An interview with UBS about digital currencies

Hyder Jaffrey is Head of Strategic Investment and Fintech Innovation at UBS

Banks have spent the last few years exploring how distributed ledger technology, or the blockchain, can help them cut costs or improve service.

To better understand how banks look at the issue we spoke to Hyder Jaffrey, Head of Strategic Investment and Fintech Innovation at UBS. In the interview he explains the utility settlement coin, a form of cryptocash a group of banks, including UBS, is working on.

Jaffrey argues that it helps to think of the world of digital currencies as a spectrum:

“At one end of it you have bitcoin, which is unregulated and operates outside of government control. At the other end you have central bank digital currencies – digital versions of existing currencies. The utility settlement coin is positioned right in the middle, with some of the benefits of bitcoin, such as the real time transfer of value (settlement), while taking on some characteristics of ‘real money’ issued by central banks. It is pegged to those fiat currencies and will always have the same value.”

You can read the full interview with Hyder Jaffrey here.

This is the third part in of our series on digital currencies, that we are publishing in collaboration with law firm Baker McKenzie.

Accumulate to innovate: Staying ahead in the innovation arms race

Last year Siemens, the 170-year old industrial conglomerate, announced the creation of something that had a strong whiff of back to the future about it.

The innovative German company hasn’t yet, unfortunately, created the world’s first time travelling train. But on October 1 it did launch a business that speaks as much to its past as it does to its future.

Indeed  in founding next47, a new unit designed to foster innovation and accelerate the development of new technologies, Siemens is focusing even more than it has in the past on partnering and investing in innovative start-ups to enhance its future growth and development.

“Siemens itself was a start-up in 1847,” said Joe Kaeser, president and CEO of Siemens. “With next47, we’re living up to our company founder’s ideals and creating an important basis for fostering innovation.”

Siemens has been partnering and investing in start-ups for the past 20-years or more. But in next47 – a play on the year Siemens was founded – the company has consolidated all its existing start-up activities, empowering the unit and essentially giving this business greater strategic importance to the entire company than ever before.

What’s interesting is that Siemens is not alone.

For years many of its blue-chip company peers – from Intel and IBM to Unilever, Google and more recently GE – have been partnering with and investing in some of the brightest start-ups in much the same way.

Unilever Ventures, the consumer goods conglomerate’s venture capital and private equity arm, was founded, for instance, in 2002. Intel Capital, by comparison, has been going since 1991.

Back then the innovation arms race was only really just getting going. And yet in the last decade this race has accelerated phenomenally, transforming the global economy in ways few knew or perhaps thought were possible.

From AI and machine learning, to distributed ledger technology, augmented reality, robotics, cybersecurity, energy storage and 3D printing, large, mature companies are today seeking out some of the most innovative start-ups in an ever increasing array of profoundly impactful areas.

Consequently, corporate venture capital investment – the means through which these companies tend to invest in or acquire start-ups via their own dedicated divisions – has rocketed in recent years.

Last year, for instance, corporate venture capital investment touched $85bn globally – roughly double what it was in 2014, according to Global Corporate Venturing.

It looks set to keep soaring.

An increase in acquisitions of innovative start-ups by larger, more established competitors is seen as one of the top themes in M&A over the next 12 months, according to over 2,000 company CEOs, CFOs and other senior executives who participated in the recent Capital Confidence Barometer survey we conducted on behalf of EY.


EY CCB: An rise in acquisitions of innovative start-ups a top theme

Ask the same executives the same question but our over a longer timeframe and the acquisition of start-ups may be nearer the top.

Part of the reason why is the recognition that internal research and development alone struggles to deliver the type of innovations companies want, when they want, and at a cost that they want to see.

Combine that with the fact that the type of environment that fosters innovation – one where staff can collaborate and operate under the freedom to create, experiment and ultimately fail – is not typically to be found flourishing in large, mature multi-billion dollar companies.

At least, not in most.

