Mactavish

The new administration received a reminder today of the tough task it faces in rebalancing the British economy away from financial services to manufacturing. IHS Global Insight, a US economics consultancy, showed that Britain has slipped one place in the world manufacturing league table to seventh. The UK is seemingly in danger of slipping out of the manufacturing Premier League and was responsible last year for value-added manufacturing output of $227bn, just $13bn ahead of South Korea. Sixth place was taken by France.


The extent of this drop should be nothing but concerning for the Government and UK industrialists. Over the past two decades British growth has been driven by Financial Services, but as we’re all now aware this has left our balance of trade precariously high and our economy dangerously unbalanced. With the pound now making exports cheaper, British manufacturers need more than ever to push on and exploit new markets opening up in the Far East and BRIC economies, whilst embracing opportunities to take the technological lead.


As the FT outlines, the fall of the share in global manufacturing output in the UK during the last three years was greater than for any other country in the top ten apart from deflation-bound Japan. If this demise is inexorable then economic growth in Britain might be more sluggish than even the bears expect.

Figures released today from EEF and accountants BDO show that British manufacturers are enjoying the highest rise in output since 1995. This comes on the back of an increase in domestic demand and orders from overseas, the latter helped by a 20% drop in sterling since the end of 2007.


Although this is undoubtedly good news for our chances of a sustained recovery the economic headwinds could still blow the good ship UK PLC off course. Manufacturers surveyed by EEF/ BDO expressed concerns about austerity measures to be introduced in the June 22 budget. Plus, contagion from the Greek sovereign debt crisis spreading to other Eurozone economies, and Europe-wide budget cutting measures announced so far totalling €120bn, could also lead to an emptying of presently buoyant export order books.


Mactavish will be testing the pulse of UK manufacturers over the course of this year. Today we are launching a new phase of consultations in the sector and we will be digging down deeper into the risk issues identified in the cross-sector study released in January. We are particularly interested in supply chain disruption, liability creep in contracts and increased service offerings (i.e. a move away from purveying ‘pure’ products to manufacturers getting increasingly involved in product design). As the study progresses we will keep you informed of interesting developments via the blog.

The volcanic ash cloud hanging over Europe has disrupted the holiday plans of thousands. Monty Python’s John Cleese was forced to take a £3,300 cab ride across Europe after being stranded in Norway, while Gary Lineker schlepped back from Tenerife just in time to present Match of the Day on Saturday evening. But the effects of the black plume up in the stratosphere are now being felt by businesses across Britain, with manufacturing firms reliant on Just-in-Time methods running low on critical parts.


This morning the Financial Times published a story highlighting how car assembly plants look set to grind to a halt as the ban on plane flights starves them of essential electrical components. Nissan believes it will have to suspend production at two of its Japanese plants tomorrow after running low on stocks of a key part made in Ireland. Airbus has issued a similar warning and thinks production at its North Wales plant will have to, at the very least, slow down. Completed wings cannot be flown to Airbus’s other plants in Hamburg and Toulouse, slowing the final assembly of new aircraft.


Interestingly, the recession may have already exacerbated these problems by forcing manufacturers to destock and cut inventories as a means of shoring up cash flow. Emma Scott, representation manager from the Chartered Institute of Purchasing & Supply thinks that companies have become more vulnerable to disruption of this kind since moving to just-in-time production methods, where minimal stocks of products are held. Although carrying excess stock to cover random black-swan eventualities like the eruption of a volcano in Iceland makes no sense, perhaps as Miss Scott notes, companies should set up supply chains that reduce their reliance on a single mode of transport and could be adapted to meet different circumstances.


Reports suggest that insurers are unlikely to pay out for business interruption caused by the dust cloud from Eyjafjallajökull as there was no “material damage” trigger. This rather unlikely event serves to reinforce a point we made in the recent Mactavish report: supply chains are becoming increasingly interconnected and disruption can work its way through the value chain at frightening speeds. To combat potential problems risk managers should map out all vulnerabilities in supply chains and ensure that continuity planning covers the scenario whereby an essential component cannot be delivered. You may think this scenario is off the radar but a volcanic eruption in Iceland has reminded us that the Earth stops for no one.


