1. Review
USIS
UoSInvestment.com
• Syria -The prospect of peace?
• Profit increases at British Gas
• Sterling reacts to EU uncertainty
• Derivatives -A portrait
• The rise of the right
• Tax avoidance? -Google it!
• Trouble ahead for the global economy?
March 2016
2. Contents
Contents USIS Review March 2016
Editor’s Letter 3
Banking and Finance
- Sterling reacts to EU uncertainty 4
- Trouble Ahead for the World Economy 5
- Tax Avoidance? Google it! 6
Economics & Global Affairs
- Syria - The prospect of peace 8
Investments and Strategy
- Profit Increases at British Gas 10
- Derivatives 11
Politics
- The Rise of the Right 13
Interested in joining the USIS Review? 14
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Our Partners
Editors, Contributors & Sources
A Word from the Editor
Welcome to the third 2016 edition of the USIS Review.
I must firstly extend a warm welcome to all our new writers and thank everyone who con-
tributed to this issue for the time and effort they have put into producing such detailed and
interesting articles.
The March edition of the USIS Review is brought to you by a range of students from a
wide variety of degree backgrounds. The financial world does not exist in isolation from
the world and geographical, political, and scientific developments frequently have a huge
impact on the way that markets operate. We are proud of how the diversity of our writers al-
lows us to fully engage with this complex interrelation of factors in order to create a review
of the world of investment for students at the University of Sheffield.
This month our Banking and Finance team took a look at how Sterling is reacting to the
uncertainty surrounding Brexit. They also analyse how a variety of trends are affecting the
Global Economy and explore the structure that allows Google to avoid tax. The Economics
and Global Affairs team have covered the narrative of the Syrian civil war, and the prospect
of peace. The Investments and Strategy team discuss the financial health of British Gas and
the impact that derivatives are having on the global economy. Finally, our Politics section
discusses the recent growth of far right political groups in response to issues such as mi-
gration.
We have also included some helpful information for readers who are interested in gaining
writing experience as part of the Review towards the end of this issue.
Our special thanks go to Rothschild, the University of Sheffield Enterprise Zone and the
Sheffield University Management School for their on-going support with this publication.
I very much hope you enjoy this edition of the USIS Review.
Simon Cummins
Editor-in-Chief
3
Editor-in-Chief: Simon Cummins
Vice Editor: Adilah Hameed
Contributors: Nathan Allaby, Anton Balint, Simon Cummins, Daniel Graham,
Adilah Hameed, Elizabeth Lanigan, Charlotte Ridley
Sources: Bloomberg, Bloomberg Businessweek, Thomson Reuters,
Financial Times, Economist, Investors Chronicle, Wall Street
Journal, Investopedia, Mergermarket, Yahoo Finance, Company
Press Releases & Company Annual Reports
USIS Review March 2016 Editor's Letter
3. Sterling reacts to EU uncertainty
British pound hits a seven year low
The pound has drastically dropped and
has hit a remarkably low level against
the dollar for the first time in seven
years. It is speculated that the cause is
closely connected to the UK potential
exit from the European Union, which
is set to be determined in June 2016
through a national referendum.
The sterling dropped as much as 2.4%
at $1.4058, its lowest level since March
2009. The fluctuation comes closely
after Boris Johnson, the current Mayor
of London, decided to go against Prime
Minister David Cameron's proposed
campaign to leave the European Union.
Since the turn of the New Year, specu-
lation over the whether the UK will exit
the EU has risen, made easier by the
coining of the term: ‘Brexit’. Such spec-
ulation and uncertainty has already had
negative results on the pound which
has already been pushed down more
than 4% against the US dollar. Analysts
say this may contribute directly to the
outcome of the vote this summer. Sam
Hill, senior UK economist at RBC Cap-
ital Markets said ‘today's weakness ap-
pears to reflect an increased probability
of ‘Brexit’ after political reaction to the
new deal on EU membership was more
split than the PM would have hoped’.
However, Kamal Ahmed, economics edi-
tor for the BBC, highlights that there are
other factors determining the slump. He
cites the recent strong run of the dollar
against the euro and the Swiss franc
which show that it is not just the pound
that is faltering. Ahmed clarifies that
this due to the Federal Reserve’s choice
to raise interest rates in December 2015,
not the prospect of "Brexit", and further
suggests that it may occur again during
2016.
The high level of confidence in the
US economy, compared to the more
hesitant confidence attributed to the
Eurozone emits, might go towards
explaining the drop in the pound. In the
meanwhile, the Bank of England and
the European Central Bank are current-
ly sending non-combative messages
regarding the rise of interest rates.
