IFM volume 5 07 04 2014

Risk Management6

What Is Happening at Heart of Midlothian FC? Part 1 15

The Dollar Dip 9

Banks Balancing Act5

Kings Entertainments 8

Financial Repression14

Private Equity 11

IFMIssue 05 / 07 APRIL 2014

Independent Financial Magazine

2 Independent Financial Magazine vol.5 07.04.2014


Issue 05

Published07 April 2014

Front Cover #05New York, 1931

IMPORTANTIFM magazine publishes information and ideas which are of interest to investors and students. It does not provide advice in relation to investments or any other financial matters. Comments published in IFM magazine must not be relied upon by readers when they make their investment decisions. Investors/Students who require advice should consult a properly qualified independent adviser. IFM magazine, its members do not, under any circumstances, accept liability for losses suffered by readers as a result of their investment decisions.Members of staff of IFM magazine may hold shares in companies mentioned in the magazine. This could create a conflict of interests. Where such a conflict exists it will be disclosed. In keeping with the existing practice, reporters who intend to write about any securities, derivatives or positions with spread betting organisations that they have an interest in should first clear their writing with the editor. If the editor agrees that the reporter can write about the interest, it should be disclosed to readers at the end of the story. Holdings by third parties including families, trusts, self-select pension funds, self select ISAs and PEPs and nominee accounts are included in such interests.

EditorAlan Konopka

EditorPete McCarthy

DesignerSarah Aoki

Farhan Tahir

Sohail Ahmed Kristopher ConnellyJeremy Kempke

The Team


3Independent Financial Magazine vol.5 07.04.2014

Capital Markets

07/04/2014Indices

Level: Weekly Change: Volatility (Std Dev):FTSE 100 6,695.55 1.21% 15.9707S&P 500 1,865.09 -0.08% 1.511EURO STOXX 50 3,172.43 0.00% 12.5841Nikkei 225 15,063.77 1.75% 190.332VIX 14.41Commodities Price: Weekly Change:

Gold 100 oz. $1,301.40 0.29%Copper $3.00 1.96%Brent Crude $106.20 -0.53%

Currencies Rate: Weekly Change:

GBP/USD 1.6580 -0.35%EUR/USD 1.3702 -0.37%USD/JPY 103.3300 0.49%EUR/GBP 0.8265 -0.01%

Bonds Yield Yield Yield24/03/2014 31/03/2014 07/04/2014

10Y UK Gov 2.74% 2.73% 2.68%10Y US Gov 2.76% 2.72% 2.73%10Y Japan 0.60% 0.63% 0.65%

FINANCIAL MARKETS INDICATORS

2013 was a blockbuster year for equities. 2014 not so much. As we enter Q2, what can we expect from the

financial markets? Taper is clearly on everyone’s mind. Also, how will the Japanese deal with their tricky mon-

etary and fiscal balance and moreover, will substantial progress be made with regards to risk management and

balance sheet repair of the major banks?

Over the coming issues of IFM, we are pleased to bring you a detailed understanding of the mechanics of

financial risk management, written by CFA and PhD student, Sohail Ahmed. The series will kick off with an

introduction to the types of risk management procedures firms adopt, whilst in later articles, a deeper analysis

of risk will be presented.

As always, enjoy the articles folks and strap yourself in for a volatile but exciting second quarter!

Editors View

4

King Entertainments

Independent Financial Magazine vol.5 07.04.2014

Contents

The Banks Balancing Act

Financial Repression

Special Report : Private EquityPrivate Equity Part 2

What Is Happening at Heart of Midlothian FC? Part 1

The Dollar Dip

Risk Management

IFM 07 April 2014

Exchanges of the week


The Banks Balancing Actby Pete McCarthy

The Lehman collapse in September 2008 sent seismic shocks that

were felt not just within the financial system but rattled the real economy and real people. Unemployment rocketed, output contracted and central banks balance sheets bulged to unprecedented levels.

It was time for central banks to provide the lifeline everyone so desperately needed. The policy: slash interest rates and implement quantitative easing (QE).