There’s an old Yiddish saying that Man plans and God laughs. Well, if you don’t even try to plan God will still be laughing today, as the Western world slowly gets moving again as the skies fill up with planes grounded by ash from a previously unheard of volcano.

Yesterday I attended a seminar by one of the leading ratings agencies. Besides telling us it had developed a model that explained, in detail, how the credit risks associated with some of the more esoteric securities were under-estimated prior to the credit crunch (by itself not the most groundbreaking of revelations), there was a fascinating presentation by the company’s chief economist on the macroeconomic outlook for 2010. Although he wasn’t as bearish as Cynicus Economicus, he did paint rather a gloomy picture.

His main argument was that consumer spending & business investment must remain cramped as households and firms continue to deleverage in 2010. This will at some point be exacerbated by fiscal consolidation by western governments as they inevitably start to address budget deficits and pull back from buying government bonds through Quantitative Easing. Long term interest rates will likely rise later this year as bond market conditions become less friendly to the companies and governments issuing bonds. As interest rate rises work their way through the system this will have a further negative effect on consumer spending and mortgage repayments. Net result, the glass is half empty.

Without wanting to sound like Eeyore, the economic recovery does look precarious. And from a risk perspective, it is hard not to be concerned by sluggish business investment over an extended period. As an example, one property underwriter I interviewed the other day was concerned that planned maintenance of plants and factories could be deferred, leading to more over-running of machines or electrical breakdown. This is just one aspect of the economic downwind that could lead to losses further down the line, a theme that looks set to run.

Royal Liver today became the eleventh firm to be fined by the FSA in 2010 after it was ordered to pay £7.8 million in compensation to customers who were mis-sold investment products.


The Mutual Insurer was rebuked by the regulator for the conduct of a subsidiary - Park Row Associates - its Independent Financial Adviser. According to the Times, Park Row advisers made 37,400 sales of regulated products to 23,700 clients from January 2007 to January 2009. Investments sold included complex Structured Products.


A Director of Operations at an Investment Management firm, consulted by Mactavish in late 2009 stated: “Liabilities around structured products will be one of the next big battlegrounds”. It seems by today’s ruling that he could well be right.

The Hedge Fund business can be a complicated beast for investors to get their heads around. Funds of Hedge Funds, by extension, can be even more arcane. Reuters carried an interesting story today about institutional investors demanding a greater emphasis on risk in the £363 billion Fund of Funds industry. This should come as no surprise to regular watchers of financial institutions and could prove to be a catalyst for greater investor scrutiny of the wider fund management sector.


Reports suggest that investors are piling the pressure on fund of funds to conduct more background checks on asset managers and third party brokers, in the wake of the failure to spot Bernie Madoff’s Ponzi scheme and after missing out on last year’s rally in the stock markets.


Mactavish work has not specifically analysed fund management due diligence on investments. But several designated risk guardians in financial services did raise not fully understanding some complex risks involved in areas like changing investment mandates and vicarious liabilities of third-party service providers. This suggested to us that, like with investors in funds of funds, the time was probably ripe for a re-emphasis on how underlying risks are investigated and controlled by asset managers.  Expect to hear more stories like this over the coming months.

A weaker pound making the UK trade deficit worse? I thought a weaker pound was going to bring about an export-led recovery? Now, although I have to root around the darker recesses of my brain to remember the J-Curve effect (a devaluation of a currency leading initially to a worsening trade deficit), I do recall that this was meant to be a short-term phenomenon. Well, as Edmund Conway shows us in his invaluable Economics Blog over at the Telegraph, we have had a weaker pound now for around two years, and there has been no discernible improvement in our trade deficit.


Today, December’s trade figures were released and they showed Britain’s trade deficit widening unexpectedly and hitting its highest level since January 2009. Taken along with news of January’s disappointing retail figures, this has caused some renewed concern among economic weather-watchers.


There may be temporary factors behind these figures - with the heavy snow making shoppers stay at home and the ending of the car scrappage scheme temporarily boosting imports in December  - but the two-year trend for the trade deficit in particular is concerning. Importing more than you export isn’t really sustainable in the long-run. And it will take more than just platitudes to address this issue. One thing is for sure, whichever party wins the next election we’ll have to hear a lot more from them about what they will do to help Britain’s manufacturing and engineering companies.

