PIABA: After Report Detailing BrokerCheck System’s Flaws, No Action Has Been Taken

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It´s been two and half years since the Public Investors Arbitration Bar Association (PIABA) reported the “serious deficiencies in the background information provided about financial professionals to investors through FINRA’s BrokerCheck website”.

Now PIABA says that “FINRA did not fix BrokerCheck. Instead, the industry self-regulatory organization made things worse by spending millions in advertising to get unwary investors to rely on the flawed BrokerCheck system”. The press release of the Association says “examples of information routinely not included in BrokerCheck reports, but available from many state securities agencies, include the circumstances of a broker’s termination of employment (especially when the broker quits during the course of his firm’s investigation of his conduct), bankruptcy filings, tax liens, and test scores”.

As the PIABA report notes: “… FINRA’s conduct in promoting the BrokerCheck system as the only way to check those backgrounds and qualifications has imposed a disservice upon those investors using the system. The reality is that investors who may have once researched their brokers by contacting their state securities regulators have been led to believe they can simply rely on an online BrokerCheck report, which they can access themselves on the internet or through brokerage firm website links. Unless an investor is employed in, or otherwise familiar with the securities industry, the chances are negligible that they know that the BrokerCheck report may well be hiding relevant information.”

Report co-author and PIABA President Hugh D. Berkson said: “Before FINRA spent millions of dollars advertising BrokerCheck, it should have fixed its broken disclosure system. The current incomplete BrokerCheck reports are of limited value. As things stand now, FINRA claims to offer information ‘You might want to know about,’ but fails to offer information you definitely want to know about. Investors should not be subject to the vagaries of their local public records laws to ensure that they gain the information necessary to fully and fairly assess their potential financial advisor. The answer to the problem is so simple, and the result so meaningful, FINRA cannot be allowed to continue to hype a broken system it knows is of limited utility.”

PIABA Executive Vice President and President-Elect Marnie C. Lambert, who co-authored the report, said: “This is a major problem when it comes to what investors are relying on for information about their financial advisors. FINRA incorrectly advertises the BrokerCheck reports as being ‘complete’ and helpful to investors but, in reality, BrokerCheck reports often omit information about brokers that is highly relevant and necessary for investors to make informed decisions about who they may want to hire.”

In calling for action, the PIABA report states: “[I]f FINRA is serious about protecting investors and truly believes, as it has professed, that researching a broker is a meaningful part of an investor’s broker selection process, PIABA calls upon FINRA to:

  1. Ensure that all complaints, arbitration awards, and settlements are promptly and accurately recorded in a broker’s and/or firm’s CRD record(s);
  2. Ensure that the data disclosed via BrokerCheck is, at a minimum, congruous with the most liberal state sunshine law;
  3. Include in BrokerCheck reports data concerning whether arbitration awards or settlements were actually paid;
  4. Add statistical information on the BrokerCheck home page to allow an investor to put an individual BrokerCheck report into context (e.g., include statistics showing the total number of registered brokers in the industry and the total number in the industry with one, two, three, four, or more investor complaints on their record);
  5. Open the entire BrokerCheck database to the public (e.g., academics and other third parties) to allow deep data analysis and development of quantitative and qualitative reports concerning brokers and brokers’ co-workers.

If FINRA fails to act, Congress should step to require more complete and transparent disclosure through BrokerCheck, according to PIABA.

September was Positive for the Investment Funds Market

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According to Otto Christian Kober, Global Head of Methodology at Thomson Reuters Lipper, assets under management in the global collective investment funds market grew US$167.6 billion (+0.5%) for September and stood at US$37.40 trillion at the end of the month. Estimated net outflows accounted for US$7.3 billion, while US$174.9 billion was added because of the positively performing markets. On a year-to-date basis assets increased US$2.43 trillion (+6.9%). Included in the overall year-to-date asset change figure were US$306.9 billion of estimated net inflows. Compared to a year ago, assets increased a considerable US$3.44 trillion (+10.1%). Included in the overall one-year asset change figure were US$664.8 billion of estimated net inflows. The average overall return in U.S.-dollar terms was a positive 0.7% at the end of the reporting month, outperforming the 36-month moving average return by 0.6 percentage point.