As we know, the QE policy has received hefty criticism by many high profiled economists, as they argue QE will cause a long-term conundrum of resource misallocation, high inflation and will result in many markets to be ‘out of whack’ with traditional themes.

The task of a central banker is the equivalent of competing in an egg and spoon race. On the one hand you know the economy needs to hit ‘escape velocity’ i.e. take the lead in the race, but on the other, you know a move too fast and the egg, the

economy in this instance, will fall off and shatter. Here are just a few paradoxes of policy so too speak that Governors of major central banks are faced with.

First off, you want people to save more therefore increasing investment, but not just yet because you need consumer spending to kick-start, avoiding a fall in consumption.

Secondly, you want banks to rebuild their balance sheets but not just yet, as this comes at the expense of lower lending ability.

Finally, the government needs to get its fiscal house in order to reduce the extortionate debt levels, but not just yet because that will also bring the economy to its knees.

The bank needs to keep the economy afloat yet there are many structural changes that need to take place over the medium to long term. Take Japan for instance. The Bank of Japan is providing monetary support via its own version of QE, yet the government needs to reduce its debt

levels so implemented a consumption tax to boost revenue. These balancing acts occur regularly.

Moreover, on a more macro level, such balancing acts take place on the foreign exchange market. Let’s continue with the UK as the example. The pound is relatively strong against most other major currencies. A stronger pound helps the UK consumer import more goods, as it means they can get ‘more bang for their buck’. Likewise for vacations aboard it’s great news. I can buy 3 shoes instead of 2 shoes. But on a more macro level, a stronger pound hampers exports. This is something the Eurozone has to deal with at the moment. They need an export lead growth story but a strong euro, due in part from significant dollar deprecation is stalling much needed momentum.

I can guarantee you Joe Blogs on the street knows what an egg and spoon race is, but whether the central banks will win this race is a question, quite frankly no one knows the answer too.

6

Risk Managementby Sohail Ahmed FRM

Sohail Ahmed, FRM PhD Student (Finance)

Risk Management

This page is dedicated to the understanding of risk management. In the beginning, a brief introduction of a risk management process, risk governance structure, and types of risks faced by a firm will be provided. Later, this page will be dedicated to the Market Risk Analysis Tool Pack. The Market Risk Analysis Tool Pack will introduce the Standardized Approach (under Basel Accord), Value-‐at-‐Risk (VaR) using Variance-‐Co-‐Variance, Historical Simulation, and MonteCarlo Simulation, and Stress Testing techniques.

Risk Management Process and the Types of Risks.

Investment is an activity that exhibits risk taking characteristic of a human being. With risk comes the possibility of a reward. Therefore, risk management is one of the important and critical components of the overall investment process. Effective risk management is a process not just an activity that involves the identification, assessment, and control of several sources of risk. These sources of risk are classified into the financial and nonfinancial risks. Identification of the sources of risk implies recognizing and classifying various exposures to risk. Assessment involves the establishment of appropriate ranges for exposures and the continuous measurement of these exposures. Control involves the execution of appropriate adjustments whenever the exposure levels fall outside the assessed target ranges. The risk management process is continuous and subject to evaluation and revision.

A typical application of risk management process for a business entity is shown in the following Exhibit 1.

In this exhibit, we see that the firm faces both the financial and nonfinancial risks. The firm reacts to these risks by establishing risk management policies and procedures. As a first step, the firm sets the

EXHIBIT 1

The Firm Financial Risks Nonfinancial Risks

Data

Policies Procedure

s

Risk Level Adjustment

Quantify Risks

Risk Tolerance

Identify Risks

Financial Derivatives

Non-‐Derivatives

Execute Risk Management Strategies

Select right Strategy (ies)

Price Strategies

Execute the transactions


This page is dedicated to the understanding of risk management.

In the beginning, a brief introduction of a risk management process, risk governance structure, and types of risks faced by a firm will be provided. Later, this page will be dedicated to the Market Risk Analysis Tool Pack. The Market Risk Analysis Tool Pack will introduce the Standardized Approach (under Basel Accord), Value-at-Risk (VaR) using Variance-Co-Variance, Historical Simulation, and MonteCarlo Simulation, and Stress Testing techniques.