Citi’s UK economist, Michael Saunders
suggests that the pound falling will have
negative effects for Europe especially
holiday destinations, which could be
damaging given Easter holidaymakers
are searching for the best prices. US
bank Citi further predicts the uncertainty will
continue to grow before the referendum date
having estimated that the chances of Britain
leaving the European Union has risen from
20-30% to 30-40%. However, the reluctance
of businesses to leave the EU might prove
to be a deciding factor in clearing up some
uncertainty; many of the FTSE 100 listed
companies are said to be preparing to issue a
warning over the threats that may material-
ize, should Britain leave the European Union.
These threats will include job losses as well as
reduced direct foreign investment.
At this point the uncertainty and specula-
tion looks set to continue over the next few
months, and the wait until 23rd June contin-
ues.
Elizabeth Lanigan
BA Business Management
Banking & Finance
England
USIS Review January 20164
companies have cut payrolls, others have
slashed dividends, and around 40 shale oil
companies in North America have declared
bankruptcy.
Nevertheless, this declining global back-
drop has meant that and central bank
actions nurtured market expectations of
further reductions in interest rates which
have fuelled concerns over the banks prof-
itability.
Central banks having been faced with
tough economic decisions, leading some to
introduce negative interest rates to boost
their economic development. The objective
of negative rates is to discourage institu-
tions from storing cash in banks, which
then leads to the cash being capitalised
into alternative investments, which then
stimulates growth and creates economic
development.
Consequently, setting negative interest
rates, previously a very rare practice, has
become a common for more countries as
many central banks search for alternatives
to stimulate long-term growth, whilst jug-
gling with the current tumble in oil prices.
In January, the Bank of Japan, shocked
markets with the introduction of negative
interest rates. This occurred about their Eu-
ropean Central Bank had stated that they
would review its current monetary policy
stance, whilst the Federal Reserve issued a
stress test guidance encouraging negative
interest rates.
However, Mark Carney, Bank of England
Governor, stated at a G20 meeting in
Shanghai, while negative rates might be
an attractive way for an individual coun-
try to weaken their currency and boost
exports, the global economy will suffer as
a whole. This statement is contradicted by
the most recent Riksbank monthly infla-
tion report, which states that the Swedish
government’s immense experiment with
negative interest rates seems to working.
Perhaps the effect of negative rates will
have a much larger impact around the
globe than previously thought.
The situation is worse than it was in 2007,
and as William White, the Swiss-based
chairman of the Organization for Eco-
nomic Cooperation and Development’s
policy review committee and former
economic advisor at the Swiss-based Bank
for International Settlements, told The
Telegraph in Davos, “our macroeconomic
ammunition to fight downturns is essen-
tially all used up,”.
Adilah Hameed
BA English and History
Global Trade
A bad outlook for the global economy?
5USIS Review March 2016 Banking & Finance
The global economy is facing an eco-
nomic turmoil which is in part caused
by governments around the world run-
ning out of monetary policy solutions.
BIS chief Claudio Borio has stated that
‘in the recent quarter, we may have
been witnessing the beginning of its
resolution’ whilst further stating that
‘we may not be seeing isolated bolts
from the blue, but the signs of a gather-
ing storm that has been building for a
long time’.
This storm is comprised of a combi-
nation of tumbling stock markets, a
rapid sink in oil prices, the collapsing
of evolving market currencies, and
the slow economic growth in China.
The increased anxiety about global
advancement has inevitably driven
the price of oil and EME exchange
rates low. Kenneth Rogoff, who is a
senior fellow at the Council on Foreign
Relations (CFR), warns of “a slowing
Chinese economy, collapsing commod-
ity prices, and the beginning of the U.S.
Federal Reserve’s rate-hiking cycle”, as
a evidence of the declining health of the
global economy. Emerging economies
like Brazil, South Africa, Thailand, and
Turkey, rather than China, will be the
real sources of concern in 2016, argues
U.C. Berkeley’s Barry Eichengreen.
Global oil prices have decreased in the
past 18 months and key benchmarks
have begun trading below $30 a barrel,
which is the lowest level in more than
a decade. The Organisation of the Pe-
troleum Exporting Countries (OPEC)
has cut its forecasts for global oil-de-
mand growth and the world economy,
saying lower oil prices were offset by
low consumer appetite. This will also
impact developing countries such as
Russia and Brazil. Traditional oil giants
like Saudi Arabia and Gulf allies, on the
other hand, will see their oil revenues
fall by $300 billion in 2016. Major oil
A Summary of the New Report from the Bank of International Settlements.