Part of Siemens’ objective for next47 is to provide existing group employees, entrepreneurs as well as external start-ups and established companies with the “freedom to experiment and grow” without the organisational restrictions so often symptomatic of a company its size.

In some sense, Siemens is just opening its doors to bring the innovations that can and do happen outside, in.

And while much of that focus is on attracting the ingenuity and flare that start-ups can bring, large mature companies are also getting in.

The first of next47’s projects is with European aircraft maker, Airbus. By 2020 they aim to show the technical feasibility of hybrid/electric propulsion systems for small to medium-sized passenger aircraft.

Innovations driven by and among large companies can of course be just as profound as any developed by start-ups, but to stay ahead in the innovations arms race, better ultimately to work together as one.

And who knows, anything might be possible – even time travel.

Who Owns Digital Currencies (and why it matters)

Digital currencies come in different shapes and forms, which in turn has important implications for their respective use and application.

A lot depends on the question who ultimately controls a specific currency. Bitcoin, for instance, is decentralised and operates outside of the oversight of a single institution. It is therefore not well suited to manage inflation.

ownership digital currencies snippetBut a central bank issued digital currency* – none exists so far, but central banks around the world are considering it – would be a powerful tool to control and manage inflation.

A third type are digital currencies issued by banks, such as the Utility Settlement Coin (USC), being worked on by a number of top tier banks.

Our infographic: Centralised versus Decentralised Digital Currencies compares the implications the characteristics of different digital currency types have.

The chart is the second iteration in our new series on cryptocurrencies, which we are publishing in collaboration with law firm Baker McKenzie.

We’d be delighted to hear your comments. You can get in touch using the contacts form. For social media, we recommend the hashtag #cryptocurrencies.

* For more on central bank issued digital currencies, check our recent article, “Life after Quantitative Easing

Deal or no deal: Protecting acquisitions amid manic market moves

Three to 12 months is a long time in global markets where so much can change in the blink of an eye.

And yet three to 12 months is the average time it takes to close a merger or acquisition – opening-up an acquirer to the risk markets may move against them.

In such unpredictable times as these this risk is increasingly real, potentially making any acquisition more expensive or, in extreme cases, unravel.

Take, for example, how markets reacted last year to the UK voting to leave the European Union and the election of Donald Trump as US president. Sterling lost almost 20% of its pre-referendum value in the weeks after, while Trumps election sent bond yields soaring in anticipation US interest rates would rise.

While such market moves only really occur when unexpected events hit, the regularity of these seismic events is undoubtedly worrying.

Indeed, over the next 6-12 months, high volatility in currencies, commodities and other capital markets is considered the greatest economic risk to the core business of companies, according to over 2,000 CEOs, CFOs and other senior executives who participated in the recent Capital Confidence Barometer survey that we conducted on behalf of EY.


At the same time, a near-record number of the companies that participated in the survey said that they plan to acquire in the next 12 months, with most of them believing that the main theme in M&A this year to be an increase in cross-border dealmaking.




So at a time when there is a resurgence in appetite for cross-border M&A and fear of higher currency and capital market volatility, what’s a deal-hungry CEO to do?

One option making something of a comeback is for companies to use derivatives to help mitigate the financial risk costs in an acquisition.

Foreign currency forwards – a derivative essentially enabling the buyer or acquiring company to purchase or sell a set amount of foreign currency at a specified price in the future, thereby protecting themselves against any wild market swings – is one such hedging solution. But it is so-called deal-contingent FX forwards, which offer buyers greater optionality, that are specifically re-emerging again.

Whereas a company must pay for a FX forward irrespective of whether or not the acquisition is completed. With a deal-contingent forward, the company can walk away – without paying to unwind the agreement – depending on how the acquisition actually progresses.

If that sounds too good to be true, the catch or downside is that deal-contingent forwards are expensive, costing between 2-5% of the notional value of the transaction – far more than a FX forward.