Most of the net new money for September was attracted by bond funds, accounting for US$37.9 billion, followed by mixed-asset funds and real estate funds, at US$6.8 billion and US$0.8 billion of net inflows, respectively. Money market funds, at negative US$46.7 billion, were at the bottom of the table for September, bettered by alternatives funds and equity funds, at US$2.9 billion and US$2.6 billion of net outflows, respectively. All asset types posted positive returns for the month, with commodity funds at 2.4%, followed by “other” funds and real estate funds, with 1.8% and 0.9% returns on average. The best performing funds for the month were commodity funds at 2.4%, followed by “other” funds and real estate funds, with 1.8% and 0.9% returns on average. Money market funds, at positive 0.3%, bottom-performed, bettered by mixed-asset funds and alternatives funds, with positive 0.5% and positive 0.6%, respectively.

Most of the net new money for the year to date was attracted by bond funds, accounting for US$409.9 billion, followed by commodity funds and “other” funds, with US$26.9 billion and US$5.5 billion of net inflows, respectively. Equity funds, at negative US$92.5 billion, were at the bottom of the table for the year to date, bettered by alternatives funds and money market funds, with US$23.6 billion of net outflows and US$20.5 billion of net outflows, respectively. All asset types posted positive returns for the month, with commodity funds at 11.9%, followed by “other” funds and bond funds, with 7.9% and 7.8% returns on average. Money market funds, at positive 2.0%, bottom-performed, bettered by alternatives funds and real estate funds, at positive 2.0% and positive 6.3%, respectively.

Most of the net new money for the one-year period was attracted by bond funds, accounting for US$420.4 billion, followed by money market funds and commodity funds, with US$219.9 billion and US$24.9 billion of net inflows, respectively. Alternatives funds, at negative US$34.8 billion, were at the bottom of the table for the one-year period, bettered by “other” funds and real estate funds, with US$0.6 billion and US$5.3 billion of net inflows, respectively. All asset types posted positive returns for the one-year period, with equity funds at 10.8%, followed by “other” funds and mixed-asset funds, with 10.5% and 8.5% returns on average. The best performing funds for the one-year period were equity funds at 10.8%, followed by “other” funds and mixed-asset funds, with 10.5% and 8.5% returns on average. Money market funds, at positive 1%, bottom-performed, bettered by alternatives funds and commodity funds, at positive 1.3% and positive 2.6%, respectively.

Looking at Lipper’s fund classifications for September, most of the net new money flows went into Bond USD Medium Term (+US$7.8 billion), followed by Equity Japan and Equity Emerging Mkts Global (+US$6.5 billion and +US$5.8 billion). The largest net outflows took place for Money Market USD, at negative US$32.9 billion, bettered by Money Market KRW and Equity US, at negative US$10.7 billion and negative US$8.7 billion, respectively.

Looking at Lipper’s fund classifications for the year to date, most of the net new money flows went into Bond USD Medium Term (+US$98.4 billion), followed by Bond USD Municipal and Money Market GBP (+US$46.4 billion and +US$43 billion). The largest net outflows took place for Equity US, at negative US$64.2 billion, bettered by Equity Europe and Mixed Asset CNY Flexible, at negative US$48 billion and negative US$47.7 billion, respectively.

Looking at Lipper’s fund classifications for the one-year period, most of the net new money flows went into Bond USD Medium Term (+US$112.8 billion), followed by Money Market USD and Money Market CNY (+US$78.5 billion and +US$68.2 billion). The largest net outflows took place for Equity US, at negative US$55.2 billion, bettered by Mixed Asset CNY Flexible and Equity Europe, at negative US$33.4 billion and negative US$33.0 billion, respectively.