4. Tax Avoidance – Google it!
Google strikes a deal with the taxman
The UK public don’t have the luxury of nego-
tiating with the taxman about how much tax
we should be paying. So why is Google able
to strike a deal with the taxman?
Over the past couple of years, the public
have become increasing aware of large
international corporations such as Google,
Amazon and Starbucks paying insignificant
levels of taxation despite benefitting from
levels sales revenue which have reached into
the billions of pounds. Since this infor-
mation came to light, and with a view to
recover tax monies owed to the public purse,
there has been a campaign to bring these
mega-corporations to light and hold them
accountable for their fair share of tax.
Following a multi-year ‘open audit’ by Her
Majesty’s Revenue and Customs, the multi-
national technology firm Google has agreed
a £130 million deal to pay taxes back dated
from 2005 as well as changing the structure
of future taxation. This could be regarded
as a significant victory for the current UK
Government as Google has previously paid
£6 million in 2011 when sales were at £395
million and £20.4 million in 2013 when sales
revenue reached £3.8 billion.
The Double Irish Arrangement
The double Irish arrangement is a tax avoid-
ance strategy adopted by many multination-
al corporations which exploits a loophole
in the definition of corporate residency
within different countries. For example,
a US based company such as Google can
create an Irish subsidiary located in a tax
haven such Bermuda called ‘Google
Ireland Holdings’ and an operating
subsidiary located in Ireland called
‘Google Ireland’. According to US
law, a company is determined a tax
resident based on its place of incor-
poration, whereas Irish law states
that tax residency is determined by
where a company is managed and
controlled.
From the view of the US Gov-
ernment, Google licences out its
intellectual property to Google
Ireland Holdings who in turn then
sub-licence the intellectual property
to Google Ireland, allowing Google
to sell its products outside the US
whilst avoiding paying US corporate
tax on profits generated outside the
US.
From the view of the Irish Gov-
ernment, Google Ireland Holdings
and Google Ireland are regarded as two
separate corporations. Therefore, revenue
generated from selling Google’s product
in Europe by Google Ireland is transferred
back to Google Ireland Holdings in Ber-
muda. Consequently, these payments can
be treated as royalty/trade costs (i.e fees
for the use of the intellectual property),
thus minimising the amount of profit that
is subject to the 12.5% corporation tax. In
this way Google Ireland Holdings can then
receive the payments in a tax free environ-
ment.
Dutch Sandwich
Despite the complex network, the Double
Irish arrangement could still see Google
Ireland’s profit subjected to withholding
taxes which is often the case for royalties.
The addition of the Dutch Sandwich creates
a simple way of avoiding such withholding
taxes and therefore furthering Googles tax
efficiency. The Dutch Sandwich is simply
6 USIS Review March 2016Banking and Finance
ECB
a stepping stone inserted between
Google Ireland and Google Ireland
Holdings. Again, intellectual prop-
erty is sub-licensed out from Google
Ireland Holdings but this time to the
Dutch Company, Google Nether-
lands which in turn is sublicensed
out to Google Ireland.
The transfer of royalties from Google
Ireland to Google Netherlands is
not subject to withholding taxes
because EU law states that payments
between EU resident companies are
exempt from such taxes. Finally,
Google Netherlands payments are
made back to Google Ireland Hold-
ings (in Bermuda) which are not
subject to withholding taxes accord-
ing to Dutch law.
You can’t dispute that Google’s
creativity extends to their efforts to
become ‘tax efficient’.
Where does the UK fit in?
The role Google UK LTD is to sup-
port Google Ireland via ‘the provi-
sion of marketing services’ and does
not sell any products to customers,
according to Google themselves.
Therefore, when a UK based com-
pany purchases a search ad from
Google, the money is sent to Goog-
le Ireland, this is the case for any
purchases made throughout Europe.
In, 2012-2013, UK sales contributed
to 11% of Googles worldwide busi-
ness which is valued at $5billion but
accounted for by Google Ireland. The
purpose of the audit by HMRC on
Googles accounts was to establish
whether Google UK is actually con-
ducting business in the form of sell-
ing. As such, it can be speculated that
Google UK LTD is acting as a front
for its sister company in Ireland,
therefore subjecting Google Ireland
to declare its profits in the UK.
