings of TBs should go down. It’s true that it is part of the monetary tools that they use. But I think eventually they should reduce the exposure and the TB holdings of the government.

April 1, 2010 0 comments

Finance

Waking up to the web

by Emma Cosgrove April 1, 2010

written by Emma Cosgrove

For many clients of international banks, a trip to a branch has become a thing of the past, as an increasing variety of services have become available online. Some institutions, such as Dutch lender ING Direct, have gone so far as to do away with branches completely. ING’s United States director, Arkadi Kulhmann, has said that the inspiration for the branch-less banking system came from enterprises in other industries such as Swiss furniture giant IKEA and the US’s Southwest airlines, both of whom choose product selection and low cost over aesthetics and frills.

Lebanon, however, has no discount airline, no IKEA, and face-to-face interaction with a bank teller is seen as a non-negotiable necessity, especially to the older generation. The result has been that, until recently, the country’s banks have kept their online service offerings to a minimum; most banks first offered online services five years ago, but these were limited to simply displaying accounts and balances, with some opportunities to transfer within the same bank.

But according to directors of online banking services, this tide is changing. Younger Lebanese, fully equipped with net books and wireless internet at every café and mall, demand more online banking access. Some banks have been eager to oblige, as a palpable move to online services would notably decrease operational costs. “Other than the infrastructure implementation, the only cost is how many bits they are taking from our system…this is peanuts,” said Ronald Zirka, head of marketing at Banque Libano-Francaise.

Antoine Lawandos, assistant general manager and chief information officer at BLOM Bank, agreed, and alluded to the day when banking services would be completely online.

“Within our strategy we consider internet banking as being a delivery channel, not a service,” said Lawandos. “We would like to compare it to [our branches].”

No safety net

Due to the antiquated laws governing banking transactions — which have not been updated and adapted to the internet age — developers of online banking services are treading in legally nebulous waters. A draft bill to officialize online signatures has been waiting for parliamentary approval for the last five years, like many other bills not deemed a priority for the backlogged parliament. Without this, banks that choose to expand their online services take a financial risk, since transactions that do not carry a physical signature are not legally binding in Lebanon.

April 1, 2010 0 comments

Economics & Policy

Pandora’s Budget

by Sami Halabi April 1, 2010

written by Sami Halabi

Among the more developed countries of the world it is customary to hold the nation’s constitution as sacrosanct, with governments that violate it swiftly shown the door by way of the ballot. The Lebanese constitution, on the other hand, is more a set of rough guidelines that successive governments have invoked when it suited their purposes, ignoring the tedious elements, such as those that deal with drafting the national budget.

Articles 81 to 86 of the constitution specifically lay out the process for Lebanon’s government to pass a budget. Accordingly, the budget for any year should be proposed by the Council of Ministers, Lebanon’s cabinet, during the second regular session of parliament in October of the preceding year. Negotiations can then be extended until January, at which point, if no agreement is reached, “the Council of Ministers may take a decision, on the basis of which a decree is issued by the president.” This enacts the budget as it was submitted to the Parliament.

“When the constitution states such an article, that means that neither the cabinet nor the parliament can violate it,” said Wassim Mansouri, lawyer and constitutional expert. “What has been happening for years now is that they have been violating this.” According to Mansouri, no legal body can actually punish these constitutional violations because none has jurisdiction to do so; that includes Lebanon’s Constitutional Court, which only deals with issues relating to the elections, not the actual constitution. What successive governments have been doing instead of adhering to the constitution is to follow the rule of the “provisional twelfth,” whereby the government spends the same amount each month as they did in the most recently approved budget — meaning the one passed in 2005.

“Now you tell me that it is mentioned in the constitution, but at that time they did not know that there would be [this amount] of political wrangling,” said Raya Hassan, Lebanon’s finance minister allied with the parliamentary majority. “If there is no budget the only way a country can spend is by the principle of the provisional twelfth, otherwise how would you be able to spend?”

Now that Lebanon has a cabinet, without the excuse of pending elections or a lack of quorum to put off the issue, Hassan has been handed the prickly task of drafting the budget and managing some $51 billion in public debt.

But new projects require new money and that does not grow on olive trees.

Perhaps the most controversial proposal on the table is increasing Lebanon’s value added tax (VAT) from 10 percent to 12 or 15 percent, part of the reforms proposed at the Paris III donor conference, in which Hassan was heavily involved before becoming the finance minister. The proposal is highly unpopular with many segments of society and across the political spectrum.

According to a study by the Lebanese Economics Association (LEA), an increase in VAT by 2 percent would more than double the percentage of the population living below the extreme poverty line from 3 percent to 6.6 percent. People who live in “extreme poverty” are defined as earning less than $2.40 per day and being unable to meet basic food and non-food needs.