Scarier than Halloween, at Least for the Markets…

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According to Anthony Doyle, Investment Director at M&G Retail Fixed Interest team, the financial world is a scary place. Debt, disinflation and deteriorating growth have plagued investors over the past year, plunging bond yields into negative territory in a number of countries. Perhaps most frighteningly, it is now eight years since the financial crisis and central banks in the developed world continue to employ an ultra-easy monetary policy stance. With government bond markets currently resembling a freak show at an extended point in the economic cycle, one may think that the next global recession could be around the corner. There is no need to watch scary movies this Halloween, as the following makes for some frightening reading.

Owning government bonds is a scary thing to do.

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Developed market government bonds have been one of the best performing asset classes in 2016, confounding many predictions at the start of the year. In general, the right trade has been to own long duration assets, indeed the longer the better. Year after year investors predict that bond yields will rise and year after year bond yields make new lows. Of course, there are some very good reasons to expect this trend continue.

However, bond markets now expect that monetary policy normalisation won’t occur until some point in the distant future. Low inflation means that central banks continue to support their heavily indebted and ailing economies, resulting in almost $10 trillion worth of developed market government bonds trading with a negative yield. As a result, many companies – including banks – are struggling in this low (and negative) interest rate world. These companies are finding their existing business models challenged in an environment of low growth and tighter regulation. Pressures in the financial system are building, and it is unclear how these issues will be resolved.

Central banks are fearless. They own a lot of the bond market.

 

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Central banks sizable purchases in government bond markets through quantitative easing means that term premiums (the extra amount that investors demand for lending at longer maturities) have been pushed further into negative territory. It was once inconceivable that investors would pay for the privilege of lending to a government. Now this phenomenon is commonplace not only in government bond markets but also for some recent corporate bond issuance.

It isn’t only central banks that are at the bond buying party. Demand continues to increase for long duration assets, from other large institutions like pension funds and insurance companies. The combination of central banks, pension funds and insurance companies has limited any sell-off in bond markets, reducing yields across the bond curve. Aging demographics means that safe haven assets may continue to remain in demand, forcing investors into riskier assets if they want to generate a positive real return.

If inflation rises, or interest rates go up, look out below.

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Despite the negative yield environment we now find ourselves in, how central banks react to the next inflationary shock will have huge ramifications for bond inventors. With global bond portfolio duration close to 7 years, investors could face large capital losses if rates were to increase in a meaningful way. This raises a number of important questions. Will central banks hike rates in an environment of stagflation? How will politicians react when the paper losses on QE bought portfolios held at central banks are reported in the media? Could central bank independence come under threat? As many banks and insurance companies own long dated assets, will financial instability increase when long-dated bonds experience large capital losses?

Currently, the market is more focused on secular stagnation than inflationary concerns, but with oil up almost 100% from the February lows and trade protectionism starting to begin to carry favour in government buildings around the world, a global inflation shock might be closer than many currently expect.

Political risks in emerging markets could lead to forced selling.

 

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Several emerging market sovereigns have been downgraded over the course of the past year, with ratings agencies highlighting political uncertainty as a major factor in the decision. The impact of the downgrade has been felt immediately, with heightened volatility in bond markets the result.

Large inflows into emerging market bond markets has left some countries vulnerable to increased political risks from abroad. Mexico is a good example given the current uncertainty surrounding the U.S. presidential election. Many emerging markets are also vulnerable should the US dollar strengthen, a possibility given the U.S. FOMC is by far and away the closest of any of the major central banks to hiking interest rates. An additional risk is the possibility of a large emerging market nation being downgraded from investment grade status, causing forced selling of hard currency debt by foreign investors.

China faces a huge debt overhang. Be afraid.

 

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The most dangerous four words in finance are “this time is different”. And when it comes to credit booms, they don’t tend to end well.