The Deal
Following this multi-year ‘open
audit’ by HMRC, Google has agreed
a £130 million deal to pay taxes
back dated from 2005, based on the
profits made by Google UK. More im-
portantly, the deal includes restruc-
turing the system Google uses to pay
its taxation in the future which will be
based on sales activity to UK customers,
rather than profit. This deal declared
that HMRC have accepted that Google
UK Ltd is merely providing support for
the main European Operations office in
Dublin, and that its complex arrange-
ment of minimising UK taxation is legal.
Is this good for the UK?
Consider the fact that the complex
structure Google adopts in order to
avoid paying taxation in the UK has
been deemed legal by HMRC. At first
glance the deal seems positive, it’s the
first major inroad the Government has
made in tackling multinational corpora-
tions tax avoidance strategies. The most
significant aspect of the deal is the fact
that taxation will now be based on UK
sales of Google and not profit; bearing
in mind that Googles UK sales revenue
reaches into the billions, this could
mean that Government will receive a
fairer proportion of taxation.
Is this bad for the UK?
As stated above, at first glance the deal
seems positive. However, Google has
stated that the amount of taxation
depends of the level of earnings gener-
ated from UK based advertisers. This is
a shrewd move by Google, as it is likely
that UK based advertisers contribute a
fraction of the total figure of UK sales
revenue, therefore only partly reflecting
the earnings Google makes in the UK. Ad-
ditionally, it has been reported that France
have refused to strike a deal with Google
over back taxes, and are seeking full repay-
ment, reported to be around £1.3 billion,
far greater than the amount Google paid to
HMRC. Furthermore, the French Finance
minister has attacked the deal between the
UK Government and Google, mounting
pressure on the EU commission to investi-
gate the deal. It is probable that Google will
try to negotiate with the French authorities
in order not to pay the full sum. However, if
France are successful in obtaining a figure
anywhere near the £1.3 billion reported,
it could be a huge blow to the current UK
Government.
What does the future hold?
There is no doubt that the tax deal between
the UK Government and Google will remain
at the forefront of global news whilst other
countries pursue Google to pay back taxes.
Consequently, the deal between Google and
the UK Government might have an unwant-
ed knock-on effect for other multinational
corporations like Amazon and Starbucks.
If the powerhouse of Google can be inves-
tigated and compromised, this might leave
other corporate giants vulnerable to public
campaigns regarding their own questiona-
ble tax arrangements.
Daniel Graham
BA Economics
ECB
7USIS Review March 2016 Banking and Finance
5. evision network which was involved produc-
ing and hosting a number of anti-government
programs in a way that could not be censored
by the Syrian state.
Another group of particular note is the Kurd-
ish Peoples Protection Units. The Kurds are
one of the largest cohesive ethnic groups in
the world that do not have their own official
country. However, in the regions of southeast-
ern Turkey, western Iran, northern Iraq, and
northern Syria, Kurdistan is a nation in all but
name. Fiercely opposed by the governments
of many of the internationally recognised
countries that they inhabit, as they wish for
independence, Kurdish forces are a significant
force in the fight against Assad. In terms of
international engagement, the Kurds receive
air support from a broad coalition of western
countries, including Canada, the UK, France,
and the US. However, they are often the
“mistaken” targets of air strikes from Turkish
warplanes.
Attempts to resolve this conflict are as old as
the conflict itself. In late 2011 the Arab League
launched two different initiatives designed
to bring representatives of the Government
and Opposition to the negotiating table. These
failed without any real progress. However, now
in early 2016, almost five years after the con-
flict began, progress is finally being made. This
is the result of a series of conferences held in
Geneva. The first of these was held on Saturday
30th June 2012 the first of what was to
be three Geneva peace conferences was
convened. Initiated by the UN Peace en-
voy to Syria at the time, Kofi Annan, the
negotiations included most of the UN
security council. However, it failed to
include representatives from the Syrian
government or opposition groups.
Geneva II was held on 22nd January
2014 and succeeded in bringing togeth-
er representatives from the opposition
and Syrian government. However, no
agreement could be reached regarding
the future of Syria after the war ends.
Consequently, the war continued.
The main objective of Geneva I, Geneva
II (2014), and Geneva III (2016) was
to create an agreed structure for the
creation of a transitional government.
Neither side could accept the other
continuing to hold power in any form.
