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Mauritius International Financial Centre: This time is different?
"An investment in knowledge pays the best interest." - Benjamin Franklin
Mauritius is at the cornerstone of significant changes domestically and internationally. Since 2 years,
the country experienced a change in government, a major financial scandal, uncertainty on the
double tax agreement with India, and a slowing down of overall productive activity. As I write this
paper, the Honourable Minister of Financial Services is on the forefront explaining the accord which
has been signed with India, which will comprise a sharing of taxation on capital gains from 2017 till
2019. India offered as grant around Rs12.7 Billion to help Mauritius to grow its financial sector and
its economy at large. Much of the political and economic debate is about the future development of
Mauritius, which from what I can understand will gravitate around smart cities, the transformational
change of the financial sector, the port and the marine economy. Whether these reforms will work
or not will depend on the attractiveness (rate of return) of the country and how adaptable Mauritius
will be in view of these changes. This paper will underline the main opportunities/difficulties
Mauritius will face in developing its financial centre and how important it is to adopt an extremely
open strategy towards the core parameters of this sector.
Mauritius Financial Centre: Current Situation
The financial centre of Mauritius lacks substance since inception, and is constructed as a fee type
economy. A lot of momentum in the financial sector was gained by the offshore/global business
activities, capitalising on the different treaties (DTAA being the flagship) the country has. To be fair,
this segment contributed at many levels to a certain form of development of the financial industry,
but bearing huge regulatory risks. The politicians and other so called visionaries are for most of them
lawyers by training, and very few have international exposure when it comes to financial
markets/engineering. By this fact, we have developed a sector around law firms, audit firms,
management companies (the latters are all cost centres) and promoting accounting degrees to the
vast majority of young people out of schools or universities. Doing that for more than a decade, we
have now a complete lack of expertise in profit centre activities, because the country has capitalised
only on the labour cost arbitrage it reaped. Adopting a call centre strategy in cost centre activities
and cannibalizing the human capital with low end degrees at all levels will be one of the main
difficulties which will face this sector in the coming years. A transformational change will not only be
very long but will demand a complete change of vision on what type of financial sector we want to
have. Activities like tax arbitrage in the current economic environment is under huge scrutiny, all
OECD and emerging countries are seeking to chase all taxable money it’s people shelter abroad.
Each time there are leaks concerning offshore accounts, all spotlights are directed at Mauritius, and
there are always some vested interests coming out to say that our jurisdiction is clean. I tried to
make a simple google search of the reference “Mauritius tax haven” I had more than 200000 hits.
Any due diligence operation made by a compliance authority will be puzzled by such a simple check
together with recent financial scandals. Furthermore, coming from an investment banking
background, and having worked in Paris/New - York, I am always surprised by the lack of
understanding of finance by the people working in it, who sometimes possesses prestigious
accreditations. Any serious discussion in finance in Mauritius is often turned into whether you are
interested to setup a GB1 or about the back office aspect of offshore. The sector also suffers from
the jack of all trades syndrome; the same person is a chartered accountant in the morning, an
economist at 2pm, a money manager at 4pm and a banker/lawyer at 6pm. This shows how
unorganised is this sector
BAI: A Mauritian Downfall
Much has been said about this story, various commentators and supposedly experts, day in and day
out talked about it. Most of the time, the debate around BAI was politically driven and very rarely
based on facts. The BAI scandal is a conjunction of many factors, a previous government losing
contact with its basic functions after 10 years in power – denial effect, willingness of private
interests to lobby authorities to ease regulation(along with getting new licences) in exchange of
campaign financing, massive conflict of interests, concentrated boards with no balance of power,
floundering regulatory bodies. This is often known in french as “Un capitalisme de barbichette".
One of the things that struck me at that time was a debate on the radio between a Hall of Fame local
Lawyer and an Economics Professor. Regardless of the poverty of the discussion, one was defending
the so called institutions when it was clear that regulatory bodies were part of the problem and the
other was struggling to define a Ponzi scheme. The BAI affair was in my opinion clearly a Ponzi
structure as defined by Hyman Mynski and not a Ponzi scheme at start. Even, if the outcome was to
be the same, I believe that BAI lost its soul when it decided to invest in many related businesses
which had no relation whatsoever with its so core activity (from insurance activities to American
Diner Restaurant). Most of these entities were loss making coupled with hefty management fees
distributed. There was also a general sentiment of too big to fail in the company and among the
population. So, when an entity is being run in this manner, it will find itself borrowing to finance its
current activities. Instead of borrowing from a bank that would perform a credit check, it was taking
in money from policyholders by capitalizing on its marketing material/sales force/ fame. The
conclusion was that good money was been thrown after bad money, and if someone does not stop
it, the risk of ruin is guaranteed. At the time of this story, I just came back after many years abroad,
Mauritius already had Ponzi Schemes stories and management at the FSC and BoM were never
troubled. Their defence slogan during the first Ponzi was “We can’t check non-regulated entities”
although scammers took deposits close to a billion rupees, mind blowing! Coming back to the BAI
story, many things surprised me about this SCBG plan and the company in general right away, they
are the following:
 How can you render a consistent return of 10 % when your economy is growing by barely
3.5% per year? Without risks, a fluke (one off) or leverage, it’s impossible. I supposed that
was not mentioned in the prospectus. I was taught that there are only 3 ways to make
money in finance: Be the first or Be the smartest or Cheat. I let you guess.
 How can the entity collecting the insurance policy funds and the entity taking care of the
assets be the same (Adviser(BAI) vs Custodian(Bramer))? This is a major red flag.
 Global Finance Magazine awards Bramer Best Bank in Mauritius. “Ashraf Esmael, Chief
Executive Officer of Bramer Bank, indicated that the results have been exceptional, with a
growth on an average of 40% per annum in some years, which is four times as fast as the
banking industry in general”( source : http://africamoney.info/global-finance-magazine-
awards-bramer-bank-as-best-bank-in-mauritius/) . Really?
 Having employees of the firm partying at a Lounge Bar in Ebene for end of year celebration,
with T-Shirts promoting in-house investment products and canvassing. Puzzling!
Concerning the resolution of this scandal, I think it’s still too soon to tell on the amount of capital
and life savings destroyed. The tackling of the crisis showed also a complete lack of understanding of
prices, value and behavioural aspects which governs the economy. Unfortunately, the political game
was more important and everyone wanted his/her fifteen minute of fame. The management of that
kind of crisis showed how politicians are unaware of similar foreign malfeasances and the way they
were dealt with. In these times, government should have initiated a private solution for Bramer and
BAI with a guarantee on losses called backstop. A backstop refers to a government pledge to incur
any losses above a certain threshold. With this mechanism, private institutions know in advance the
maximum potential loss they have to bear if they take over a distressed entity. A cost benefit
analysis should be done along with the backstop figure. Only this analysis can be presented to
shareholders for approval. This would not curb moral hazard but would have not created the void
which echoed internationally and would have been cheaper for the country. Now we have embarked
in a strategy of chasing the funds which will eventually cover the bonds issued to pay policyholders.
Whenever we will be close to a tranche payment maturity there will be rumours about a non-
payment of government debentures. The signal is already negative on prices. As a rule of thumb, the
difference between the outstanding payment to policy holders and what’s left to be sold, valued at
market value will be an economic rent I would challenge as a raider investor. If I would be a buyer of
those assets, I will know where it bleeds for the state given the high debt/GDP ratio levels. This
mechanism seems like a forward guidance for future selling of assets. Forward guidance never
worked for Central Banks because it disrupts prices and investment behaviour. It is highly unlikely it
will work here.