One measure economists look at determine excess credit growth is a country’s credit overhang. This measures the difference between the credit-to-GDP ratio and its long-term trend. It has proven to be a reliable indicator, with the Bank of International Settlements stating that “in the past, two-thirds of all readings above this threshold (of 10) were followed by serious banking strains in the subsequent three years”. China’s credit-to-gross domestic product “gap” now stands at 30.1 percent, the highest for the nation in data stretching back to 1995, suggesting the banking system could already be coming under severe pressure.

“Numerous warning signs are flashing amber or red in the Chinese financial system, given that huge swatches of renminbi have gone into financing large-scale real estate projects and new production capacity for industrial sectors of the economy. This toxic combination of high and rising debt in a slowing economy tends to lead to an economic deterioration. As authorities continue to chase economic growth, capital is funnelled into unprofitable projects and overcapacity. Eventually, prices begin to fall and borrowers face large capital losses. Additionally, much of the finance available for investment projects was made available through the shadow banking system, which is more susceptible to a sudden stop in capital flows and a run on deposits.” He concludes.

OppenheimerFunds Launches an International Growth and Income Fund

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OppenheimerFunds, launched the Oppenheimer International Growth and Income Fund (Ticker: OIMAX). The fund is managed by Robert Dunphy, co-portfolio manager of Oppenheimer International Growth Fund, who joined the firm in 2004.

“We’re delighted to build on the success of our Oppenheimer International Growth Fund which celebrated its 20th anniversary earlier this year,” said Krishna Memani, Chief Investment Officer of OppenheimerFunds. “The fund seeks to expand on the success factors of the Oppenheimer International Growth Fund to investors looking for income in addition to long-term capital appreciation.”

The Oppenheimer International Growth and Income Fund will seek total return by investing in cash generative, dividend paying companies that may benefit from long-term secular growth trends. “Long-term investing must involve a disciplined investment process and the ability to look beyond index compositions or fleeting trends,” said George Evans, CIO, Equities, and Portfolio Manager Oppenheimer International Growth Fund. “Our strategy for this fund aims to do exactly that, to ascertain the true growth potential of companies.”

“Our investors want access to international companies that have structurally sustainable growth advantage, ignoring index biases,” commented Kamal Bhatia, Head of Investment Products and Solutions, OppenheimerFunds. “Designing products that can simultaneously participate in shareholder friendly income satisfies multiple client needs.”

OppenheimerFunds, a leader in global asset management, is dedicated to providing solutions for its partners and end investors. OppenheimerFunds, including its subsidiaries, manages more than $222 billion in assets for over 13 million shareholder accounts, including sub-accounts, as of September 30, 2016.

Managing Political Risk in Investment Portfolios

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What should investors expect in the forthcoming months in terms of political agenda? Is the European Union in the eye of the storm, with countries such as Italy currently under the scrutiny of markets, or is it the US, where the outcome of the presidential election will decide whether the country will enjoy a fiscal stimulus or not? According to Unigestion, rising income inequality and the drop in GDP per capita in the Western world help explain the behaviour of voters. How should investors hedge their portfolios against this political risk? Most of these factors are potential sources of volatility, but what if a genuinely anti-market leader comes into power in a large Western economy? 

Political risk is everywhere these days: just look at the Brexit headlines, the US election debates and the drama around Brazilian President Rousseff. The resurgence of political risks is probably a result of a turnaround in the perception of what globalisation does to the world. Globalisation has been a rising trend since the end of World War II and it has accelerated since China joined the World Trade Organisation (WTO) in 2000. It has been an economic game changer: China experienced double-digit GDP growth at a time when Western economies had entered a period of structurally slower growth. The public is now showing signs of frustration regarding this phenomenon: what seemed a necessary evil, greasing the wheels of the world economy, is now perceived as a “rip-off”, as Donald Trump put it during his first debate with his Democrat opponent, Hillary Clinton. Beyond the theoretical debate around free trade, the perceived loss of economic sovereignty in the developed world is fuelling the rise of anti-establishment parties. The Brexit vote was the first crystallisation of this anti-establishment sentiment, and this anti-establishment theme will play a significant role during the heavily loaded political agenda in the remainder of 2016 and into 2017. We think political risk – the rise of political parties challenging the 20th century’s economic solutions – needs to be cautiously monitored as it is likely to be a factor in the performance of many investments. 