A 5 percent rise in VAT would send 8.9 percent of Lebanese into extreme poverty. The number of people living at or under the “upper poverty line” (defined as earning between $2.40 and $4 per day) would also be expected to increase, from the current rate of some 28 percent of Lebanese, to between 30.9 percent (with a 2 percent VAT increase) and 34.7 percent (with a 5 percent increase). What makes matters worse is that most of the revenues from any VAT increase would not come from the poor — it will just create more of them.

Estimated impact of a rise in VAT on household consumption in Lebanon

“VAT is imposed on consumption, so the more they consume the more they pay; but the poor people don’t consume that much, they don’t really pay a lot of it,” said Jad Chaaban, acting president of the LEA and co-author of the report. “The problem is whenever they spend a bit more they are immediately subject to the tax.”

While Hassan has not officially announced that she is planning to include a VAT increase in the next budget, she does concede that there is little more she can do to increase government revenues in Lebanon.

“You have very limited room today to think of any revenue measure except VAT,” said Hassan, who spoke to Executive on condition that figures from the budget would not be released.

In case she does decide to propose an increase, Hassan said she intends to “exempt” those living in extreme poverty and offer upper poverty Lebanese “mitigating” measures. One is exempting certain products from the VAT, and Hassan insisted Lebanon has the largest exemption base on earth.

According to the LEA, the exemptions on food items, which constitute almost twice the percentage of household spending for the poorest families (18 percent) than for the wealthiest (9.2 percent) “appear to be progressive.” However, other exemptions, such as those related to education and books, are “highly regressive.”

List of VAT-exempted products and services in Lebanon

Goods:

Livestock, poultries, live fish and agricultural alimentary products sold in their raw state.
Bread, flour, meat and fish, milk and yogurt and their derivatives, rice, borghol, sugar, cooking salt, vegetable oil, macaroni and all different kinds of pasta and baby’s food.
Books, magazines, newspapers, paper and paperboard of a kind used for writing and printing, newsprints in rolls or sheets, printing ink.
Postal and fiscal stamps and paper money.
Gas for household consumption (butane).
Seeds, fertilizers, feeds and agricultural pesticides.
Agricultural machinery.
Medicines, drugs and pharmaceutical products including those used for health and pharmaceutical purposes.
Medical tools, installations and equipment.
Precious and semi-precious stones, precious and semi-precious stones destined for mounting or renewed, pearls, diamonds, gold, silver and other precious metals.
Negotiable money in paper or coins.
Yachts and other excursion or sports sailboats with a length exceeding 15 meters that are only owned by non-Lebanese.
Means of air transportation used for persons and goods.

Services:

Services offered by physicians or persons performing a medical activity, and hospital fees.
Education.
Insurance and reinsurance, and medical coverage provided by mutual assistance fund and employers and related services.
Banking and financial services.
Non-profit organizations and the activities performed for non-profit purposes.
Collective transport of persons, including transport by taxicabs.
Supply of gold to the Central Bank.
Betting, lotteries and other forms of gambling.
Sale of built properties.
Residential letting of built properties.
Farmers’ activities concerning the supply of their agricultural production.

Source: Ministry of Finance & Lebanese Economics Association

Then there are the more striking items which aren’t exactly the target investments of a pauper’s portfolio. Yachts and other excursion boats longer than 15 meters and owned by non-Lebanese are exempt from VAT, as is gambling, air transport, precious stones, sale and rent of built property, as well as banking and financial services. Hassan’s explanation for these exemptions was that they are also exempt in other countries for reasons that are both economic and technical.

The other way

Marwan Iskandar, an economist and managing director of MI Associates, said delaying a VAT increase “can be justified” in part, if the government’s treasury account surplus ($4.3 billion at the end of February) is used to cover half of this year’s projected deficit of some $4.2 billion, according to Byblos Bank. He suggested that the rest of the money could be generated from increasing revenues resulting from general economic growth, as tax revenues have grown 48.7 percent in the last two years. At the end of 2009, government revenue stood at some $8 billion, $5.98 billion of which came from tax revenue. Moreover, Iskandar pointed to another source of funds as being the $480 million currently tied up in the Beirut municipality’s account, due to political wrangling between the mayor and the mouhafiz, or provincial governor. He also reckons that some of the pledges from Paris III can still be secured, but doubts the seriousness of many of the donors since the pledges were made before the onset of the global financial crisis.

“[The government] have no right to tax us when they have assets which are underutilized,” said Iskandar. “They need to think about how they can activate the economy. The solution is not in taxation. The solution is attracting major investments in essential, important projects.”

He stressed the need to develop Lebanon’s water, oil refining and exploration potential — a prospect that is harrowing to others.

“Today we are not taking care of our agriculture, environment or industry,” said the LEA’s Chaaban. “If we find oil we will never take care of it; we’ll become more of a banana republic.”

