Ségolène Royal: entre Jeanne d’Arc et François Mitterrand

A l’occasion des primaires présidentielles du Parti socialiste, les médias tant français qu’étrangers ont pris la juste mesure du phénomène Ségolène Royal. D’ores et déjà, elle est sûre d’être présente au second tour de l’élection présidentielle en 2007 et beaucoup d’observateurs la donne comme favorite face à Nicolas Sarkozy. Ce n’est pas seulement le résultat des primaires qui impressionne - Mme Royale fut élue au premier tour avec une majorité sans appel de plus de 60% des voix, mais aussi la manière dont elle a investi le Parti Socialiste. Son approche fut davantage celle d’un raider, qui prend le contrôle d’une entreprise, que celle d’un politicien classique, respectueux des usages et des dosages.

En dehors de pays scandinaves, les femmes politiques sont suffisamment rares pour l’autre. Inévitablement, Ségolène Royal sera comparée à Mme Thatcher, Angela Merkel ou Hilary Clinton. De telles comparaisons mettent davantage en évidence les différences que les similitudes. Madame Royale n’a pas l’ardeur idéologique et réformatrice qui habitait Margaret Thatcher. Elle joue de sa féminité et de son expérience familiale d’une manière qu’Angela Merkel ne pourra jamais émuler. Son profil semble le plus proche de celui d’Hilary Clinton, dont elle partage la discipline du comportement, une démarche politique basée sur l’enracinement local et les interrogations sur le rôle effectif de son conjoint (partenaire dans le cas de Mme Royal).

Toutefois, pour ma part je pense que les véritables références de Ségolène Royal sont en France et se situent d’une part dans l’histoire et, d’autre part, dans la pratique politique récente. La référence historique est celle de Jeanne d’Arc, la référence politique, celle de François Mitterrand.

On observant et en écoutant Mme Royal on ne peut qu’être frappé par son allure. Souvent habillée en blanc, elle parait animée d’une foi quasi-mystique en sa capacité de communion avec ses électeurs. Bien entendu, elle ne le dit pas, mais tout dans son comportement suggère un sens de la vocation et d’une destinée. Elle fait le don de sa personne à la France.

De François Mitterrand, elle a appris le sens de la manœuvre, la nécessité de la distance par rapport à son entourage, l’art de gérer les relais politiques et celui d’une communication ambigüe.

Bien mieux que ses concurrents socialistes, elle a compris le rôle déterminant de la personnalité dans l’élection présidentielle et a construit le sien sur mesure. Plus encore que les élections précédentes, celle de 2007 se jouera sur les impressions et les détails humains plutôt que sur les programmes économiques et sociaux. Et la tâche de Nicolas Sarkozy s’annonce délicate : il ne réussira que s’il arrive a déstabiliser son adversaire sans apparaître trop agressif.

Nymex IPO: not another bubble

What a week for publicly listed financial markets. On Tuesday and Wednesday, November 14 &15, European exchanges, which had been outperforming the broader market for months, fell substantially: Euronext by 8.9%; Deutsche Börse by 6.25%, and LSE, by 5.7%. The immediate catalyst for the fall was the announcement by seven international banks that they plan to set up a competitor to the European exchanges (see our blog dated November 17 below). Many analysts interpreted as the end of exchanges’ bull ride.

And then, on Friday, Nymex went public in a most spectacular IPO of 2006. On the first day of trading it gained 125%, the biggest daily increase in an IPO since 2000. Its market capitalisation stands at $11.59. Some analysts, Jim Kramer for instance, consider this price excessive, compared say to NYSE, which has a market cap of 14 billion. It also has a (much) slower growth, lower operating margin and more precarious competitive position. A better comparison is with Intercontinental Exchange (ICE), which owns the only competitor to Nymex, International Petroleum Exchange (IPE). However, Nymex has a market share of over 60% market share in energy futures, its revenue are double that of ICE. And its market cap is slightly under 200% of ICE’s market cap ($5.9 billion). So, in relative terms, compared to its peers, and in light of its growth prospects, NMX is not overpriced. However, as many observers noted, the IPO process was completely botched, crowding out retail investors and forcing selling shareholders to leave substantial money on the table. Underwriters, who represented a cream of Wall Street did not cover themselves with glory.

