Category Archives: Other

How Regulation is Shaping the Technological Revolution in Finance

We hear a lot nowadays about how Artificial Intelligence (AI), algorithmic trading, robo-advisors, blockchain and other technologies are shaping how investment services firms operate and even how investments are structured. There is no doubt that technology has had a considerable effect on virtually every industry and that new technologies will continue to develop and cause change and disruption to the “old way of doing things”. When it come to the financial services industry however, which is a highly-regulated industry for obvious reasons, one must keep in mind how the regulations will directly or (sometimes more importantly) indirectly allow the technology to operate.

You can have the best technology in the world, capable of reducing costs drastically, of improving productivity to new heights and capable of presenting the best returns for clients consistently – but you must never underestimate the restraints of regulation. Unfortunately, as more and more regulation is developed we see the concept of proportionality always decreasing and in some instances non-existent. Thus, if a start-up has managed to develop the best investment idea using the best technologically advanced method, but fails to get the regulatory approval to operate – it is essentially useless.

Getting Licensed

Some countries like the UK, the USA, Switzerland, Dubai and Australia have tried to bridge this gap by offering what is known as a “regulatory sandbox”. These initiatives aim to give a space where financial firms or more specifically Fintech firms can test their innovations in a less restrictive regulatory environment for a limited period. Although the initiatives a very good step, one should keep in mind the fact that once such companies would like to fully open-up for business they would still need to abide by the regulations just as other companies would. The initiative helps on the front of getting licensed and developing in a way that will get the entity compliant in a more efficient manner, however getting licensed is not the end of the process, but the beginning. Financial companies are subject to capital requirements, on-going monitoring, risk-management, internal audit requirements and must also abide by other regulations besides the ones directly applying to finance.

Beyond the Initial License

From a capital requirement perspective, the current situation is that a 3-person start-up has to abide by the same capital requirements of a multinational firm that holds the same type of license. There has been an initiative from the EU front to try to make a distinction between the systemically important entities and the smaller firms that pose a much lower market risk, however there have been no conclusive results yet and it could take years to ever get to a workable solution. An important feature of the capital requirements of such firms which is particularly punitive on Fintech and other technologically centred firms is the fact that intangible assets are deducted from the capital base of a company. For capital requirement purposes, the fact that firm has a highly valuable asset in the software and goodwill it has created through its technological advancement is actually penalised. This is a clear example of how regulation is going against the technological advancement of the financial sector.

Another factor to consider is that financial regulation is just one piece of the puzzle. Entities and individuals operating in the industry must also abide by other regulations. One source that continues to grow in importance is the tax regulation. Pressure is always growing for more substance, more tax reporting, more client details – these all add up to more costs. If a start-up fails to factor in these costs it could become insolvent due to the higher ‘un-exepected’ costs.

The Bottom Line

In conclusion, it is safe to say that regulation is having an effect on how the financial services industry can develop. Although certain technological advances are here to stay and will continue to develop as the years go by, their disruption to the more traditional way of doing things is severely hampered by the initial and ongoing regulatory requirements. Thus, the regulatory environment is a very important area to focus on for countries that would like to see the development of their financial industry embrace the technological advancements and take advantage of them. Only once this is done will we ever see the true potential of the Fintech revolution. This is not to say that regulation needs to be lax and more self-regulation is needed, however a more adaptive system is definitely a requirement. The system needs to still incorporate the basic overriding aim of safeguarding stakeholders, most importantly the clients. However, it must be adaptive enough to regulate different entities differently on a risk-based approach and in a proportional manner.

Beyond Malta’s Financial Services Industry

There has been a lot of news lately concerning the whole #MaltaFiles incident with a number of journalists, bloggers, industry experts and others covering this topic. I do not wish to get into the merits of the whole case but would like to highlight the strategic timing of the whole incident just as the country is in election mode and following the #PanamaPapers and corruption allegation at the highest level of governance of our country.

There is no arguing that our country has suffered a reputational blow over all these incidents. Regardless of one’s political views and who one blames for all this, the fact of the matter is that we are all affected by these incidents and we all must act collectively to restore our reputation.

With this post my main aim is to show how all industries are affected by our reputational damage and this is not simply something that has to do with the financial services industry in isolation.

The Multiplier Effect

First of all it is important to recognise the interconnection of industries and the multiplier effect that an industry has on the whole economy. If we take the financial services industry, one may read how it makes up around 15% of Malta’s Gross Domestic Product (GDP) – this means that statistically the income generated by this industry is roughly 15% of all income generated by Malta’s economy. That is just the direct effect – it is estimated that the indirect effect can raise the financial services industry’s contribution to GDP to as high as 30%.

But How?

Easy – think of the residential rental income and properties bought by foreigners working in this industry. Think of the commercial premises bought or rented by companies and practitioners working in this industry. Think of the money that clients and promoters of this industry spend on dining and subsequent personal holidays to Malta. Think of the people who have relocated to Malta entirely and the amounts they contribute across the board to our economy through their spending. The cars they rent to get around or the taxis they hire while visiting, the flights they pay for and accommodation they take up while here.

Not Just Financial Services

It is also very important to keep in mind that the country’s reputation has a direct effect not just on the financial services industry but on any industry that is in some way or another linked to foreign direct investment. So this will include the manufacturing industry, the export and tourism industry, the meetings and conferencing industry, the software development and IT network servicing industry, the gaming industry and so forth. In turn, all these industries have a multiplier effect on the economy. What this means is that even the store keeper of a hotel, the maintenance man of a manufacturing company (like the large semiconductor manufacturer in Kirkop), the checkout person at the supermarket, the cleaning staff of a restaurant and so many other jobs are all affected.

One must also keep in mind the large amount of direct and indirect taxes employees and owners of these entities pay. Thanks to the collective contribution, Malta is boasting a budget surplus, low unemployment and a growing economy. These things do not develop following a short term initiative but are the fruits of medium to long term collective efforts. As many will appreciate, reputation is something that takes years to build but days to ruin. Thus, in these challenging times it is of the utmost importance to give this matter serious recognition and devote all necessary resources to maintain our good name.

The Government’s Role

Although it is true that the government of the day has a bearing on the overall progress of the country and its reputation we must not fool ourselves by thinking that it is solely the government’s role to do so. The private sector has to be proactive at its own initiative to safe guard the name and reputation of our country. One has to see beyond the political noise and mudslinging that only benefits the few and not the many. Regardless of one’s political views, having a situation where the Police Commissioner, the Attorney General, the Financial Intelligence Analysis Unit (FIAU), the Malta Financial Services Authority (MFSA) and other high ranking institutions, as well as the rule of law itself, coming into question, is highly unacceptable. Whoever is in power after June the 3rd should give this the utmost importance and work with industry experts (from the many different industries) in order to have a public-private initiative that can truly benefit the whole economy.