Talk of increasing taxation seems even less warranted when many of the staples of good financial management are still not in place. According to the finance ministry, last year the government transferred 4.3 percent of GDP ($1.5 billion dollars) to Électricité du Liban (EDL), the state-owned electricity company, with 94.4 percent of that figure going to reimburse the Kuwait Petroleum Company and Algeria’s Sonatrach, Lebanon’s fuel and oil suppliers, for gas and fuel oil purchases.

Hassan said the country’s primary expenditures were split equally between salaries, debt servicing and the cost of EDL. That being the case, one would think that the government would hedge against any future increase in fuel costs as major airlines do to predict their future financing options. However, the Lebanese government still does not have a program to hedge its fuel purchases, which totaled $1.55 billion in 2009.

“It could be something that needs to be explored but today you have structural problems that you need to address irrespective of hedging against an increase in fuel prices. We don’t even have cost recovery; we are not [even] at this stage,” said Hassan in reference to EDL.

Tax evasion is also rampant in Lebanon, with many businesses and individuals keeping two sets of books, one for themselves and one for government auditors. The government has made some headway in terms of tax collection, with the ratio tax collectors to the general population being within internationally accepted bounds, according to the LEA’s Chaaban. But public auditing methodology is outdated, still following Lebanon’s decades-old public accounting law. The finance ministry is now beginning to implement a risk compliance audit system, whereby auditors are not required to assess each and every business — a task that caused public audits to lag behind their respective tax years — but study only segments of the economy that are prone to tax evasion.

An indebted surplus

Ultimately, the issue of Lebanon’s public debt is what weighs heaviest on the budget, with interest payments constituting the largest expenditure item in 2009 at some $3.8 billion. In late-February a media frenzy ensued in Lebanon over the financial management of the governments treasury account, the national equivalent of a personal current account. It was then that the account was found to contain a $4.3 billion surplus [6,500 billion Lebanese lira], while at the same time the VAT increase was being floated as an idea to increase government revenue.

“I didn’t understand the logic behind this and neither did many people in the banking sector,” said Nasib Ghobril, chief economist and head of research at Byblos Bank.

The LEA’s Chaaban added that: “If you hold this [borrowed] money and you don’t invest it you are paying [interest] on it anyway, you have to invest it in the right way. They want to keep it as a buffer which doesn’t make sense.”

Responding to such criticism last month, Hassan called a press conference where she stated that the surplus was “pre-funding” that would not increase the amount of payments at the end of the year and would be used as a buffer to pay off future debt for a period of three months.

Back to basics

While media reports have quoted the level of expenditures in the upcoming budget at anywhere from $10 billion to $13.6 billion, the finance ministry has remained tight-lipped on a final figure. Aside from enacting procedural reforms, many other options are also on the table, including raising taxes on interest profits in the banking sector and levying higher taxes on Lebanon’s booming real estate sector.

Lebanon owes itself billions

By definition, a central bank is meant to be the “lender of last resort.” But in Lebanon, the issue of the who owns and who owes the debt is complicated by the central bank’s holdings of Treasury bills and Eurobonds, which it is also in charge of issuing and managing for the government. Considering that the Banque du Liban (BDL), Lebanon’s central bank, now holds some 15 percent of the public debt, it could do a lot more to decrease the government’s mounting burden.
What’s more, part of the money that the BDL uses to purchase this debt comes from its reserves, which include “financial sector deposits,” amounting to $39.1 billion in liabilities on the BDL’s balance sheet by mid-March. But this figure also includes Lebanese commercial banks’ required reserves, which stand at 15 percent of total deposits in the country. This has created a potential systemic risk in the country’s banking sector. “The problem with that is if they do [use the reserves] and the bank needs the money, it is not liquid,” said Nassib Ghobril, chief economist and head of research at Byblos Bank. Youssef el-Khalil, director of the financial operations at the BDL, declined Executive’s request for comment.
Makram Sader, secretary general of the Association of Banks in Lebanon, confirmed that the BDL was indeed using required reserves and defended the BDL’s right to do so, as he believes the bank needs to play the role of a market maker in the public debt market, as well as exercise its right to practice its monetary policy as it sees fit. “Nobody can hold them accountable, not even the Ministry of Finance,” he said of BDL’s policies.
Sader said he saw no systemic risk in this arrangement because, in case a crisis occurs, he calculates that there is enough liquidity to cover up any run on the banks. “If Israel attacks and $10 billion leave the country, we have the money to cover it and we don’t have a problem,” he said. “[But] the central bank should be wise enough to ensure that this usage [of required reserves] is wise and in the interest of monetary stability and not for any other reason.” Jad Chaaban, acting president of the Lebanese Economics Association, however, reckons that the issue boils down to the seemingly complicit arrangement between the banks and the government, to continue their symbiotic debt relationship instead of dealing with the conflation of accounts at the central bank.
“The central bank, with its reserves, buys debt from the government, so you don’t know where the borders of the debt actually are,” he added.

