corporate governance and financial regulation
You should not use quotations from the article but explain it entirely in your own word. You must not repeat what has been provided in the article. Ensure you research the literature (Academic Journals) and find your own material to support your arguments. Ensure that you back up the points you make by appropriate references to the literature.The word limit for this assignment is no more than 3,000 words. Correct academic referencing of all sources is essential.
Read the following GDI case study and respond to the questions in the three sections (A-C) at the end.
BANKS PRICE FIXING SCANDALS– A CASE OF ‘GOLD DUST INDUSTRIES(GDI) PLC’
Gold Dust Industries (GDI) is a large quoted investment banking and finance company with headquarters in the UK. GDI has investments across sectors in four continents namely Europe, United States, Africa and Asia. The sectors include energy (electricity), oil and gas, construction, insurance, Information Technology, and general commodities trading. Morgan Commodities is a US incorporated company and fully owned subsidiary of GDI Group. GDI got into physical commodities trading during the so called ‘commodities ‘super cycle’ era in the late 1990s, when prices rocketed and price volatility spiked’.
According to a McKinsey’s report, Resource Resolution, ‘the value of commodity related assets managed by financial services firms increased nine fold between 2005 and 2011 to $450bn. Also the number of outstanding derivative (options and futures) contracts on commodity exchanges grew six times between 2000 and 2010. Futures contracts allow the producers and purchases of a commodity to set a price for future delivery and they have been a valuable way of smoothing the market since time immemorial. For example, a rice farmer would agree to deliver a certain number of bushels after the harvest at acertain cost, hence, giving both sides somecertainty on supply and price.
Although, entities that trade a commodity can act as direct counterparties and help reduce market risk for clients, but the deep knowledge that comes with both physical trading and control of goods can also lead to greater ability to manipulate it. For this reason the Federal Reserve Bank (the US Central Bank) is now considering revoking banking permits to trade physical commodities as bank ownership of physical commodities could be a threat to financial stability in say, the event of an oil spill.
ALUMINIUM PRICE FIXING
Over the last decade there have been allegations of manipulation of the price of several commodities, and of associated financial products. The markets that came under suspicion went from energy (electricity) and crude oil, to aluminium, gold, silver and agricultural products. GDI and another competitor (also a major player in the banking and finance sector) are currently accused of taking advantage of regulations to construct supplies of aluminium to drive up prices.
As stated earlier, GDI owns Morgan Commodities which in its Detroit warehouse holds more the 33% of the aluminium available in the US market. This large holding is due to the recent financial crises which more than doubled the quantity being warehoused. Further, GDI is accused of shifting the metal block back and forth between warehouses and make money from rent charged to buyers, bending regulations and ensuring that a certain quantity is shipped to the market.The investigation into the aluminium business is on-going but banks including DGI may have decided to leave the physical commodities market.GDI is reported to be looking for buyers for the metal warehousing units. GDI has a number of reasons for wanting to distance itself from commodity trading including reputational risk.
Another embarrassment involving GDI is the London gold price fixing scandal. Although, the practice of gold fixing has been around for over a century and was done face to face, now it is done over the phone and involves five market making banks of which GDI is one of them. The banks speak to each other at least twice a day to agree the benchmark price of gold in the same way a number of other banks decide the price of silver, platinum and palladium.
The accusation is thatthe banks may have abused the window between setting the price and the price becoming public and take profits on their accounts. As aresult, the German regulator,BaFin, has begun an investigation of potential manipulation and demanded explanation from GDI. Although the UK Financial Conduct Authority (FCA) has not opened an investigation into gold fixing, it is nonetheless looking at it as a part of a wider examination of financial benchmarks. The London Bullion market Association has engaged lawyers to ensure that its benchmarks are in line with the principles of Organisation of Securities Commissions.
An ECMI/CEPS task force report, price Formation in Commodities Markets, Financialisation and Beyond, reports that ‘empirical analysis… confirms that demand and supply fundamentally remain the sole drivers of futures price formation across commodities markets’. The 2010 Dodd Frank Act has given greater powers to the markets regulator in the US, the Commodity Futures and Trading Commission, to impose position limits.
Recently, the press reported that the banking giant GDI has agreed to pay $1.5bn (£940m) to US and European regulators (including UK) for attempting to manipulate the London inter-bank offered rate(Libor) which is set daily. Libor tracks the average rate at which the major international banks based in London lend money to each other.Bank executiveshave been accused of lying about their real borrowing costs, in order to manipulate Libor for profit, and to make their banks look stronger particularly during financial crises. Hence, regulators worldwide are investigating a number of banks for rigging Libor. GDI has also admitted to manipulating Euribor and Tibor – the equivalent interest rates set by lenders in the eurozone and in Tokyo.
FOREIGN EXCHANGE SCANDAL
GDI has 87% interest in the ordinary voting shares of CP FUTURES (CPF), a company quoted on the Hong Kong Stock Exchange (SEHK). Recently, over a period of 8 month,CPF share price plunged by 92 per cent, falling from a highof HK$43 to HK$3.66 due to a foreign exchange scandal which led to a loss of some US$2 billion. This loss was attributed to the unauthorised betting on foreign exchange derivative contracts that were supposedly hedges against currency risks. CPF’s investment in a Western Australia iron ore mining project involved an estimated capital commitment of A$1.6 billion (Australian dollars, AUD) and €85 million (euros, EUR).