The Bottom Line

It must be recognised that as a country we are constantly in competition with other jurisdictions. If Germany can attract a company to open shop or expand its operation in Germany, then it will do its utmost to attract such business. To whine and complain that other jurisdictions are targeting us and playing dirty is futile. It is a competition, so one must expect the other players to be competitive and use whatever opportunity they get to make us look bad and make themselves look good. Of course this does not mean that we just sit back and accept whatever is thrown at us. We must be prepared for the competition and have strategic plans to defend our name. The current political scenario is putting us at a disadvantage for sure, but every country goes through political issues and no political system will ever be free from its drawbacks.

The upcoming general election has made the situation worse by increasing the political barrage and giving more ammunition to our competition who seek to portray us as an offshore country with shady practices. I will however end on a positive note, we all know that the allegations against us in relation to Malta being an offshore financial centre are untrue and hence we can defend our good name with the truth and with facts. Governance issues can be rectified by replacing the people who have caused the issues and the country’s reputation can be restored. One powerful tool all citizens have is their vote and they must use this tool in a conscientious way to choose the party and political representatives that they feel can best help us on our mission to continue developing our economy and restore our good name.


Attracting FinTech and other new Business Models to Malta

There has been a lot of hype over the last years to attract new types of businesses to Malta such as the FinTech (Financial Technology), WealthTech (Wealth Management using Technology), Algo-trades (investing using algorithms) and more recently Investment-based Crowdfunding Platforms. Rightly so, entities such as FinanceMalta have held several seminars and initiatives to attract these types of business and in fact their 2017 annual conference will be focusing on this theme.

Through this post I would like to give a brief description of these types of entities and to also provide some thoughts on the factors which could deter these types of entities from seeking to be registered in Malta. From personal experience of being involved in a start-up Fin-tech, Wealth-Tech and Algo-trading company Novofina I would like to shed some light on the difficulties faced in attaining a suitable license and remaining compliant to rules and regulations which are based on a one size and one type fits all regime.


FinTech can describe any financial services entity that uses technology to perform its service or offer its products. The technological innovation can be applied in different parts of the process from research, retail banking, investment selection and even crypto-currencies such as bitcoin. Technologies can include things like Artificial Intelligence (AI) that could be applied to investment instruments selection or to research gathering for estimating market sentiment for example.

Originally FinTech referred to technological innovations applied to the back office of banks and investment firms, nowadays it refers to a wider variety of technological interventions in the retail and institutional markets. The level of technology used varies depending on the type of company and the services it seeks to offer. It can range from mobile wallet systems to robo-advisor services. Even within a category of firm types the technologies applied can be wide ranging. For example, if we take the robo-advisory firms, you could have companies that simply use online data entered by the client to determine their risk profile, financial bearability and knowledge and experience in order to offer a bundled Exchanged Trade Fund (ETF) solution. You can also have so called forth-generation robo-advisors that use algorithm based trading in combination with AI in order to trade different investment strategies on behalf of clients.

An Algo-trader would use a mathematical algorithm that would be pre-programmed with certain rules in order to trade large amounts of instruments (example shares) on the market. The algorithm would be programmed to trade a particular trading strategy and configured in a specific way relating to price, position sizing, timing and risk-mitigating techniques. Thus, not all robo-advisors are the same and even more so not all FinTech or WealthTech firms are the same. This makes it even more difficult to fit into the local financial services regulatory framework and categories of licenses.

Investment-Based Crowdfunding

Crowdfunding, as the name suggests involves the process of gathering a lot of small amounts from a lot of people in order to collectively raise a larger amount. This can range from a simple project such as raising the funds to finance the publication of a book to more complex issues such as using the funds to invest into a new FinTech start-up through an equity stake. So far in Malta investment-based crowdfunding is not really possible since the current regulatory framework dose not really provide for this form of investment. However, we have seen some progress here with a donations-based crowdfunding initiative being launched that raises money against donations and can give back certain perks. There has also been a consultation paper issued by the regulator late last year which period had closed in March 2017. So we are beginning to see some progress here. A very interesting article for anyone looking to find more information on investment-based crowd funding can be found on the latest publication of the Malta Business Bureau here.

Barriers to Entry and Operate

It is a great initiative to attract the most technologically advanced financial services companies to Malta. However, there are certain issues that are hindering their entry and once operative, their operational viability. One of the largest barriers is the regulatory issue. Our current regulatory framework was not designed for these technologically advanced firms and the current situation is that these firms either fit themselves into an existing license category or else they are not welcomed. This is a major issue since it could be forcing firms to have in place certain items which are not applicable to their business model, are costly to maintain and would lead to deterring a potential newcomer from setting up shop in Malta.

To put it more simply, if a FinTech company would like to attain a license to provide services A B and C, why does it still have to apply for a license that caters for services A to G? Although there is some flexibility in the license application process and certain derogations may be applied it is still far from being an attractive preposition balancing investor protection and the reputation of the local financial services industry on one side and attracting the right players that could take the Maltese financial sector to a whole new level attracting cutting edge, niche market firms. On the other hand, the current regulatory framework may present certain loopholes for certain types of FinTech companies since the current regulatory requirements may not fully appreciate the different risks such firms pose to investors and the financial sector in general which could be quite different compared to more traditional financial services entities. Having said that, risk management has taken a much more prominent role nowadays.

With respect to the ongoing obligations of such entities once they have been licensed it is not logical that their capital requirements should be the same as those of other more traditional firms. To put it simply, certain investment services providers are subject not only to minimum initial capital requirements but also to on-going minimum capital requirements. This capital requirement is not simply a calculation of asset less liabilities, but involved certain amendments to arrive at the regulatory capital requirement. One of the deductions from an entity’s capital figure is its intangible assets figure in its balance sheet. Given that FinTech, WealthTech, Algo-Traders, Robo-Advisors and all the rest of these firms invest heavily in software and licensing of such software, and software is an intangible asset, they are currently being penalised for doing so. So on the one hand we want to attract the most technologically advanced firms and on the other hand we are telling them that their software is worth nothing and must be deducted from their capital. To be clear, this is not simply imposed by the local regulator but comes out of the EU Capital Requirement Directive. Simply blaming the EU legislation is not a solution however and when it comes to these technologically advanced firms it is even more so that we are not simply competing just with other EU countries but the whole world. Being online based makes it even easier to setup anywhere in the world with a decent internet connection.

Another problem we are facing locally is the shortage of talent. The gaming industry has brought many benefits to Malta, however it has also created a shortage in IT developers. Administrative staff is also becoming a problem for some firms, especially since most FinTech firms are start-ups and thus have a higher risk of going bust compared to the larger players in the industry. Another problem I see locally is the lack of promotion and support for being an entrepreneur. This last obstacle may the most difficult to overcome since it could be considered a cultural issue. However, with proper incentives and moral support from a young age there is no reason why we cannot produce more students who desire to become business owners. Interestingly enough, investment-based crowdfunding could be a very good avenue where such budding entrepreneurs could find funding to start off their project until they get to a level where other sources of finance could become available to them.