Banks, Asset Managers, Insurance, Accounting firms, OMCs, Promotion Agencies, Stock Market,
Law Firms, Regulatory Bodies : The Hateful Nine
We are again suffering from the lack of breadth of experience the decision makers have when it
comes to developing the financial markets in Mauritius. To be able to develop the financial sector
you need to have intermediaries which will be able to know exactly how to raise, allocate and invest
capital through various vehicles. By allocating funds, I mean matching savers money with investment
decisions of borrowers. When listening to the participants of the financial sector, we only hear about
attracting law firms, audit firms but no financial platform will live off these cost centres. To develop a
financial centre you need to have merchant banks, asset managers, broker-dealers, prime-brokerage
activities, venture capitalists, technologists, fintech start-ups, financial software providers and
research centres in finance partnering with universities. It’s these players who will attract the cost
centres not the inverse. At this moment, a deputy is debating with the Minister of Financial Services
on the newly signed tax treaty with India. In spite of the ungentlemanly manner of the conversation,
there is a clear lack of understanding concerning the microeconomics of the sector. However, the
minister deserves some credit because we know that the treaty will be “caduc” in the future (check
India’s debt/GDP ratio and fiscal deficit). He is ready to accept the risk of a transformational change
of the sector instead of protecting the economic rent of some management companies. Creative
destruction is inevitable especially for a sector where only an accord confers its comparative
advantage and some collateral damage can be expected. A financial sector should be diverse and
any particular interest of some sub segment of the sector should not prevail on the entire financial
sector. That’s why a certain diversification inside the sector is of utmost importance else we have a
concentration risk which is detrimental to the whole economy.
Banks
Banks in Mauritius are pure retail players. There are two banks which control significant market
share. Their roles should be vital in developing the financial sector of Mauritius, but we see little
innovation from these banks. On the retail side, it’s still the old age concept of banking, with tellers,
queues, cheque deposits form and of course, some bureaucracy. With time, intermediation activities
will tend to be attacked by new players, a certain form of uberization* will take place.
The MCB accounts for about 40% of credit to the economy and the SBM accounts for around 18% of
the market share. The banks in Mauritius are for most of them pure players in the retail segment of
banking. However, they do have and develop non-banking activities such as Capital Markets, Asset
Management, Factoring, Trade Finance etc. As opposed to the massive financialization of the US
and Europe, Mauritian banks kept their role of authentic financial intermediary and as such, do
finance the development of the real economy in many ways. The financilazation of the economy
contributed a lot to the surge in asset prices in the US and it also lead to the global financial
recession in 2008. Mauritius, however, was preserved from this change because the local banks are
risk averse and financial innovation is absent.
After the global financial crisis in 2008, a number of regulations came into place to protect the
financial system and to lesser extent taxpayers. The set of rules in the Dodd Frank Act (2010) and
the Basel III are mainly the following:
 Identifying and Regulating Systemic Risk.
 Proposing and end to too big to fail.
 Expanding the responsibility and authority of the Federal Reserve.
 Restricting discretionary regulatory interventions.
 Limitations of Proprietary Trading.
 Regulation and transparency of derivatives.
 Addition Capital Levels.
 Liquidity Coverage Ratio.
 Leverage Ratio.
Dodd Frank is mainly an American law, so for Mauritian banks, it’s Basel III which will need to be
implemented by March 2019. The MCB and the SBM have capital adequacy ratios which are above
the Basel III minimum requirements. This proves that these banks are well capitalised and would be
able to resist to any tail risk event which could impact their balance sheets, ceteris paribus.
With the failure of the Bramer Bank in 2015, it proved that given the relative tininess of the financial
sector and the lack of credibility of regulatory bodies, we can purport that any institution in
Mauritius could face a cascade of shocks which can permanently affect the Mauritian economy.
These shocks can be unintended and thus, it would be difficult to predetermine how to correct them
in advance.
The bankruptcy of Bramer Bank was mainly due to a series of malfeasances at all levels. But, at that
time and still, there has been no real assessment about the risks inherent to our banking sector. The
concept of ‘Too Big/Complex to fail’ is unheard of, and post analysing the rescue of Bramer Bank we
can realistically suppose that authorities would be in a very bad posture in terms of the right
response to be given if there is another major crisis affecting a much bigger bank.
A tale of two banks
The MCB and the SBM are known to be the 2 historical banks in Mauritius. They have been financing
the economy since decades, acting as the backbone of many investment projects across the island
and through time. A sound banking system is vital in the long term development of a country. There
are numerous examples, of crisis which started with banking failures, 2008 being the latest one.
Banking crises, according to Rogoff & Reinhart, weaken the fiscal positions of governments. It is also
known that banking crises are typically preceded by asset price bubble, large capital inflows and
credit booms.
During the 2008 financial crisis, Bear Sterns and Merrill Lynch were bailed out while Lehman
Brothers was left to die in order to curb moral hazard. It is believed that the fall of Lehman
originated the crisis and a new normal is being now ‘en vogue’ since 8 years. As far Mauritius is
concerned, we are far away from these considerations but still we might face the same kind of
challenges if we are not able to comprehend the risks involved inside a banking sector which has a
lot of players and at the same time heavily concentrated.
If we were to analyse the systemic risks posed by these 2 banks, we will need to calculate what is
known as the D-SIB, which is the Domestic – Systemically Important Banks coined by the Basel
Committee. This additional framework is an enhanced supervisory regime for banks to reduce their
probability of failure.
This set of rules will help to identify any domestic financial institution having systemic importance
(D-SIBs) and it also formulates a regulatory regime to reduce their probability of default by
increasing their going-concern loss absorbency.
The main measurable elements of the D-SIB are as follows:
 Size.
 Interconnectedness.
 Substitutability.
 Complexity.
 Domestic Sentiment.
These factors accounts for the systemic risk which banks can pose to the whole financial system, it is
therefore important to take into consideration their sizes in their capital protection policies.
The current capital ratios (extracted from the financial statements) of these two banks are
MCB SBM
Tier 1 under Basel III 15.10% 18.05%
Leverage Ratio ( > 6% for SIBs) 19% 13%
Estimation for 2014.
We note that these 2 banks are well capitalised and have also a leverage ratio which accounts for
their systemic risk feature.
Computing the D-SIB score
With the lack of granularity in data, especially for less important banks, I have based the estimation
of the D-SIB based on the figures of MCB and SBM, and extrapolating the rest with a factor
corresponding to their weighing in the total credit market. The computation will not be precise but
still will give an idea about the risks involved with these 2 banks.
The score for MCB is approximately 2155 and for SBM is 1010. Given that, these two banks are very
important in the local banking scene, their exposures to the Indian market through offshore should
be closely monitored. Fortunately, they are adequately capitalised and any additional loss
absorbency threshold calculated above can be accounted in their capital ratios which are over BASEL
III recommendations.
Capital Markets and Investment Banking
The development of the financial market in a country depends on the vision of the policymakers, tax
regime and on the regulatory framework of the environment. The government, the central bank,
commercial banks, broker-dealers, asset managers, insurance should compete in order to offer a
range of products/services which can be used for investment, diversification, hedging, speculation or
0
800
1600
2400
3200
4000
4800
MCB SBM
MCB
SBM
Additional Loss Absorbency 1.5%
Additional Loss Absorbency 1 %
Scores
s
tailored made structured type instruments. Unfortunately, banks in Mauritius don’t have the
necessary expertise/infrastructure to develop these asset classes. The following diagram shows an
overview of the capital markets:
More precisely the following markets should be developed for equity but more importantly for fixed
income market.
With the help of the Central Bank and the authorities, the primary dealer system should be made
more efficient with the right technological infrastructure, an optimal auction system to develop local
government securities market and a better transmission of monetary policy.
Fixed Income Development
The fixed income market is the most important market in the world. Its development is crucial for
the development of a relevant financial centre.
Commercial banks acting as Primary Dealers are important investors in the government bonds
market. In developed markets, these banks provide a valuable source of demand for bonds.
Insurance companies are also a very significant player in the demand for these securities. However,
in an environment where the banks are very present in this segment, the authorities should create
an environment where the sale of these securities to other players (insurance, mutual funds,
brokers, fund houses). For example, there should be reform in the pension and retirement funds to
encourage investment in government bonds.
A significant primary market in government bonds must be supported by a liquid and efficient
secondary market. Inside the bond market in general, there need to be a tangible development of
market microstructure, instruments, transaction types, trading mechanisms and the intermediaries.
To enable this, authorities needs to have low intermediation costs, fair trading policies and good
level of consumer of protection.
Taking in and out positions in such securities plus the deployment of cash makes bonds attractive
just like cash. To compete with money, the secondary market must offer with immediate purchase
and sale of government securities. Spot transactions must possess the following: low cost
transactions, widely and continuous pricing, wide access to trading systems and intermediaries that
provide immediate execution, safe and rapid settlement and good custodian services.
