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IN THIS ISSUE Hannes Apitzsch CFO Infrastructure & Cities Sector, Siemens AG Harald Benink Founding Chairman, European Shadow Financial Regulatory Committee John Defterios Anchor & Emerging Markets Editor, CNN International Stefan Dohler Senior Vice President, Asset Optimisation and Trading, Vattenfall AB Dr. Ingrid Hengster Country Executive Germany, Austria & Switzerland The Royal Bank of Scotland plc. Ralph Heuwing Chief Financial Officer, Dürr AG Prof. Dr. A. Stefan Kirsten Chief Financial Officer, Deutsche Annington Immobilien Stefan Klebert Chief Executive Officer, Schuler AG Luis M. Linde Governor, Banco de España Lawrence A. Rosen Chief Financial Officer, Deutsche Post DHL Hussain Al Shahristani Deputy Prime Minister, Iraq Axel Strotbek Member of the Board of Management, Finance and Organization AUDI AG …AND THE STERN STEWART INSTITUTE’S ANNUAL SUMMIT REVIEW AND POLL RESULTS #9 DECEMBER 2013 SCHUMPETER REVISITED The Rise of Creative Destruction

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In thIs Issue Hannes ApitzschCFO Infrastructure & Cities sector, siemens AG

Harald Benink Founding Chairman, european shadow Financial Regulatory Committee

John Defterios Anchor & emerging Markets editor, Cnn International

Stefan Dohler senior Vice President, Asset Optimisation and trading, Vattenfall AB

Dr. Ingrid Hengster Country executive Germany, Austria & switzerland the Royal Bank of scotland plc.

Ralph Heuwing Chief Financial Officer, Dürr AG

Prof. Dr. A. Stefan Kirsten Chief Financial Officer, Deutsche Annington Immobilien

Stefan Klebert Chief executive Officer, schuler AG

Luis M. Linde Governor, Banco de españa

Lawrence A. Rosen Chief Financial Officer, Deutsche Post DhL

Hussain Al Shahristani Deputy Prime Minister, Iraq

Axel Strotbek Member of the Board of Management, Finance and Organization AuDI AG

…AnD the steRn stewARt InstItute’s AnnuAL suMMIt ReVIew AnD POLL ResuLts

#9

D e C e M B e R 2 0 1 3

SCHUMPETER REVISITED – The Rise of Creative Destruction

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M A R k u s P e R t Le D I t O R I A L C O M M e n t

"Creative Destruction" – Schumpeter stuck firmly to his belief that strong entrepreneurs and continuous innova-tion are the most important pillars of economic growth. We started revisiting Schumpeter at our Annual Summit in September and enjoyed the most interesting and inspir-ing insights. In this edition of The Stern Stewart Institute’s Periodical, we are continuing with this discussion. But, first, let’s take a moment to examine our role as leaders and how innovation, changes and entrepreneurial thinking can be anchored in our companies.

When Schumpeter defined entrepreneurs as the driver of innovation, the world itself and the business world were not as complex as they are today. The role of entrepreneurs is not getting any easier as globalization makes our world appear smaller and smaller. Entrepreneurs are not only re-sponsible for innovation, entrepreneurs are also responsi-ble for steering huge enterprises and complex interna-

tional organizations. Today’s organizational charts look more like a piece of modern art given that companies work in various sectors with global functions and are present at the local level all over the world.

No doubt, managing such companies is a bold venture for every management board. And since no management can embark on this venture without the support of the entire company, we find ourselves in a bit of a bind: Faster chang-ing markets require much faster decision making, top management has to be involved and informed about all major issues and, lastly, top management has to make the “big entrepreneurial” decisions. At the same time, entre-preneurial thinking should be stipulated by every leader of the company, and business unit leaders should have as much freedom as possible to act like entrepreneurs. This is not an easy combination and certainly presents a chal-lenge that seems akin to a tightrope walk. Nevertheless, it

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M A R k u s P e R t Le D I t O R I A L C O M M e n t

Markus Pertl Chairman of The Stern Stewart Institute

is a feasible one: Feasible with a company structure that clearly defines the decision-making processes and makes room for entrepreneurship on all levels and feasible in that management is focused on its tasks and stands strong at the helm of the company. So, for me, the focus is on recog-nizing that leadership means to lead as opposed to serve. Let's call for the creative destruction of corporate centers. We all have to focus more on giving strategic direction. We need to interface directly with the leaders of our busi-nesses rather than with corporate functions. We need to build smaller but stronger leadership teams and, in doing so, focus on the important aspect of interacting.

For my part, I consider this a challenge we should all be willing to take. Let’s prove that not only concepts, products and businesses evolve, but that leadership also has to evolve in order to keep pace with the ever changing busi-ness world.

But now, let’s find out just what it is that changes and turns the business world today. Have a look at how and espe-cially where Schumpeter’s viewpoint is still very valid to-day. When you take the time to read through the articles, you will see what I mean. I invite you to see for yourself that creative destruction can be found in so many different fields. It is up to you whether you agree with me in saying that Schumpeter has been proven right again…

I hope you find the periodical an interesting and stimulat-ing read.