The Bottom Line 

All-in-all I truly believe that Malta has the potential to become a major player in the FinTech arena. It has already proved itself in the fund industry and the online gaming industry for example and there is no reason why a market for FinTech and other technology based financial services firms should not also be successful. However, to reach such a realisation there must be more support and initiatives for such firms to choose Malta. Some barriers like certain regulatory issues are not entirely under our control. However, if our regulator decides to gold plate an EU directive this would hurt our chances of attaining success in this sector. One such example that comes to mind is the “holding and controlling” of clients’ money requirement locally, when the EU directive speaks only of “holding” clients’ money.


The views expressed are the personal opinion of the writer and do not necessarily reflect the opinion of any entity the author is associated with.

Algorithmic Systems Trading – The Modern way of Trading

Algorithmic Systems Trading is sometimes confused with some impossible to understand formula that is too complicate to trust. In reality it is just a fancy way of describing the combination of trading using the advantages of computers, mathematics and statistics. It is a scientific approach to investing based on technical analysis and is typically characterised by many trades held for short periods of a few days. Thus, using what is called the law of large numbers, enough wining trades will end up outweighing the losing trades leading to a positive return for investors.

Is this high level of trading available to everyone?

An initial concern investors may have is that this type of high-end investing would only be available to high net worth clients having millions to invest. In reality companies like Novofina which are so called FinTech (Financial Technology) and WealthTech (Wealth Management through Technology) companies make this type of investing available to investors willing to allocate at least €30,000. These sort of companies are bringing high-end investing previously reserved just for elite clients to the retail space.

Novofina, which is licensed by the Malta Financial Services Authority, applies algorithmic systems trading to investing in US large capital stocks, the so called blue chip companies. These are the largest companies quoted on the US stock markets, companies like Amazon, McDonalds, Apple, Exxon Mobil and the like. The company combines different systems that trade based on different criteria such as stochastic systems, Bollinger bands and other technical analysis schools. It combines these different strategies to make up its two main products which clients can invest into. So as opposed to trying to invest on their own based on some gut feeling or long term expectation that may never come to fruition clients get access to cutting-edge computer based equity selection. Best of all the systems operate on their own without the need for client intervention except to decide on how much to invest and what level of risk they are prepared to take on.

Is this a get rich quick scheme?!

Definitely not. Investing in shares has historically been the best form of investment time and time again. However, it is still a long term investment for clients having a minimum 5-year investment horizon. Looking at the returns on equities versus bonds (gilts) versus retail prices between 1899 and 2011 (thus including the great depression, the world war periods and the 2007/09 financial crisis), as reported by Barclays Bank, it is clear how much better off equity investments are over the long term:

By investing smartly into the equity market using such systems employed by Novofina you will not turn €50,000 into €500,000 within a year. That sort of return is not sustainable and would be too risky to attempt to achieve in a short period of time. Nonetheless, turning €50,000 into €500,000 over a ten year period for example is very much possible. This is particularly interesting given the current interest rate scenario whereby we are finally starting to see central banks increase interest rates following a prolonged period of virtually 0% rates. Keeping in mind that prices of bonds move inversely to interest rates, should there be an indication that the European Central Bank could be increasing its base rate all local bonds (especially the longer dates ones) would suffer a fall in price. We have already started to see some “risk-on” movement with the prices of Government Bonds across the EU countries falling in price. This appears to be happening due to an improved appetite for risk whereby investors are selling their government bonds and opting for investments that are perceived to be riskier, such as shares.

Therefore, considering a shift into an equity based investment such as the algorithmic systems based products mentioned in this post could prove to be a well-timed investment decision. Adding equities to one’s portfolio has been proven historically to offer a better balance and overall higher average return. By doing it wisely, using statistically proven methods which are objective as opposed to a human traders’ subjective tendencies, one has a better chance of managing the downside and benefitting from the upside.

The Bottom Line

Algorithmic systems trading is nothing to fear and is based totally on statistical real returns. It is considered by many to be the best investment method available since it uses the latest stock-selection methods which consider many important characteristics of trading successfully such as entry points, profit targets, maximum holding periods and batch sizes. Combining all this and achieving lower risk through diversification of the investment portfolio should prove to be a long term winning formula for any investor. Best of all, such products are already available locally through Novofina starting from a low minimum investment of €30,000.

* This post was issued by Kyle Debono, Managing Director and Portfolio Manager at Novofina Ltd. The information, views and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice. Novofina Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions appearing on this link. Please refer to usual general disclaimer here.

Non-Performing Loans – an EU perspective


The bread and butter of a traditional bank is the provision of loans. Although banks have reduced their dependency on this main source of income by branching out into other fields of the financial services world, the creation of loans is still a very important economic service. These loans are granted to households, business and to other banks, can be short or long term in nature, having a fixed, flexible or no interest rate and will be subject to different assurances such as collateral.

What is common between all loans is that they all carry a risk – the most basic of which is the risk that the loans become bad-debts or non-performing because the person or entity that took the loan can no longer service it. Non-performing loans will always be a problem for all banks since no model can ever cover all the risk involved and from time to time some borrowers will inevitably be faced with situations that were thought unlikely to happen.

From a regulatory point of view, a loan becomes a non-performing loan once more than 90 days elapse without the borrower paying the agreed instalments. Sometimes the banks can manage to agree new terms with such borrowers but at other times the bank would simply have to write off the loans and try to collect on the collateral and guarantees it would have secured before granting the loan. Banks also have the option of selling off the loans, but this will be at a discount and is dependent on finding someone to take on that debt.

What is the cost of non-performing loans?

It should be kept in mind that the cost of non-performing loans is a direct burden on the bank but an indirect burden on potential borrowers. As a bank is faced with more and more non-performing loans it would inevitably have to tighten credit and thus lend out less money. It must do this since its profits will start getting eaten away by the cost of managing the non-performing loans. Although loans are an asset for a bank they also come at a cost. The cost is not just the opportunity cost of using the same money for a different venture, but also the regulatory cost of keeping the loan on its books.

Therefore, as the number of non-performing loans rises the greater economy will suffer as loans become more expensive and less available. The expense could be in the form of higher interest rates, higher requirements for collateral and more stringent terms for the borrowers. As these factors come into play it would automatically become more difficult to obtain credit from a bank and thus some people and entities will be rejected for a loan. As credit becomes more difficult to obtain businesses will invest less and private individuals will take on less projects. So the effect on the whole economy is multiplied since less work is generated.

How do EU countries compare on Non-Performing Loans?