Before developing these ancillary services, a standardization of arrangements for spot transactions is
needed. It involves establishing conventions concerning pricing, trade execution services and
settlement requirements. The important aspect in the organizational feature is the time frame from
trade execution to settlement. Shorter the time frame, the more the instrument will be regarded as
cash. The convention framework needs to be taken in line with the design and infrastructure of the
clearing and settlement systems. Therefore, it is important to take into consideration about the
technological infrastructure of execution among primary dealers and other clients. If the
technological environment is not comparable, there will be non-homogeneous treatment of trades.
Else trading should take place in a stock market framework, and this demands time for clearing and
settlement.
To have a vibrant secondary market, authorities should develop the use of repurchase agreements,
as they can be utilized for both the private sector and the monetary authority. A repurchase
agreement is effectively a collateralized loan that is realized through the sale and subsequent
repurchase of a security at a specified date and price. More specifically, it is the combination of an
immediate sale of a security with the agreement to reverse the transaction at a specified future
date. Borrowing and leading among market participants, can be fostered on a safe and secure basis
through the use of repos that reduce both counterparty risk and transaction costs. Securities dealers
use repos to finance their inventories of government bonds that are needed to mark markets and
provide two way quotes. For this purpose, dealers lend out (or repo) securities that are in their
inventory but are not expected to be immediately sold. Thus, dealers are able to leverage their
capital and hold a larger inventory. Central Banks can temporarily inject liquidity into the system by
buying securities under repo. Because of the many uses of repos, the demand for government
securities increases, while the underlying conditions for liquid secondary markets are put in place.
The development of a derivatives market will also help develop the secondary market which will
eventually provide for risk management through the development of various instruments whose
pricing can be derived from government securities markets. Futures and forward contracts provide
the ability to hedge risks, a strategy that involves choosing assets such that the prices of the assets
systematically offset each other. Furthermore, the greater the correlation between the price
movements of the underlying investment instrument and the hedge instrument, the larger is the
scope for reduction of risk. For example, yields on government securities serve as benchmarks for
pricing yields on private securities, and there is usually a complete pass-through of changes in the
general level of interest rates on government securities to other fixed-income securities of the same
maturity. The generally strong correlation between government and yields on private debt securities
means that government securities can be used to hedge general interest rate risks.
Other means to develop the secondary markets are allowing short selling, strips/zero coupon
development, swap and option desks in banks.
We often hear these past days about the future opening of a derivatives market in Mauritius.
Unfortunately, without the development of a meaningful debt and stock market, it will be difficult to
bring liquidity on this market. We have already examples in Mauritius where Indian Exchanges came
and it never took up. We also have in our time zone, Dubai, Johannesburg, Nairobi competing in the
same time frame i.e the European trading hours; it is very unlikely these venues will not want to
have their part of market share in the sales and trading activity. Dubai enjoys a no tax jurisdiction
and Nairobi is already a significant player in the technology industry in Africa.
Market structure for fixed income
A market structure is the organisational aspects of any market. Its characteristics affect the nature of
competition and pricing. There are many forms of organising a market:
 Periodic Markets
 Continuous Markets
 Dealer Markets
 Auction Agency Markets
All these mechanisms have its pros and cons but they all can encourage liquidity on secondary
market. Also, the central bank must consider helping banks to support market making by
transmitting information and trade execution advantages. Short selling should also be allowed.
Market making is very important in order to reduce bid offer spreads. It also encourages the build-up
of the necessary expertise like discriminating between informed and non- informed traders which is
important when running these books. As a starting point, Mauritius, being in the nascent state of its
financial development, with thin markets can be a good candidate for periodic markets.
I have not gone into the very details of the market structures as this article is just an illustration of
the possible paths we should take for the development of a fixed income market. The same thing
should be applied to the corporate equities market, where the SEM needs to invite more
participants to trade and banks should have dedicated market making desks.
However, the difficulties which may arise in the development of a bond market are:
 Access Ability.
 Relative Cost and Returns from Participating.
 Ability to match supply and demand
 Perceived risk of market framework.
If a deep bond market gets traction, it will help price discovery and allow a smoother liquid yield
curve which will help financial engineering, risk management and macroeconomic analysis.
Eventually, these markets will help banks going into Debt and Capital advisory. Helping clients to
devise the most appropriate funding objectives and structures, identify the best source of funds and
subsequently extract attractive terms from the market - as well as reduce execution risk and costs.
Services which can be offered are:
 Refinancing
 Financing relating to acquisitions, ring-fenced projects, disposals and mergers
 Restructuring services
 General Financial Advisory
Asset Managers
The asset management industry is still at an infant stage. Fund Managers in Mauritius are very
equities centric and for most of the time, they are still managing funds through classical fundamental
analysis which is, in my point of view, less and less relevant especially the way it’s done here. I
strongly believe that for Mauritius to be relevant in this domain, it should explore the world of
quantitative asset management by mixing core research in financial modelling and systematic
management techniques. To be able to gain a comparative advantage against already established
markets, the use of technology for fund management, clearing and settlement should be enabled.
But here again, our education system and over reliance on offshore activities will limit the expansion
of these activities. The only way to remedy the problem is to import qualified foreign labour to
execute these tasks. I have been working in the hedge fund industry in which the knowledge of
markets, information technology and microstructure of markets are so important that any operator
or player short of that will simply not stand a chance against foreign competitors. In order to
develop a significant asset management industry, there is a need for a large saving pool, an
insurance driven economy , a clearly defined market pension system which will help funds to engage
markets(through different instruments created) in various forms, for example through stocks, bonds,
ETFs, derivatives or hybrid products. Furthermore, distribution channels for these funds should be
created in Africa in order to promote the local asset management industry. On the retail side, robo-
advisors should be a path which should be explored.
Insurance
Insurance companies need to play a major role in the support and development of the local financial
centre. The bond market is a natural candidate for their investments specifically the long end
maturities but they should also explore equity markets by providing more liquidity. They should also
be encouraged to turn their books more often instead of adopting a static buy and hold strategy. It’s
a natural behaviour here in Mauritius to collect wholesale funds and externalise it to foreign fund
houses or distribute foreign investment vehicles locally(with rebranding) due to lack of domestic
engineered financial instruments. The insurance company should develop their asset management
arm in order to develop an in-house expertise. I still remember a press interview of the Head of
Asset management of a big insurance company speaking about leading indicators to time his
investments. This is an illustration how knowledge of the markets are poor. Timing in finance or
investment does not depend on indicators but regimes, price dislocation, economic
environment/drivers and market microstructure. Out of sample testing for indicators often gives bad
results. A possible area of business could be the development of insurance products on financial
instruments, credit default swaps being one and exploring the African market.
Accounting firms
They are very important but their importance is largely overestimated locally. It’s a mainly a fee
business, which does not bring any value added in terms of expertise to generate dollar value
growth in the sector. Unfortunately, we got a glimpse of how their credibility got hit during the BAI
scandal. WorldCom, Enron, Lehman went bankrupt for bad business strategies but also because of
questionable practices, internal and external. The business models of these firms have always been
an issue and in such a small country, special attention should be directed to these companies with
independent checks and balances. In the scheme of things, accounting firms will be impacted by
FINTECHs in the coming future. Their strategy to become one stop shop is also bringing more risks of
conflict of interests. As a result, a series of fines have been charged to the big firms at international
level.
Offshore Management Companies
These companies were the conduit for the development of the offshore centre. Most of them offer
the same old package GB1, GB2, Trusts and relied heavily on the DTAA. A new agreement has been
signed and with the willingness of the current government to move in the value chain of financial
services, a lot of the local players will simply not have the expertise to beef up their activities. As
Warren Buffett once said “Only when the tide goes out do you discover who’s been swimming
naked”. Losing on the offshore front, I believe, opens up many possibilities to develop more
coherent activities within the financial sector. It will be a long and difficult path but the sooner
Mauritius will build its edge away from tax optimisation related companies, the more the country
will attract foreign direct investments which will increase the sector’s expertise and productivity.