The House of Lords is today debating a bill that could restore the right to compensation for sufferers of pleural plaques - a normally benign scarring of the lungs that can, in some cases, lead to Mesothelioma.


Bloomberg reports that a change in the law to allow pleural plaques claims could cost insurers up to 28.6 billion pounds, though a report by the Ministry of Justice released in 2008 estimated costs could be as low as 3.7 billion pounds. The uncertainty around the possible impact of the law change reflects the fact nobody knows how many of these claims will eventually materialise.


Two Ratings Agencies - Fitch & A.M. Best - think that a right to bring claims may force insurers to increase their reserves. Several insurers have already come out publicly and announced that Asbestos reserves have been boosted by several hundred million pounds to take account of the possible law change. In reality, as Catherine Thomas, Senior Insurance Analyst at A.M. Best states: “The estimation and provision of asbestos reserves is subject to much greater uncertainty than other classes of insurance.”


The Actuarial Profession’s UK Asbestos Working Party has recently upped its estimate of the future cost of UK Asbestos-related claims to the insurance industry. A change in the law by the House of Lords to allow compensation for sufferers of Pleural Plaques might mean the Working Party’s actuaries having to return to their spreadsheets for a second time to adjust their projections.

The credit crunch hasn’t been kind to Britain’s Mutual sector. Consolidation – a polite euphemism for bailouts in many cases – has been widespread, with the Derbyshire, Cheshire, Barnsley, Catholic and Dunfermline and Chelsea Societies all being swallowed up by larger rivals. Ratings agency downgrades have beset many Mutuals and fraud losses have been widely reported. But the full extent of the financial crisis on Building Societies has today been laid bare by the Building Societies Association (BSA)

A total of over £32 billion has been withdrawn from Society’s coffers, the result of Local Authorities taking their deposits elsewhere, savers deserting the sector because of the low interest rate environment and access to the wholesale money markets freezing up.


This arctic breeze of developments has severely impacted the mortgage market in the UK. The Council of Mortgage Lenders have announced that net funding was just £11.5 billion last year, the lowest level recorded since 1987 (when records began) and down from some £111 billion in 2006. These are astonishing figures that prove just how challenged Britain’s Mutual sector is.


There has been a raft of recent developments that have affected Britain’s 52 Building Societies: from ratings agency downgrades, to increased regulatory oversight to a marked increase in competition for retail deposits from the nationalised banks. Understanding how these have affected business operations (and consequently risk exposures) must now be a key priority for risk managers and insurance buyers alike.

A recent spate of product recalls involving carmakers has hit the beleaguered global automotive industry. Although it could be a misperception on my part, there does seem to be an increasing number of product recalls nowadays - and not just cars. Perhaps this is a function of our increasingly globalised economy? As the recent Mactavish Research Study highlighted, supply chains are more interconnected now than they have ever been, changing and concentrating risk.

The most interesting aspect of the recall involving Toyota is that Peugeot Citroen, Europe’s second-biggest carmaker, has been forced to recall specific models that were manufactured in the same factory in the Czech Republic as the faulty Toyotas. This plant is a joint venture between the two companies and churns out models of cars that are very similar and often share components.

Reading this caused our CEO to pull out from his cupboard a dusty, mothballed report Mactavish wrote on the automotive industry some ten years ago. In it, we majored on the emerging trend towards common platforms as a key efficiency driver. Car manufacturers even then were beginning to use the same components for many different makes of car, sourced from the same suppliers.  Although this drove down costs, it also increased the severity and cost of any damaging product recall. Now, when a component breaks down, it can lead to the recall of multiple brands of cars - and can hit more than one company (e.g. Toyota & Peugeot Citroen).

This is a classic case of seemingly innocuous operational changes having profound and not always obvious implications for risk management.  Businesses will always change operations: after all, innovation is often the key to growth. But if change is pervasive, it must be communicated internally within the business and externally to shareholders and other capital providers, like lenders and insurers.