Risk Management Process and the Types of Risks.Investment is an activity that

exhibits risk taking characteristic of a human being. With risk comes the possibility of a reward. Therefore, risk management is one of the important and critical components of the overall investment process. Effective risk management is a process not just an activity that involves the identification, assessment, and control of several sources of risk. These sources of risk are classified into the financial and nonfinancial risks. Identification of the sources of risk implies recognizing and classifying various exposures to risk. Assessment involves the establishment of appropriate ranges for exposures and the continuous measurement of these exposures. Control involves the execution of appropriate adjustments

whenever the exposure levels fall outside the assessed target ranges. The risk management process is continuous and subject to evaluation and revision.

A typical application of risk management process for a business entity is shown in the following Exhibit1.

In this exhibit, we see that the firm faces both the financial and nonfinancial risks. The firm reacts to these risks by establishing risk management policies and procedures. As a first step, the firm sets the level of risk that it is willing to take and able to bear.

7

The data collection and information sources help it to identify the risks and quantify the risk exposures to each type or source of risk identified. These steps define the effective mechanism of risk identification and measurement. The firm can then take steps to adjust the risk exposures whenever these exposures deviate from the defined risk tolerance levels. The risk adjustment is in itself a separate process which involves execution of the risk management strategies. This process consists of steps of identification of risk management transactions, pricing and execution. The risk management process loops around the quantification of the risk exposures and continues in that manner. In this way it provides continuous monitoring and adjustment of the risk so that the risk level is maintained within the defined tolerance levels.

Risk management plays an important role in the risk governance structure. Since senior management is responsible for all kinds of activities in a firm, their involvement is must for the success of the risk management. This leads to the establishment of the policies, procedures and standards under the risk management framework. The risk management system can be either centralized or decentralized. Under the centralized risk management

system, a single group monitors and controls all the risk-taking activities of an organization. However, in the decentralized system, the responsibility falls on the manager of each business unit to monitor and control the risk. There are advantages of decentralized risk management system as the people managing risk would be closely watching the people taking those actual risks. The centralized system offers the benefits of the economies of scale as well as allows taking the benefits from recognition of offsetting exposures that a firm faces in day-to-day operations. Suppose a UK company has two subsidiary firms. One subsidiary firm buys from the US and the other subsidiary firm sells to the US. The transactions of the both firms are denominated in US dollars. Therefore, both firms are exposed to GBP/USD exchange rate risk. Under the decentralized system, each subsidiary determines its foreign exchange risk and hedges it. However, in the centralized system, both transactions have offsetting effects. The overall exposure to the foreign exchange risk is reduced and thus, the costs of hedging will also be lower.

Not only the benefits of offsetting thus reduced risk exposure are obtained, but also the benefits of diversification can be achieved. For example, two subsidiaries

of a firm are exposed to the interest rate risk by borrowing funds with different maturities. The first subsidiary issues bonds with long-term maturity. The second subsidiary issues bonds with short-term maturity. For the company, the overall exposure to the interest rate risk may be less than the sum of the individual exposures reported by each subsidiary because the short-term and long-term interest rates are not perfectly correlated.

The centralized risk management system is recently termed as Enterprise Risk Management. Under this system, a firm identifies all the risk factors to which firm is exposed and then measures the exposure to these risk factors both before and after the diversification benefits.

The exposures to various types of risk are categorized into financial risk and nonfinancial risk. Financial risk includes market risk, liquidity risk and credit risk. Nonfinancial risks include model risk, settlement risk, regulatory risk, tax risk, sovereign or political risk, operational risk, and accounting risk. Market risk refers to the risk related to the exchange rates, interest rates, commodity prices, and stock or equity prices.


8

King Entertainmentsby Jeremy Kempke


Recently the financial markets have started to become wary

of a potential technology bubble popping. I will not go into any detail discussing this, but let’s just say that prices of tech-stocks currently stand at unusual high levels. Are they worth that amount of money? For this article it doesn’t matter. Additionally we are experiencing a wave of Initial Public Offerings (IPOs) as discussed within this magazine several weeks ago. From this, one can imagine the amount of hype an IPO from a major technology company would receive; close to the Twitter or Facebook level certainly.