Markus Pertl

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Contents

Editorial Comment by Markus Pertl Markus Pertl, Chairman, The Stern Stewart Institute

The Business Case for Resilient CitiesHannes Apitzsch, CFO Infrastructure & Cities Sector, Siemens AG

The New Normal in the European Electricity SectorStefan Dohler, Senior Vice President and Member of the Executive Group Management, Head of Business Division Asset Optimization and Trading, Vattenfall AB

Carbon Accounting and Controlling – A Journey to ExcellenceLawrence A. Rosen, Chief Financial Officer, Deutsche Post DHL

»… there will always be more demand for oil.«Hussain Al Shahristani, Deputy Prime Minister, Iraq John Defterios, Anchor & Emerging Markets Editor, CNN International

Who is Financing the Real Economy?Dr. Ingrid Hengster, Country Executive Germany, Austria & Switzerland, The Royal Bank of Scotland plc.

Path to Sustainable Recovery in Spain Luis M. Linde, Governor, Banco de España

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Preparing for a European Banking UnionHarald Benink, Founding Chairman, European Shadow Financial Regulatory Committee

Managing Complexity: How to Succeed in Today’s Automotive BusinessAxel Strotbek, Member of the Board of Management, Finance and Organization, AUDI AG

How to Recover from the Economic Goldilocks Hangover Prof. Dr. A. Stefan Kirsten, Chief Financial Officer, Deutsche Annington Immobilien

Slimming Solutions and Driving Performances – Challenges in automotive lightweight designStefan Klebert, Chief Executive Officer, Schuler AG

Interview: The Value of Continuous Global Process Improvement Ralph Heuwing, Chief Financial Officer, Dürr AG Dimitri Belobokov, Partner, Stern Stewart & Co.

The Stern Stewart Institute Annual Summit 2013 Review: What the Future Holds For UsThe Stern Stewart Institute

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It is an unfortunate reality that many cities, from Bangkok to Boston, will face more serious weather events at some point in their futures. Combined with rapid urbanization and settlement patterns that are often poorly planned, this means that increasing numbers of people, along with their industrial assets and private property, are at risk.1

Increased realization of this fact is prompting a shift in thinking within many city administrations. From a pri-mary focus on climate change mitigation, aimed at reduc-ing emissions, many leaders are now adding a new focus: resilience. The reason is clear: Climate risks are rising quickly as made evident by a range of recent disasters. Over the past century a clear trend emerged, and the frequency and in-tensity of floods, droughts, heat waves, tropical storms and other weather events have increased sharply, and are fore-cast to continue along these lines (see chart). The human and economic toll from these events has been severe and is rising fast. The UN Office for Disaster Risk Reduction (UNISDR) reported in March 2013 that for the first time in history, the world has experienced three con-secutive years where the economic cost of natural disasters has exceeded $100 billion.

In New York, for example, Hurricane Sandy in 2012 cost an estimated $19 billion in damages. By mid-century, ac-cording to outgoing Mayor Michael Bloomberg, this could cost $90 billion or nearly five times as much.2 This has prompted a more thorough evaluation to find a better way forward. Globally, UNISDR is promoting “building back better for next time” as an important principle for future city investment post-disaster.3

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The Business Case for Resilient Cities New research reviews the costs and benefits of adapting to a changing climate

Hannes Apitzsch CFO Infrastructure & Cities SectorSiemens AG

Figure 1: number of recorded disasterssource: eMDAt-CReD, Brussels

storms Regression LinesFloods

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1 “economic losses from disasters set new record in 2012”, unIsDR, 14 March 20132 Mayor Bloomberg's presentation of the city’s long-term plan to further prepare for the impacts of a changing climate, nyc.gov, 11 June 20133 “Building back better for next time”, unIsDR, 2010

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PLAnnInG FOR A MORe ResILIent FutuRe

For city leaders who are already grappling with tight budg-ets, expanding future costs of climate-related risks is of growing concern. Nevertheless, it is quickly becoming clear that investing in more resilient cities will be neces-sary given that the costs of not acting are simply too high. What does increased resilience entail? From a technology and infrastructure perspective, city leaders need to invest across five core categories, as outlined below.4 These work collectively, even though the relative importance of each will inevitably vary from one city to another:

Robustness. Creating infrastructure that is physically able to withstand future hazards without significant damage or loss of function.

Redundancy. Ensuring spare or capacity to cope with sudden demand surges, as well as backup for failures.

Diversity and flexibility. Ensuring services that can be supplied via a number of pathways, even if some fail.

Responsiveness. Automated monitoring and short feed-back loops, enabling transparency and rapid adjust-ments to maintain functionality.

Coordination. Ensuring shared knowledge, collabora-tive planning and integrated responses.

Such planning is equally key for both developed and emerging market cities. While some fortunate cities face fewer climate risks, the distribution of at-risk urban areas does not distinguish between richer and poorer countries. Indeed, for many emerging market cities, resilience will become an essential part of how they compete for future investment. Take Bangkok, where prolonged flooding in 2011 devastated its competitiveness as a manufacturing zone; thousands of factories were inundated which af-fected supply chains around the world. The country has

pledged to invest $11.1 billion to bolster the city’s resil-ience – and investor confidence.5 Opting not to do so will simply be more costly over time.