Promotion Agencies
To promote a financial centre, there should be a solid expertise in various fields which unfortunately
don’t exist. Our main selling product is the tax optimisation related companies, with IRS type
projects/attracting rich individuals and the right to go till the Privy Council if there is dispute. A bit
light…
Stock Market/Derivatives Markets
The stock exchange has to play a central role in the process of raising and allocating capital. In my
opinion, the basic function of any exchange is to provide the infrastructure, market data or the price,
and a regulatory environment for the fair and orderly trading of securities. Exchanges around the
world moved away from being membership-type organizations, or the utilities structure, to the for-
profit structure. For-profit exchanges have to respond to the needs of their users. That is why there
is a proliferation of new markets and new services. For example, there is a venue for someone who
wants to trade a large block of shares with a lower market impact, or for someone else who wants to
trade very, very quickly. It has also encouraged investment banks to build dark pools. It is difficult for
the exchanges to meet these kinds of specialized needs if they keep their traditional product
structure and their traditional, simple market structure. The Stock of Mauritius should first build its
brand, its venue in order to attract new and diverse IPOs. And this should be done with a whole
ecosystem, for example, syndicated banks, law firms, rating agencies, technologists, advisory firms.
They should hunt in packs. The exchange should also encourage OTC (over the counter) markets of
banks in order to achieve price discovery for less known instruments. Competition with other
exchanges should also be allowed by the authorities in order to stir innovation. By definition,
proliferation is because of innovation. Each exchange is trying to adjust its model and test different
approaches to pricing. Different markets structures help grow the business. There are two different
types of innovation. There are new products, and there is no need of new exchange to create a new
product. But if there is a will to tweak the model just a little bit, regulation requires that you need
another exchange. This has been good for the customer. In the options industry, we have seen the
growth of exchanges in the US. Each new exchange has caused the other industry participants to
step up their game, to develop better technology, to create better pricing for the customer, along
with more transparency and more products. Competition, as measured by the number of exchanges,
is an indicator that innovation is alive and thriving.
Concerning exchanges for commodities and other asset classes similarly provide an important
mechanism for pricing, risk transfer, and risk management. However, to be relevant in the
commodities market, we should have a vibrant port city and significant warehousing facilities. In this
mechanism, suppliers and consumers of financial products are a critical part of the overall financial
infrastructure and in the broader task of helping regulators manages systematic risk. Here’s another
theme that played out heavily over the last few years. The after-effect of any new secondary market
is that investors, both institutions and individuals, have skin in the game. Their investments in
companies and in other assets give them the opportunity to participate in economic growth. Their
values rise and fall with business performance. That is how investors compound wealth. That is also
how they plan for retirement and secure their own well-being. And the so-called wealth effect,
through rising markets, drives consumer spending. That, in turns, leads to further growth and
investment. When it works as planned, it is a virtuous circle.
Exchanges have to evolve to meet new challenges. The capital markets are becoming increasingly
interconnected and global, particularly in the derivatives space where capital can flow between
venues and geographies with relative ease. At the same time, regulators are increasingly concerned
about systemic risk. It is more important than ever that exchange regulation and market regulation
is coordinated on a global level.
There are four things that an exchange must do to survive. First, it must have a strategy that has a
clear goal for growth. Many exchanges around the world take their business for granted. You can
have the most innovative, creative, brilliant system, if there is no growth of market share there is a
high probability of going out of business. Anything short of the latter, will not allow you to sell
market data and it will be difficult to sell new services or products around it. Thirdly, an exchange
must be sustainable meaning that it should be generating profit pretty quickly after launch in order
to grow the activity. The final point, which is very important, is the social utility of an exchange.
There need to be a reason to be here. The social reason must be to drive transaction costs down for
a better good. Consequently, this will lower the cost of capital if a company decides to issue more
shares. This will benefit the economy at large.
On the technological side, there are huge challenges in terms of quantity of data that exchanges
have to process in shorter time frames. Cloud computing facilities should be put in place for
historical analysis. Data warehousing and fast computing should be looking into to provide for the
needs of customers. An intelligent matching engine should be set up in order to process efficiently
incoming orders. Latency should be also enhanced to allow smoother execution. That innovation has
to happen at all levels. Some of it is pure technology innovation, some of it is business model
innovation, and some of it is asset class innovation. And it is the management job to make smart
decisions about where to put the investment dollars. All this should be done while running the rest
of the business effectively.
Law Firms
The country is said to be under the rule of law but with time it’s the rule of lawyers which is
prevailing. The legal framework in a financial system is very important; but it defines only the
general framework. Law firms are specialised in offshore related advisory and as a result of the crisis
in 2008, these firms should have known that tighter regulations would make their lives harder in the
future. After eight years, and they are surprised with the new DTAA amendment, it seems they got
into a denial mode where economic, political and geopolitical considerations are inexistent.
Furthermore, lawyers are known to be pretty much politically connected which does create a group
who does not behave in the best interests of the sector/country but in its own. With more foreign
competition in this sector, this will hopefully bring more transparency and as a result, competition
will drive expertise in all fields of law.
Regulatory bodies
Financial regulators in Mauritius are many and all government related bodies. Deterrence and
business facilitating should be in the doctrine of every regulator. However, they proved during the
past years that credibility and enforcement practices are remote concepts. Their independence is
hence questioned. It is widely known that regulators fall under the umbrella “Police Vs Hackers”. The
compensation structure for employees working for regulators does not attract the best talents and
thus the industry has always a leap forward when it comes to the comprehension of the markets,
grey areas and innovation. Regulation is not only a Mauritian problem, however, we need to admit
that when it comes to expertise of markets/financial innovation, having examiners with
accounting/law degrees and an exclusive local experience, we should not be surprised that
convoluted financial structures with complicated instruments can be of daunting task to examine.
When there was an outbreak of Ponzi schemes in the country, there was the impression as if it was
the first time they heard about this term. As much as regulation is important, enforcement,
whistleblowing and strong charges should be pressed on white collar crimes because it disrupts
confidence and gives rise to reputational risk. In 1992, after many years of imprudent regulation,
short sighted economic policy, the Swedish banking system was insolvent. The government bailed
out the banks but also put in prison all the incriminated bankers.
Conclusion
This article is just a small overview of what should be done in order to go up in the value chain when
it comes to the financial sector. Mauritius since at least 10 years has done meagre reforms of its
education system, tax system, its production machine and its sector targeting. As a matter of fact,
the domestic production of goods and services is trapped in the low end price elastic segment.
Moreover, the productivity has been stagnant for many years and there is an omnipresence of
government/politics in all matters which creates a lot of red tape. To achieve economic growth,
there is should a clear vision of how to front-run the major technological advances which are
happening every day in advanced countries, by constantly adapting the working population.
Nowadays, in this era of technology and big data, being flexible and light are of utmost important,
sadly enough, we have accumulated excess capacity/bureaucracy everywhere and anywhere,
especially in government and government related services. The output growth is anaemic and our
economic model has become like a European welfare model relying on domestic consumption, high
transfers from government with a structural deficit, a kooky monetary policy, a very bad cost/benefit
ratio concerning health, education and other public services. All these factors contribute to the
significant debt we have been accumulating since many years. Relying on the development of
temporary trade agreements or some ‘effet de mode’ activities will not only damper structurally the
ability to achieve significant prosperity but will also provoke a permanent delay in the application of
necessary reforms. Not to mention that the natural course would be an increasing debt and
inflation, emergence of real estate bubbles which de facto will inflate artificially credit rating while
reducing credit standards of financial institutions when giving loans. There is also a growing
consumption dependence of imported goods accompanied by a decreasing savings rate thanks to
inappropriate deposit rates. This environment will bring a misallocation of resources, huge income
inequality, the emergence of shadow banking and if above that, there is no independent oversight of
institutions, this may lead to economic and/social unrest.
To be able to develop a relevant financial sector, there is should be sound management of the
economy, where investment and savings should be at the centre of the game. Investing in human
capital, technology and core infrastructures should be a priority. Importing foreign talented labour
on the high end in order to develop a strategic sector like finance for example is vital. This will
enable a knowledge transfer in the medium term and competition in the labour force. The debt
market should be developed with the help of the central bank, regulators, rating agencies, insurance
companies and banks. There should be a constant adaptation of our production machine through
technical training and targeting its output towards innovation which will be transformational for the
world i.e. diverting from repetitive or predictive jobs. Most importantly, the mind-set must evolve,
and to reach that goal, personal responsibility at all levels should ultimately not be outsourced to
some third party or to the state. The agency relationship which exists between the people and the
government should be tested more often by stronger independent institutions, but to achieve this
goal, competence, integrity, merit and track record should be the only drivers in our society.
To conclude, I would end with this table which should shed light on the possible eventuality to real
estate development without human capital/productivity enhancement, project discrimination
monetary policy and fair settings of market prices.
The skyscraper index surely bears the flaws of all indicators but it does indicate certain precautions
when embarking in large scale real estate development.