“Taxation serves as a correction facility for sectors that have gone out of control,” said Chaaban. “You cannot keep taxes low on real estate investment. It’s a crime. It’s wrong.”

Quite predictably, real estate executives have balked at the proposal of raising taxes on their operations. Currently taxes in Lebanon specific to real estate fall on consumers, not developers.

As Executive went to print, Hassan confirmed that individual ministerial budgets had been set. In the end however, any budget that does emerge will not be one based on performance because, with the exception of the education ministry, the finance ministry has yet to implement a performance-based budget using key performance indicators (KPIs) to evaluate expenditures.

Not having such a system in place to appraise a ministry’s performance is tantamount to floating money down a river and hoping it arrives where it is intended. The lack of standards also neuters the public’s ability to judge their ministers’ performance come election time. Making matters worse, state-owned entities like the Regie Libanaise de Tabacs et Tombacs, the body which controls the tobacco trade, and Ogero, the incumbent fixed-line telecom operator, are granted unmonitored lump sum payments by the finance ministry, with any surpluses later annexed to the treasury after these entities close their books.

Lastly, entities such as the Central Fund for the Displaced, the Council for the South, and the Council for Development and Reconstruction are funded outside the budget and approved by special laws and ministerial decrees. While there is some financial rationale behind this, given that some foreign financing must adhere to donor guidelines and not government ones, Hassan believes that the amount of government spending outside the budget could exceed 20 percent of total spending.

With so much at stake, so much being wasted and structural reforms only beginning to emerge, the prospects for Lebanon’s public finances are far from rosy. If no new budget is passed — as has been the case for the last five years — no new major government projects can take place in the country; meaning Lebanon’s people and businesses will have to remain content with the country’s decrepit infrastructure, among a multitude of other failings.

Without a budget, “We will not [be] able to do much,” said Hassan. Indeed if the status quo does persist, Hassan may find herself submitting next year’s budget before this year’s — at least then, it might be constitutional.

April 1, 2010 0 comments

Finance

Lurching forward

by Emma Cosgrove April 1, 2010

written by Emma Cosgrove

With the financial crisis winding down, hiring is set to cautiously resume in the region’s banks. Executive spoke with Panos Manolopoulos, vice president for the Middle East at Stanton Chase, an executive search and compensation consultancy, to find out what financial jobseekers can expect to see in 2010.

E Did the banking sector see the trimming down of personnel as much as other sectors?

There were a lot of losses in most parts of the banking sector. The mortgage losses were the centerpiece of the crisis and of course that led to many layoffs and, in turn, restructuring. So all the players took a hit and no one can claim to have been unscratched. JP Morgan, HSBC, Goldman Sachs, Bank of America; everyone has felt it.

There has been a trimming down of personnel as much as other sectors and in some cases even more. But things are getting back to normal a little bit right now, because we are seeing some light at the end of the tunnel. Some financial institutions are again searching for talented people, but they are very cautious right now. They don’t want to revisit the nasty experience that they had in 2009.

E How has compensation in the banking industry changed since the financial crisis?

In terms of base salaries for top performing senior managers it has not changed much. Of course, finding the right [chief executive officer], [chief financial officer] or head of capital markets is not an easy task. And the list of competent people who can deliver is short. So the top jobs continue to post top salaries. Where do we see changes? It is in bonuses and payouts, which are not being paid by many organizations this year. Some housing allowances dropped approximately 40 percent, or in some extreme cases they have been completely cut from the budget. There are some clients that are much more reluctant to [hire internationally], as they feel that the talent in the local pool is far more accessible to them.

This is a trend that we see growing over the coming years. Generally speaking, this ‘Emiratization,’ or general nationalization of human resources is the trend. And of course at the forefront is the banking sector.

E Which countries in the region have the highest paid bankers and is there any explanation as to why?

Generally Saudi is booming and everyone is trying to get a piece of the pie. I think that the bankers with key relationships in the region will simply be doing better than their peers and make the most money.

In a very simplistic approach I would say that Saudi, being the least regulated market in terms of salary levels, and at the same time having big opportunities is the reason for some bankers there making good money.

E How much does compensation differ from bank to bank in the region? What is the reason behind these differences?

Unfortunately, compensation differs tremendously from bank to bank and the main reason is that it isn’t a mature market. During the boom, banks could not find enough staff to manage their gold, so they hired people who could grow into the roles to which they were assigned. This created internal inequity, because all of a sudden you had someone with eight years of experience earning the same as someone with three years of experience. The banking market is fragmented and I think it will take some time for there to be some regulation.

E Does compensation at the state-owned banks hold up to private institutions?

[State-owned banks] are sometimes forced to be competitive when it comes to top executive jobs. Other times, with middle management jobs, they use the argument of being state-owned with some sort of rules about salary levels in order to negotiate, and because of that sometimes they are losing some good candidates. [Compensation at state-owned institutions] is lower.

