MARKET WATCH - A BRIGHTER OUTLOOK FOR GLOBAL MARKETS?
By Christopher Bates
Equity markets started 2013 with more than their usual bout of new year enthusiasm, buoyed by an improvement in investor confidence and tentative signs that the global economic landscape may be stabilising.
The latest fund flow data suggests that this year may be the start of a "great rotation" out of bonds into equities, as risk aversion declines and investors focus more closely on the minimal inflation-adjusted returns available on cash and government bonds. The S&P 500 Index finally broke through 1500 for the first time in over five years and three quarters of S&P 500 companies beat analyst forecasts for fourth quarter corporate earnings. However the payroll tax hikes agreed as part of the fiscal cliff deal could prevent a strong resumption of US economic growth. Valuations in many sectors are looking quite stretched, but for the first time in many months this hasn't stopped equity funds from attracting more inflows than bond funds.
Rocky road continues
UK equity markets have made a particularly strong start to the year, despite renewed signs that 2013 is likely to be another tough year for the British economy. Provisional data showed that GDP contracted 0.3% in the final quarter as temporary factors that boosted growth in the summer, faded. Despite a positive rerating in 2012, UK market valuations still compare favourably to many of its developed peers, including the US and Japan. Gilt yields have crept back up to around 2%, but are still low by historical standards. Combined with near zero interest rates at the bank, demand for income is likely to remain a dominant theme this year. Small and midcap companies remain relatively inexpensive, and there are tentative signs that the valuations of cyclical and defensive stocks are starting to converge once more.
Signs of healing
Sentiment towards Europe continues to improve as the economic data for the region, while still poor, shows signs that the European Central Bank's (ECB) actions over the last 12 months have brought a period of relative calm. Many investors believe this paves the way for leaders to get the single currency project back on track. However, negative reaction to the deadlock in the recent Italian general elections is further evidence that markets are likely to remain focused on the political issues facing the region. The ECB released data showing that European banks (278 in total) plan to pay back around €137bn of the €1trn in loans issued through the central banks' LTRO programme. This suggests that the troubled European banking system is beginning to heal and confidence is returning to the interbank lending market. Equity market valuations look attractive on a relative basis and if the evidence of the economy bottoming out persists, it could further improve investor sentiment towards the region.
Expectations running high
Growth of 2% of the Chinese economy in the final quarter meant full year growth in 2012 was 7.9%, beating forecasts and confirming that the economy had bottomed in the third quarter. The measure of success for the new government will be evidence of wealth transferring from the state to households, while keeping potential social unrest to a minimum. Attractive valuations and government reforms to improve access to equity markets by domestic and foreign investors should support Chinese equity markets. In Japan, there are high expectations of Shinzo Abe's Liberal Democratic Party with his pledge of reining in the yen and tackling deflation. So far markets have responded positively, with the yen falling around 15% against the dollar and Japanese equities continuing to rally. The pressure is on to maintain the pace of stimulus and any signs of slippage are likely to produce disappointment in the financial markets.
TO LIST OR NOT TO LIST? - MANY COMPANIES RECOGNISE THE BENEFITS OF AIM BUT ARE HESITATING TO LIST.
By David Mackey
David Mackey looks at some of the current obstacles to listing on AIM.
Tough trading conditions and depressed lending mean that raising finance remains a big issue for many SMEs. Our 2011 AIM survey, as well as anecdotal evidence from clients and advisers, suggests that more and more companies are hesitant about listing on AIM. On the other hand, nearly two-thirds of our survey respondents said an AIM listing was good for their business. It would therefore seem that AIM companies remain confident about the benefits of listing, despite difficult market conditions.
Listing on AIM can significantly raise a company's profile and status, particularly internationally. But a successful listing requires a major commitment and drive to succeed from management.
Reasons for choosing whether or not to list will vary from company to company, but below we highlight three key issues for companies to consider.
Time is money
The timing of a listing can significantly affect the value of funds raised. Many of the factors that determine the success or failure of a listing are outside the control of both the company and its advisers. Strategic planning and market awareness are key to reducing the impact of external factors on raising the necessary target funds.
Investor confidence is notoriously volatile for small-cap companies, resulting in an exponential effect on fundraisings. In the year to December 2012, £3,116m was raised compared to £4,269m during 2011. As the economic outlook is not too dissimilar to a year ago, it would appear that investors are diverting funds away from AIM to secure an investment that carries less risk. Weak investor confidence acts as a disincentive to listing for many companies.
Weighing up the cost
The benefits of being a listed company on an exchange- regulated market are numerous, but seldom without expense. According to the Financial Times, listing fees have soared to 11% of funds raised, compared to just 7% from 2008 to 2010. This represents a significant reduction in the funds available for investment, as well as impacting profitability in the year of listing. It is no surprise that this has made alternative forms of funding more attractive to potential growth entities.