End
Uberization *: Intermediaries are being replaced by a direct relationship between a service provider
and the final client. Alienation of middleman.
About the author.
Davin Appanah studied in Paris. He worked as a Quant/Structurer/Trader on Interest Rate and Exotic
Derivatives within the investment banking sector for more than 10 years in Paris and some time in New York.
His areas of interests are financial mathematics modelling, interest rate derivatives, quantitative hedge fund
strategies, Python and MATLAB, market microstructure and financial microeconomics.

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MIFC (1)

  • 1. Mauritius International Financial Centre: This time is different? "An investment in knowledge pays the best interest." - Benjamin Franklin Mauritius is at the cornerstone of significant changes domestically and internationally. Since 2 years, the country experienced a change in government, a major financial scandal, uncertainty on the double tax agreement with India, and a slowing down of overall productive activity. As I write this paper, the Honourable Minister of Financial Services is on the forefront explaining the accord which has been signed with India, which will comprise a sharing of taxation on capital gains from 2017 till 2019. India offered as grant around Rs12.7 Billion to help Mauritius to grow its financial sector and its economy at large. Much of the political and economic debate is about the future development of Mauritius, which from what I can understand will gravitate around smart cities, the transformational change of the financial sector, the port and the marine economy. Whether these reforms will work or not will depend on the attractiveness (rate of return) of the country and how adaptable Mauritius will be in view of these changes. This paper will underline the main opportunities/difficulties Mauritius will face in developing its financial centre and how important it is to adopt an extremely open strategy towards the core parameters of this sector. Mauritius Financial Centre: Current Situation The financial centre of Mauritius lacks substance since inception, and is constructed as a fee type economy. A lot of momentum in the financial sector was gained by the offshore/global business activities, capitalising on the different treaties (DTAA being the flagship) the country has. To be fair, this segment contributed at many levels to a certain form of development of the financial industry, but bearing huge regulatory risks. The politicians and other so called visionaries are for most of them lawyers by training, and very few have international exposure when it comes to financial markets/engineering. By this fact, we have developed a sector around law firms, audit firms, management companies (the latters are all cost centres) and promoting accounting degrees to the vast majority of young people out of schools or universities. Doing that for more than a decade, we have now a complete lack of expertise in profit centre activities, because the country has capitalised only on the labour cost arbitrage it reaped. Adopting a call centre strategy in cost centre activities and cannibalizing the human capital with low end degrees at all levels will be one of the main difficulties which will face this sector in the coming years. A transformational change will not only be very long but will demand a complete change of vision on what type of financial sector we want to have. Activities like tax arbitrage in the current economic environment is under huge scrutiny, all OECD and emerging countries are seeking to chase all taxable money it’s people shelter abroad. Each time there are leaks concerning offshore accounts, all spotlights are directed at Mauritius, and there are always some vested interests coming out to say that our jurisdiction is clean. I tried to make a simple google search of the reference “Mauritius tax haven” I had more than 200000 hits. Any due diligence operation made by a compliance authority will be puzzled by such a simple check together with recent financial scandals. Furthermore, coming from an investment banking background, and having worked in Paris/New - York, I am always surprised by the lack of understanding of finance by the people working in it, who sometimes possesses prestigious accreditations. Any serious discussion in finance in Mauritius is often turned into whether you are interested to setup a GB1 or about the back office aspect of offshore. The sector also suffers from the jack of all trades syndrome; the same person is a chartered accountant in the morning, an
  • 2. economist at 2pm, a money manager at 4pm and a banker/lawyer at 6pm. This shows how unorganised is this sector BAI: A Mauritian Downfall Much has been said about this story, various commentators and supposedly experts, day in and day out talked about it. Most of the time, the debate around BAI was politically driven and very rarely based on facts. The BAI scandal is a conjunction of many factors, a previous government losing contact with its basic functions after 10 years in power – denial effect, willingness of private interests to lobby authorities to ease regulation(along with getting new licences) in exchange of campaign financing, massive conflict of interests, concentrated boards with no balance of power, floundering regulatory bodies. This is often known in french as “Un capitalisme de barbichette". One of the things that struck me at that time was a debate on the radio between a Hall of Fame local Lawyer and an Economics Professor. Regardless of the poverty of the discussion, one was defending the so called institutions when it was clear that regulatory bodies were part of the problem and the other was struggling to define a Ponzi scheme. The BAI affair was in my opinion clearly a Ponzi structure as defined by Hyman Mynski and not a Ponzi scheme at start. Even, if the outcome was to be the same, I believe that BAI lost its soul when it decided to invest in many related businesses which had no relation whatsoever with its so core activity (from insurance activities to American Diner Restaurant). Most of these entities were loss making coupled with hefty management fees distributed. There was also a general sentiment of too big to fail in the company and among the population. So, when an entity is being run in this manner, it will find itself borrowing to finance its current activities. Instead of borrowing from a bank that would perform a credit check, it was taking in money from policyholders by capitalizing on its marketing material/sales force/ fame. The conclusion was that good money was been thrown after bad money, and if someone does not stop it, the risk of ruin is guaranteed. At the time of this story, I just came back after many years abroad, Mauritius already had Ponzi Schemes stories and management at the FSC and BoM were never troubled. Their defence slogan during the first Ponzi was “We can’t check non-regulated entities” although scammers took deposits close to a billion rupees, mind blowing! Coming back to the BAI story, many things surprised me about this SCBG plan and the company in general right away, they are the following:  How can you render a consistent return of 10 % when your economy is growing by barely 3.5% per year? Without risks, a fluke (one off) or leverage, it’s impossible. I supposed that was not mentioned in the prospectus. I was taught that there are only 3 ways to make money in finance: Be the first or Be the smartest or Cheat. I let you guess.  How can the entity collecting the insurance policy funds and the entity taking care of the assets be the same (Adviser(BAI) vs Custodian(Bramer))? This is a major red flag.  Global Finance Magazine awards Bramer Best Bank in Mauritius. “Ashraf Esmael, Chief Executive Officer of Bramer Bank, indicated that the results have been exceptional, with a growth on an average of 40% per annum in some years, which is four times as fast as the banking industry in general”( source : http://africamoney.info/global-finance-magazine- awards-bramer-bank-as-best-bank-in-mauritius/) . Really?  Having employees of the firm partying at a Lounge Bar in Ebene for end of year celebration, with T-Shirts promoting in-house investment products and canvassing. Puzzling!
  • 3. Concerning the resolution of this scandal, I think it’s still too soon to tell on the amount of capital and life savings destroyed. The tackling of the crisis showed also a complete lack of understanding of prices, value and behavioural aspects which governs the economy. Unfortunately, the political game was more important and everyone wanted his/her fifteen minute of fame. The management of that kind of crisis showed how politicians are unaware of similar foreign malfeasances and the way they were dealt with. In these times, government should have initiated a private solution for Bramer and BAI with a guarantee on losses called backstop. A backstop refers to a government pledge to incur any losses above a certain threshold. With this mechanism, private institutions know in advance the maximum potential loss they have to bear if they take over a distressed entity. A cost benefit analysis should be done along with the backstop figure. Only this analysis can be presented to shareholders for approval. This would not curb moral hazard but would have not created the void which echoed internationally and would have been cheaper for the country. Now we have embarked in a strategy of chasing the funds which will eventually cover the bonds issued to pay policyholders. Whenever we will be close to a tranche payment maturity there will be rumours about a non- payment of government debentures. The signal is already negative on prices. As a rule of thumb, the difference between the outstanding payment to policy holders and what’s left to be sold, valued at market value will be an economic rent I would challenge as a raider investor. If I would be a buyer of those assets, I will know where it bleeds for the state given the high debt/GDP ratio levels. This mechanism seems like a forward guidance for future selling of assets. Forward guidance never worked for Central Banks because it disrupts prices and investment behaviour. It is highly unlikely it will work here. Banks, Asset Managers, Insurance, Accounting firms, OMCs, Promotion Agencies, Stock Market, Law Firms, Regulatory Bodies : The Hateful Nine We are again suffering from the lack of breadth of experience the decision makers have when it comes to developing the financial markets in Mauritius. To be able to develop the financial sector you need to have intermediaries which will be able to know exactly how to raise, allocate and invest capital through various vehicles. By allocating funds, I mean matching savers money with investment decisions of borrowers. When listening to the participants of the financial sector, we only hear about attracting law firms, audit firms but no financial platform will live off these cost centres. To develop a financial centre you need to have merchant banks, asset managers, broker-dealers, prime-brokerage activities, venture capitalists, technologists, fintech start-ups, financial software providers and research centres in finance partnering with universities. It’s these players who will attract the cost centres not the inverse. At this moment, a deputy is debating with the Minister of Financial Services on the newly signed tax treaty with India. In spite of the ungentlemanly manner of the conversation, there is a clear lack of understanding concerning the microeconomics of the sector. However, the minister deserves some credit because we know that the treaty will be “caduc” in the future (check India’s debt/GDP ratio and fiscal deficit). He is ready to accept the risk of a transformational change of the sector instead of protecting the economic rent of some management companies. Creative destruction is inevitable especially for a sector where only an accord confers its comparative advantage and some collateral damage can be expected. A financial sector should be diverse and any particular interest of some sub segment of the sector should not prevail on the entire financial sector. That’s why a certain diversification inside the sector is of utmost importance else we have a concentration risk which is detrimental to the whole economy.