E Are there any other trends that you expect to play major roles in 2010?

There will always be a fight to attract talented people, because it’s a hosting region. That will always continue to happen. But at the same time gradually over the years we will be seeing more and more locals occupying top jobs and climbing up the ladder.

E Are Lebanese bankers still in demand around the region or is this trend shifting as well?

[Yes, but] not because of their technical skills — we have found very strong bankers from multiple nationalities — but I think it is because of their overall package. And it is not a phenomenon particular to the banking sector, it is in all sectors. Why are Lebanese at the top of the list of the most wanted executives in general? It is because they have this combination of the Middle East experience with European, Western experience.

They speak three languages and have Arab culture but at the same time have Western culture. And the last, which I think is the most important, is that they have some entrepreneurial spirit, unlike the overall perception of the rest of the countries including the Levant neighbors.

The Lebanese can start a business and they are a lot better in business development. I wouldn’t say that they are better bankers in the sense that they are more technically equipped, but I think the whole package that they are carrying makes them look more attractive.

E What is the role of nepotism in hiring in the banking sector? Does this hurt the actual human talent of the bank?

Absolutely. We are beginning to see a trend of family conglomerates getting rid of nepotism, but it’s something that will not happen overnight. In most of the cases what we see is that there is good willingness, but when it comes to crises or decision-making processes, it is always an implication; meaning that the involvement of nepotism is higher than expected.

Sometimes the processes are not very transparent, because at the end of the day, the last word is the major shareholder or the family member that is the leader of the group. I think that the social structure of this region is influencing this and it will remain so for many years to come. It will be very difficult to get rid of it.

We are working outside the financial sector with a number of family conglomerates and we see that there is a willingness to get rid of [nepotism], but at the end of the day, it is part of the culture. It will not happen overnight or even over a generation.

It also varies across the region. It is a lot less in Lebanon. It’s a lot more in Saudi, in Oman and in Qatar.

April 1, 2010 0 comments

Real Estate

Out with the old

by Nada Nohra April 1, 2010

written by Nada Nohra

In the late 1940’s after World War II, to avoid tenants from being thrown out of their homes and exacerbating the economic and social distress of the time, the Lebanese government issued an exceptional law stating that all rental contracts would be extended until a new law is issued in that regard; and, until 1992, all those new laws only extended the old one.

This meant owners could only repossess their properties under two circumstances: for family needs or demolition, while paying a compensation fee of 25 to 50 percent of the value of the property, the exact amount determined either between the two parties or by the courts. In 1992, two laws were issued distinguishing between contracts made before 1992 and the ones made after: Law 160/62 extended the former rental law and applies to contracts made before 1992. The second law (159/62) applies to contracts made after 1992, and stipulates that rental agreements should be signed for at least three years, unless otherwise agreed upon. The 160/62 law was also extended many times, most recently this past February.

The problem

When the Lebanese lira began to devaluate in late 1980’s, old rental rates was not allowed to rise in line with inflation and thus the money collected by owners was negligible. Even though the 160/62 law in 1992 included an increase in rents, they were still well below market value and owners were not allowed to implement any further increases.

Georges Rabahiye, president of the Owners’ Association, which has been active since 1988, said some rents total only $120 a year. Consequently, owners are demanding to cancel the old contracts so rents can align with the true market value, while also giving tenants a three-year window to vacate. Although owners have been promised a new law for a number of years, it has not yet been issued.

“Every one or two years they draft a law and fool the owners,” said Rabahiye. “We can no longer accept tenants with this low rent.”

On the other hand, Marie Nassif Debs, the president of the Tenant’s Association, said that most of the old-rate tenants belong to the lower-income bracket and older age groups, and thus they are concerned about the impact canceling the contracts may have. The increasing rents, especially in Beirut and its suburbs, and the absence of a housing plan to accommodate low-income tenants will create a housing problem for many families, said Debs.

“There is a substantial number of tenants who, if they are [forced to vacate], will not be able to rent new apartments,” she said. “We are not against freeing the contracts but it should be done, taking into consideration the social and economic situation of the tenants.”

Under the old law, it is not easy for an owner to repossess his property. Nader Obeid, partner at the law firm Alem and Associates, explains that if the two parties don’t agree and they go to court, these cases could take years to resolve.

“We have a judicial system which is not known for its high speed,” he said, adding that, “These cases are not considered as priority and they could take a year, two or three, or could end quickly depending on the speed of the courts…it is unpredictable.”

The new law

The Parliamentary Administration and Justice Commission has come a long way in drafting the new law, but sources from the commission said that there are still two major points being discussed. The first is the time frame within which the old contracts should be canceled — arguments thus far generally place this between four and seven years. The second point is compensation for tenants upon vacating. The commission is still deciding whether to implement a fixed percentage on the value of the property or if the compensation should vary depending on the time in which the tenant vacates.