In this week issue of Barron’s, Andrew Bary asserts that exchange stocks are the new Internet stocks. I think the argument is overdone for the following reasons:

• All listed exchanges have good track records and are profitable. Moreover, many of them generate substantial cash

• The exchange play is a consolidation play and there is no reason to believe that the consolidation will not continue. Indeed it barely started. And so far, announced deals (CME-CBOT, NYSE – Euronext) make both strategic and financial sense

• The relative ranking of valuation is rational, with derivatives valued more highly than cash markets and bigger markets worth more than smaller markets. The discrepancy between multiples of US and EU exchanges (a weighted P/E for the former is over 40 and for the later is 25) is less justified (and based on broader historical precedents, which may not apply in this case) but it creates arbitrage opportunities.

MGM trading platform project

Emergence of financial exchanges as a major player in financial services has been a major if not always expected aspects of financial sector evolution of the last twenty years. Since the late 1990s, it became quite clear that their relationships with their erstwhile shareholders in particular global investment and commercial banks were getting more complex and many of banks saw exchanges as potential competitors. In a paper written in July 2003 for the European Federation of the Stock Exchanges and published by the European Capital Markets Institute, I wrote:

“While their [exchanges] official communication stress the competition among exchanges (Euronext vs. LSE vs. DBAG), it is becoming more evident every day that the economic dynamics create a growing rivalry between exchanges and their major users, banks and securities brokers and dealers.”

Since then, all major US exchanges went public, reaching higher relative and absolute valuations than their European counterparts, while the latter continue to (far) perform their national indices and the rest of the financial sector.

So the announcement by seven global investment banks (Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS, often referred to as MGM), made on November 14 that they are going to set up a common trading platform, which will openly compete with the exchange, is not really surprising. The only question is: Why it took them so long?

And the answer: because they know how difficult and risky the trading platform project is likely to be. Its chances of success have to be rated below par. If they were raising public funds for this project, the risk factors section in the prospectus: would have longer than the usual and contain at the minimum the following:

• Speed of implementation (time to market): The project will not go live before at least a year (and this estimate is may be overly optimistic). In the meantime, its competitors, whether existing exchanges or other ECNs , will have plenty of time to adjust their technology and their offering

• Project scope: the project is presented as direct competitor to existing exchanges (equities and equities derivatives) rather a platform for trading new instruments or new combinations of instruments, where the competition is likely to less intense

• Choice of technology supplier: In order to reduce time to market, the project could choose an existing system, including ones, which are sold by exchanges. This however would reduce the competitive edge of the project. On the other, the choice of an innovative technology will require higher costs and entail higher risks.

• Open or proprietary access standards: Will the platform use open access standards, making it easy to join but also easy to leave or closed access standards, which would be proprietary and make exit from the system more difficult

• Willingness of non-consortium banks to use the system: will other banks, which have not been invited to join the project, be willing to use the platform to provide liquidity in not an obvious challenge and odds of its success are not necessarily very good.

• Attitude of other sources of liquidity and order flow: How would other sources of liquidity, both institutional and retail, asset managers, hedge funds or online brokers, react to the new platform? Will they see as an useful alternative to existing platforms or an attempt by large players to preserve their power

• Competitive response of exchanges: Existing exchanges, whether cash or derivatives, are unlikely to remain passive. They have a wide range of potential responses. The most obvious one is to adjust their tariffs. They can also accelerate the deployment of new trading platforms and accompanying facilities. But their response can be more disruptive. Several exchanges are considering opening direct access to trading, via Internet, to final investors. This would reduce the order flow of major intermediaries.