Almost two weeks ago the industry has seen exactly this coming. On 25th March, King Entertainment (KING:US) officially listed on the NYSE, raising $500M therefore valuing itself at a grand total of $8bn. Many have argued that KING’s astonishing books, in particular for 2013, are simply down to the success of one product – Candy Crush. Is King a one hit wonder? Seeing that it dropped 12% on the first day of trading the general consensus seems to be so. Was the IPO a bad idea? Did the management make a huge mistake? Or did the fault lie with the lead underwriters (namely JP Morgan, Credit Suisse and Bank of America Merrill Lynch)?

One could argue that this IPO was actually an act of brilliance. You heard right, no sarcasm. But before I go into detail, I believe one needs to really understand the goal of an IPO. It’s quite simple: to raise money. Most people tend to forget the fact that come the second day of trading the company doesn’t have much interest in its share price unless it plans to hold further offerings, keep clear of takeover attempts or simply maintain good publicity. As the term “underwriter” suggests several Investment Banks share the privilege of ensuring the issuer receives the full money it intends to raise. Essentially the banks buy the shares at the agreed offering price and sell them on to potential investors. Given the 12% drop, those banks will face tremendous difficulties selling on those shares with a profit (partly explaining why Goldman Sachs didn’t get involved at all). Prior to the actual IPO, the banks and the corporation’s top officials will hold presentations to potential investors in order to a) encourage share sales then and there and b) estimate what the market value of the client’s equity stands at. This is called a roadshow. This process results in non-binding commitments, called “subscriptions”, to purchase shares and leads to the saying “Company X is Y times over-subscribed”. Where is the brilliance? The brilliance lies right at the origination of the deal;

the initial valuation proposed by King Entertainments. Just recently I was talking to a friend of mine, conducting a small experiment I have come across during my studies. Me: “Do you think that in Burma the population is more or less than 10M?” Friend: “Less.” Me: “How many people do you think live in Burma?” Friend: “Around 7M maybe.” Me: “It’s 52M actually” He did have a rough idea of the size of Burma, but based on the initial question, estimated it to be close to 10M. Psychologists call this the “Anchoring Effect”. Arguably King Entertainments took advantage of exactly that. Given the current market conditions for technology companies it was a golden opportunity to raise as much money as possible and going by the drop in price, King did just that. By setting a company valuation that is ridiculously high alongside the fact that companies within that sector are extremely difficult to price it seems to make sense to use the idea of the anchoring effect. Maybe the underwriters were just a little bit too keen on that commission (obviously raises proportionally to the issuing price). If Goldman Sachs doesn’t want to get involved, then you shouldn’t either. King Entertainments 1 : Investment Banks 0.

An act of brilliance?


Sentiment towards the world’s largest economy has been tilting to

the positive side of late. However, the dismal weather conditions has thrown a sizeable spanner in the works with regards to economic data. The question at the moment is, should you take the recent US data with a pinch of salt?

The past week has seen the greenback make an impressive run in anticipation of a stronger US economy and a fall in the unemployment rate. On Friday things turned sour as the non- farm payrolls (NFP) report spewed out a forecasted figure, causing markets to sell off amid a risk- off mood. Equity markets took a nosedive whilst safe haven assets saw gains with the yen and gold making ground.

You might be reading this thinking, so the US added 192,000 jobs (all in the private sector) and the forecast was a number of 200,000; in effect matching forecasts and given recent weather disruptions the figure is actually quite acceptable.

Now that’s the traditional view and one would expect stock markets to rally and take a risk- on mentality. We saw exactly the reverse, but why?

Perhaps the markets were expecting a much higher number. A few large investment houses were expecting a figure in the mid 300,000s. Remember, the consensus is not always the most accurate or reliable source.