The commission is also planning to increase rents gradually, so that at the end of the seven years, they will reflect market rates.

Rabahiye said that owners should completely refuse to pay any compensation. He argued that owners should be the ones compensated since they suffered huge losses due to decades of low rents.

“Compensation usually goes to the damaged. Therefore it should be given to the owner and not the tenant and it should be retroactive,” he said.

None of the parties know what the new law will actually include; they simply lobby the commission hoping their demands will be heard.

“The commission has met with both parties, taken their demands into consideration and now is trying to reach a common ground,” said a source from the Admissions and Justice Commission, which is responsible for drafting the new law. “The municipality law might delay the rental law for a while…but I still think it should be done by the end of 2010.” If the law is not issued, the old law will again be extended.

The lease to own ‘solution’

In 2006, a ‘lease to own’ law was introduced, to be implemented by the Public Corporation for Housing (PCH). It included giving incentives to developers to build low-income housing, which tenants can either buy, or rent with the possibility of later purchasing. The PCH found that, under the law, buyers would pay some $80 to $120 per month for 40 years without a down payment. The implementation decree of this law has yet to be issued, however, and therefore it cannot be applied.

Debs from the Tenants’ Association expressed hope that this scheme would be part of the solution for old tenants, allowing them to buy affordable houses. She said that the compensation given by the owners would serve as a first payment to the PCH, which would thereafter be paid in small installments. Debs doubted, however, whether the implementation decree would ever be delivered.

Abdallah Haidar, president of the PCH, explained that the corporation first introduced the project for new university graduates and was not meant for long-standing tenants. He added that the older tenants would not meet the loan’s age requirements. “Even if we change the law and gave loans to this age bracket, what assurance could be given to us to ensure that the loans will be paid?” asked Haidar. The loans cannot be given without life insurance, which will be costly for the elderly.

One solution often heard is for the loan to be signed in the name of the tenant’s children, but, “The law says that a citizen can only benefit from the loan once in their lifetime, so if children take the loan they won’t be able to buy a house for themselves later on,” said Haidar.

He added that although the PCH is already accepting some 6,600 loan applications each year, it is not organizationally or financially ready to manage the new scheme.

Number of properties in Lebanon rented before 1992, by region

Waiting for a solution

While tenants worry about canceling the old contracts in the absence of a housing plan, owners are eager to reclaim their properties; between the two stands the Adminstration and Justice Commission, trying to find a solution. All parties Executive spoke to said the government must ensure the tenants ability to find adequate housing.

However, with the PCH unable to handle the burden, the property market witnessing skyrocketing prices and no housing plan in the pipeline, the some 140,000 tenants who would be affected by the new rental law will surely not be relishing the day their contracts are finally canceled.

April 1, 2010 0 comments

Comment

The region’s rising risk

by Paul Cochrane April 1, 2010

written by Paul Cochrane

Getting labeled as a high risk country for firms to operate in, or receiving a low financial rating by an agency, is like a movie getting slapped with a XXX rating instead of the General Release investors had hoped for — meaning the mainstream conservatives are going to stay well away. Recently, ratings agency Moody`s downgraded seven state-linked firms in Abu Dhabi by a notch or more due to “no explicit formal” government guarantee to support the companies, and is considering downgrading four United Arab Emirates banks.

This comes as predominantly Western financial analysts are mulling not only higher risk ratings for Middle Eastern and North African (MENA) countries, but the region at large. The recent situation in Yemen, ongoing insurgency in Iraq and Israel’s sabre-ratting on Lebanon’s border are all causes for concern, as is as the potential for widespread conflict if the situation between Iran and the United States/Israel deteriorates into actual war.

On top of this, US regulatory watchdog, the Treasury Department’s Financial Crimes Enforcement Network (FinCen), is widening its offensive on the global financial system, from the now well-established anti-money laundering and counter terrorist financing regulations all banks operating with the US have to comply with, to a heightened focus on corruption – the Foreign Corrupt Practices Act (FCPA). This onslaught by Washington and US-based ratings agencies is making life hard for Middle Eastern financial institutions and foreign firms that work in the region, and in particular for raising capital in an already tight lending environment. But while the UAE is being a touch sensitive about the downgrades — after all, British and American banks received lower ratings following the financial crisis and resultant government bailouts — the regulatory side is decidedly political.

Since the creation of the US Patriot Act in 2001, doing business with the “wrong sort” has been taken increasingly seriously. Early last year, British bank Lloyds TSB was slapped with a $400 million fine by a New York court for illegally transferring funds on behalf of clients in Iran and Sudan, both of which are under US sanctions.

The lesson to be learned is clear: if you do business with the likes of Iran, don’t get caught, and if you do get caught, make sure you are making enough profit to pay the fines. Lloyds TSB was slapped on the wrist financially — eventually agreeing to pay $350 million — but the bank was not blacklisted by the US. It is hard to imagine a Middle Eastern bank, caught playing the same game, would be let off as easily.