It’s a tough call to know whether it is worth it or not. But amid more volatile markets, what price does a company put on being protected?

Similarly, just as currencies can appreciate during the time it takes to close a deal, financing conditions can of course change rapidly too.

Most large-scale M&A transactions are financed initially using a bridge loan before being refinanced on the bond markets, but if interest rates rise during this time the cost of finance does too.

To manage this risk derivatives called forward-starting swaps offer something of a solution, essentially enabling the acquirer to lock-in current rates for an asset or liability and on a deal-contingent basis.

Similar to a deal-contingent FX forward, a company can walk away from the hedging agreement depending on how the deal progresses.

Such interest rate derivatives have been used for some time in infrastructure and project financing, where the long-dated nature of it means it is particularly susceptible to interest rate changes over time.

They haven’t, as yet, become as prevalent in the shorter-dated corporate bond markets. But interest is expected to grow. After all, interest rates can only go one way after being so low for so long.

Digital Currencies: Powerful Tools for Central Banks


Today, we are launching a new project on digital currencies.

Over the next weeks and months we will investigate different types of cryptocurrencies and consider their benefits and potential downsides to financial institutions, central banks and the real economy.

We will discuss regulatory hurdles, explain digital payments systems, and look at distributed ledger technology.

We will also be speaking to central bankers and blockchain developers, commercial and investment bank experts, fintech visionaries and other stakeholders who will play a role in shaping the future of cryptocurrencies.

In the first part of this new project, which we are publishing in collaboration with law firm Baker McKenzie, we are examining why central banks are looking seriously at creating digital versions of fiat money. The article explains how the issuance of digital currencies will provide central banks with a new powerful tool that will give them unprecedented control over economies and markets.

Upcoming pieces in the series will include interviews, videos, animations, infographics and more.

In the meantime, please head over to our partner’s website to read our first article, “Digital Currencies: Life after Quantitative Easing”.

We hope you will find this new article series interesting. As ever, we would be delighted to hear your thoughts. You can get in touch using our contacts form. For social media, we recommend the hashtag #cryptocurrencies.

Aviation Finance and the Cost of International Tax Reform

Tony Ryan, the Irish businessman, is best remembered as the co-founder of the low cost airline that carries his name. Ryanair launched in 1985 with a single 15-seat turboprop connecting Waterford with London Gatwick. Today, it is Europe’s largest airline. More than 106 million customers boarded Ryanair planes last year.
But before popularising no-frills flying in Europe, Ryan had already revolutionised the aviation industry in a different area: In 1975, as the founder and CEO of Guinness Peat Aviation (GPA), he invented aircraft leasing as it exists today.

Patrick Blaney, who succeeded Ryan in the CEO post, described in an interview with the Irish Independent in 2016 how the GPA founder created the new industry almost single-handedly. It began when Aer Lingus, his employer at the time, tasked Ryan to solve an overcapacity problem by ridding the company of two unneeded planes.

“Tony Ryan was dispatched by [Aer Lingus] to find a home for these two planes and he found an airline in Thailand called Air Siam, which needed not just the planes but a flight crew and cabin staff,” Blaney said.

“So he very neatly organised for two aeroplanes that Aer Lingus had bought but didn’t need, they had trained crews and all the rest to fly, and he shipped the whole lot out to Thailand.”

With the creation of GPA soon after sealing the Air Siam deal, Ryan filled a niche in the market: leasing allowed airlines to quickly increase capacity in growth times, or scale back when demand dropped. In addition, there are certain advantages to airlines in the way leased planes are accounted for on the balance sheet.

Aircraft leasing and financing became big business. Today, 40–50% of all commercial planes are leased. While Ireland still dominates the industry, other jurisdictions including Singapore, Hong Kong, Cyprus and Malta have also sought to attract the sector.

New Challenges

But the business model is facing new challenges created by changes to the international tax environment. Supranational organisations have agreed measures to curb tax avoidance and the question arises whether this will have a detrimental impact on aviation finance.