AssessInG the BusIness CAse OF CIty ResILIenCe

Just as modifying and storm proofing a home is costly, so is rebuilding a city’s defenses. However, investing in city resilience is broadly comparable to taking out an insur-ance policy, one that will help to mitigate the future effects – and costs – of climate risk. As with any insurance policy, the payback in the event of a disaster can be significant. Shaun Donovan, US Secretary of Housing and Urban Development, who led a Presidential taskforce in the wake of Hurricane Sandy, argues that for every $1 spent on haz-ard mitigation, at least $4 of costs are avoided when disas-ter strikes again.6 But unlike a pure insurance policy, in-vesting in resilience can deliver significant benefits even in the absence of a disaster, by creating a more efficient and sustainable city. To verify this, Siemens recently partnered with Arup (an engineering company) and the Regional Plan Association (a civic organization devoted to urban planning in the New York-New Jersey-Connecticut region) to conduct a new study. It explores the role of technology and the ena-bling framework required to enhance the resilience of cit-ies and their critical infrastructure systems.7 It focuses on the New York City metropolitan area and looks specifi-cally at its electricity grid to evaluate vulnerabilities and possible mitigation steps to assess the business case for in-creased resilience. This is no abstract example as the fail-ure of a vital electricity substation during Sandy cut power to nearly 250,000 homes and businesses, forced the evacu-ation of hospitals, and resulted in several neighborhoods being disconnected for six days.

4 these are outlined in more detailed within: “toolkit for Resilient Cities" www.siemens.com/urban-resilience, Arup, Regional Plan Association and siemens, 20135 “thailand cuts key rate to support recovery from floods amid global slump”, Bloomberg, 25 January 20126 “sandy taskforce: build stronger homes to withstand worsening storms”, the Guardian, 19 August 2013 7 “toolkit for Resilient Cities" www.siemens.com/urban-resilience, Arup, Regional Plan Association and siemens, 2013

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The study outlined a range of investment options, span-ning three broad levels. First, it considered how to make key equipment more robust, for example, by flood proof-ing key substations. Second, it expanded demand reduc-tion programs to reduce peak electricity demand and net-work congestion through the use of advanced metering infrastructure and energy management systems, just to name a few. Third, it mapped out the development of a smart grid to bolster flexibility and responsiveness. This includes, for example, automated demand management, which connects buildings to the grid and can automati-cally power down non-critical appliances. Its findings are clear. Taking no defensive action at all would ultimately cost approximately $3 billion. By taking partial action, by investing in increased robustness, an in-vestment of approximately $400 million would cut the costs of repair and response by some $2 billion (see chart). However, if all of the outlined steps were implemented, numerous spillover benefits could be achieved. This would require a significant investment of about $3 billion. However, it would not only cut future losses by $2 billion, but also generate a net gain of $3 billion through enhanced grid capacity, stability and increased energy efficiency.

nO teChnOLOGy PIPe DReAM

When considering a business case like this, the obvious question is about how realistic such an assessment is. Can it be done with existing technologies or does it require a leap of faith in unproven solutions? To eliminate this risk, only existing technologies were considered, several of which are already being tested in New York. Of course, these outcomes are not dependent upon tech-nology alone. Several other dimensions are vital too from changes in urban planning to improve land use, right up to better governance, improved knowledge sharing and sus-tainable financing mechanisms. As a CFO, the latter is an especially important considera-tion for me, as sustainable funding is a basic precondition of any such project. From a financial perspective, many of these costs do not need to be considered as exceptional in-vestments, but are merely amendments to existing mainte-nance and capital investment programs. For example, an existing program to maintain or replace customers’ elec-tricity meters, can simply be modified to roll out smart meters instead.Nevertheless, additional financing will still be needed. But there is considerable scope for innovation here. Cities could move inner city electrical substations underground, freeing up space to be sold to real estate developers, for example. Granting concessions to private companies to lease public infrastructure, with the agreement to own, operate and maintain the assets at a certain level is another option. The 2012 launch of a C40 city-led network focus-ing on Sustainable Infrastructure Finance will surely help to uncover other new approaches too. Overall, while as individuals we buy insurance with the hope that we will never actually have to make use of it, even as we incur the cost, the calculation differs for cities. Investing in resilience not only makes sound financial sense for future risks, but it also offers long-term rewards, including a safer and more sustainable future. Partial Investment Full Implementationno Action

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Much has been said and written about the dawn of smart, decentralized and digitalized electricity systems of the fu-ture that challenge the conventional business models of incumbent utilities, specifically in Europe.

Until Fukushima, the conventional wisdom of large European utilities relied on a number of key principles:

A joint understanding in the EU to move toward a more integrated electricity and gas market with a common set of rules.

A joint (although not always unanimous) push for CO2 reduction through a market-based mechanism under the EU Emission Trading System (ETS).

Security of supply does matter. Size does matter. A politically stable investment framework is given to

motivate investments into the sector.

It was that stable set of rules that would allow market par-ticipants to make long-term investment decisions with payback periods in excess of 25 years.