Taper is back. Well it never went. A strong US result means the Federal Reserve (Fed) have a bigger case to take its QE program off the table. Consequently one would expect to see a fall in bond prices, but yes, you guessed it, the exact opposite happened. The large spike in the US 10yr was a sharp reaction to the data but then traded sideways at the new higher price level for the remainder of the day.

Economically speaking, the relationships that one has to get their head around to correctly spot an outcome is very, very challenging, particularly when traditional thinking was chucked out the window a while ago.

One crucial takeaway the market has taught us, is drops in relevant markets do not automatically mean the underlying economy is worsening. Monetary policy has caused seismic shifts across many asset classes but of

course, there are a multitude of factors that were responsible for the moves we witnessed on Friday.

So the key question on everyone’s mind is, ‘where do we go from here?

The Fed is continuing down its tapering path whilst European profits are still elusive. In the UK, sentiment is picking up, in part due to the stronger retail sales and is helping to offset a weaker export figure thanks to the staggering Eurozone.Over the past 12 months, the US dollar has shed around 15% to sterling. However since the opening of 2014, the current rate is almost identical to what it was on the 1st of January (1.6566). Has cable plateaued for the time being? As the Fed tapers and eventually ends QE all together, cable will likely take a hit to the downside, especially if the UK’s biggest trading partner is still stagnant.

Time will tell if the dollar dip is a continuing theme, but one thing’s for sure, the greenback will stage a solid fight back for the rest of 2014.

The dollar dipby Pete McCarthy

10

Frankfurt Stock Exchange

Tokyo Stock Exchange


Measured on a market capitalization basis, the Tokyo Stock Exchange

(TSE) is the world’s second largest bourse (January 2014) and was founded over 130 years ago in 1878.

All trading sessions at TSE commence at 09:00 a.m. to 11:30 a.m. and from 12:30 p.m. to 3:00 p.m. (local time) on all days of the week except Saturdays, Sundays and holidays.94 domestic and 10 foreign securities companies participate in TSE trading.

The TSE works closely with London Stock Exchange (LSE) to develop jointly traded products and technology. In 2008, the stock exchanges of Tokyo and London announced a new joint venture, a Tokyo-based market, which will be situated on the LSE’s Alternative Investment Market (AIM).

The major indices traded on Tokyo Stock Exchange are the Nikkei 225, TOPIX, and the J30 (an index of large industrial companies).

The Frankfurt Stock Exchange was founded in 1585 and is owned and

operated by Deutsche Borse Group. It is classified as 10th largest stock exchange in the world by market capitalization (January 2014).

Currently there is no open-cry floor trading as the exchange moved into an electronic execution system. All trading is completed exclusively via the Xetra platform that is used by more than 14 international exchanges.

There is more that 250 international trading institutions and more than 4,500 traders actively trading in Frankfurt. Investors who directly connect to the Frankfurt Stock Exchange represent 35% of the world’s investment capital.

Some indices that are actively traded in Frankfurt are DAX, DAXplus, CDAX, DivDAX, LDAX, MDAX, SDAX, TecDAX, VDAX and EuroStoxx 50.

Exchanges of the week


Special Report:Private Equity

NY Times.com © Daniel Vasconcellos

12

fig 1 : Global PE fund-raising


by Alan Konopka

A basic overview of private equity in last week’s edition of IFM gave

us some fundamental principles of the industry. We discussed different types of funds that exist within Private Equity (PE) firms with an emphasis on Venture Capital (VC) and Buyout funds. In this issue I will discuss the Mezzanine and Growth Capital that are too very important but not as well known types of PE financing. Mezzanine capital is simply the issuance of debt with some attached rights to convert it to an ownership or equity interest in the issuing company, providing the repayments of interest or principal are in orderly or strategic default.

In practice mezzanine capital is used to fill a financing gap between less expensive debt (senior debt, junk bonds issue etc.) and equity capital. The higher cost of mezzanine finance arrangements is due to its nature of being unsecured, subordinated (or junior) obligation in a company’s capital structure. Private equity firms will usually resort to mezzanine capital to reduce the amount of the total capital invested and when other sources of financing are already exhausted.