• Regulatory uncertainty: The new platform would operate under the regulatory regime of Multilateral Trading Facilities, which offer less stringent legal requirements than the full-fledged exchanges. MTFs were seen a way for exchanges to deploy more flexible solutions. Will regulatory authorities in the UK and in Brussels accept the proposed legal framework for the platform or will they query it, in response to probable intense lobbying of exchanges and their allies.

• Co-operative curse: Co-operative projects are notoriously difficult to implement (not only in banking but also in telecommunication, software or e-commerce) as the overall project speed implementation needs to be adapted to the slower and less nimble participants. Furthermore, participants are often reluctant to put their best people and most advanced technology at the disposal of the project.

• Internal strategy conflicts: Project participant banks are very large institutions, which use a variety of trading platforms in order to serve the diversified demand both from their clients but also from various internal departments. Their top management has been historically reticent to reduce this variety and prefer to tolerate internal conflicts, particularly in a fast moving and uncertain environment. Therefore, the extent of use of the platform by the founding members cannot be guaranteed and in any case, the platform is unlikely to capture the dominant share of the order flow.

In addition to those risk factors, one needs to consider the past experience, which further reinforces scepticism concerning the chances of success of the project. While ECNs have been quite successful in the United States, with Archipelago becoming a merger partner of NYSE, and Brut and Inet acquired by NASDAQ. In Europe, alternative equity trading attempts have been unsuccessful in taking market share from the existing exchanges.

One can also consider the example of what is arguably the most successful co-operative trading project, EBS, which was founded by very much the same group of banks as the proposed trading platform, and which quickly became the market leader in spot foreign exchange trading:

• It took three years to design and implement the EBS trading platform
• Participating banks were by far the dominant players in interbank foreign exchange trading
• There was only one other established player in FX trading, Reuters
• FX is a largely unregulated market
• In 2006, EBS was sold to ICAP, the dominant interdealer market broker for a consideration of $854 million.

In view of all these elements, of which the founding members are as aware as any outside analyst, one should wonder about the rationale for the project. The timing of its announcement suggests that it is intended primarily as a signal to the exchanges, another, but certainly not final, move in a complex co-opetition game between exchanges and their erstwhile shareholders.

From long tail to variegated tails

For close to 200 years, social scientists lived under the tyranny of normal distribution, which focused their attention on most probable outcomes and on the averages, means and medians. We now need to be careful not to commit the same error with the long-tail distribution. Book on this subject, The Long Tail, became a bestseller and a required reading for management consultants and investment analysts. Its author, Chris Anderson, has been promoting the long-tail persistently and intelligently, using all traditional and new media channels at his disposal as editor of Wired. We are firm believers in the pertinence of long-tail. There is however a risk of overselling and overstating the importance of long-tail in the economy and society.

Under a long-term distribution, probability of various events is widely dispersed rather than concentrated: low frequency events represent a larger share of the total than under normal distribution. Thus, in order to understand the future and earn money in e-commerce, one no longer needs to focus exclusively on most probable events or on biggest selling items. The main message of long tail is the increasing variety. This message also applies to statistical distributions itself. Normal distribution will remain dominant, as long as random events dominate all aspects of economic and social interactions. Furthermore, there is more than one family of long-tail distributions. Those discussed by Anderson follow the power law, according to which relative frequency of events is inversely proportional to their size. One example of power law is the frequency of earthquakes: bigger earthquakes happen less frequently than the big ones. The relationship between the two is regular and scale independent. The only parameter that changes is speed at which the frequency decreases. Anderson argues that as the costs of search on the Internet are drastically cut, frequency decreases more slowly. However, while this may be true for purchase of books and records, it is not necessarily true for the ranking of online bookselling and music shops (or search engines for that matter). Such ranking usually follows Zipf or Pareto power law, which reflects oligopolistic concentration, where the biggest firm is twice as big as the second largest, which three times bigger than the third largest, etc. Those laws are also called 20/80, as 20% of firms generate 80% of revenues.