With the German decision to expedite the nuclear exit and to more or less unconditionally support the massive exten-sion of renewable capacity, a clear paradigm change has taken place:

Investment security is no longer given since the rules of the game keep changing. The industry has been coping with decision-making in a competitive, market-based environment. This is no longer possible since the defi-nition of what is left to the market is constantly being changed by political interventions.

Security of supply has been taken for granted assuming that the addition of capacity will automatically increase security of supply. However, it has meanwhile become clear to most stakeholders that the addition of non-de-pendable capacity does add to the instability of the sys-tem since the incentive to operate dependable capacity is not rewarded in a system that unilaterally privileges renewable capacity.

The basic market design concept that typically has a supply-demand curve has been more or less suspended in Germany. Renewables are incentivized to produce wherever, whenever and whatever they want while German customers still need power at a specific loca-tion, at a specific time and in a specific volume.

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The New Normal in the European Electricity Sector

Stefan Dohler Senior Vice President and Member of the Executive Group Management, Head of Business Division Asset Optimization and TradingVattenfall AB

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With the development of capacity-subsidized renewables in Germany, the existing system of an energy-only market is being put to the test. Not only Germany is affected; its direct neighbors are also currently at the receiving end of a mixed bag. On the one hand, they profit from cheap German exports at times when a large part of the wind (>30 GW installed) and PV (>35 GW installed) are pro-ducing while Germany may only need half of that during a typical weekend. However, as in Germany, this export ca-pacity at basically zero marginal cost is putting pressure on the running hours of the existing capacities in these coun-tries, specifically those which are at the margin, i.e. mostly gas-fired units. Furthermore, the physical flows are add-ing stress to the neighboring Transmission System Operators by so-called loop-flows (e.g., renewable over-supply in northern Germany finding its way to the south via Poland, the Czech Republic and Austria).

Besides these developments which were accelerated post-Fukushima, a number of additional trends have been evolving over the past decade with mixed speed and suc-cess, such as Emobility, smart grids, smart metering, smart homes, prosumers and demand-side management. Most of them have not unfolded their full potential since their value contribution to the system landscape is not priced

adequately within the current framework. The unilateral requirement to balance the system is put on shoulders of the Transmission System Operators which, in turn, tap into the relatively restrictive ancillary system services markets. A broader and more integrated market mecha-nism, which would need to include renewable production, could bring about a change.

Why is it that in the German energy sector there is a grow-ing tendency to re-regulate and even re-nationalize (often on the regional/municipal levels) parts of the sector? This is clearly a spill-over from the financial sector where meanwhile the state seems to be considered the better en-trepreneur by some. However, the transformation of that approach to the electricity sector will lead to less efficient and more costly solutions. As a recent example, the potential full classification of the physically-based electricity and gas wholesale markets un-der EU financial regulation requirements will occupy bal-ance-sheet capacity for what would be better released to infrastructure investments instead and will drain liquidity from the wholesale market.Given the New Normal whereby decision-making will have to happen under considerable uncertainty in the years to come, the industry will need to come up with so-lutions that do not require massive capital expenditure for projects. Rather than investing in a top-notch plant with supercritical technical parameters, it would be more real-istic to identify capex-light solutions since plant operating hours will be less certain.

One of the key challenges ahead will be the increasingly complex integration of the evolving energy system. This will require a stable set of rules and should be based on a competitive and market-based system rather than on a set of uncoordinated and short-sighted political interven-tions. At the moment, there is much discussion about the need for a capacity mechanism in Germany as a conse-quence of the massive renewable capacity that is pushing

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out conventional plants from the merit order. But rather than addressing the real course, i.e. the lack of market inte-gration of renewables, there is a quick call for the next level of intervention that will further diminish the role of the market. A better answer would be to let the market de-velop scarcity signals and to safeguard the security of sup-ply by a strategic reserve without distorting market-based pricing.

ETS is a good example of an efficient and effective system aimed at reducing carbon emissions in a way that is supe-rior to direct subsidies for specific types of technology that in the case of PV has led to a misguided development of German solar companies.The continuation of this unfortunate trend of believing in spiraling political interventions where the administration is replacing the market is now leading to even worse ef-fects.

An example for this is that after increasing the surcharge for renewables to soon above 6 ct/ kWh (against a whole-sale base power price for 2014 of 4 ct/ kWh) and increas-ing grid fees it now has become economic to develop de-centralized, own-use concepts with small-scale CHPs and

renewables. “Grid parity” is reached because these solu-tions are seeking an exemption from those cost elements that have been driven up by the massive expansion of re-newables in Germany. It is very evident that this “out-smarting” of the system is not sustainable, and that we will need to see the introduction of a system participation charge that is linked to infrastructure usage rather than kWh consumption. This will have to apply for the grid cost and for the system integration cost of renewables. In addi-tion, exempting self-generating renewable consumers who are connected to the grid from the renewables sur-charge is not sustainable.

The new German government will need to find answers to facilitate the continued development of renewables which is widely supported by German citizens while ensuring a cost-effective approach combined with a strong system-integration incentive. At the same time, this needs to be compatible with the neighboring countries while still re-maining within the EU framework. On a European level, there needs to be a political answer to the question if the concept of an integrated and market-based energy system is to be continued and revitalized.