In addition, annual operating expenditure of at least A$1 billion for up to 25 years was projected. CPF’s cash projections were denominated in USD, but these expenses were paid in Australian dollars and Euros, thus exposing CPF to fluctuations in foreign exchange rates. To hedge against these risks, CPF entered into contracts to deliver USD in return for AUD and EUR. These actions were common to mitigate business risks.
CPF’s compensation strategy
CPF’s compensation scheme was set to cultivate a pay-for-performance culture. CPF’s senior management personnel had a substantial portion of cash compensation linked to performance-based variables to reflect their contribution to the firm’s financial performance. CPF CEO’s total remuneration was made up of 94 per cent of discretionary bonuses and share-based payment. CPF’s traders and other managers of CPF are compensated accordingly.This performance related pay structure of CPF’s has been approved by the board and similar to the compensation strategy of the GDI Group.
INNER CITY AIRPORT
GDI has recently diversified into other sectors. Following the upsurge in travel within Europe, the company has acquired two major airports one of which is Inner City Airport, a large airport serving the capital city. It is one of Europe’s major airports and attracts passengers who wish to travel to or from the capital city for business or leisure purposes. Apart from domestic flights, the airport also servesintercontinental flights to major cities in Europe, America, Africa and Asia.The airport has a huge traffic and is becoming increasingly congested with the three runways, and may be unable to cope with traffic in the next 2-3 years.
Consequently, Inner City CEO, seconded from GDI Group head office, has applied for permission to build a fourth runway. As a first step to gaining initial permission to commence with the project, a detailed plan must be prepared and submitted to the government’s Planning department. Inner City Airport management has set aside£80m on feasibility studies, architects’ plans and on marketing the proposal just to get to the stage of obtaining permission to proceed. The company has received major commitments from airline operators who wish to use inner City to expand their services upon completionof the new terminal.
However, the proposed construction of this fourth runway has upset a number of environmental campaigners and residents. Firstly, they argue that the new runway will lead to a tremendous increase in air travel, with negative effects on the global environment and so the project should be stopped. Secondly, the campaigners fear the new terminal will increase noise pollution, traffic congestion and lower the value of properties around the airport. The board members of GDI have conducted a number of local community consultations, addressing many of the campaigners’ concerns, in the process of gaining planning permission for the new runway. The Board’sproposal is that the runway will be situated such that the approach flight path will pass over an area of woodland, hence avoiding residential districts andthe new runway will have separate road access for commercial vehicles.
It is unlikely these efforts by the airport management and GDI Board have assuaged the environmental campaigners and local residents. It is thought that the campaigners may lobby the government to reconsider its decision on planning permission. A recent independent survey conducted show that these environmental concerns may encourage passengers to consider alternative forms of transport such as high-speed rail links for journeys within Europe. This would take business away from the short flights that the committed airline operators provide.
GDI’s board chairman has decided to call an immediate meeting of the non-executive directors to brief them of the impasse, to be followed by a meeting of the fullboard to prepare a statement for release to the media to reassure them of Inner City Airport focus on environmental issues, and its proposed introduction ofenvironmental audit, accounting and disclosure programmes. It is hoped that these programmes,in addition to a commitment to publish data on the business’ environmental footprint,will lead to the campaigners agreeing to sell the land which they purposely acquired along the proposed runway in order to forestall the project.
COMPOSITION OF GDI BOARD OF DIRECTORS
The members of the Board should collectively possess a broad range of skills, expertise, industry and other knowledge, and business and other experience useful to the effective oversight of the Company’s business. 9 of our 12 directors are independent, which provides strong independent oversight of the firm and senior management. Independent leadership is provided by an active senior independent Director, who has expansive responsibilities and there is arguably independent oversight of key areas such as CEO performance and compensation, succession planning, strategy and risk Management. The Board engages outside consultants who provide advice on certain areas of management. The Board of Directors has established four committees: Audit; Compensation; Corporate Governance, Nominating and Public Responsibilities; and Risk Committees, each of which is comprised solely of independent directors.
ECMI/CEPS Task Force (2013) Price Formation in Commodities Markets, Financialisation and Beyond, Available online at: http://www.ceps.eu/system/files/COM_TFR_ONLINE_DRAFT.pd , Accessed on 6 March 2014
McKinsey’s Global Institute (2011) Resource Revolution: Meeting the world’s energy, materials, foods and water needs, Available online at: file:///C:/Users/ictadmin/Downloads/Resource_revolution_summary_v2.pdf , Accessed on 7 March 2014
The London Bullion market Association (2014) A GUIDE TO THE LONDON PRECIOUS METALS MARKETS, Available at: HTTP://WWW.LBMA.ORG.UK/ASSETS/OTCGUIDE20081117.PDFAccessed on 7 March 2014
The Dodd-Frank Wall Street Reform and Consumer Protection Act (2010) Available at http://www.cftc.gov/ucm/groups/public/@swaps/documents/file/hr4173_enrolledbill.pdf, Accessed on 7 March 2014