In a global survey of more than 400 industry experts, conducted by Euromoney Institutional Investor Thought Leadership in conjunction with Deloitte, 78% of aviation experts working for airlines, and 87% of those working for lessors agreed that the industry will feel the impact of anti-tax avoidance measures.

General impact chart 1One of the main drivers for changes to international taxation is the OECD’s Base Erosion and Profit Shifting (BEPS) Action Plan. This project aims at closing gaps in international tax rules that allow multinationals to minimise their tax bills by playing the tax regimes of different jurisdictions against each other.

Haroun Asghar, Head of Tax at Etihad Airways, thinks that “the political support underpinning [the] BEPS [Project] can’t be under-estimated”. He adds that “the speed and scope of these changes has been impressive. It is the most significant development to international tax architecture for over half a century.”

The anti-tax avoidance directive (ATAD) is the EU’s implementation of the BEPS Action Plan. Agreed last year, the ATAD will come into effect from January 2019 and apply to all EU members, including Ireland, the global centre of aviation finance.

What financial impact will the new measures have? While the survey results display considerable uncertainty — 30% of respondents didn’t take a view — a narrow majority of the survey panel, 53%, expects the cost for leasing aircraft to increase. Only a 13% minority does not think so.

Double tax treaty changes

More recently in focus of the BEPS Project have been double tax treaties. An OECD signing ceremony scheduled to take place in June in Paris will set in motion changes to more than 2,000 tax treaties– about two-thirds of the worldwide total. First treaty amendments could come into effect from January 2018.

In addition to the other measures, the prospect of changing double tax treaties will draw increased attention to tax gross-up clauses.

Included in most standard aircraft lease agreements — but rarely triggered — gross-up clauses could almost be considered a mere formality: added to every contract, but never expected to become relevant. Now that tax bills are set to increase, they will be subject to closer scrutiny.

Half of respondents to the survey agree that “proposed double tax treaty changes will have an impact on the negotiation of aircraft lease agreements, in particular the provisions of tax gross-up clauses”.

Gross up clauses Q18Again, a considerable number of respondents refrained from taking a view, underlining the lack of clarity around the impact of international tax reform.

If — as the survey indicates — aircraft leasing costs are set to go up, who will pay for it?

Lessors’ largest customers might have sufficient buying power to force lessors to absorb rising costs themselves. It’s an indicator for market expectations that 41% of experts believe (vs 25% who disagree) that the implementation of the BEPS Action Plan via the ATAD will result in a drop of lessor profits.

Lessor profits decline Q11

But that does not mean that the aircraft leasing business invented by Tony Ryan in the 1970s has seen its best days. Leasing aircraft offers more than just tax-related advantages, and therefore it is unlikely that its popularity with airlines will change significantly. “Ultimately, the amount of leasing will depend on wider market and business factors,” comments Etihad Airways’ Haroun Asghar.

And Markus Ohlert, Head of Leasing at Lufthansa, adds that this might be particularly true for companies that don’t have strong balance sheets. For them, “leasing may be the only way to get access to aircraft,” he says.

The survey and report “Game Changer not Game Over: Aviation Finance and International Tax Reform” has been prepared by Euromoney Institutional Investor Thought Leadership in conjunction with Deloitte. The complete research is available for free download here.

Aviation Finance in the Hot Seat

Aviation finance is not an industry on everyone’s radar even though it’s huge. The term refers to the business of aircraft leasing: up to 50% of planes globally are no longer owned by airlines directly. Instead, those planes are on lease from specialist companies.
International tax reform might change the way competition among global aviation finance centres from Ireland to Singapore plays out in the future.

Leasing is an attractive way for airlines to manage their aircraft fleets. Compared to owning planes leasing increases flexibility and does not require airlines to take on huge amounts of debt.

The top 50 aircraft lessors have planes worth $260 billion under management, according to Airfinance Journal, which gives an idea about the size of this growing industry.