  • 4. Banks Banks in Mauritius are pure retail players. There are two banks which control significant market share. Their roles should be vital in developing the financial sector of Mauritius, but we see little innovation from these banks. On the retail side, it’s still the old age concept of banking, with tellers, queues, cheque deposits form and of course, some bureaucracy. With time, intermediation activities will tend to be attacked by new players, a certain form of uberization* will take place. The MCB accounts for about 40% of credit to the economy and the SBM accounts for around 18% of the market share. The banks in Mauritius are for most of them pure players in the retail segment of banking. However, they do have and develop non-banking activities such as Capital Markets, Asset Management, Factoring, Trade Finance etc. As opposed to the massive financialization of the US and Europe, Mauritian banks kept their role of authentic financial intermediary and as such, do finance the development of the real economy in many ways. The financilazation of the economy contributed a lot to the surge in asset prices in the US and it also lead to the global financial recession in 2008. Mauritius, however, was preserved from this change because the local banks are risk averse and financial innovation is absent. After the global financial crisis in 2008, a number of regulations came into place to protect the financial system and to lesser extent taxpayers. The set of rules in the Dodd Frank Act (2010) and the Basel III are mainly the following:  Identifying and Regulating Systemic Risk.  Proposing and end to too big to fail.  Expanding the responsibility and authority of the Federal Reserve.  Restricting discretionary regulatory interventions.  Limitations of Proprietary Trading.  Regulation and transparency of derivatives.  Addition Capital Levels.  Liquidity Coverage Ratio.  Leverage Ratio. Dodd Frank is mainly an American law, so for Mauritian banks, it’s Basel III which will need to be implemented by March 2019. The MCB and the SBM have capital adequacy ratios which are above the Basel III minimum requirements. This proves that these banks are well capitalised and would be able to resist to any tail risk event which could impact their balance sheets, ceteris paribus. With the failure of the Bramer Bank in 2015, it proved that given the relative tininess of the financial sector and the lack of credibility of regulatory bodies, we can purport that any institution in Mauritius could face a cascade of shocks which can permanently affect the Mauritian economy. These shocks can be unintended and thus, it would be difficult to predetermine how to correct them in advance. The bankruptcy of Bramer Bank was mainly due to a series of malfeasances at all levels. But, at that time and still, there has been no real assessment about the risks inherent to our banking sector. The
  • 5. concept of ‘Too Big/Complex to fail’ is unheard of, and post analysing the rescue of Bramer Bank we can realistically suppose that authorities would be in a very bad posture in terms of the right response to be given if there is another major crisis affecting a much bigger bank. A tale of two banks The MCB and the SBM are known to be the 2 historical banks in Mauritius. They have been financing the economy since decades, acting as the backbone of many investment projects across the island and through time. A sound banking system is vital in the long term development of a country. There are numerous examples, of crisis which started with banking failures, 2008 being the latest one. Banking crises, according to Rogoff & Reinhart, weaken the fiscal positions of governments. It is also known that banking crises are typically preceded by asset price bubble, large capital inflows and credit booms. During the 2008 financial crisis, Bear Sterns and Merrill Lynch were bailed out while Lehman Brothers was left to die in order to curb moral hazard. It is believed that the fall of Lehman originated the crisis and a new normal is being now ‘en vogue’ since 8 years. As far Mauritius is concerned, we are far away from these considerations but still we might face the same kind of challenges if we are not able to comprehend the risks involved inside a banking sector which has a lot of players and at the same time heavily concentrated. If we were to analyse the systemic risks posed by these 2 banks, we will need to calculate what is known as the D-SIB, which is the Domestic – Systemically Important Banks coined by the Basel Committee. This additional framework is an enhanced supervisory regime for banks to reduce their probability of failure. This set of rules will help to identify any domestic financial institution having systemic importance (D-SIBs) and it also formulates a regulatory regime to reduce their probability of default by increasing their going-concern loss absorbency. The main measurable elements of the D-SIB are as follows:  Size.  Interconnectedness.  Substitutability.  Complexity.  Domestic Sentiment. These factors accounts for the systemic risk which banks can pose to the whole financial system, it is therefore important to take into consideration their sizes in their capital protection policies. The current capital ratios (extracted from the financial statements) of these two banks are MCB SBM Tier 1 under Basel III 15.10% 18.05% Leverage Ratio ( > 6% for SIBs) 19% 13% Estimation for 2014.
  • 6. We note that these 2 banks are well capitalised and have also a leverage ratio which accounts for their systemic risk feature. Computing the D-SIB score With the lack of granularity in data, especially for less important banks, I have based the estimation of the D-SIB based on the figures of MCB and SBM, and extrapolating the rest with a factor corresponding to their weighing in the total credit market. The computation will not be precise but still will give an idea about the risks involved with these 2 banks. The score for MCB is approximately 2155 and for SBM is 1010. Given that, these two banks are very important in the local banking scene, their exposures to the Indian market through offshore should be closely monitored. Fortunately, they are adequately capitalised and any additional loss absorbency threshold calculated above can be accounted in their capital ratios which are over BASEL III recommendations. Capital Markets and Investment Banking The development of the financial market in a country depends on the vision of the policymakers, tax regime and on the regulatory framework of the environment. The government, the central bank, commercial banks, broker-dealers, asset managers, insurance should compete in order to offer a range of products/services which can be used for investment, diversification, hedging, speculation or 0 800 1600 2400 3200 4000 4800 MCB SBM MCB SBM Additional Loss Absorbency 1.5% Additional Loss Absorbency 1 % Scores s
  • 7. tailored made structured type instruments. Unfortunately, banks in Mauritius don’t have the necessary expertise/infrastructure to develop these asset classes. The following diagram shows an overview of the capital markets: More precisely the following markets should be developed for equity but more importantly for fixed income market. With the help of the Central Bank and the authorities, the primary dealer system should be made more efficient with the right technological infrastructure, an optimal auction system to develop local government securities market and a better transmission of monetary policy. Fixed Income Development The fixed income market is the most important market in the world. Its development is crucial for the development of a relevant financial centre. Commercial banks acting as Primary Dealers are important investors in the government bonds market. In developed markets, these banks provide a valuable source of demand for bonds. Insurance companies are also a very significant player in the demand for these securities. However, in an environment where the banks are very present in this segment, the authorities should create an environment where the sale of these securities to other players (insurance, mutual funds, brokers, fund houses). For example, there should be reform in the pension and retirement funds to encourage investment in government bonds. A significant primary market in government bonds must be supported by a liquid and efficient secondary market. Inside the bond market in general, there need to be a tangible development of
  • 8. market microstructure, instruments, transaction types, trading mechanisms and the intermediaries. To enable this, authorities needs to have low intermediation costs, fair trading policies and good level of consumer of protection. Taking in and out positions in such securities plus the deployment of cash makes bonds attractive just like cash. To compete with money, the secondary market must offer with immediate purchase and sale of government securities. Spot transactions must possess the following: low cost transactions, widely and continuous pricing, wide access to trading systems and intermediaries that provide immediate execution, safe and rapid settlement and good custodian services. Before developing these ancillary services, a standardization of arrangements for spot transactions is needed. It involves establishing conventions concerning pricing, trade execution services and settlement requirements. The important aspect in the organizational feature is the time frame from trade execution to settlement. Shorter the time frame, the more the instrument will be regarded as cash. The convention framework needs to be taken in line with the design and infrastructure of the clearing and settlement systems. Therefore, it is important to take into consideration about the technological infrastructure of execution among primary dealers and other clients. If the technological environment is not comparable, there will be non-homogeneous treatment of trades. Else trading should take place in a stock market framework, and this demands time for clearing and settlement. To have a vibrant secondary market, authorities should develop the use of repurchase agreements, as they can be utilized for both the private sector and the monetary authority. A repurchase agreement is effectively a collateralized loan that is realized through the sale and subsequent repurchase of a security at a specified date and price. More specifically, it is the combination of an immediate sale of a security with the agreement to reverse the transaction at a specified future date. Borrowing and leading among market participants, can be fostered on a safe and secure basis through the use of repos that reduce both counterparty risk and transaction costs. Securities dealers use repos to finance their inventories of government bonds that are needed to mark markets and provide two way quotes. For this purpose, dealers lend out (or repo) securities that are in their inventory but are not expected to be immediately sold. Thus, dealers are able to leverage their capital and hold a larger inventory. Central Banks can temporarily inject liquidity into the system by buying securities under repo. Because of the many uses of repos, the demand for government securities increases, while the underlying conditions for liquid secondary markets are put in place. The development of a derivatives market will also help develop the secondary market which will eventually provide for risk management through the development of various instruments whose pricing can be derived from government securities markets. Futures and forward contracts provide the ability to hedge risks, a strategy that involves choosing assets such that the prices of the assets systematically offset each other. Furthermore, the greater the correlation between the price movements of the underlying investment instrument and the hedge instrument, the larger is the scope for reduction of risk. For example, yields on government securities serve as benchmarks for pricing yields on private securities, and there is usually a complete pass-through of changes in the general level of interest rates on government securities to other fixed-income securities of the same maturity. The generally strong correlation between government and yields on private debt securities means that government securities can be used to hedge general interest rate risks. Other means to develop the secondary markets are allowing short selling, strips/zero coupon development, swap and option desks in banks.