The below chart depicts the amount of non-performing loans as a percentage of total loans for the EU countries as at March 2016:

As expected the countries with the biggest economic problems have the highest percentage of non-performing loans. Countries like Cyprus which experienced a banking sector crises in 2012/13 and the so called PIIGS (Portugal, Ireland, Italy, Greece & Spain).

If we focus on the worst two countries (Greece and Cyprus) we can see that almost half the loans that have been issued are not being serviced. This of course is a very worrying situation for these two countries which is very difficult to get out of. These two countries are quite apart from the rest of the pack with the next worst country having a percentage of around 20%, which is still worrying. Ireland has started to improve as an economy but the percentage of non-performing loans is still quite high at around 15%. Having said that, the figure has gone down from the 20% registered in September 2015. Malta is sitting around mid-table, however it is worrying to see that over a period of 6 months the figure went up from 3.7% to 6.8%.

The below figure shows the same rates 6 months earlier as at September 2015:


The Bottom Line

Non-Performing loans are an indicator of economic health. The higher the percentage of such loans to total loans the more difficult and more expensive it is to obtain loans. This has a ripple effect on the economy as less investment and private consumption is registered. This is why the regulators place great emphasis on the measurement and management of these loans. Supervisors monitor the overall level of non-performing loans across euro area banks. They also check whether individual banks adequately manage the riskiness of their loans and if they have appropriate strategies, governance structures and processes in place. This is part of the common supervisory review and evaluation process (SREP) that is carried out for each significant bank every year. Furthermore, the European Central Bank regularly carries out coordinated exercises to review the asset quality of the banks it directly supervises.


MLRO: Friend or Foe?

Money Laundering

A Money Laundering Reporting Officer (MLRO) is responsible to ensure that the company they work for is compliant on aspects of Anti Money Laundering (AML) and Countering the Financing of Terrorism (CFT). Having just attended a 2 day seminar on AML, which for a change was not a total waste of time, I was inspired to write a post on the position of an MLRO. A person occupying this role can be considered as both a great friend and a great enemy by their colleagues.


The friend part comes from the point of view that a good MLRO will ensure that the business is abiding by the AML laws and regulations. Besides meaning that the entity would be compliant, it also means that the business is not taking on any unnecessary business risks. An effective MLRO would have in place robust systems and procedures to ensure the entity they are working with is covered from all angles. This involves detailed written procedures that everyone in the organisation is made well aware of. It is useless to have the best system possible for your particular business but then the people who have client contact are not made aware of the system. Thus, regular and effective internal training is necessary in order for the MLRO to explain to the people working in the organisation about their duties and responsibilities from an AML point of view.

In order to have an effective system the MLRO has to be approachable and people have to be made aware of who the MLRO actually is. Although the MLRO must be a senior officer within the company, they cannot be just sitting in a head office with nobody on the ground floor knowing who they are. Also, simply sending an email with the company’s AML manual or giving an employee a copy of such manual is not enough. Most people would simply ignore it or read it once and just dismiss it. So the MLRO must find a way to get people interested in the work they do and get them to understand its importance.

An easy way to do this is to simply explain how an AML breach could be detrimental to the person’s job and the whole organisation’s existence. The fine that the entity might receive if it is in breach of AML rules and regulations is just one aspect – the reputational risk of the entity could perhaps be the largest risk factor. So if colleagues see their MLRO as the one who helps them stay in check and avoid costly risks they will see them as a friend.


Of course, like with anything to do with compliance it is much more common to look at the MLRO as the enemy. From the point of view of directors and shareholders the MLRO, like the Compliance Officer could easily be regarded as being an extra expense that causes more expenses and disruption of potential business. While senior management might want to take on a risky client and try to justify the risk-reward trade off of doing so, the MLRO would be the person to highlight the risk part and perhaps seen as exaggerating this aspect.

From the point of view of the people who are actually in contact with clients the MLRO could be the one that would bar them from pursuing certain potentially lucrative client accounts. They could also look at the MLRO as the person who is forcing them to get a stack of useless paperwork on a client that they have known for years that could cause the business to lose such a client.

To be fair certain MLROs do not make it easy on themselves and tend to be too strict and annoying in their pursuit of carrying out their duties. Just because an MLRO needs to be sure that absolutely everyone is covering all aspects of the AML rules it does not mean that they should be policing their colleagues in an antagonising and perverse manner. If people see their MLRO as the enemy the system will not work effectively and mistakes and oversights would be inevitable.

Furthermore, if an MLRO is over-reaching and going over and above the requirements then they would definitely be seen as the enemy. Over stepping and being extra safe is also bad for business. No profits can be made without certain risks and if an MLRO is holding back business due to over-reaching and trying to be holier than the Pope, then it will ultimately back fire through loss of good business. I am a great opponent of over-regulation, which can be either brought upon by regulators or by the people who are in charge of enforcing the regulation within organisations.

Finding a Balance

The key is to finding a balance. Unfortunately being seen as an enemy and a necessary evil that comes with the job. The MLRO must recognise that it is not his/her responsibility to decide what degree of risk a company would like to take. That decision remains always at the discretion of the directors who are responsible for the overall direction of the business. However it is the MLROs job to notify top management about the risks involved from an AML perspective and to work with them to develop the best working environment.

A very interesting exercise that was undertaken during the seminar I recently attended was to divide participants into groups and work on a case study. The case study involved coming up with a scheme on how to launder €150Mln for a multi-national consortium. The beauty of the exercise was that it put people who are responsible for counteracting money laundering on the other side of the situation. The game helps one appreciate the level of complexity that is needed and the mind frame that launderers would be in. It ultimately will help in finding loopholes in the system of the company that each participant works in. So the exercise helps people learn by putting themselves in their counterparty’s situation. I believe this is an interesting and effective method that an MLRO could use in getting the AML message across to people.

Does the Regulator play a Role?

The Malta Financial Services Authority (MFSA) and the Financial Intelligence Analysis Unit (FIAU) are the regulators that authorise and monitor the work of MLROs. Do they have a role to play in the effectiveness of the work of the MLRO? The simple answer is yes, but one must not end up “depending” on the regulator to do something. Although there is a requirement for the MLRO to present an annual report to the FIAU which also includes training received and conducted there is no specification of what is actually required. So in November and December it is a common practice to see many AML “training” programs which would suffice for the purposes of filling in the MLRO training requirements.

Of course one can argue that from year to year they would still remember the laws and regulations and if there are new ones they can easily read up on them on their own. With this I agree 100% and find the “training” courses that simply go through the legislation as utterly boring and useless. In my view, it would make much more sense if the training required involved something more. Something with practical examples, case studies and something that is more interesting than watching paint dry on a humid day! It would make sense to use practical examples that have actually happened locally and training has to be targeted depending on the type of business. An MLRO of a bank has a totally different situation compared to an MLRO of an investment service company or and MLRO of a real estate agency. So having group training sessions is definitely not the ideal setting.