Aircraft leasing is concentrated in a few jurisdictions globally, and about half of that business is conducted from Ireland. It’s so important to the Irish economy that The Economist recently described aircraft finance as “perhaps the city’s [Dublin’s] most successful industry”.

This makes the country, with its population of just 4.6 million, the biggest player by far in aviation finance, competing with a handful of other territories around the world including Singapore, Hong Kong and Chinese free trade zones.

But with international tax reform on the horizon there are concerns that Ireland’s leading position will come under increased pressure from other jurisdictions.

The EU Anti-Tax Avoidance Directive

Being a member of the European Union, it is the EU’s anti-tax avoidance directive (ATAD) that poses the biggest threat to Ireland as a destination for aircraft leasing. The ATAD, which comes – with a few exemptions – into effect in January 2019 introduces a variety of measures designed to make it harder for corporations to play the tax laws in different countries in and outside the EU against each other.

When Euromoney Thought Leadership and Deloitte teamed up recently to survey the aviation finance community, it turned out that the experts are worried about the impact the ATAD may have on their business.

53% of 400 experts surveyed told us that they expect airline’s aircraft leasing costs to increase in the wake of the directive coming into effect. Only 13% disagreed.

And 40% also believe that the ATAD will result in fewer planes being leased.

ATAD statements Q11


That sounds like bad news for Ireland, the leading aviation finance jurisdiction not only in Europe, but globally. It appears to make intuitive sense: if the ATAD puts pressure on lessors and lessees based in the EU, they’ll move elsewhere.

And indeed, our survey reveals that the industry is prepared to take action if deemed necessary. Aircraft lessors expect to relocate 28% of their business on average in the wake of anti-tax avoidance initiatives.

In addition, when asked which aviation finance location will see the fastest growth in the next five years, Chinese free trade zones and Singapore came first and second, with Ireland in third place. The data appears to confirm expectations that the ATAD might have a direct impact on Ireland as a centre for aviation finance.

Map growth expectations

But it’s not that simple. While aircraft leasing is concentrated in jurisdictions with favourable tax regimes, there are  reasons other than low taxation that make those locations attractive.

It’s not about taxation only

“Ireland’s competitive strength is its double tax treaty network, which is hard to duplicate in a hurry,” Edward Hansom, Chief Investment Officer at Seraph Aviation Management, says. Focusing on the low tax rate in Ireland would be “a bit of a red herring in the context of aircraft leasing because companies anywhere tend to have enough legitimate capital allowances to defer tax liability”.

Our survey data concurs.

reasons for picking a location (chart 2)

Yes, the effective corporate income tax rate matters (38% of all respondents say it is very important), but double tax treaty networks get an even higher score (42% of all respondents, and 54% for lessors only).

While on the one hand other factors in addition to the tax environment are at least as important to the aviation finance community, it is on the other hand also necessary to look beyond the ATAD when it comes to taxation.

EU member states set their own respective corporate tax rates, and Ireland’s 12.5% rate is the lowest within the Union. This won’t change in light of the anti-tax avoidance directive coming into effect. “The low corporate tax rate is not going to go anywhere soon regardless of what the European Commission wants to do,” Eamonn Brennan, CEO of the Irish Aviation Authority, notes.

Other aspects include the strong and supportive regulatory environment in Ireland, an effective legal system, and a strong skill set that comes from over four decades of experience in aircraft leasing in the country.

In the end, the situation might be less bleak for Ireland than the numbers suggest, when taking into account all the factors that matter. Tax is an important ingredient, but not the only one. In the words of Markus Ohlert, Head of Leasing at Deutsche Lufthansa: “In many countries purely tax driven aircraft investments are not attractive any more. You must have a real business case behind it.”

The survey and report “Game Changer not Game Over: Aviation Finance and International Tax Reform” has been prepared by Euromoney Institutional Investor Thought Leadership in conjunction with Deloitte. The complete research is available for free download here.