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Lawrence A. Rosen Chief Financial OfficerDeutsche Post DHL

The old adage “you can’t manage what you can’t measure” certainly applies in the field of carbon efficiency manage-ment. In the past few years, DP DHL has integrated Carbon Accounting and Controlling into its financial systems to ac-company its GoGreen environmental protection program with its ambitious carbon efficiency improvement targets. With its Carbon Accounting & Controlling, the Group cre-ated a program within Finance that went beyond measure-ment and reporting, and successfully transferred manage-ment methods, tools and processes to the area of carbon ef-ficiency. This, in turn, has made it possible for Deutsche Post DHL to establish a sophisticated system of carbon manage-ment and a very strong basis for decision-making and plan-ning.

CARBOn MAnAGeMent – nICe-tO-hAVe OR InDIsPensABLe? Just for reporting or a real management tool?It has been a long time since mere reporting on sustaina-bility indicators was considered sufficient. More and more, customers and investors are interested in the sus-tainability performance of their service providers and portfolios. In logistics, the focus is on emissions as the transport industry is responsible for 13 percent of global

greenhouse gas emissions. Increasingly, customers are re-questing detailed information on greenhouse gas emis-sions and carbon efficiency, and are looking to optimize their own value chain in this regard. In addition, large investor associations such as the CDP, previously known as the Carbon Disclosure Project, are taking a much closer look at company strategies. Finally, lawmakers at the national and international levels are issu-ing compulsory reporting requirements, such as the EU Emissions Trading System (EU-ETS) or French decree No. 2011-1336, which requires companies to establish comprehensive, detailed and precise reporting systems. Just a few years ago, a company might have demonstrated its commitment to climate issues by providing an estimate of its overall carbon footprint. Today, stakeholder groups expect fact-based, verifiable numbers and clear efficiency improvements and targets. In addition, there are significant economic implications. In 2012, Deutsche Post DHL spent over 2.2 billion euros on energy and fuels and an additional 18.8 billion euros on outsourced transport services. Every percentage point of efficiency gain brings double the reward in terms of lower-ing operating costs, taking advantage of opportunities and avoiding risk over the long term.

Carbon Accounting and Controlling – A Journey to Excellence

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Transparency across the value chainEffective carbon management depends on a clear and comprehensive understanding of a company’s own carbon emissions. At Deutsche Post DHL and many other compa-nies, a large portion of carbon emissions results from up-stream and third-party services. The Greenhouse Gas Protocol, an international account-ing tool for calculating emissions, considers the value cre-ation chain in terms of three distinct scopes: Scope 1: A company’s direct emissions resulting, e.g.,

from the combustion of fuels in facilities owned or leased by the company itself

Scope 2: Indirect emissions from electricity and other utilities

Scope 3: All other emissions generated across the value chain, such as subcontracted transport services, busi-ness travel, commuting or the production and supply of fuels, other goods and capital goods.

At Deutsche Post DHL, over 80 percent of greenhouse gas emissions can be attributed to Scope 3 and are generated by the Group’s partners throughout the value chain. In 2012, carbon emissions from the company’s own facilities, aircraft or ground transportation fleets totaled 5.37 mil-lion tons while emissions from transportation providers totaled 22.67 million tons. Deutsche Post DHL’s total an-nual emissions are roughly equivalent to the emission footprint of 3 million German residents (based on the 2010 figure of 9.05 tons of carbon per German resident).Frameworks and norms such as the Greenhouse Gas Protocol, the ISO 14064 or the EN 16258 provide not only a valuable reference for calculating emissions for defining accounting purposes, but also help prioritize emissions sources in reporting and management. Creating transpar-ency across the value chain is thus the first step toward op-timizing a company’s own processes with regard to carbon emissions.

Climate goals in businessSuccessful management requires goals. For an efficiency goal, emissions are considered in relation to a measure-ment parameter which reflects the company’s perfor-mance. For example, a company can define its goal to re-duce emissions per employee, per production unit or per euro of revenue across a given period of time. Relative goals allow companies to work toward emissions reduc-tion goals while they continue to grow in their respective markets. As a leader in the growing global logistics mar-ket, Deutsche Post DHL has set an ambitious efficiency goal for itself and its environmental protection program GoGreen. By the year 2020, the group has committed to improve carbon efficiency by 30 percent compared to the 2007 levels. Finance supports these goals by ensuring transparency and a system of controlling which facilitates good decision-making.