Since many Trump fans are unlikely to openly admit to pollsters that they will vote for him, his real popularity is probably higher than the opinion polls suggest. Political uncertainty is therefore challenging for markets not because it brings about change but because that change is often preceded by a period of uncertainty. When listing potential hedges against political risks, investors typically think of gold, forex, equity volatility, bonds and the US dollar. 

On average, implied volatilities display a tent-shaped pattern around US elections, rising in the month preceding elections along with the build-up in expectations and then falling quickly thereafter as the event becomes “priced in” or passes. A long position in volatilities therefore would work as a shock absorber to any risk-oriented portfolio. Safe- haven assets offered little protection on average. In the case of gold, it actually shows a reverse tent shape, posting negative returns ahead of and after elections: volatility seems the best potential hedge for such short-lived episodes.

“Political risk is on the rise, yet markets show little sign of pricing this in. There are fundamentals explaining its rise, and most of them will remain with us for an extended period of time: globalisation, lower standards of living and limited government leeway to change these fundamentals, fuelling popular frustrations. The US elections and later the Italian referendum are the next two events that investors should follow cautiously, especially as next year will feature potential anti-establishment votes. We recommend using forex and equity volatility to hedge this risk as these are the assets that show the strongest connection to such episodes of heightened volatility and the drying up of liquidity. The only caveat is that these approaches ought to work provided the political risk creates only short-term shocks, and not a longer-lasting blow to markets.” They conclude.

S&P Global Names Maria R. Morris to Board of Directors

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S&P Global announced that its Board of Directors has elected Maria R. Morris to its Board, effective immediately.

Morris is Executive Vice President of MetLife, Inc., responsible for the company’s Global Employee Benefits business, and is interim head of MetLife’s U.S. business. As head of Global Employee Benefits, she is responsible for expanding the business in more than 40 countries through local solutions, partnerships with multinational corporations and distribution relationships with financial institutions.

“Maria has demonstrated exceptional business leadership at MetLife,” said Charles E. “Ed” Haldeman, Jr., Chairman of S&P Global. “Her business and financial acumen and understanding of international markets further strengthen our talented Board of Directors.”

“We are delighted Maria is joining our Board and look forward to benefiting from her deep operational experience managing large, global enterprises,” said Douglas L. Peterson, President and Chief Executive Officer of S&P Global.

Morris joined MetLife in 1984, holding a number of senior leadership roles. She has served as interim Chief Marketing Officer, Head of Global Technology and Operations, Executive Vice President for Employee Benefits Sales; Vice President and head of MetLife’s Group and Individual Disability businesses, and head of the Dental business.

Morris serves on the Boards of Directors of MetLife Property and Casualty Insurance Company, the MetLife Foundation and the American Council of Life Insurers.  She is also a member of the Board of Trustees for the Catholic Charities Archdiocese of New York and is Vice Chair of the All Stars Project, Inc.

The addition of Morris brings the number of S&P Global Directors to 12. Morris’ nomination follows the appointments of Rebecca Jacoby in 2014 and Monique Leroux last month. These women are leaders with critical experience in finance, investing, technology and global business operations.  Their appointments underscore the Company’s commitment to inviting diverse backgrounds, perspectives, skills and experience into the Board room to guide the growth and performance of S&P Global.

Deutsche Bank is Looking to Sell its Banking and Securities Subsidiaries in Mexico to InvestaBank

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Deutsche Bank vende sus filiales mexicanas al banco de crédito InvestaBank
CC-BY-SA-2.0, FlickrPhoto: Tony Webster. Deutsche Bank is Looking to Sell its Banking and Securities Subsidiaries in Mexico to InvestaBank

Deutsche Bank has entered into an agreement to sell its Banking and Securities subsidiaries in Mexico to InvestaBank, Institución de Banca. Deutsche Bank will centralize its Mexican Global Markets and Corporate & Investment Banking coverage function in its global hubs.