Non-cash costs to the business can also have a negative effect on entities looking to list. The most significant is the public scrutiny that comes with listing. Following a listing the board must be prepared to act for a public company under greater scrutiny by the market and media, and which must now comply with the AIM rules.
While choosing advisers carefully may lead to a reduction in costs, given that investor confidence is low, a key factor in selecting advisers may well be appointing those with a proven track record to increase the probability of success. It is crucial that you find advisers who understand your company and with whom you can have a good working relationship.
Putting a value on success
The success of any listing is measured by the value of the funds raised. An appropriate valuation is vital to raise the funds required by the project and to avoid the potential PR disaster of a failed listing. Management has the difficult task of looking past their enthusiasm for success and ensuring they work with their advisers to set a realistic price to generate the cash required.
R&D TAX RELIEF - ARE YOU MISSING OUT?
By Laurence Bard
Laurence Bard looks at the opportunities potentially missed by companies not claiming R&D tax relief.
Despite being on the statute books for over a decade, and gradually increasing in size and scope over this period, qualifying companies are still failing to claim hugely valuable research and development (R&D) tax reliefs – usually because they don't realise they are eligible.
Location of R&D
UK-quoted international groups are often unaware that you don't have to carry out R&D in the UK to make a claim. Many groups have overseas subsidiaries and conduct little R&D activity in the UK. But if they carry out R&D activity overseas within a UK-resident company, they are still eligible for the benefits of the UK R&D regime. Company profits subject to the UK's main corporation tax rate are currently taxable at 24% (year to 31 March 2013), but this reduces to 21% by April 2014.
R&D relief is currently given as an enhanced deduction, but from April 2013 there will be the option of obtaining an R&D credit instead. Should profits qualify for the patent box regime these will be taxable at rates of around 10%, subject to the staged introduction of this rate from April 2013 to 2017. Provided R&D activity is of a sufficient level for companies within the patent box regime, the R&D tax relief should still be available at the non-patent box rate of corporation tax.
What qualifies as R&D?
Projects must seek to achieve an advance in science or technology through the resolution of scientific or technological uncertainty to qualify as R&D. Such work may be undertaken even where similar development is instigated by a competitor but retained as a trade secret. This issue inevitably raises considerable ambiguity, so each case must be looked at on its own merits.
R&D is not restricted to the oft-cited life sciences but covers companies in virtually every industry undertaking some form of innovation. This includes innovation in products and services, as well as in their support functions.
Industries include construction, resource and exploration, advertising, telecoms, financial services and gambling, as well as the more obvious manufacturing, energy, defence and life sciences. Software, internet and communications are good examples of industries where R&D takes place in support functions, as well as within the industries themselves.
Qualifying R&D expenditure includes employee and agency costs, software and consumables and sub-contracted expenditure. All are subject to detailed rules and interpretation.
What's it worth?
The extra relief can now be worth 31% of the cost to a company paying tax (for certain profits taxable in the year to 31 March 2013). Alternatively, where a company is making a loss the relief can result in tax repayments of as much as 25% of the cost, even where no corporation tax or NICs for periods ending after 31 March 2012 have ever been paid. This is of considerable help to start-ups in need of cash to fund their R&D.
To qualify for these levels of R&D relief the company must be an SME. This means they should have fewer than 500 employees and either turnover not exceeding €100m or a balance sheet total not exceeding €86m, including any associated companies. Relief is still available for large companies but at a lower level.
Making a claim
There are numerous other rules that will also need to be considered. Any claims must be made within two years of the end of the relevant accounting period. HMRC gives no leeway on this and also has special R&D units that consider claims in detail, so it pays to prepare them carefully.
BRINGING CLARITY TO INTERNATIONAL REPORTING: CHANGES TO IFRS – AN UPDATE
By Philip Quigley
Concerns over the accounting for off-balance sheet arrangements and special purpose vehicles has led to the introduction of new accounting standards. Philip Quigley explores what this means for business.
In a major project the International Accounting Standards Board (IASB), in conjunction with the US Financial Accounting Standards Board (FASB), has sought to address concerns that emerged during the financial crisis in relation to off- balance sheet arrangements. The project has looked to both tighten the rules for when consolidation is required and improve transparency of all interests in other entities by requiring further disclosure.
Three new standards
In May 2011 the IASB published a package of three new standards which resulted in broad alignment of IFRS and US GAAP.
- IFRS 10 'Consolidated financial statements' continues to require consolidation based upon the existence of control, but modifies the definition of control.
- IFRS 11 'Joint arrangements' covers both joint ventures and joint control.