As for the FCPA, FinCen going after firms using bribes to get deals in the MENA region would open a Pandora’s Box given the rampant and endemic nature of corruption here, as a cursory glance at Transparency International’s Corruption Index shows. British aerospace firm BAE felt this when it was investigated in London for greasing palms in Saudi Arabia to secure multi-billion dollar contracts. While cracking down on corruption is laudable, the case of BAE, like Lloyds, is a relative exception to the rule; corruption is blatantly practiced by Western firms, domestically and internationally.

In any case, a greater focus on corruption and a higher collective risk level for the MENA would not necessarily dampen business or financial confidence; if that was the case, many firms and multinationals would have given the region the cold shoulder long ago. There is, after all, the maxim that big risks equal big rewards. Then there is the classic of “getting around” the rules and the regulations. On the regulatory level, institutions use tactics such as acquiring stakes — silently or not — in local banks and firms to operate in riskier markets. What such international firms need to watch out for is how far down the money trail US regulators may want to go. But unlike in the movies, financial institutions cannot edit or re-write the script where politics is involved; risks have to be faced head on, and it will no doubt come down to who you know.

PAUL COCHRANE is the Middle East correspondent for International News Services and writes for Money Laundering Bulletin

April 1, 2010 0 comments

Finance

Sprinting from the storm

by Natacha Tannous April 1, 2010

written by Natacha Tannous

Sprinting from the storm - First quarter results mask challenges around the bend

Once a hurricane passes, those left in its wake assess the damage, pick up the pieces and look ahead to how best to get on with life. The first quarter of 2010 was akin to such a moment for the six biggest United Arab Emirate banks, unbattening their hatches as the financial storms of 2009 slowly abated in the distance.

Ostensibly, exposure to poorly performing sectors and bad loans generally did not prevent Emirati banks from posting attractive numbers on first quarter financial statements.

But one must sift through the statistics to be sure whether faults in the findings have not been masked by opaque disclosures of asset quality and a recent UAE central bank circular to reduce provisioning.

The headline of the first quarter

Most UAE banks posted better-than-expected results, leading to improvements in ratings and paving the way for an upward trend in 2010 estimates.

According to profit and loss (P&L) statements, quarter-over-quarter (QoQ) improvements in first quarter net income stemmed from higher operating profits coupled with lower credit costs, which had peaked in the fourth quarter of 2009.

April 1, 2010 0 comments

Business

Going your own way

by Carla Haibi April 1, 2010

written by Carla Haibi

After 18 years of partnership, the agency formally known as Saatchi & Saatchi Levant has split from the Saatchi & Saatchi worldwide network to become M&C Saatchi Middle East and North Africa, under Eli Khoury’s strategic leadership. Through this new partnership with M&C Saatchi, Khoury, chief executive officer of Quantum Group, is adopting a business model that may be a harbinger of a new way to conquer the market: one client at a time, one ad at a time.

Khoury says his drive for growth and continuous learning force him to challenge his status quo with every coming decade. After launching Quantum Group and its components in consultancy, content and communications in 2000, the advent of 2010 was a catalyst for Khoury to reassess his company’s standing and the way it provides services.

Companies need to design strategies in line with new trends in tools and technology if they want to stay on top of the communications game. The inability of big networks to keep pace with the shifting momentum of the industry fueled Khoury’s decision to split from Saatchi & Saatchi. “If you want to offer a client something in communications, you have to walk in knowing what is happening online, offline and everywhere else,” he said. In a transforming industry, Khoury advocated a thorough mastery of the new trends in communication and how to apply them to any agency or network’s core strategies.

“It’s not only about bringing the cyber age into communication,” he said. “You have to really understand it. It has to be part of your first thinking.”

When Khoury first partnered with Saatchi & Saatchi network, as Saatchi & Saatchi Levant, it was still with the brothers Maurice and Charles, who founded the firm in 1970. The brothers later split from the network to start M&C Saatchi in 1995. In the mean time, Saatchi & Saatchi turned into a global network owned by Publicis Group. But then the network’s advertising spirit lost its essence, said Khoury.

Splitting from the pack

With half of the region managed by Saatchi & Saatchi and the Levant area managed by Eli Khoury, under the Quantum Group, the network was much less concerned with the small Middle East market than it was with the larger and more lucrative emerging markets of Brazil, Russia, India and China. After careful examination, Khoury could no longer see the relevance of being bound to a global network.

“Their agenda for the Middle East was something that we could not find our way through,” he said, noting that the agenda was not just about the future plans and strategies, but also about the clients they cater to, as well as allocation of their competencies and talents.