  • 9. We often hear these past days about the future opening of a derivatives market in Mauritius. Unfortunately, without the development of a meaningful debt and stock market, it will be difficult to bring liquidity on this market. We have already examples in Mauritius where Indian Exchanges came and it never took up. We also have in our time zone, Dubai, Johannesburg, Nairobi competing in the same time frame i.e the European trading hours; it is very unlikely these venues will not want to have their part of market share in the sales and trading activity. Dubai enjoys a no tax jurisdiction and Nairobi is already a significant player in the technology industry in Africa. Market structure for fixed income A market structure is the organisational aspects of any market. Its characteristics affect the nature of competition and pricing. There are many forms of organising a market:  Periodic Markets  Continuous Markets  Dealer Markets  Auction Agency Markets All these mechanisms have its pros and cons but they all can encourage liquidity on secondary market. Also, the central bank must consider helping banks to support market making by transmitting information and trade execution advantages. Short selling should also be allowed. Market making is very important in order to reduce bid offer spreads. It also encourages the build-up of the necessary expertise like discriminating between informed and non- informed traders which is important when running these books. As a starting point, Mauritius, being in the nascent state of its financial development, with thin markets can be a good candidate for periodic markets. I have not gone into the very details of the market structures as this article is just an illustration of the possible paths we should take for the development of a fixed income market. The same thing should be applied to the corporate equities market, where the SEM needs to invite more participants to trade and banks should have dedicated market making desks. However, the difficulties which may arise in the development of a bond market are:  Access Ability.  Relative Cost and Returns from Participating.  Ability to match supply and demand  Perceived risk of market framework. If a deep bond market gets traction, it will help price discovery and allow a smoother liquid yield curve which will help financial engineering, risk management and macroeconomic analysis. Eventually, these markets will help banks going into Debt and Capital advisory. Helping clients to devise the most appropriate funding objectives and structures, identify the best source of funds and subsequently extract attractive terms from the market - as well as reduce execution risk and costs. Services which can be offered are:  Refinancing  Financing relating to acquisitions, ring-fenced projects, disposals and mergers
  • 10.  Restructuring services  General Financial Advisory Asset Managers The asset management industry is still at an infant stage. Fund Managers in Mauritius are very equities centric and for most of the time, they are still managing funds through classical fundamental analysis which is, in my point of view, less and less relevant especially the way it’s done here. I strongly believe that for Mauritius to be relevant in this domain, it should explore the world of quantitative asset management by mixing core research in financial modelling and systematic management techniques. To be able to gain a comparative advantage against already established markets, the use of technology for fund management, clearing and settlement should be enabled. But here again, our education system and over reliance on offshore activities will limit the expansion of these activities. The only way to remedy the problem is to import qualified foreign labour to execute these tasks. I have been working in the hedge fund industry in which the knowledge of markets, information technology and microstructure of markets are so important that any operator or player short of that will simply not stand a chance against foreign competitors. In order to develop a significant asset management industry, there is a need for a large saving pool, an insurance driven economy , a clearly defined market pension system which will help funds to engage markets(through different instruments created) in various forms, for example through stocks, bonds, ETFs, derivatives or hybrid products. Furthermore, distribution channels for these funds should be created in Africa in order to promote the local asset management industry. On the retail side, robo- advisors should be a path which should be explored. Insurance Insurance companies need to play a major role in the support and development of the local financial centre. The bond market is a natural candidate for their investments specifically the long end maturities but they should also explore equity markets by providing more liquidity. They should also be encouraged to turn their books more often instead of adopting a static buy and hold strategy. It’s a natural behaviour here in Mauritius to collect wholesale funds and externalise it to foreign fund houses or distribute foreign investment vehicles locally(with rebranding) due to lack of domestic engineered financial instruments. The insurance company should develop their asset management arm in order to develop an in-house expertise. I still remember a press interview of the Head of Asset management of a big insurance company speaking about leading indicators to time his investments. This is an illustration how knowledge of the markets are poor. Timing in finance or investment does not depend on indicators but regimes, price dislocation, economic environment/drivers and market microstructure. Out of sample testing for indicators often gives bad results. A possible area of business could be the development of insurance products on financial instruments, credit default swaps being one and exploring the African market. Accounting firms They are very important but their importance is largely overestimated locally. It’s a mainly a fee business, which does not bring any value added in terms of expertise to generate dollar value growth in the sector. Unfortunately, we got a glimpse of how their credibility got hit during the BAI scandal. WorldCom, Enron, Lehman went bankrupt for bad business strategies but also because of
  • 11. questionable practices, internal and external. The business models of these firms have always been an issue and in such a small country, special attention should be directed to these companies with independent checks and balances. In the scheme of things, accounting firms will be impacted by FINTECHs in the coming future. Their strategy to become one stop shop is also bringing more risks of conflict of interests. As a result, a series of fines have been charged to the big firms at international level. Offshore Management Companies These companies were the conduit for the development of the offshore centre. Most of them offer the same old package GB1, GB2, Trusts and relied heavily on the DTAA. A new agreement has been signed and with the willingness of the current government to move in the value chain of financial services, a lot of the local players will simply not have the expertise to beef up their activities. As Warren Buffett once said “Only when the tide goes out do you discover who’s been swimming naked”. Losing on the offshore front, I believe, opens up many possibilities to develop more coherent activities within the financial sector. It will be a long and difficult path but the sooner Mauritius will build its edge away from tax optimisation related companies, the more the country will attract foreign direct investments which will increase the sector’s expertise and productivity. Promotion Agencies To promote a financial centre, there should be a solid expertise in various fields which unfortunately don’t exist. Our main selling product is the tax optimisation related companies, with IRS type projects/attracting rich individuals and the right to go till the Privy Council if there is dispute. A bit light… Stock Market/Derivatives Markets The stock exchange has to play a central role in the process of raising and allocating capital. In my opinion, the basic function of any exchange is to provide the infrastructure, market data or the price, and a regulatory environment for the fair and orderly trading of securities. Exchanges around the world moved away from being membership-type organizations, or the utilities structure, to the for- profit structure. For-profit exchanges have to respond to the needs of their users. That is why there is a proliferation of new markets and new services. For example, there is a venue for someone who wants to trade a large block of shares with a lower market impact, or for someone else who wants to trade very, very quickly. It has also encouraged investment banks to build dark pools. It is difficult for the exchanges to meet these kinds of specialized needs if they keep their traditional product structure and their traditional, simple market structure. The Stock of Mauritius should first build its brand, its venue in order to attract new and diverse IPOs. And this should be done with a whole ecosystem, for example, syndicated banks, law firms, rating agencies, technologists, advisory firms. They should hunt in packs. The exchange should also encourage OTC (over the counter) markets of banks in order to achieve price discovery for less known instruments. Competition with other exchanges should also be allowed by the authorities in order to stir innovation. By definition, proliferation is because of innovation. Each exchange is trying to adjust its model and test different approaches to pricing. Different markets structures help grow the business. There are two different types of innovation. There are new products, and there is no need of new exchange to create a new product. But if there is a will to tweak the model just a little bit, regulation requires that you need