The Syrian government maintained
that a rebellion, no matter how pow-
erful, is still merely a rebellion and has
no legitimacy. In contrast, the opposi-
tion essentially argued that the crimes
committed by the Syrian government
against their own people, both before
and during the war, meant that any
legitimacy that it may have once
possessed was voided. The curious ele-
ment is how the international commu-
nity has played a role in both continu-
ing the conflict, with many countries
giving military aid to their preferred
victor, whilst publicly maintaining,
in a variety of peace conferences, that
peace needs to be achieved as soon
as possible for the sake of the Syrian
people.
On the 27th of February 2016 a
ceasefire was finally announced after
the US and Russia began to jointly
pressure both conflicting groups to
negotiate. This truce is being mon-
itored by international observers.
Unfortunately, as Karen DeYoung of
the Washington Post described on
the 2nd of March, a number of vio-
lations to the terms of the ceasefire
have already been reported. However,
none of these violations have been
formally recorded by either the US or
Russia, who oversee the internation-
al observing task force. One source
reported that “The approach doesn't
seem to be finding a violation - it's
more in trying to dodge them”.
Perhaps if the illusion of peace can
last it will lead to the emergence of
peace.
Simon Cummins
BA History and Philosophy
9Economics & Global AffairsUSIS Review March 2016Economics & Global Affairs USIS Review March 2016
Syria - The prospect of peace?
8
The land currently known as Syria has
been a centre of civilisation for nearly
four thousand years. Its capital city, Da-
mascus, can claim to be one of the oldest
continuously inhabited cities in the
world. However, the roots of the modern
state are much younger. Today's Syria
was formed after the collapse of the Ot-
toman Empire, at the end of WW1, when
the country became a French “mandate”
or colony. Independence from France
came on the 24th of October 1945 when
the latest descendent of this grand
ancestry of states and empires became
a founding member of the United Na-
tions.
In March 2011 the Syrian people erupt-
ed in protests as part of a widespread
wave of dissent that spread across the
Arab world, which came to be known as
the “Arab Spring”, that removed lead-
ers from power in Libya, Egypt, and
Tunisia. These uprisings and protests
were particularly significant because of
the central role played by social me-
dia networks. Facebook, Twitter, and
YouTube became weapons for organi-
sation and allowed activists to operate a
decentralised structure that was capable
of sharing their revolutionary message
and ideals with a unprecedented global
audience. Revolution had been brought
into the 21st century.
In a number of cases, state violence and
police crackdowns, that were intended
to quell the uprisings, were recorded
using smart phones. These images only
fuelled further further protests. This
article is primarily concerned with Syria
because the severity and long lasting na-
ture of the popular dissent here stands
out even in this context.
When protests erupted in Syria the
government’s response was to send
in the army and crush resistance with
force. This is most vividly captured by
the fact that the state laid siege to an
entire town, called Jisr al-Shughour,
and caused almost 10,000 of their own
citizens to flee to Turkey. Navi Pillay, the
U.N. High Commissioner for Human
Rights, reported in December of 2011,
a mere nine months after the protests
began, that the actions of the Syrian
state had already led to the deaths of
over 5000 people, including at least 300
children. Today the figure is substan-
tially more. The man who ordered
these crimes against humanity, Bashar
al-Assad, has occupied the official office
of President of Syria, and the semi-un-
official role as dictator, since he was
“elected” unopposed in 2000.
The defection of a sizeable portion of
the Syrian army caused a situation of
Syria
severe unrest to morph into one of
civil war. However, it is also clear that
the sectarian nature of the conflict is a
major obstacle to peace. Although the
majority religion is Islam, government
forces are primarily Alawite, a school
of Shia Islam, whilst the opposition are
primarily Sunni Muslims. However, the
groups themselves refuse to accept that
the conflict has any basis in religion
and insist that the root problem lies in
international interference. Although it
seems difficult to totally disregard reli-
gion when considering why the conflict
is so severe, it is undoubtedly true that
international intervention has led to the
deaths of many Syrians.
From the early stages of the civil war the
Syrian government received support
from Russia, Iran and Iraq. This took the
form of military and economic assis-
tance. Various opposition movements
also receive substantial support from
countries such as the US and Saudi Ara-
bia. Some of the information released
by WikiLeaks, in the form of diplomatic
cables between the State Department
and the US embassy in Damascus, show
that the US was giving financial assis-
tance to groups that politically opposed
the Syrian government until at least
September 2010. This included almost $6
million given to the “Barada” satellite tel-
An overview after five years of civil war
6. Energy
Profits increase at British Gas as pressure mounts
How the collapse in commodity prices is affecting the British energy sector.