“Only two months after announcing the sale of our Argentina subsidiary, we are pleased to mark another major milestone in simplifying our bank by selling our subsidiaries in Mexico as part of Strategy 2020,” said Karl von Rohr, Chief Administrative Officer at Deutsche Bank. “We will work in partnership with our clients, regulators, employees and other stakeholders to ensure a smooth transition to the new arrangements.”

The bank is committed to serving its governmental, corporate and institutional clients in Mexico from global hubs and will continue to offer these clients the full range of investment banking products. As of 2015, Deutsche Bank had 131 employees in Mexico.

The transaction, which is part of the bank’s Strategy 2020 plan to rationalize its global footprint, is expected to close in 2017, subject to regulatory approvals and other customary conditions. Terms of the transaction were not disclosed.

Where Can You Find the Wealthiest Individuals in the World?

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Estados Unidos repite como país con más riqueza privada del mundo mientras Mónaco lidera la renta per cápita mundial
CC-BY-SA-2.0, FlickrPhoto: Kurt Bauschardt . Where Can You Find the Wealthiest Individuals in the World?

According to New World Wealth’s latest study, the United Stated is the wealthiest country in the world, followed by China and Japan. For them, total individual wealth refers to the private wealth held by all the individuals in each country. This includes all their assets (property, cash, equities, business interests) less any liabilities. Though they exclude government funds from their figures.

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One thing to note is that Australia only has 22 million people living there, making its 9th place quite impressive. New World Wealth also highlighted that China was the fastest growing W10 country over the past 15 years (in terms of US$ wealth growth).

Besides the richest countries by total assets, the firm also ranked countries by per capita wealth. The wealthiest people in the world are found in Monaco, Liechtenstein and Switzerland.

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Only Australia, the United States and the UK showed up in both lists.

 

Wine Investment Fund Posts 32.2% Four-Year Net Return

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The Malta-domiciled Wine Source Fund, investing in a diversified portfolio of international fine wines and spirits, has recorded a net return of 32.2% since its inception four years ago (as at 31 August 2016).

The fund, also registered under the Alternative Investment Fund Manager’s directive of the European Union has outperformed wines and spirits’ industry benchmarks. The Liv-ex 100 and the Liv-ex 1000 indices have reported cumulative net returns of 7% and 15.6% respectively over the same period.

The Wine Source Fund’s portfolio currently comprises more than 1,000 different wines and spirits from the world’s top producers, primarily located in France, Italy, Spain and the US. Over half of the fund’s investments are made in Bordeaux and Burgundy wines while spirits account for almost 10% of the portfolio. Also the Wine Source Fund holds Macallan Lalique bottlings of aged whisky.

About 40% of the portfolio is made up of assets purchased directly from producers at preferential prices, hence differentiating from competitors according to the managers of the fund.

The value of the wines appreciates monthly at a fixed rate and the fund sells them at the cumulative index price to fine dining establishments around the world through its affiliate, Wine Source Group.

Philippe Kalmbach, CEO of wine services provider Wine Source Group and co-manager of the Wine Source Fund, said: “The fund’s performance highlights how we have a unique head start in identifying investment opportunities through our daily dealings with producers and international fine dining establishments. These first-hand market insights led us to fine tune our strategy by investing in select markets and benefiting from favorable price dynamics in an overall quite challenging environment.”

The Eagerly-Awaited Tax Bill Has Been Submitted to Colombian Congress… Finally

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Credicorp Capital’s, Daniel Valendia, Director of Research and Chief Economist, together with Camilo Andres Durán, Macro and Credit Analyst evaluate the consequences of the eagerly-awaited tax reform in Colombia.   