An important characteristic of Anderson distribution is that there is no significant variation in the value of events. If this assumption is relaxed and large variation is allowed, a new type of distribution appears - the so called Gauchy distribution. Under Gauchy, events at the end of tail can take extreme values. Thus Gauchy allows the modelling of low-frequency, high impact events. Airline accidents provide a good example here. These are considerably, very considerably, less frequent than car-driving accidents (official US statistics indicate about one accident for 600 000 flying hours.) Yet, should the accident happen, the chances of survival are much much lower for airline accident than for a car crash. The implication of this fact is that air safety cannot be approached using normal distribution and looking at most probable events (which is no accident). The notion of average has no operational meaning. Airline operators need to focus on extreme cases and plan their safety measures for extremely low probabilities.

Cauchy distribution is significant in financial markets. Fro instance, Cauchy distribution arises when one seeks to compare listed UK and German software companies. If one ignores value, UK software sector appears better performing than the German one: more listed companies in a greater variety of sectors and application. But one cannot ignore the value: the leading German company is SAP and its market cap is close to 50 billion euros, ten times larger than the best-capitalised UK company (Sage plc), and over thirty times larger than the second biggest German company (Software AG).

Thus, while long-tail distribution directs our attention to weak signals, Cauchy distribution demonstrates the non-linearity of low probability events. Both of them (and a normal distribution as well) are necessary to understand the interactions of chance and purposefulness in our complex world.

Stern report: Impressive piece, unlikely to work, not that it matters

Report on global warming by Sir Nicholas Stern, ex-Chief Economist of the World Bank and (of EBRD before that), unveiled on October 29, was greeted by Tony Blair and Gordon Brown, who commissioned the report, as the most significant piece of policy research ever produced by the UK government. From now on, the fight against global warming is to be the “moral imperative” of the UK government, which will embark on a major campaign to enlist active participation of other national governments, including not only the OECD countries but also the emerging giants of India and China.

Stern report is indeed impressive. It brings together complex data from various disciplines to make a strong case that global warming is a man-made phenomenon, caused by excessive carbon gas emissions. It provides a coherent and quantified economic framework which shows the estimated costs of action and inaction. At the same time, it is careful to put the case in the language of probabilities and risk assessment. It is also politically astute, as it argues that a rapid action against global warming is virtually costless.

And yet, for all its heft and persuasiveness, I believe that the odds for the report ever being implemented are long, very long. This belief is based on three considerations:

• Past history of similar initiatives


• The nature of the global warming problem


• The intricacy of proposed solutions

Let’s take those considerations in turn.

It is somewhat ironic that on the very same day Stern report was unveiled, UN agency in charge of monitoring compliance with Kyoto protocol issued its own report. The conclusion of the UN report is that industrialised countries, which all pledged a reduction in emissions, actually increased them. And those who are most sceptical are not the most culpable. Between 2000 and 2004, the US, which has not signed the protocol, had a slower increase in emissions (1.3%) than the members of the EU (2.4%), who did. The executive secretary of the agency, Yvo de Boer, recognised that the “rising trend is worrisome,” before expressing optimism that by 2012, Kyoto targets will be attained. However, according to Mr. de Boer, "This means that industrialized countries will need to intensify their efforts to implement strong [reduction] policies." This is unlikely to be costless.

The non-compliance with Kyoto goals is not an exception in international co-operation efforts. It is more of a rule. “Group of Eight (G-8) summits have a long track record in delivering lofty promises that are swiftly broken, especially to the world’s poorest countries.” This sentence was written not a conservative critic of international aid but by the authors of the UNDP Human Development Report 2005. In the next sentence, they wonder whether the same fate awaits pledges made at Gleneagle July 2005 summit, hosted by Tony Blair and Gordon Brown. Well, according to preliminary assessments of results, it looks like while some progress has been made on funding and deploying health programs, on the issues requiring extended co-operation such as trade or universal primary education, there was either no progress or an actual setback (the collapse of Doha talks).