Over the last 12 months the UK’s largest
energy supplier British Gas has seen
a growth in profits of 31%. Despite the
fact that weather temperatures have not
exceeded the usual average, there has
been an increase of gas consumption
in Britain by 5%. This is surprising as
temperatures in 2014 were very mild.
The chief executive of Centrica (the
parent company of British Gas), stressed
that the rise in profits at British Gas
was due to the wholesale costs decrease.
These savings were naturally passed on
to the consumer. The increase in profits
were entirely to do with the global col-
lapse in commodities prices rather than
shifts in the weather or popular con-
sumption trends. John Moylan’s analysis
shows that the company’s profits were
just returning back to normal levels,
after having falling in the previous year
due to the warmer weather.
E.ON, EDF, SSE, Scottish Power and
Npower have already made gas price
cuts. However, British Gas took un-
til last week to announce that it was
cutting gas prices by 5.1%. This makes
them the last of the big six to make a
reduction in gas prices. This is not the
first time that energy suppliers have
been slow to reduce prices when their
costs fall. The UK Markets Authority is
currently conducting an investigation
into the UK’s energy suppliers and
initial estimates suggest that consumers
overpaid as much as £1.2billion a year
between 2009 and 2013.
Over the last past year British Gas has
cut standard gas prices three times and
customers may see a further reduction
in gas prices this year if the wholesale
prices remain low. However, wholesales
cost of electricity only account for 40%
of customers’ bills and other costs like
government levies continue to increase.
Energy companies with higher profits
like British Gas are now under greater
pressure.
The implications of the commodity
slump are not limited to British Gas.
10
Centrica’s share price fell by 12% due to
the dramatic decrease in global whole-
sale gas prices. Centrica shares value is
currently down by £2.4 billion for its oil
and gas assets and power stations. No
surprise British Gas revealed 500 job cuts
within the energy efficiency business.
However, this trend seems set to reverse
as Centrica was one of the largest risers
on the FSTE 100 in recent days, with
shares closing up as much as 6.85%.
The increase in profits from the big six
has led to added pressure to cut energy
bills to fall in line with wholesale prices.
Especially, after campaign group, Fuel
Poverty Action released figures showing
British Gas was profiteering in a year
when there was an increase of winter
deaths. More generally, the report implies
the company could have reduced dual fuel
bill by almost £100 per year. The cam-
paign group blamed the government for
not intervening when the big six focused
on increasing profits, whilst citizens died.
Others critics argue only small saving
were made due to the collapse in the
global price of oil and gas. Conn, chief
executive of British Gas’ emphasised the
company delivered the diminishing com-
modity prices to customers.
Charlotte Ridley
BA Business Management
USIS Review March 2016Investments & Strategy 11
The 2002 Berkshire letter to its
shareholders, authored by Warren
Buffet and Charles Munger once
famously stated that derivatives
are 'financial weapons of mass
destruction, carrying dangers that,
while now latent, are potentially
lethal’. Unfortunately, they were
right, as derivatives played a cru-
cial role in the 2007-2009 financial
meltdown. Remember the housing
bubble that burst in the United
States of America? Derivatives
magnified the impact of the US
housing collapse on the financial
services industry. However, what
are these financial products that
are still some of the most contro-
versial on the market and how are
they used by investors and traders?
The Derivative Contract
The term ‘derivative’ is a generic
umbrella for a diverse spectrum
of financial products. A generic
definition would be – a derivative
is a security (a contract essentially)
with a price that depends on or
derived from one or more under-
lying assets. Also, there are several
types of derivatives that are most
used in the financial markets,
with options and futures being
Derivatives: A portrait
A danger to the global finance system?
the most well-known. The fundamental
difference between the two lies in the
contractual feature of derivatives. Options
are financial instruments that represent a
contract which offers the buyer the right,
but not the obligation, to buy or sell a cer-
tain asset at an agreed price at a specific
date or during a specified period of time.
On the other hand, a Future is a contract
that places an obligation on the buyer to
purchase a certain asset (or on the seller to
sell a certain asset) at an agreed (predeter-
mined) future price and date. Please note
two things before moving on to their use.
Firstly, the derivatives are the rights
conveyed by the contracts – in the case of
an obligation, the derivative is the right to
have an option to buy or sell the asset at
an agreed price for a certain period or on
a specific date and in the case of the fu-
ture, the derivative is the obligation to buy
or sell an asset at a predetermined future
date and price. The rights and obligations
given by these contracts is what you buy
or sell when you are trading derivatives,
be it on a stock exchange or over-the-
counter.