The Bottom Line

Whether we like them or not the MLROs do play an important role in the organisation. There is no secret formula that works for every organisation, but each MLRO has to adopt a risk-based approach to cover the issues that affect their organisation. Undoubtedly the MLRO needs to understand their organisation very well and they need to identify the weaknesses that exist from an AML perspective. However this is not enough, any system and procedures they develop are only as good as far as how they are implemented. Thus, MLROs need to find a way to monitor and incentivise the people with client dealings and transaction processing so that they actually implement the AML measures.






Arbiter for Financial Services Act – A Review


Currently the Arbiter for Financial Services Act is being finalised following a series of discussions between representatives of the government and the opposition. The Act, which will be coming into force in the coming months, will have an effect on any company that offers financial services from Malta. This act generally gives the authority to one person to settle a dispute between two or more parties which have an issue which is connected to financial services. The idea is to have a faster and more focused court-like setting where the Arbiter has the power to mediate, investigate, and adjudicate complaints filed by a customer against a financial services provider.”  So this act is going to give quite a bit of power to just one person and the Board of Management which would be managed by such person.

The idea looks nice on paper, but how will this all work in practice?

Here I have 3 main reservations

1.      Independence of Arbiter

One of the first issues I am finding with this setup is that it is going to be quite difficult to find someone who has the competence required and at the same time is independent. The requirements to be appointed as an Arbiter are that the person shouldpossesses the necessary expertise in consumer related issues in respect of financial services, including a general understanding of law.” The draft Act also mentions some instances where a person cannot be considered as an Arbiter which again all look nice to have on paper.

So we are saying here that it has to be someone who has acquired an amount of knowledge and expertise in the financial services industry, specifically in consumer related issues. In my view this is not going to be an easy task since the issue of independence is going to be a problem for many potential candidates. Let us consider appointing someone who has been working with the regulator for an amount of years. Such a candidate would have been involved directly with consumer issues in the financial services industry which qualifies him/her for the post. However, if this person has never worked with a financial service provider or has not done so in a very long time, then that person would lack the knowledge and expertise of how things work in the field. 10, 15, 20 years of always hearing one side would not really allow that person to be independent.

What if we consider appointing a current or an-ex judge/magistrate who would possess the legal acumen to actually give a legal ruling – the problem here is finding one with expertise in financial services. Ok, let us consider finding a lawyer who is specialised in financial services. This may well be the best option however the issue of independence is going to come up more than once. Given the small size of the local industry, Malta’s financial services practitioners tend to use the services of a handful of legal firms which have expertise in this industry. So if an employee from such an entity was to be appointed as the arbiter it could well be the case that many a time such person would have a conflict of interest through his/her previous dealings with the financial services practitioner.

What about appointing someone who has been working in the industry in a senior position for many years and thus has the knowledge and expertise of dealing with clients, keeps up to date with financial services regulations and would have a deep knowledge of different financial services instruments. Two main problems here: i) Why would such a person leave his/her current position which is likely to be more financial rewarding and flexible? ii) How can such a person be independent when most financial practitioners know each other and may have done business together?

2.      Excessive Powers of the Arbiter

Another very troubling issue is the excessive powers being granted to this one person (or office) which may be beyond the competence of such person and quite possibly anti-constitutional. Here I am referring to the fact that the Arbiter will have the authority (according to this Act):

“to consider complaints which are being dealt with or which have already been dealt with by the Malta Financial Services Authority, and its recommendations, rulings, directives or decisions shall not be considered as a res judicata of the complainant’s case and the consideration of such a complaint by the Arbiter shall not be construed as going against the principles of natural justice”

This is by far the most dangerous clause that exists in this act. It is being said that even when a complainant and a financial service provider have come to a contractual agreement on a settlement, the Arbiter has the authority to supersede such agreement. This creates a very dangerous precedent whereby the legal stance of previously settled cases which have been contractually agreed to by both parties is put into question!

According to the lawyers present during the discussions, up until now it has always been the case that any dispute about the validity of a contract would have to be scrutinised in the Civil Courts. Thus this clause is giving a dangerous and unprecedented authority to one person who is only required to have “a general understanding of law”. So we went from a formal well established procedure in the civil courts to being judged by a person who generally knows the law!

This very dangerous clause, coupled with the fact that the Arbiter can decide on cases going back to 2004 (and not anything earlier than that date) makes one wonder the exact reasoning behind inserting such clauses. It begs the question:

Is this law being enacted in light of the La Valette Multi-Manager Property Fund incident?

One cannot help but wonder about the above question and at the same time keep in mind that at the end of the day the Government (which is pushing for the enactment of this law) is the largest shareholder in Bank of Valletta (BOV) with its 25.23% shareholding. Furthermore, BOV is a publicly listed company with its shares trading on the Malta Stock Exchange. So wouldn’t it be only logical to consider whether one should sell his shareholding in BOV if this Act is passed through parliament as it currently stands?

What does this mean for the Insurance industry? Companies within this sector are involved in many settlements on a regular basis – such is the nature of their business. So if an insurance company can no longer bank on the legal validity of the claims it has settled – how does it provision for this in the policies it issues? Again, Mapfre Middlesea Plc, GlobalCapital Plc and all the publicly listed banks are involved in the insurance industry to one degree or another – so should one also sell all his holdings in such companies if this Act remains unchanged?

In a nut shell, saying that this dangerous clause would open up a Pandora’s Box would be an understatement.

3.      Who really benefits?

At the end of the day, no matter what ruling the Arbiter gives in his hastily 90 day target time the right of appeal from that sentence cannot be removed. Thus the end result would most likely be that both claimants and service providers would end up worse off and the people that have most to gain from all this are the lawyers and consultants appointed by both parties. Interestingly enough, it had been proposed in the discussions about this Act that there should be a cap established on the fees that a person representing a complainant can charge. The proposal was to have a cap amounting to the higher of €500 or 0.5% of the net proceeds won on behalf of the complainant. This would serve to protect the complainant from ending up paying exorbitant legal and consulting fees. To date I am not aware that the Government has introduced this clause as it was stated that it needed to be studied further.


The Bottom Line

Like I have said many times before, the best way to help consumers and protect them is to educate them. If consumers are better equipped to assess the products and proposals that service providers propose or recommend to them we will have a much better result. Increasing regulation ends up marginalising the small investors since they become uneconomical to service. The risk involved and the time involved to service the small investor would not make it viable to service them. So as a result they would end up only being offered the same few products and thus creating a concentration risk in those few products. This concept of educating investors has to flow both ways however, the industry and quite possibly to a certain degree the government should come up with ways of organising educational clinics, seminars, conferences, courses and other incentives about the subject to the investors. But from the other hand, the investors have to be make an effort to look for such learning opportunities and not simply play the fool that wants to shift all the responsibility to the service provider. In the words of many before me: “Knowledge is Power” and thus through more knowledge investors would possess the power (ability) to better decide on their financial matters with guidance from the financial practitioners.