Diverging agendas with the Saatchi & Saatchi network was not the only problem though. The impact of the economic downturn on the mega group trickled down to the regional agencies and then to the clients, due to budget restrictions and lack of investment opportunities. The disagreement was also rooted in the disparity between how the Saatchi & Saatchi network wanted to do business, how it could adapt to the change in the industry, and Khoury’s vision and aspirations. Saatchi & Saatchi worldwide, a network operating in many countries, had an inefficient formula that, according to Khoury, was outdated in today’s changing industry.

While he agreed that larger networks provide a presence worldwide, this presence does not always deliver as it should.

“That big network name doesn’t give you added value,” said Khoury. “The myth of a network agency doing better because it belongs to an enormous machine doesn’t exist.”

In reality, the network’s operating costs were high, its resources, core competencies and talents diluted, and the investment opportunities were limited as a result of the economic downturn. Consequently, agencies in the Middle East were penalized by budget restrictions and their relationships with clients were jeopardized.

“If you look at networks that are owned by mega groups, [they] cannot invest as we speak, [even] if they have an important client they need to cater to,” Khoury explained. “Somebody who lives in a far off land is taking decisions on behalf of the region, whereby [that] region might have its own specific needs, its own specific hunger and investment requirements.”

Another issue was that business coming from the network was limited.

“Some 95 percent of our revenue and of our work is from our agency’s clients, which did not come from the network,” said Khoury.

The network was also squeezing the already limited resources to maximize services for minimum fees, while the revenues and operating costs remained the same. As a result, the network was not accommodating clients properly, and neither could Saatchi & Saatchi Levant, given the nature of the agreement with Saatchi & Saatchi worldwide network.

Additionally, having a fully operating agency in almost every market is no longer optimal, as it erodes both revenues and talents.

“The thickness of your talents working together is nuclear,” said Khoury. “It is like any good paste, you dilute it too much [and] it becomes watery.”

On the other hand, through the strategic partnership with M&C Saatchi, an agency that also has a multinational presence, Khoury claims he is acquiring more flexibility in terms of his core strategies, resource and competency allocation and, more importantly, decreasing operating costs.

A fresh start

Along with a new name and partnership, comes a new business model. With M&C Saatchi, Khoury sees it as more efficient and effective to behave like a consulting group, with a back office — which he calls the “lighthouse” — being the main hub of competencies in Lebanon, and a front office of consultants and talents, acquired as necessary.

Such a centralized business model with an expansion strategy helps his company make use of economies of scale to provide a better service for the client, at a lower cost. It also offers flexibility to service choice clients and concentrate on lucrative markets, while still having the freedom of getting in and out.

The focus will not be on increasing market share or on going after market advertising expenditure, but rather on following target clients.

“We will be driven by the client not the market,” said Khoury.

Similar to supply-chain management, the new business model relies on building a competitive and competent infrastructure and leveraging the logistics, all in synchrony with demand. Hence, new acquisitions, if any, will be to diversify the services, and supply new competencies to the clients.

Completing the Saatchi circle

Quantum Group’s communication services are now referred to as M&C Saatchi MENA, with a minority stake going to M&C Saatchi. The MENA agency also features Brand Central, Fusion Digital and Vertical Media, regional brands that offer expertise for offline and online communications and brand building tasks, servicing clients with a wider range of interests.

Geographically, there will be no more limitations as to which clients Quantum with M&C Saatchi can access, in the Near East, Middle East, North Africa, and beyond if need be. Without the restrictions set by alliances with mega-networks, Khoury can also cater to any client anywhere without worrying about having an office in that specific location, with the specific competencies that will deliver a quality service.

“If our client is a multinational and wants us to be in five different countries, we will be in five different countries at the same time,” he said.

Having established a firm regional standing in media and communications, Khoury endeavors to thrive on continuous growth and push industry standards higher every decade. The value of his group has been its propensity to push the red lines, acting unconventionally while addressing the effects of new media on the industry, and incorporating new tools into core strategies that better serve the client.

In spite of the current industry changes, Khoury believes that when delivering a message, the principles will always be the same. The template, through which that message is delivered, however, is in flux.

In the process of globalization and the extension of the worldwide network, Khoury felt advertising work lost its zest.

“It’s becoming so mechanical that it is not even interesting anymore,” he said.

With little added value from the global network, the split was a natural progression, with the criteria for choosing the best new partner for Quantum tied to increasing their coverage and the thirst for learning new skills.

“We are aiming at a competency relationship rather than just a network membership,” he said. Nostalgic for the 1980s and 1990s, and the era of “true-spirited advertising”, Khoury saw in M&C Saatchi a shared passion. Just like in most industries, enthusiasm and dedication were most likely to be found in smaller agencies where creative people still thrive on making ads, rather than expanding.

“M&C Saatchi is an independent network, but it’s not a machine. It’s about Soho, it’s about Charlotte Street. We did our lengthy turn to go back to Saatchi, from Saatchi & Saatchi to M&C Saatchi. Basically, you can call us Saatchi. This is where it all started, and, it seems, where it had to end, or to start again.”

April 1, 2010 0 comments