Secondly, derivatives are a category of
securities and not a specific kind. There-
fore, there are several different types of
derivatives that are used for a wide range
of purposes, from hedging or insuring
against systemic risk to increasing a position
in a trade. In addition to the above mentioned
ones, other important derivatives include
forward contracts (which are only traded over-
the-counter and not on a stock exchange), swap
agreements (contracts between two parties
agreeing to trade loan terms, such as switch-
ing from a variable interest rate loan to a fixed
interest loan) and the recently-made-famous,
MBS (mortgage-backed security) – the ‘weapon
of mass destruction’ that triggered the finan-
cial slaughter of 2007 - a type of asset-backed
security that is secured by a mortgage or a pool
(collection) of mortgages.
The ‘hard work’ of Derivatives
Above we have read a brief introduction to what
derivatives are in their essence. This section
will look to offer an overview of what are their
most common uses and what risks they present
to financial markets.
Derivatives can be traded on or off an exchange.
For example, they can be Exchange-Traded
Derivatives (ETDs), which are, according to a
JP Morgan 2013 Guide, ‘standardised contract
traded on a recognized exchange’. Moreover,
the contract terms of ETDs are non-negotiable
and their prices are publically available. On the
other end of the spectrum you have Over-the-
Counter Derivatives (OTCs), which according
to the same JP Morgan 2013 Guide, are ‘bespoke
contracts traded off-exchange with specific
terms and conditions determined and agreed
by the buyer and the seller’.
It is well known amongst the financial servic-
es industry that derivatives are used to hedge
against systemic market risk which includes
USIS Review March 2016 Investments & Strategy
Financial Instruments
7. Financial Instruments
market volatility. As the New Zea-
land Bankers Association explains,
derivatives help corporations to
manage risk and to protect them
against the volatility of financial
markets. One of the most common
uses for these securities is to hedge
against foreign currency fluctu-
ations. For example, futures and
forwards are particularly useful to
agree an exchange rate in advance
which reduces the exposure to cur-
rency depreciation or strengthening,
especially for companies heavily
dependable on importing raw mate-
rials from these economies.
Other common uses include hedg-
ing against interest rates, usually
through swap agreements which
exchange loan terms between the
parties and to account for commod-
ity price changes, mostly through
futures if you are a seller or options
if you are a buyer. Therefore, it can
be argued that derivatives assist with
the better management of cash flows
and their existence is justifiable by
their role in mitigating the impact
of market volatility on the capital
invested in business operations.
However, are the risks outweighing
the benefits?
The complex jargon aside, derivatives
are a formal way of simple bets on fu-
ture events. Various sources, includ-
ing the well-known Investopedia.
com, list the risks associated with de-
rivatives to be: market risk (as in the
risk associate with any investment,
i.e. the chance you accept and take
that you can lose money), counter-
party risk (the risk of one party of a
derivative contract defaulting on the
contractual terms), liquidity risk and
interconnection risk (the risks pre-
sented by the systems of connection
between derivatives instruments and
dealer). I am not referring to these
risks because they are noisy consid-
erations that distract us from the real
issue: the risk derivatives pose to the
fabric of financial markets. In other
words, we need to answer one ques-
tion only: are these instruments a
danger for the function and purpose
of financial markets?
Are derivatives that dangerous?
My answer is yes. Derivatives are a
danger to the very fabric of financial
systems across the world. Here is why:
going back to Warren Buffett’s reasons
for calling derivatives ‘weapons of mass
destruction’, we can see that these secu-
rities involve parties exchanging money
at some future date, with the amount
of that money to be determined by the
value (defined as the market price) of
an asset plus many more factors such as
interest rates, stock prices and currency
values. For example, if you are either
long or short on a FTSE 100 futures
contract, you gain or lose depending on
how the market fluctuates. The market
fluctuates irrationally in short-term –
therefore, the likelihood of you losing
money is unknown. Moreover, because
derivatives have different time lengths,
with some running as long as 20 years,
you are taking a leap of faith – the risk
you are taking is not rational, it might
make mathematical sense but not com-
mon sense for no formula can gauge the
future which is the result of collective
human action.
The above was a simple, very simple,
example of a derivative. However, take
into account two things: firstly, most
derivatives are much more complex
and secondly, the all market actors that use
derivatives have the same goal: not to lose
money.
Sounds crazy?
That is because it is – they all expect to have
their money protected by using the same
tools and dealing in the same way with the
same environment! Also, just to give you a
tinny flavour of how complex some deriva-
tives can be, let’s look at the notorious MBSs.