Additionally, middle market companies with restricted access to debt and equity capital markets (inability to raise new capital) might find flexibility of private mezzanine capital as an attractive option. Choice of the mezzanine financing might also be

due to the company’s low credit rating and consequently increased borrowing costs, either from a bank or via other sources.

Mezzanine funds within PE firms tend to be of smaller value than VCs or Leveraged Buy-out (LBO) operations. Mezzanine funds of KKR PE closed on over $1.0 billion in 2011. Within the industry, mezzanine capital seems to be an addition to the core operations of the firms. Head of KKR’s mezzanine business, Frederick M. Goltz said, “We have a healthy pipeline of opportunities and look forward to putting this additional capital to work by continuing to partner with private equity sponsors and management teams to support their objectives”.

Growth Capital on the other hand is a minority investment in companies that are looking to expand into new markets or new industries. Growth Capital similarly to mezzanine capital does not shift the control of the business to the finance providers but simply supports the growth strategy. Unlike VC, growth financing mostly targets mature companies with sufficient earnings to service debt obligations, but an acceptable level of debt is required that will not prevent additional future debt raisings. The structure of growth capital consists of common or preferred equity, or a mixture of the two.

Special Report : Private Equity

Private EquityPart 2

Mezzanine or Growth?

Source : EY Report, Global private equity watch 2014

fig 2 : PE IPO’s since 2001

“Current economic conditions of cheap financing and high valuations will prompt many PE firms into exit strategies”


Special Report : Private Equity

Distressed Capital is another important variation of a PE operation and seeks to invest in financially distressed companies. There are two main types of the PE investment and those include ‘Distressed-to-control Financing’ in which investment in debt is made with hope of priority claim on firm’s assets in an event of insolvency and ‘Turnaround Financing’ in which investment in both debt and equity is made in order to support the firms financial stability and bring back to black by making it more cost efficientHedge funds also employ a variety of distressed investment strategies, which includes active trading of distressed firm’s debt.

Cost efficiency was an objective that PE firms have raised many social concerns over the years. It is seen that the industry’ aim of producing hefty returns to the investors is in direct conflict of the firm’s employees. The public debate has been largely focused on buyout investments. It is perceived that the buyout transactions are strongly correlated with subsequent layoffs of the employees. Although such practices do occur, within the industry it is not as common as the public portrays. Buyout target companies usually undergo restructuring which involves hiring staff, rather than laying them off. Also, many PE firms have endorsed and promoted the Principles for Responsible Investment (UN PRI) and abide by them. Recent academic research suggested that, on average, the buyout transactions

have a positive or at least neutral impact on the target firm’s competitiveness, profitability and longer‐term prospects. Deeper research is required to fully understand the impact such processes and decisions have on the wider society. Private Equity activity tends to come in waves similar to those of mergers and acquisitions and initial public offerings. Current economic conditions of cheap financing and high valuations will prompt many PE firms into exit strategies from existing deals and involvement in new ones. Table below shows the most recent exit transactions made by private equity firms. Are we experiencing a boom in transactions, or is it only due to the strange times we live in?

Save or sell?

fig 3 : PE investment by sector, by value and volume

Table : Top 10 in 2013

Private Equity versus the Society

14 Independent Financial Magazine vol.5 07.04.2014

Financial Repressionby Farhan Tahir

Financial repression has been used throughout history, in both the

developed and developing world. In the post World War 2 era, financial repression enabled the US to reduce its debt-to-GDP levels from 122% in 1945, to about 30% in 1979. Likewise, Japan has attempted to use financial repression in order to stabilise its economy - an approach that other East-Asian countries have since imitated - thus making financial repression a truly global economic tool that is used in both the developing and the developed world. But is it a good thing? Before getting to that, it may be useful to describe what financial repression is. In its simplest definition, financial repression is negative interest. Its purpose is to essentially allow governments to increase the amount of money that is available to them (explains Japans huge debt-to-GDP levels...). Essentially, it’s a move away from ‘laissez fair economics’ and is a shift to increased regulation, in which the main benefactors are governments (as in a financially repressed economy, banks offer poor interest rates to savers, which government debt is expected to beat, therefore transferring funds to governments). It’s often likened to a tax - with interest rates being negative, savers lose out given that their savings erode with the passage of time. In its