  • 12. another exchange. This has been good for the customer. In the options industry, we have seen the growth of exchanges in the US. Each new exchange has caused the other industry participants to step up their game, to develop better technology, to create better pricing for the customer, along with more transparency and more products. Competition, as measured by the number of exchanges, is an indicator that innovation is alive and thriving. Concerning exchanges for commodities and other asset classes similarly provide an important mechanism for pricing, risk transfer, and risk management. However, to be relevant in the commodities market, we should have a vibrant port city and significant warehousing facilities. In this mechanism, suppliers and consumers of financial products are a critical part of the overall financial infrastructure and in the broader task of helping regulators manages systematic risk. Here’s another theme that played out heavily over the last few years. The after-effect of any new secondary market is that investors, both institutions and individuals, have skin in the game. Their investments in companies and in other assets give them the opportunity to participate in economic growth. Their values rise and fall with business performance. That is how investors compound wealth. That is also how they plan for retirement and secure their own well-being. And the so-called wealth effect, through rising markets, drives consumer spending. That, in turns, leads to further growth and investment. When it works as planned, it is a virtuous circle. Exchanges have to evolve to meet new challenges. The capital markets are becoming increasingly interconnected and global, particularly in the derivatives space where capital can flow between venues and geographies with relative ease. At the same time, regulators are increasingly concerned about systemic risk. It is more important than ever that exchange regulation and market regulation is coordinated on a global level. There are four things that an exchange must do to survive. First, it must have a strategy that has a clear goal for growth. Many exchanges around the world take their business for granted. You can have the most innovative, creative, brilliant system, if there is no growth of market share there is a high probability of going out of business. Anything short of the latter, will not allow you to sell market data and it will be difficult to sell new services or products around it. Thirdly, an exchange must be sustainable meaning that it should be generating profit pretty quickly after launch in order to grow the activity. The final point, which is very important, is the social utility of an exchange. There need to be a reason to be here. The social reason must be to drive transaction costs down for a better good. Consequently, this will lower the cost of capital if a company decides to issue more shares. This will benefit the economy at large. On the technological side, there are huge challenges in terms of quantity of data that exchanges have to process in shorter time frames. Cloud computing facilities should be put in place for historical analysis. Data warehousing and fast computing should be looking into to provide for the needs of customers. An intelligent matching engine should be set up in order to process efficiently incoming orders. Latency should be also enhanced to allow smoother execution. That innovation has to happen at all levels. Some of it is pure technology innovation, some of it is business model innovation, and some of it is asset class innovation. And it is the management job to make smart decisions about where to put the investment dollars. All this should be done while running the rest of the business effectively.
  • 13. Law Firms The country is said to be under the rule of law but with time it’s the rule of lawyers which is prevailing. The legal framework in a financial system is very important; but it defines only the general framework. Law firms are specialised in offshore related advisory and as a result of the crisis in 2008, these firms should have known that tighter regulations would make their lives harder in the future. After eight years, and they are surprised with the new DTAA amendment, it seems they got into a denial mode where economic, political and geopolitical considerations are inexistent. Furthermore, lawyers are known to be pretty much politically connected which does create a group who does not behave in the best interests of the sector/country but in its own. With more foreign competition in this sector, this will hopefully bring more transparency and as a result, competition will drive expertise in all fields of law. Regulatory bodies Financial regulators in Mauritius are many and all government related bodies. Deterrence and business facilitating should be in the doctrine of every regulator. However, they proved during the past years that credibility and enforcement practices are remote concepts. Their independence is hence questioned. It is widely known that regulators fall under the umbrella “Police Vs Hackers”. The compensation structure for employees working for regulators does not attract the best talents and thus the industry has always a leap forward when it comes to the comprehension of the markets, grey areas and innovation. Regulation is not only a Mauritian problem, however, we need to admit that when it comes to expertise of markets/financial innovation, having examiners with accounting/law degrees and an exclusive local experience, we should not be surprised that convoluted financial structures with complicated instruments can be of daunting task to examine. When there was an outbreak of Ponzi schemes in the country, there was the impression as if it was the first time they heard about this term. As much as regulation is important, enforcement, whistleblowing and strong charges should be pressed on white collar crimes because it disrupts confidence and gives rise to reputational risk. In 1992, after many years of imprudent regulation, short sighted economic policy, the Swedish banking system was insolvent. The government bailed out the banks but also put in prison all the incriminated bankers. Conclusion This article is just a small overview of what should be done in order to go up in the value chain when it comes to the financial sector. Mauritius since at least 10 years has done meagre reforms of its education system, tax system, its production machine and its sector targeting. As a matter of fact, the domestic production of goods and services is trapped in the low end price elastic segment. Moreover, the productivity has been stagnant for many years and there is an omnipresence of government/politics in all matters which creates a lot of red tape. To achieve economic growth, there is should a clear vision of how to front-run the major technological advances which are happening every day in advanced countries, by constantly adapting the working population. Nowadays, in this era of technology and big data, being flexible and light are of utmost important, sadly enough, we have accumulated excess capacity/bureaucracy everywhere and anywhere, especially in government and government related services. The output growth is anaemic and our economic model has become like a European welfare model relying on domestic consumption, high transfers from government with a structural deficit, a kooky monetary policy, a very bad cost/benefit
  • 14. ratio concerning health, education and other public services. All these factors contribute to the significant debt we have been accumulating since many years. Relying on the development of temporary trade agreements or some ‘effet de mode’ activities will not only damper structurally the ability to achieve significant prosperity but will also provoke a permanent delay in the application of necessary reforms. Not to mention that the natural course would be an increasing debt and inflation, emergence of real estate bubbles which de facto will inflate artificially credit rating while reducing credit standards of financial institutions when giving loans. There is also a growing consumption dependence of imported goods accompanied by a decreasing savings rate thanks to inappropriate deposit rates. This environment will bring a misallocation of resources, huge income inequality, the emergence of shadow banking and if above that, there is no independent oversight of institutions, this may lead to economic and/social unrest. To be able to develop a relevant financial sector, there is should be sound management of the economy, where investment and savings should be at the centre of the game. Investing in human capital, technology and core infrastructures should be a priority. Importing foreign talented labour on the high end in order to develop a strategic sector like finance for example is vital. This will enable a knowledge transfer in the medium term and competition in the labour force. The debt market should be developed with the help of the central bank, regulators, rating agencies, insurance companies and banks. There should be a constant adaptation of our production machine through technical training and targeting its output towards innovation which will be transformational for the world i.e. diverting from repetitive or predictive jobs. Most importantly, the mind-set must evolve, and to reach that goal, personal responsibility at all levels should ultimately not be outsourced to some third party or to the state. The agency relationship which exists between the people and the government should be tested more often by stronger independent institutions, but to achieve this goal, competence, integrity, merit and track record should be the only drivers in our society. To conclude, I would end with this table which should shed light on the possible eventuality to real estate development without human capital/productivity enhancement, project discrimination monetary policy and fair settings of market prices.
  • 15. The skyscraper index surely bears the flaws of all indicators but it does indicate certain precautions when embarking in large scale real estate development. End Uberization *: Intermediaries are being replaced by a direct relationship between a service provider and the final client. Alienation of middleman. About the author. Davin Appanah studied in Paris. He worked as a Quant/Structurer/Trader on Interest Rate and Exotic Derivatives within the investment banking sector for more than 10 years in Paris and some time in New York. His areas of interests are financial mathematics modelling, interest rate derivatives, quantitative hedge fund strategies, Python and MATLAB, market microstructure and financial microeconomics.