Regulating the Financial Services Industry – Finding a balance


Why Regulate?

I recently watched the movie “The Big Short” which is about a few traders who actually predicted that the US housing bubble was going to burst and that the collapse of the sub-prime mortgage market was inevitable. These traders used financial instruments (mainly credit default swaps) to bet against the market and the major banks – which as we all know now, was a very profitable thing to do in the end.

The reason I opened with a reference to this movie is not to get into the merits of how they profited from the situation but to highlight a point that struck me the most while watching it. In the move the actor Steve Carell plays hedge fund manager Mark Baum who appears to be on vendetta against the big Wall Street banks who he describes are nothing but crooks. At first the character thinks that the big banks do not have a clue what they are doing and that they are being naïve by not recognising the problem and continuing to deal in sub-prime mortgages which are literally worthless. But at the end he finally comes to the realisation – which now with the benefit of hindsight is quite obvious to see – that the big banks knew exactly what they were doing and what’s more, they knew that they would have to be bailed out since they were too big to fail. So they deliberately made as much profits as possible until they would reach the point of no return and have the tax payer bail them out.

This notion that the banks know that they are too valuable to the financial system and that bank failures would be devastating on any economy puts them in a particularly advantageous position. In more technical jargon we would say that it creates a moral hazard situation. This is the main reason why the financial sector is so highly regulated. Thus, many would agree, especially many small investors who do not trust the big banks and believe they need to be protected from them, that regulating the banks and other financial services practitioners is very important. The more regulated they are, the better they would argue.


Could too much regulation actually leave investors worse off?

More specifically, could the small retail investors that the politicians and policy makers so heroically swear to protect against these big bad financial practitioners, end up worse off?

Let us start with reviewing a bit the EU investment services rules since in Malta we are subject to the same/similar regulations & directives. So in 2007 we saw the introduction of the Market in Financial Instruments Directive (MiFID) which introduced much more pro-consumer rules and put much more onus on the service providers. What this means is that investment service providers had to start recording much more data in order to ensure that they were abiding by the many more procedures and regulations that had been introduced. This in turn lead to much more forms to be filled in and checks to be put in place to ensure that the sales staff were actually adhering to the rules and not putting the company they work for at risk of breaching any of them.

On the whole this is obviously a good thing since it ensures further that the investment service providers are acting fair and responsible in carrying out their business. At the same time, this increased regulation comes at a cost in the form of time and money that investment services firms have to spend per transaction. Furthermore, such firms also have to assess the risk and reward of entering into transactions with clients. Are the various risks of selling this product to this client worth the compensation that the company is earning?

In most cases the highest risk is when dealing with the smaller less knowledgeable investor, who is also the same investor that will generate the lease return for the service provider. So it is quite common for investment firms to exclude certain investors from certain products based primarily on the higher risk such investors pose. This in turn will leave these investors with lesser choice and higher concentration risk since they will only be offered a small choice of investments. So regulations that had the aim of protecting investors could actually be leaving them worse off by excluding them unnecessarily from certain investments. What is even worse is that such investors, who are the ones who would need investment advice the most, could be shun away altogether from investment advice due to the higher risk of offering investment advice to them.

You may think that I am exaggerating a bit here – which firm would reject business just because a product is classified as complex and presents more risk to the investment service provider? Let us look at real examples of how this is actually happening. Any HSBC Bank Malta Plc (HSBC) customer had been informed that a few years ago the bank decided that it would only be offering execution only transactions and would absolutely not be offering investment advice. Furthermore, the same bank has recently informed its customers that it would no longer be allowing its customers to hold investments on their nominee accounts. That is to say that HSBC would no longer be holding the custody of clients’ investments and has actually written to clients to transfer their holding to other providers (which are competitors of the same bank).

Some may argue that this is a one off case and that it is a direct result of directives by HSBC’s parent company to reduce risk as much as possible across the many subsidiaries, especially in the smaller jurisdiction such as Malta. So let us look at another example – the subordinated bond issued by Bank of Valletta Plc (BOV) late last year which is basically a Contingent Convertible Bond (Coco). Due to the nature of the bond it was rightly so rated as a complex instrument by our regulator. Under MiFID rules such instruments must be accompanied by more paperwork to ensure that it would be appropriate for an investor based on such investor’s knowledge and experience.

What happened in practice? A bond which from a scale of 1 to 10 in its complexity would be rated at less than 1 in my view, was made subject to more scrutinising procedures by the listing authority. It had to be sold in two tranches – tranche 1 imposed a minimum of €5,000 which had to also be accompanied by investment advice, thus putting the highest level of onus on service providers, while tranche 2 imposed a minimum of €25,000 and had to be accompanied by an appropriateness test. Our regulator argued that due to the vast network of retail clients that such a bond would have appealed to, such clients needed to be protected even further than MiFID suggests. The result – many investment services providers including other banks simply did not bother with the issue. The bond was sold by a smaller amount of firms which got back logged in the paperwork and the issue had to be prolonged until all the work by the investment firms had been carried out. Looking at the trading of the same bond on the secondary market – virtually non-existent. I went into much more detail in a previous post which focused specifically on the bond issue. Here I simply wish to highlight the negative aspect of too much regulation.


So how do you strike a balance?

I started the post by pointing out why regulation of this industry is such an important aspect. We then saw a few examples of how regulation could leave investors worse off by marginalising the smaller less knowledgeable ones. So how can regulators and policy makers stick a balance between these two opposing forces? In my view, the answer lies in being more pragmatic in the imposition of the rules and regulation governing investment services. The one size fits all approach of putting all complex instruments into the same basket is redundant and disruptive. While firms that are found guilty of negligence and misconduct should be properly dealt with, regulations should not be acting as an impediment to business.

Another very disruptive and damaging practice is having an ultra pro-investor approach when regulating investment services firms. As I have just stated, when found guilty of purposeful negligence and unethical behaviour the regulator should be given as much ammunition as possible to deal with such perpetrators. However, feeding the idea that if someone loses money when investing in a financial instrument they have a good chance of getting compensation creates a misconception that investment firms are guaranteeing every instrument that they sell. This is a very dangerous situation which will only lead to a negative situation for both the investors and the firms selling the investments.

Could there perhaps be a solution whereby staff that work with the regulator must spend a certain amount of time working with an investment service provider? Thus they would attain hand-on experience and would ultimately be able to implement the directives more effectively and efficiently. Moreover, this would have to be an ongoing exercise and not a one time thing. Just because someone worked in the industry 10 years ago and has been working for the regulator ever since does not qualify as still being in touch with reality.