UK Aviation after Brexit

Serving almost 76 million passengers in 2016, London Heathrow is Europe’s busiest airport. The decision by the UK government in October last year to support a third runway to be built by 2025 — after eight years of political squabbling — should pave the way for further growth.

But does it?

While a third runway might address the crucial capacity issue that is currently holding back the airport from serving more customers, the future of aviation in the country will also depend on, like almost all other aspects of the British economy and life, the terms of Brexit. And those are yet unknown.

International aviation is based on terms agreed between different countries in so-called air service agreements (ASAs).

In the early 2000s the European Court of Justice had ruled that any ASA between an EU member state and a third country needs to be open to airlines from all EU states. On that basis member states renegotiated around 340 bilateral ASAs in the past fifteen years to make sure they comply with the court ruling.

More and more often, the European Commission (EC) also took over as direct negotiator with countries outside the Union. Instead of leaving it to each member state to amend their respective bilateral ASAs, the EC negotiated new agreements with third countries that would cover all EU members. To date, the EC has negotiated new horizontal agreements with 41 countries, representing 670 bilateral agreements.

The implications for aviation in the UK in a Brexit-context are twofold: firstly, the country will need to come up with a plan to deal with those arrangements the EU has in place in the name of its member states. Most likely the UK will have to negotiate its own bilateral agreements with third countries currently covered under EU-wide horizontal agreements. And secondly, the UK will need to negotiate an ASA with the EU to address their future relationship in the skies.

Replacing the US-EU Open Skies agreement

One — crucial — example for an ASA negotiated by the EC in the name of EU member states is the Open Skies agreement with the United States. From the UK perspective this ASA, which came into effect in 2008, replaced the bilateral US-UK Bermuda II agreement, which had limited transatlantic competition from London Heathrow to just two US and two UK airlines.

It was the EU-US Open Skies agreement that opened up the market for competition as it exists today. Without Open Skies, disrupters like Virgin Atlantic would not challenge incumbents for routes to New York and other US destinations.

That’s why not replacing Open Skies, or doing so with an agreement inferior to the current arrangement, could have serious consequences for Heathrow as the dominating international airport in Europe.

Open skies

To find out how aviation experts expect this to play out Euromoney Institutional Investor Thought Leadership teamed up with Deloitte to survey more than 400 aviation experts globally.

Specifically, we wanted to know whether experts expect the UK to negotiate agreements that are, in essence, similar to the existing US-EU Open Skies agreement. We asked this question with regard to a future UK-US agreement, and to a UK-EU agreement.

The good news is: most of the respondents to our global survey think such agreements will come in the foreseeable future. Only 23% believe reaching agreement with the US will take longer than four years or not happen at all.

Less optimism about a deal with the EU

Interestingly, our survey panel — more than two thirds of which are C-level, VPs and senior directors — takes a somewhat more pessimistic view when it comes to a deal with the EU. 5% think the UK won’t be able to negotiate a deal with the Union at all (only 2% think so for the US), and 18% believe it will take longer than four years.

This expectation, that it will be harder to negotiate a deal with the EU than with the US, is confirmed even by those who generally think deals can be struck within the foreseeable future: Only 37% expect a deal with the EU to come within two years, versus 40% for a deal with the US. And, in line with this finding, 42% believe a deal with the EU will take between two and four years, but only 37% think so for the US. In short: Our panel thinks it will be easier and faster to get a deal with the US than with the EU.

If panellists are correct in their predictions, this could be bad news for Heathrow and the wider UK aviation industry. Europe is by far the most important destination for flights from the UK. According to the latest available data from the UK Civil Aviation Authority (for the rolling year ending Q1 2016), 61% of UK flights originate from or go to Europe. Only 9% of routes connect the island with North America.

In addition to the impact of Brexit, our report “Game Changer not Game Over” also looks at the challenges facing aviation and aviation finance in particular in light of upcoming international tax reform. The report can be downloaded for free from the Euromoney Thought Leadership website.

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