The Minister of Finance, Mauricio Cárdenas, finally submitted the long-awaited tax bill to Congress. According to the government, the proposal indeed represents a structural tax reform as it incorporates modifications to tariffs of direct and indirect taxes, the widening of tax bases for both corporates and individuals, measures to fight evasion and avoidance, and actions to simplify the tax code.

Therefore, according to the MoF, the submitted tax bill aims not only to raise new, fresh revenues to fill the fiscal gap created by the sharp drop in oil prices, but also improve the quality of the Colombian tax system in order to foster investment and formal employment. 

The tax bill came broadly in line with the overall proposal presented to the government by the Tax Experts Commission ten months ago as the main recommended changes were addressed (particularly the increase in VAT from 16% to 19% and the cut of the corporate tax to 32%), which is favorable, in their view. Likewise, some points of the reform would be implemented gradually (i.e. in several years), which is consistent with the fiscal rule and their long-held view.

The government expects the proposed bill to increase tax collection by 2.7% of GDP by 2022, above their estimate of 2.0% of GDP.

In any case, Credicorp Capital continues to acknowledge that the risk of dilution remains non-negligible after the ‘no’ victory in the peace deal’s plebiscite. Having said that, Valendia and Durán maintain the hypothesis that political incentives remain aligned for the approval of a tax reform: i) the 2017 budget, which excludes fresh revenues from a tax reform, represents no growth in real terms with investment falling 10%; thus, a tax reform would allow to introduce budget additions, which should be in the interest of Congressman; ii) considering that presidential elections will be held in May-18, political parties including those favored by the plebiscite’s results (e.g. Centro Democrático) will likely prefer to have the fiscal (big) issue solved by then.

In addition, Credicorp Capital believes that the tax bill submitted to Congress already incorporates the possibility of some dilution, providing the government room to negotiate with all political forces. Credicorp Capital would expect the current sovereign rating of BBB to be held should the size of a potential dilution not be significant.

The proposed tax bill would affect both their current 2017 GDP growth and inflation forecasts (2.7% and 3.8%, respectively) mainly as a result of the VAT increase while improving economic prospects in the longer term through higher competitiveness. Likewise, it could impact their current call for a rate cut cycle by the BanRep starting in December 2016 – first quarter 2017 to some extent, although maybe not material as the effect on inflation is a one-off. Credicorp Capital will estimate the potential effect of the proposed changes on macro variables and valuation models for Colombian equity issuers, and provide the results in upcoming reports. Undoubtedly, the debate in Congress and potential modifications to the bill will be relevant for the results:

The size of the reform. The proposed tax bill aims to increase tax collection by 2.7% of GDP by 2022 while additional resources for 0.6% of GDP from higher formalization would be also expected, so that total fresh revenues could amount about 3.3% of GDP by that year. For 2017, the increase in tax collection would be close to 0.8% of GDP, in line with the required decrease in fiscal deficit by 0.6% of GDP according to the fiscal rule.

VAT from 16% to 19% from 2017 onwards. The tax bill proposes to increase the VAT tax by 3pp to 19% as soon as in 2017, in line with the recommendations of the Experts Commission. Credicorp Capital expected a gradual implementation to avoid a material impact on both inflation and private consumption. That said, Credicorp Capital thinks that this decision was made considering that basic products such as food and education will continue to be excluded/exempted vs. a low but positive tariff proposed by the Commission (5%). In any case, Credicorp Capital does not rule out that a gradual implementation in the VAT hike may be the result after the debate in Congress. In that sense, the final one-time impact on 2017 inflation can be much lower than thought at first glance; likewise, the government estimates that the impact on the 2017 GDP will come primarily from lower private consumption growth by 0.3pp vs. the scenario without tax reform.

New home sales. The sale of new housing units exceeding COP 797 million will have a 5% VAT rate. At the same time, the government stressed that the social interest housing programs for low income individuals will not have any VAT.