FROM CARBOn ACCOuntInG tO CARBOn COntROLLInGOrganizational structure at Deutsche Post DHLAchieving the goals of the GoGreen environmental pro-tection program requires dedicated and committed man-agers with intelligent approaches and creative, new ideas which generate specific initiatives to improve efficiency of the Group’s greenhouse gas emissions. The carbon ac-counting system serves as the foundation and makes it

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possible to accurately track the success of various imple-mented measures.Back in 2008, Deutsche Post DHL’s Board of Management assigned this responsibility to a working group that brought together experts from both finance and the GoGreen team. The interdisciplinary collaboration en-sured the optimal combination of financial tools with en-vironmental know-how. In a very short amount of time, by mid-2009, the working group was already generating monthly reporting on the company’s own energy and fuel consumption (within Scope 1 and Scope 2). The processes of data delivery, consolidation and quality assurance con-tinue to be applied today, and are based largely on the standard processes that have long been applied in finance. While data-driven carbon accounting makes it possible to

measure progress and goal attainment, it also makes it possible to discover trends and potential and provides a basis for planning and decision-making. In short, it makes carbon controlling possible.Thus, in 2010, the Carbon Accounting & Controlling pro-gram was established as a separate department within Corporate Controlling. The cross-divisional team works to continually improve existing data collection and devel-ops new processes for analyzing, planning and managing the Group’s greenhouse gas emissions and carbon effi-ciency. Carbon Accounting & Controlling reports exter-nally on the Group’s progress as part of the Annual Report and Corporate Responsibility Report and also generates internal reporting formats. Just a few years ago, it would have been almost unthinkable for financial experts to inte-

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grate environmental data so extensively.The Group already began integrating carbon efficiency goals into its regular planning over a year ago. This has helped define a clear path toward achieving the 2020 effi-ciency goals and as a way to measure progress and set tar-gets along the way for the individual businesses. This is further supported by the inclusion of efficiency parame-ters in internal Management Scorecards, as well as Business Review Meetings, which take place quarterly in the divisions. As part of the Business Review Meetings, the CEO and CFO come together with the respective divi-sional boards to review the operational progress, key fi-nancial data and now also progress in carbon efficiency and to plan the necessary actions and measures.

Controlling as a reliable partner to managementAs with financial data, creating transparency through (carbon) accounting is only a first step toward a system of carbon controlling that can truly support management de-cisions. First, regular reporting makes it possible for the

Group to communicate both internally and externally on its carbon emissions and the progress it has made toward efficiency goals. This has facilitated a systematic dialog across various management levels on the levers and driv-ers of carbon efficiency.

In this context, controllers and GoGreen managers can use targeted analysis and reports to provide new insights and set priorities and guide decision-making. Carbon re-porting at Deutsche Post DHL was not created as an iso-lated activity. It has been integrated from day one into fi-nancial reporting and is now also included in the Group’s overall planning and strategy. The result is an integrated perspective that continues to guide decisions. This is fur-ther supported by integrating carbon goals into incentive schemes.To be able to pass on the successes in carbon-efficiency management (as measured by Carbon Accounting) to cus-tomers so that they can reduce their own carbon footprint and to be able to provide useful data for customer-specific optimization efforts, calculations for customer-specific carbon reports and individually tailored environmental services also rely on the results provided by the Carbon Accounting & Controlling system.

The success of DP DHL’s Carbon Accounting & Controlling function reinforces the importance and inter-dependencies of the classic triad of economic, environ-mental and social sustainability. The responsible use of resources is not only a central aspect of environmental sustainability, but is also a critical cost driver and risk fac-tor for financial performance. The solid analytical basis thus not only serves as a foundation for optimal decision-making, but as an early warning system, as a tool for mak-ing customers more successful and as a way to ultimately secure long-term business success.

L A w R e n C e A . R O s e nC A R B O n A C C O u n t I n G A n D C O n t R O L L I n G – A J O u R n e y t O e x C e L L e n C e

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R A L P h h e u w I n G t h e V A L u e O F C O n t I n u O u s G L O B A L P R O C e s s I M P R O V e M e n t

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L A w R e n C e A . R O s e nC A R B O n A C C O u n t I n G A n D C O n t R O L L I n G – A J O u R n e y t O e x C e L L e n C e

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D A V I D M A R S HT o w A R D S A n e w w o R l D c u R R e n c y c o n S T e l l A T I o n

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J O h n D e F t e R I O s & h u s s A I n A L s h A R I s t A n I… t h e R e w I L L A L w A y s B e M O R e D e M A n D F O R O I L

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We are on the way towards a shake-up in interna-tional monetary arrangements. “New world currency or-der” would be overstating the case, because the new set of circumstances linking the dollar, the euro and other parts of the world currency set-up is a long way from being an “order”. Still less is it a “system”. There is still very little to fill the vacuum created by the demise in 1971-73 of the Bretton Woods fixed exchange rate system established af-ter the Second World War. Still, it is incontestable that, as a result in fundamental and probably irreversible shifts in the world economy during the past 10 years, a watershed has been reached. The word that is appropriate for the era that is now approaching is “constellation”, describing a state of affairs where a number of monetary and economic aspects are co-existing, linking the rapidly-coalescing de-veloped and developing parts of the world.

What are the highlights of the new constellation?

First, the two pivotal world currencies – one, the dollar, long-established; the second, the euro, the new-comer formed in 1999 as the result of a risky monetary fusion in Europe, are both under threat, for different rea-sons.

Second, the developing nations or “emerging market economies” (a better word might be “transition economies”) are becoming better represented on the global currency scene, commensurate with their growing world monetary role.