These were pools of mortgages that includ-
ed anything from AAA to toxic mortgages.
However, because they contained thousands
of such loans, the rating agencies deemed
them diversified enough to rate the entire
pool with AAA! Therefore, not only that the
MBS was priced based on thousands of other
products but they were valued so high based
on mindless assumptions such as the con-
tinuous (apparently towards infinite) of the
US real estate market. When the borrowers
started defaulting on these loans, the entire
MBS market collapsed like a domino and
the financial slaughtered that nearly wiped
financial systems was triggered in early 2007.
Complexity is the enemy of profit making
and capital allocation. That is why derivatives
are dangerous.
Anton Balint
LLB Law
12 Investments & Strategy USIS Review March 2016
US Politics
13
in migrants has led to the menacing
prospect of unemployment for locals,
whilst a study by
Oxford University’s Migration
Observatory reported that each 1%
increase in the share of migrants in
the UK-born working age population
leads to a 0.6% decline in the wages
of the 5% lowest paid workers, and
to an increase in the wages of higher
paid workers. Thus, it is apparent that
migration leaves the poorer sections of
society worse off, whilst the rich
become richer. Therefore, this could
explain the paradox of the working
class leaning away from the more lib-
eral approach towards migration from
the left. Media company Vocativ also
produced an interesting study looking
at the increase in social media support
for right wing parties in Europe during
the height of the crisis. As a result, the
impacts of the migration crisis provides
some compelling evidence for the rise
of right-wing populism across Europe.
In a sentence, the European debt crisis
arose because several Eurozone mem-
ber states (Cyprus, Greece, Ireland,
Portugal and Spain) failed to repay their
government debt. However, in addition
to this, the economic sanctions against
Russia enforced by the US and EU after
the Crimea incident, also significantly
The gradual rise of right
wing parties has been an interesting
concept to look at. As 67% is led by a
right wing party, does pose a stark
contrast to the political environment
in Europe in the late 1990s. But why the
sudden desire for a more conservative
nationalist society, greater capitalism
and social stratification? Why are the
obvious beneficiaries of left wing politics
deciding to sway their vote towarxads
right wing parties like UKIP? This can
be answered and explained by two main
factors: the migration crisis and eco-
nomic turmoil in Europe. However, the
concept of increased individualisation
is also a convincing argument for the
rising popularity of the right.
The overarching cause of the rise of
right-wing populism is the recent
migration crisis beginning at the start
of 2015. A culmination of the Syrian
Civil War, discrimination in the Bal-
kans, those fleeing from violence and
war in parts of South Asia and certain
African countries, has meant that the
number of refugees seeking asylum in
Europe has increased dramatically. The
number of displaced people reached 60
million at the end of 2014, the highest
level since World War Two. As a result
of this, many feel that their indigenous
culture is threatened by the expanding
diaspora created. Moreover, the surge
damaged economies in Europe. This was
because Russia is Europe’s third largest
trading partner, with Die Welt (German
Newspaper) reporting that sanctions on
Russia alone could eventually cost Europe
£82 billion and up to 2 million jobs. Both
these factors subsequently led to a whole
host of labour market problems, causing
extremely high levels of unemployment,
reaching 27% in both Spain and Greece.
Due to this, people’s vote is driven by fear,
often longing for economic stability above
all other factors, and this is seen to be bet-
ter provided by more right leaning parties.
Looking back in history can also help us to
see this trend. For example, Hitler gained
the majority of his support by appealing
to the 6 million unemployed Germans in
1932 with the promise of jobs and national
security. Thus, the combination of econom-
ic insecurity and the influx of migrants
created a perfect political environment for
right-wing parties to thrive.
Individualism is the social theory that fa-
vours freedom of action for individuals over
collective or state control. The term was
first coined in the 19th century generally
showing us that it is a relatively modern
phenomenon. The concept has arguably
developed in popularity significantly over
time, shown by the growth of capitalism
and the freedom of expression. Moreover,
the decline of trade unions and the fact
that the number of self-employed people
in the EU is at a 40 year high also supports
this theory. This links into the waning
popularity of the left, as their ideology is
more focused on collectivism through state
intervention and the spread of wealth,
which goes against the movement of indi-
vidualism.
This leads us to wonder which, out of the
three, has been the real reason for the rise
of the right wing.
Nathan Allaby
BA Business Management
The rise of the right
Is the rise of the right wing party a result of individualization?
USIS Review March 2016 Politics
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