tax sense, it’s actually quite a powerful tool, given that in some countries, it accounts for 20-40% of total tax revenue. But is it a good thing?If the only thing we cared about was government debt, then yes. Looking at the shutdowns that occurred in the US in 2013, it’s clear that too much debt is dangerous. So, given that financial repression can liquidate debt-levels (basically make the currency lose value...), then it’s a good thing to have lower debt levels. With OECD countries having historically-peaked debt levels, in this sense it’s good to reduce it.But the more compelling arguments lie in the ‘cons’ side - financial repression is a poor tool. And there are many reasons in support of this. Firstly, financial repression has historically been linked with poor economic growth - it causes the financial sector to be ‘repressed’, and this actually defies the efficient capital allocation goal of financial intermediaries.

Taking an article based on this Chinese economy, it was shown that financial repression holds back GDP growth (see chart below). And obviously this isn’t a good thing.

However, in light of financial repression being bad for the economy, it’s quite disturbing to see that major economies are actually using financial repression again (evident in both UK and US)... In the US, it was reported that pensioners are worried in case financial repression kills of all their savings - and that point in itself shows financial repression can be stupid, unless the only thing we care about is the government....

How Much Does Financial Repression Hold Down GDP Growth? (Percentage Points)

Source: Huang and Wang (2010).

15

What is happening atHeart of Midlothian FC? Part 1


Heart of Midlothian FC also known as Hearts, is a football

club based in Edinburgh. We as students of Heriot-Watt University see their players walking around the campus in their training gear usually after or before a training session and they seem to be happy. I’m almost certain it’s just a brave face.

For right now at Hearts lays a period of uncertainty and desperation as they try to keep the club going through its day-to-day business activities. Let’s see how this financial distress all began for Hearts.

Ten years ago, Hearts were in financial trouble for a separate reason. Huge debts owed resulted in management taking the brave decision to try and sell their stadium Tynecastle and work a deal with the Scottish Rugby Union to use Murrayfield Stadium.After agreements for the sale of Tynecastle and the use of Murrayfield were completed; a glimmer of hope was seen with the arrival of Vladimir Romanov, the chairman of UBIG investments.Vladimir Romanov was looking to

invest in Scottish Football for the interest of seeing how well Lithuanian footballers could do abroad. He tried buying Dundee, Dundee United and Dunfermline but each club turned him away. He then approached Hearts with the promise that the Stadium would be kept and the debt would be wiped; this was very popular with the fans.

In 2004 Vladimir bought 19% shares in Hearts and immediately called for an AGM to exercise the clause in the sale of Tynecastle which allowed them to discontinue the agreement.Slowly for the rest of that decade Romanov acquired more and more stock to become the vast majority shareholder of Hearts with 80% of the shareholding. Footballers from Lithuania during his venture did join Hearts from FBK Kaunas in which some became very successful.Although there were many great times under the reign of Romanov for Hearts; there were also unsettling times. On numerous occasions Hearts failed to pay their players on time and they owed a reported £36 million debt.

Hearts in 2008 announced an issue of debt to equity in order to reduce the debt by £10 million which was agreed at a general meeting. Reducing the debt to £25 million was great for the club and things began to look better. However this wouldn’t be the case.In 2009, 2010 and 2012 Hearts were issued with winding up orders by the Court of Session for not paying

HMRC tax bills on time. Every time they managed to agree a deal with HMRC but there was a sign of distress at the club.Then it began.In 2013, two Lithuanian companies UBIG Investments and Ukio Bankas became insolvent. Both companies were owed the vast majority of Hearts debt with the combined total of £23 million.With uncertainty over whether or not the liquidator of the Lithuanian businesses would force Hearts to pay back the full amount owed, Hearts entered administration.This sees the introduction of BDO and Bryan Jackson.

by Kristopher ConnellyThe Romanov Era

“Wall Street is the only place that people ride to in a Rolls-Royce to get advice from those who take the subway.”

- Warren Buffet -

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