Third, the governance structures of world money are gradually shifting towards reflecting this changed power balance.

suggested by Paris – would be completely inap-propriate. The functionaries and politicians of Europe and America should not hide behind protective structures that have become progressively irrelevant. As the tectonic plates governing the world economy shift into a new ar-rangement, how the IMF handles its own transition is of pivotal significance on a much wider plane.

D A V I D M A R S HT o w A R D S A n e w w o R l D c u R R e n c y c o n S T e l l A T I o n

Towards a new world currency constellation

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»…There Will Always Be More Demand for Oil.«

John Defterios: Mr. Sharistani, Iraq has passed 3 million barrels a day of produc-tion for the first time since 1990, but you are making a relatively bold declaration that production is going to surpass 3.5 million barrels a day by the end of 2013. Give us a sense of why you are confident that could happen.

Hussain Al Shahristani: Well, in August our production was about 3 and a quarter million barrels per day. This month, we brought 2 new fields into production, the Gharraf field in Nasiriyah in the South and the Majnoon field in Basra, also in the South. These two fields will add about 300,000 barrels. There is excellent pro-duction from the other fields, so when you add up these numbers you will get to 3.5 or 3.6 million barrels before the end of the year.

A few years ago, you declared that you wanted to reach 6 million barrels by the end of 2013, and later said 12, 13 million by 2020. Would it be possible for you to say, in the long term it will be at 9 million over a long period of time?

No, the previous numbers that we were talking about, 6 million, were based on the contracts with the major interna-tional oil companies that oblige them to reach that kind of production level. Since then we have been working with these oil companies and asking ourselves what serves Iraq's best interests. Is it to reach that production level quickly or to have a more realistic production plateau that can be kept for a much longer time? We decided to go for the second option to maximize recovery rather than hit the highest possible production in a short

time. So the overall production target was reduced down to about 9 million bar-rels. In order to achieve this goal, it was decided to extend it until 2020 and keep it at that level for almost 20 years. So, based on the revised integrated energy strategy for Iraq it has actually been revised down to 3.5 million barrels before the end of 2013 and we think we will reach this.

You are aware that the IEA (International Energy Agency) is suggesting that you can only get to 6 million barrels by the end of this decade?

Yes.

That’s a gap of 3 million.

Indeed.

John Defterios Anchor & Emerging Markets EditorCNN International

Hussain Al Shahristani Deputy Prime MinisterIraq

In an interview with CNN's Emerging Markets Editor and Abu Dhabi based anchor, John Defterios, Hussain Al Shahristani, deputy prime minister in charge of energy-related issues in Iraq, talks about the situation in Iraq, developments in Iraqi oil production and oil pricing. Al Sharistani is an impor-tant figure in Iraqi politics and has been cited by some analysts as a serious contender for the position as prime minister.

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So, what is your comment on this estima-tion?

Well, with due respect to that analysis, I have to say that Iraq has signed contracts with the largest international oil compa-nies, with the best know-how in this field and very strong financial muscles. If they say they can do it then they can do it. They have signed contracts with us, they have committed themselves to reach that kind of level and I’m confident they will do it. Besides, we are talking about two things that are totally different and must be kept apart: On the one hand, you have the production capacity; on the other hand, you have what Iraq actually is go-ing to produce and only this is what the IEA is talking about. For the latter you have to take into account what the world can absorb, how much demand there is around. So having the capacity does not necessarily mean that you actually are going to produce this quantity unless there is demand for it. I am confident that by the end of the decade we will have a capacity of about 9 million barrels per day. But how much Iraq really will be producing depends on how much the world needs and how much the market can absorb.

You know hindsight is always 20-20: Should you have been a bit more generous with the major oil companies on the ser-vice contracts? You are offering between 1 dollar 15 cents a barrel to about 2 dollars 50 cents; they have asked to revise those. You lost some time by keeping a very tight

rein on your budgets: Was that a mistake?Well, I do confess that our contracts have been very tight, perhaps the toughest that the oil companies had to deal with with any major oil producing country. We want the companies to make good profit in Iraq and that’s why we are willing to reconsider those contracts. But this has to happen in such a way that it will gener-ate more revenues for Iraq and generate better profit for the companies and that’s what we have done by revising the plateau production to be more realistic with re-gard to the world oil demand again and to maximize the oil recovery. This has been a win-win situation and now the compa-nies are confident that they will be able to produce more oil from each field.

Deputy Prime Minister, let us take a step back and take a look at your targets for Iraq right now. With the shale gas and oil coming on in the United States, 100 dol-lars a barrel is a price that will be very dif-

ficult to defend in the future. We have had that level for three years now, but it doesn’t look realistic in the future. What are you setting your budgets on, if you will?