Corporate taxes. Under the proposed tax reform, the corporate tax structure in Colombia will be simplified as there will be just one enacted tax compared to four different schemes under the current regime. In that sense, the wealth tax will disappear by 2018 as originally planned. Major firms (i.e. those with a net income above COP 800 million) will have a corporate tax rate of 34% in 2017 with a surcharge of 5% for a total rate of 39%. The corporate tax rate for 2018 will placed at 33% with a surcharge of 3% for a total rate of 36%. Finally, the corporate tax rate from 2019 onwards is expected to decline towards 32%. Recall that under the previous tax reform, the corporate tax rate for 2017 and 2018 was placed at 42% and 43%, respectively. Last but not least, the new tax reform considers an exemption of VAT tax on capital goods; in other words, companies will have a tax benefit for investing in new technologies, machines, and the overall expansion of the business.

The government also plans to foster job creation. The new tax reform sets a decline of the employer’s contribution towards health and pensions for those with a salary above 10 times the monthly minimum wage. The government’s total goal in terms of formal employment with the reform is the creation of 255,000 jobs.

Tax on dividends. The tax bill includes this provision as it was expected. Accordingly, local individuals will be charged (starting in 2017) with a tax rate of 5% if dividends reach between COP 17.8 million and COP 29.7 million per year, while the rate may increase towards 10% should dividends exceed COP 29.7 million. Meanwhile, the tax on dividends for foreign investors will be placed at 10%. Importantly, local firms will not be subject to the tax on dividends.

Income tax for individuals. The structure will be simplified through maintaining only one system (ordinary rent) vs. three currently (ordinary rent, IMAS and IMAN). As expected, the tax base would be increased for individuals, so that the income tax will be paid for those earning above COP 2.7 million per month vs. COP 3.5 million currently from 2018 onwards. Likewise, the cap to exemptions for individuals will be 35% of the total income with a maximum amount of COP 104 million. Overall, the reform aims to make the system more progressive.

Evasion. Among other measures, the tax bill proposes imprisonment between 48 to 108 months for those omitting assets or declaring non-existent liabilities above COP 5 bn and a penalty equivalent to 20% of the value of the non-declared asset or non-existent liability. Likewise, more inspectors will be hired in DIAN.

Financial transaction tax (4×1000). As broadly expected and in line with the Experts Commission recommendation, the 4×1000 tax will be permanent.

The non-profit organizations regime (ESAL). This measure aims to reduce tax evasion and avoidance through the use of this scheme, and to control the proper fulfillment of the social function of such organizations. Currently, non-profit organizations operate under a special tax regime. This regime will remain ahead, although a stricter classification and verification of such entities will be implemented. In particular, the DIAN will oversight non-profit organizations and the compliance of the requirements to remain under the special tax regime.  The government will create an information system in which non-profit entities should declare their organization charts, payments to executives, donations, investment programs, current and future projects, among others. Any direct or indirect distribution of income to shareholders or founders of these entities would be prohibited due to their non-profit status.

Monotax (Monotributo). It aims to formalize the small retailers and to simplify the transaction process of their tax dues. Retailers could choose between this new regime and the current income tax, as the Monotax does not imply an additional charge. The MoF declared that the main target of this tax is to create benefits to small retailers rather than to collect high additional revenues for the government. Formalization would allow small retailers to have access to the financial system, and a better social security.    

Sugar-sweetened beverages and cigarettes additional tax. The cigarettes’ price in Colombia is among the lowest in the world; the target is to converge towards the region’s average. Thus, the specific tax on cigarettes will triple in 2017, and will be indexed to inflation (inflation + 4%) from 2018 onwards. Moreover, the sugar-sweetened charge will be COP 300 per liter. Those taxes add to the VAT in each case. 

The eagerly-awaited reduction of the TES withholding tax for foreigners was not included in the tax bill, contrary to expectations. Credicorp Capital believes that this was mainly due to concerns regarding financial stability, as foreigners’ share on the TES COP market has increased from 24.7% in February 2016 to 32.8% currently. Thus, the withholding tax would remain at 14%.