As for any initiative involving international fiscal co-ordination, the history of EU efforts to introduce such coordination shows how difficult and time consuming it is.

There is no reason to believe that an international co-operation, which would go far beyond Kyoto protocol, would be easier to set up and implement that aid or trade efforts. It is actually likely to be more difficult, given the nature of the problem and the intricacy of the proposed solution.

Global warming is a hard problem. For all assertions of “broad scientific consensus,” the case is far from being entirely convincing and proven beyond doubt. Let’s admit for the sake of argument that the increase in temperature is real, as is the increased concentration of carbon gases. Clearly, the increased concentration is man-made. Yet, those facts do not necessarily form a strong casual link, which inexorably leads to the “consensus” conclusion that global warming is primarily provoked by man-made carbon emissions. There are solid reasons to be agnostic if not outright sceptical about the conclusion:

• We have heard this story before. We can recall three recent cases of global scares, where we were told by people with impeccable credentials that unless urgent action is taken major catastrophe would occur. Lot of money and trees was spent on ozone hole, Y2K computer shutdown and, more recently, avian flu pandemic, before dire forecasts proved wrong.


• Among complex phenomena, whose causality remain mysterious and behaviour largely unpredictable, climate occupies a top rank. Despite huge expense of brainpower, supplemented by the most powerful computers available, we can only make short-term forecasts. Climate patterns are chaotic and subject to huge variations, under the influence of great many factors. Furthermore, those variations are non-linear: greatest fluctuations are not necessarily caused by the most important or visible factors. The long history of climate contains periods of warming and periods of cooling and we are still at loss for explanations. Ice age started and finished without, as far we know, any human interference. Implication of this view of climate change is that we simply do not know how the it will evolve over the next fifty years and your (or my) guess is as good as the output of the most sophisticated climate and weather model. Nor de we know which are the decisive factors influencing the climate pattern.

This scepticism leads to a different interpretation of the principle of precaution, which motivates the call for urgent and wide-ranging global warming action. Why spent vast amount of money for policy measures, which are very risky (particularly in terms of their potential impact on economic growth) for an outcome, which is fundamentally uncertain? In other terms, the lack of vast global warming efforts reflects not a political short-termism and scientific ignorance but a rational economic choice by concerned governments.

If this is the case, then the proposed solutions, which involve the most ambitious efforts of coordination on both national and international levels to date, are unlikely to succeed not because of the political myopia but because, given the calculus of potential risks and losses, many important countries, both in the OECD zone and in the developing world, will have no real incentive to co-operate. What is missing in the Stern report is a game-theory model, which would explore the interplay between conflicting motivations to highlight the probabilities of active co-operation vs. lip-service window dressing. In this respect, global trade talks, where in the end, participants refused to accept short-losses for their side in order to secure global long-term gain, provide an instructive and not very encouraging example.

And, yet even if I am sceptical about the effectiveness of the recommendations of Stern report, I do believe that the gas emission problem is manageable and will be managed. The key to its manageability is the carbon emissions markets, which is already quite active and began to set a price on this commodity. This will led to its more efficient use in the business sector. This may or may not mitigate the global warming but it will lead to market-driven adjustments in economic behaviour of households and firms, and a greater economic resilience. A highly pertinent example here is that of energy. Since the first oil shock in the early 1970s, governments embarked on ambitious efforts to reduce our dependence on fossil fuels. While explicit co-operations proved difficult and the results have been disappointing both in Europe and in the US, which are more dependent today on oil imports than they were 30 years ago, the global economy has developed a remarkable resilience to the energy shocks. Oil price fluctuations we experienced over the last twelve months would have provoked deep economic dislocation, including stagflation, in the past. Yet, this time around, the global economy largely shrugged off price increases and continued to grow.

In a similar way, the global economy should be able to absorb the current effects of global warming, further increase its energy efficiency and reduce gas emissions. As for the future global warming trend, call me an incurable optimist but I do trust the ‘invisible hand’ of nature to prevent the climate variations from going over the cliff.