- IFRS 12 'Disclosure of interests in other entities' sets out the disclosures for entities that have interests in subsidiaries, joint arrangements or associates.
All three standards have been endorsed by the EU and apply for periods beginning on or after 1 January 2013.
IFRS 10
When determining whether one entity controls another, IFRS 10 requires reference to three elements of control.
- Power over the investee.
- Exposure or rights to variable returns from involvement with the investee.
- The ability to use power over the investee to affect the amount of the investor's returns.
'Power' is defined by the new standard as when an investor has existing rights that give it the current ability to direct the relevant activities. A simple example would be voting rights, but the IFRS also requires consideration of the economic substance of the arrangements existing between the two parties. Assessing control by reference to the three elements will not always be straightforward and in more complex situations, significant judgement will be required. Furthermore, if there are changes to one or more of the three elements of control after it is initially established, the IFRS requires an investor to reassess whether it has gained or retained control.
IFRS 11
IFRS 11 introduces two categories of joint arrangements – joint operations and joint ventures. Under the new standard a joint venture is required to recognise an investment and to account for it using the equity method. The option that existed in IAS 31 to account subsequently for joint ventures using proportional consolidation isn't available under the new standard. Any change in accounting arising from adopting IFRS 11 will have to be accounted for retrospectively, giving rise to a restatement of comparative figures in the first year of adoption.
IFRS 12
IFRS 12 aims to provide users of financial statements with information about all interests the reporting entity has in subsidiaries, joint arrangements, associates and unconsolidated structured entities. The new requirement will provide quantitative data about the effect of interests in other entities on the reported consolidated figures and also qualitative information about the nature of these interests and the risks associated with them. The disclosure requirements are extensive.
A comprehensive model for fair value
Within IFRS the term 'fair value' is widely used but until now there have been inconsistencies as to how fair value should be measured.
IFRS 13 'Fair value measurement' introduced one single definition and a consistent measurement approach to fair value throughout IFRS. It also introduced enhanced fair value disclosures.
Fair value will be the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The standard explains that the fair value is measured by reference to the principal market for the asset or liability being measured. In the absence of a principal market, reference should be made to the 'most advantageous market'. The standard defines the principal market as the market with the greatest volume and level of activity for the asset or liability that can be accessed by the entity. Generally, the market in which the entity transacts most frequently will also be the market with the greatest volume and deepest liquidity.
The principal market is likely to be the same as the most advantageous market. However, in some cases this will not be the case and applying IFRS 13 could change previous measurement bases.
The new standard also states that the value of a non- financial asset must be based on the 'highest and best use' of the asset, being that which is physically possible, legally permissible and financially feasible. IFRS 13 presumes that an entity's current use of an asset is generally its highest and best use, unless market or other factors suggest that a different use of that asset by market participants would maximise its value.
Among the new disclosure requirements is a specific requirement to quantify and disclose any unobservable inputs used in fair value calculations. This could result in disclosures which may be commercially sensitive to some entities. Furthermore, detailed fair value disclosures previously only made in relation to financial instruments, will be extended to some non-financial assets and liabilities held at fair value.
Revenue recognition and leasing – the debate continues
These two areas remain the subject of debate and comment and, although the main principles are settled, there will be significant changes before the final standards are issued.
Revenue recognition
While no significant changes are anticipated in relation to revenue recognition from sale of goods, the provision of services and long-term contracts has been more challenging.
The following are among the areas being addressed by the IASB.
- Defining when, in the context of services, a transfer is deemed to be continuous and how it should be recognised in the accounts.
- Clarifying what is meant by 'distinct' in terms of identifying separate performance obligations within a contract, following concerns that the proposed definition could result in an overly large number of separate performance obligations being identified.
- Modifying the method by which revenue is recognised in circumstances where there is uncertain consideration. The IASB appears to have accepted that the originally proposed probability weighted method was unlikely to be useful or relevant except for portfolio type transactions. It is now suggested that the 'best estimate' should be used for most such transactions.
Leasing
In considering the responses to the 2010 exposure draft, the IASB is particularly focusing on changes regarding initial recognition and subsequent measurement. Some of the key changes highlighted to date are summarised below.
A lessor and a lessee will recognise and initially measure lease assets and lease liabilities at the date of the commencement of the lease.
- The method used in terms of recognising the present value of lease payments when extending or terminating a lease will be modified. A lessee will be required to determine the present value of lease payments payable during the lease term on the basis of expected outcome, not probability weighted as previously proposed.
- On subsequent measurement, the IASB has tentatively decided that a lessee and a lessor should reassess the lease term only when there is a significant change in relevant factors such that the lessee would then either have, or no longer have, a significant economic incentive to exercise any options to extend or terminate the lease.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