On the other hand, should compliance officers and Money Laundering Reporting Officers (MLROs) be given training by the regulator on a regular basis for example? This would help to get the perspectives of both the regulator and the practitioners more in line. Here I am not talking about the usual boring courses that just present what is in the regulations. Anyone can read the regulations on their own and no presentation is needed for that. What I am speaking about here is offering real life examples of what the regulator is dealing with in order to create a more understanding environment between the regulator and the practitioners.

The Bottom Line

At the end of it all, it is always going to be a difficult task to find the ideal level of regulation. What is important is that both regulators and practitioners work towards the common goal and try to understand each other’s perspective. Both can learn from each other and both need each other whether they would like to admit it or not. Regulating by empowering is far more effective then regulating by imposing. Thus, I truly believe that more effort and resources need to be channelled towards the education of the investing public. After all education = power since by educating people you will empower them to be able to regulate the financial practitioners themselves.

Teleworking – A Financial Perspective


Teleworking refers to the work arrangement whereby employees work from home and do not physically commute to a central work location as is normally the case. This post will aim to highlight the financial aspect of this arrangement to argue why it makes financial sense to use such an arrangement.

First of all it must be understood that just because a company introduces a teleworking program it does not mean that employees who decide to use this option have to decide between always working from the usual workplace or always working from home. In fact a mixture of the two would be the most beneficial in many cases. Certain tasks would require an employee to visit the place of work by their very nature, such as when a face-to-face meeting with a client needs to be held. However a lot of other office work can be done more productively when the employee remains at home.


The Benefits

Improved Productivity

The obvious benefit is the increase in productivity that would result when one does not need to leave the comfort of one’s home to work. Consider commuting time for example. If you consider that on average people in Malta take 30-45mins to commute from home to work and the same time back from work to home that means that on average a person would use up 1-1.5hrs per day just commuting. This means 5-7.5hrs per week. This does not include time used up for parking in both locations and preparation time to go out in the morning. So when you add this all up a person could save easily 20% of his time by working from home and dedicating those hours to his normal 40hr work week.

Less stress due to commuting would result in better productivity as well. It is no secret that stress is the cause of many other psychological and physiological illnesses such as eating disorders, insomnia and depression. By reducing the stress caused from commuting the individual would be able to be more focused on their work and produce better work in less time. Other stress factors related to the work place would also be reduced and would in turn improve productivity.

Reduced Costs

This is another important benefit. From an employer’s point of view, when less employees are physically present in the office less overheads are incurred. For example less electricity is consumed through a lesser use of electronic devices such as PC/laptops, heating/cooling devices and so on. From the point of view of the employee he/she would have higher electricity bills on a personal level since they are using their own space. However there would be the reduced costs in the form of transportation costs for example. Especially if an employee was used to eating out everyday during their lunch break they could easily now eat for less by eating from their own kitchen.

More Flexibility   

This is perhaps my favourite benefit. When one is working at his own pace it is much easier to work flexibly. So if the goal is to work 40hrs in a week or to get x amount of tasks done by this week, the individual can choose when best to work on those tasks. One may have to attend to a personal matter during the day that would occupy him/her between 10am and noon, which he can make up for at a different time. There is no restriction to when one can work on certain tasks. Of course there will be certain daily tasks that might need to be done by a specific time each day. However there will also be overall tasks that one might feel more comfortable working on at 9pm or on a Saturday afternoon.

This feature is perhaps the most beneficial for people with young children who would like to return to their job but cannot commit to the usual working times. Tied to the benefit of reduced costs and better productivity, employees with young children who would have to take leave days without much notice or sick leave due to their children feeling unwell could still work from home in such instances. Thus the employer does not lose a full work day and the employee can still meet his/her targets by working more flexibly.

This flexibility feature could also be used so that both parents could spend more time with their children. It is not only the mothers that could work remotely, but also the fathers could do so. If both parents are working from home there would be more family time and more participation from both parents in their children’s lives. Other setups could be used of course whereby either the parents work on alternative dates from home or just one works from home when the other needs to go to the work place.

More Free Time

From the point of view of the employee, time saved from commuting to work and the added benefit of working more flexibly would free up time for other things. One could use such time to practice a sport, go to the gym at off-peak hours, take up a new hobby or simply spend more quality time with their family at times when they would have otherwise been at the workplace. Another possibility is to pursue other career enhancing initiatives such as pursuing further studies or doing something that would generate additional income.


The Requirements

Of course it must be recognised that not all jobs could be done remotely. For example you would not expect a pilot to try to work remotely or a chef to cook from home. But in today’s age many people have office jobs which could in fact easily be done remotely. Even teachers could easily give lectures remotely with the help of some simple technology – so one should not assume that his/her job could not be done remotely, but should brainstorm on some form of compromise that could work.

Life is not black and white and there will rarely ever be a definitive no or yes response to doing something. Most of the time even office jobs require the employee to meet clients face-to-face so it might be the case that a combination of remote and on the job working could be used. One should not exclude having non-physical meetings with clients such as through conference software such as Skype. This might actually be preferred by certain clients who are also usually quite busy and could appreciate the benefit of not having to leave their workplace.

There are certain requirements that must be put in place in order to have a good teleworking programme:

Use of Technology

One of the first things any entity considering teleworking should consider is the upgrade or better use of its software. The obvious choice here is a form of cloud technology whereby all hardware is setup in a remote data centre. This is good for business continuity and it adds more layers of security by adding additional login barriers that would make it less likely for hackers to access. A secure remote connection setup must be established and all files and virtual spaces that the employee would normally need access to should be made available to them whether they are working from home or from the workplace.

Technology can also be used to address another major concern of employers. The usual complaint when I discuss this subject with managers and employers is that they would not have direct oversight on what their employees are actually doing. First of all it must be pointed out that just because an employee is working a few meters away in the same building does not mean that they are not slacking off. No manager or employer can afford to be checking up on their employees at all time, regardless of where the employee is working from. So in my view, this argument is quite flawed. Secondly, believe it or not one can invest in software that tracks the progress of employees. So whether the employee is working form an office, from the beach or from their own home the software will track their progress on the tasks assigned to them.

Definitive Tasks and Procedures  

In order for the whole operation to work well there should be a definitive course of action set in writing. If it is for daily tasks this process is easy since a simple procedures manual could be drawn up explaining what tasks the employee is responsible for doing. So called “How to” lists also help and these add to business continuity since if an employee needs to be temporarily or permanently replaced their daily tasks would be documented and could more easily be taken over by someone else.

In the case of tasks that are specific to a project, such as an IT software development project, the tasks of each employee need to be clearly marked. The tracking software can then be configured around this plan to keep better track of each employee’s progress. In most cases such detailed plans are already used and thus the basis is already set.

Clear Consequences and Responsibility

Responsibility for ones actions form the point of view of the employees is the key to any successful teleworking setup. Employees need to be knowledgeable, responsible and act fairly in order for such a setup to be possible. Furthermore, failure for one to meet his/her targets should have clearly defined consequences and need to be respected. Besides doing the work, such work also has to be up to standard so the employee must still ensure that they can work from a suitable environment. A home office would be the ideal setup in most cases. Furthermore the employee needs to ensure the security of the data they are accessing so that no unauthorised person can also access it accidentally for instance.

The Bottom Line

I hope this post has highlighted the possibilities that one could apply to their own work situation. Of course the initiative should not only be taken up by employers and managers but also by the employees themselves. One should assess their own situation and consider whether such a setup could work in their own situation. Many a time the solution is not necessarily a straight forward one and a combination of different setups could be the ideal solution.



Buy to Let, a Bubble in the making?


With historically low interest rates the attractiveness of the property market, and more specifically the “Buy to Let” sector has increased significantly, and this for a number of reasons:

  • Low interest rates means low yielding alternative fixed income investments such as bonds and the various types of bank accounts;
  • Low interest rates means that it is cheaper to finance the purchase of the property through a bank loan (even though technically these should be considered as business loans rather than home loans);
  • There seems to be no form of regulation on the property market with estate agencies advertising buy-to-let rates as investment products, without any form of warnings;
  • The inherent historical obsession of the local investor with the property market and the attitude that “land always appreciates” – I guess they have not heard of the 2007/09 financial crisis in which the property market was the key source of all the turmoil?!
  • The influx of foreign workers who re-locate to Malta as the demand for certain jobs that might not be fully catered for by the local work force has increased significantly. Such workers would typically be specialised IT developers who would more likely be looking to rent, at least in the first few years.
  • The increase in marital separations and divorce has also led to a demand for rental properties as proceedings can take a while to be concluded and it would involve some form of division of assets that would make it more affordable to rent a property as opposed to buying one.


What are the risks?

Although buying a property for rental income is not a bad thing in itself, there still are risks involved in such an investment. First of all, I am always sceptical of “investments” that are not regulated. Since property investing does not fall under the definition of a financial instrument it is not regulated by the very investor-centric regulations that financial instruments are. What this means is that as an investor you are not protected and the person selling the property to you has no obligation to explain the risks involved in investing into the property market. He/she doesn’t even need to know about the risks

Another risk of buying to let is that property investing typically takes up a large portion of one’s portfolio of assets. We all know how the advice is always to spread your risk by diversifying into different investments. If a person has for example €150,000 invested into a property for rental purposes and then has €20,000 in other investments, such an investor has a high concentration risk whereby 88% of his investments are in one single investment. In the same logic that one should never buy into one single investment when considering financial instruments, one should not have such a high concentration into property.

By its very nature, property is an illiquid asset, meaning it cannot easily be converted into cash. Even if one is lucky and manages to sell his property in say 3 months, there typically will only be a promise of sale first and then 6 months to a year later the contract will be done which could be subject to other things such as development approval, approval of a bank loan and so forth. If on the other hand an investor has a Malta Government Stock (MGS) and wants to sell €1mln in one day he will get his money in 3 working days.

The hidden costs are also a major factor to keep in mind. Since property as an investment is not regulated there is no obligation to mention all the costs from beforehand:

  • The initial costs in buying a property are typically a commission if a property dealer is used (not an agency, those are normally paid by the seller). There is then a tax to be paid on purchase of a  property. There are the notary fees to be paid for research and drafting of the contract. There are then the bank fees if a loan is being taken out to finance the project.
  • The on going costs – if an agency is going to be used in order to find tenants (which is the most convenient option), then the agency would take its commission for doing its work. If you are renting out a furnished property which is typically the case you not only need insurance on the property but also insurance on the content (furniture, fixtures and fittings). If your property is an apartment part of a block you also have the annual maintenance fee to be paid (for maintenance and upkeep of the common areas). There is of course the ongoing typical maintenance costs involved in keeping any property in good form such as painting and plastering from time to time and so on.

So when you add all the costs together you quickly realise that the advertised 4-6% rental income is just a gross figure and not the real net return. This is besides the fact that like other investment income the income from renting is subject to 15% withholding tax as well.

Another risk is the interest rate risk that exists. Here we have two factors in play.

  1. One factor is the current cheap  mortgages attributable to the current low interest rates. Some “investors” who are buying property with the aim or renting it out are not factoring in the event that interest rates could start rising and with them the cost of maintaining their bank loan. As interest rates rise the monthly payment needed to pay the mortgage on the property goes up and it might very well go up to the point were many would not consider it viable to keep renting out the property. In such a situation there will be a rush to sell properties. 
  2. The other factor is when you consider the income of renting out a property (with all the hassle that brings along with it) compared to the income from a regular bond or bank deposit.  As interest rates start to rise the difference starts to narrow and could even end up reversed whereby one could get a better interest on financial instruments as opposed to rental income. This scenario would also lead to a rush to sell property and hence a fall in the price of such property.

A final risk to consider is the dependence on foreign occupants for certain sectors of the rental market. Many rental properties around the Sliema, St. Julians, Gzira and Ta’ Xbiex area are occupied by foreigners form the IT, Gaming or Financial Services sectors. These tend to be employed by foreign companies that have been attracted to Malta mainly for the advantageous tax setup for non-resident shareholders. Imagine what would happen if the EU had to pressure Malta to change such tax setups and a number of these foreign companies had to relocate elsewhere!


Are we witnessing a bubble in the making?

When you have a situation that a lot of investors are switching to buying property in order to rent them, you quickly start to build up more supply of rental properties. This, coupled with all the reasons listed above as to why the demand for buy-to-let is going up, could end up creating a situation where property values go up in value too high, too fast. At the end, you end up with a situation where prices have to be corrected and you have a fall in the asset value.

Although I do not think that we have entered this phase yet, history teaches us that we are slowly heading in this direction. I am not talking about 20 years ago history, I am talking about a few years ago when there was a big drive for many people to knock down their house and build a number of apartments. All of a sudden ever Tom Dick and Harry became a contractor – at first it was quite a lucrative venture, eventually however the demand reached its limits and the supply outweighed it.

The Bottom Line

Like any other investment, investing into a buy-to-let property has to be taken in the context of one’s total portfolio. One should not over expose him/herself just to get into this market. On the other hand, if it is affordable, an investment into the property market is considered a good addition as it will not move in the exact same direction as other investments and can lead to more diversification.

Just like not all bonds are the same, not all shares are the same and so no, not all property is the same. Location, property size and other factors will have an effect on the rent-ability and potential saleability of any property one might consider. So advice from a professional is always recommended.

Furthermore, one should note that there are other ways of entering this market without actually buying property. There are many investments issued by property renting firms which one could invest indirectly into this market. One could also add different investments from different geographical locations and different sectors of the rental market. This could be done much cheaper and provide for much better diversification of one’s risk than actually buying property directly.