That is right, the price has been at that level for almost 3 years while we have seen the interruption of the Libyan oil, while we have seen the sanctions against Iran’s and reduction in Iran’s oil exports, and when we have seen the euro crisis and so on. It doesn’t seem as if oil prices are being affected much by a production reduction or political crises. I believe, the oil price will eventually find its way, de-pending on how much oil is needed and the demand is on the increase, despite all these difficulties. Of course, the produc-tion costs of marginal oil fields also play a role, because if you depend only on con-ventional oil suppliers to OPEC, like the Gulf states or countries like Iraq, the prices can of course be artificially fixed. By “artificial” I mean independent of

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J O h n D e F t e R I O s & h u s s A I n A L s h A R I s t A n I… t h e R e w I L L A L w A y s B e M O R e D e M A n D F O R O I L

supply and demand. But to bring the market mechanism into play – which you should as with any other commodity – you have to be able to develop the sources. And the resources are the marginal fields, where the production costs cur-rently amount to 80 dollars a barrel; so don’t expect the oil price to get much lower than that.

We have a weak recovery in the West, par-ticularly in the euro zone and slowing de-mand in the emerging markets: It seems that it’s very difficult to hold on to 100 dol-lars a barrel with the sort of climate we’re entering for 2014. You don’t agree with that?

Well, I wouldn’t say disagree, but again: I don’t think these developments are going to affect the oil prices in a significant way. Everybody seems to agree that there is a

slow-down, but slowing down means that the growth is still higher than in the OECD countries and these countries are at a stage of their development that any growth, even modest growth, totally de-pends on their fuel supply. The West in comparison today has basically reached a level where it has saturated its demand, it doesn’t need more oil to grow. The emerging markets and the developing countries are going to need oil to grow and despite all these difficulties you have never seen a reduction in the oil demand.

We’re seeing sectarian violence taking out 30, 50 or even 60 people a day, certainly not a business climate that people find comfortable. What’s going to allow for sta-bility to return to the country with Syria still in the state that is in today?

There has been a resurgence of violence

in Iraq, mostly because of the situation in Syria. With some funding from several regional countries, Al Qaeda has man-aged to establish themselves in the coun-try, and these are the ones who are cross-ing the deserts between Syria and Iraq and attacking the Iraqi people. As much as it hurts, Iraq is losing innocent lives, and the fact remains that none of the oil companies have been bothered by this; on the contrary, their fields, mostly in the south, are well protected, some of them are ahead of schedule in their field devel-opment and we are on target as far as the oil production is concerned.

This is an extraordinary window of time with the new government in Iran. What do you think, could we see in 2014 sanc-tions lifted against Iran and an agreement between the United States, Iran and the European Union to move forward?

We have seen very positive signs from Iran in particular and from the interna-tional community. We are hopeful that the negotiations on the Iranian nuclear program will proceed in good faith and quickly. Whether that will have an effect on the Iranian oil production at short no-tice is to be seen. I personally doubt that 2014 will give sufficient time even if the sanctions are relaxed gradually. I don’t think, it will give Iran enough time to be able to raise production quickly. In the oil industry a lot of work is required, a lot of investment, a lot of skill before you can reach the level as that Iran had before the sanctions were imposed.

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D R . I n G R I D h e n G s t e Rw h O I s F I n A n C I n G t h e R e A L e C O n O M y ?

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Before the financial crisis, few in Germany, and indeed more broadly in Europe, would have thought of asking this question, as the answer was so obvious: the banks, of course! Today, however, this is a question that is not only legitimate but also no longer possible to answer with just a single simple phrase. Or so it seems.

Numerous regulatory initiatives have acted to constrain the operating latitude of banks. At the same time, non-bank entities such as insurance companies, hedge funds and other institutional investors have discovered lending as an alternative to investments offering meager returns.

On top of this, more and more corporate borrowers have sought to free themselves of being dependent upon their banks, tapping the capital markets to diversify their sources of finance. Thanks to the combination of low in-terest rates and strong investor interest, Germany has seen its bond markets, in particular, grow significantly in im-portance.

CAPItAL MARkets & OtheR sOuRCes OF FInAnCeOne consequence of these trends is that many more German companies will tap the capital markets than we have been seeing until now. In the US, roughly 75 percent of corporate finance comes from the capital markets. In Europe, even today, some 75 percent continues to come from the banks. This will change: Within the German market, we expect this to change over the next two years to more like a 50 – 50 distribution. In fact, the primary reason that we do not expect this shift to be even greater is the country’s strong legacy of bank-corporate relationships.

Alongside traditional bank lending, we have in recent years seen the rise of a range of alternative sources of fi-nancing. A survey of participants at the Stern Stewart Annual Summit 2013 on the significance of various fi-nancing sources made it abundantly clear that, in particu-lar, internal financing sources and corporate bonds will play a greater role in the future.

t h e A u t h O R

Who is Financing the Real Economy?

Dr. Ingrid Hengster Country Executive Germany, Austria & Switzerland The Royal Bank of Scotland plc.

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With this, the role of banks will also change, as they will no longer be able to act as pure providers of finance. The role in which they serve the so-called “real economy” has to become more comprehensive. Let us take a practical ex-ample from the experience of RBS: Before the financial crisis, the question of providing financing in support of corporate acquisitions was not given the highest attention. This has completely changed, not only in the sense that such financings are today at the very top on the scale of importance, but also because this is what drives the trans-action in many cases. For this reason, we are discussing the details of financing at a very early stage, as our client is still planning a potential acquisition. We act as trusted advi-sors, with whom these issues can be discussed construc-tively.

ChAnGe & ChALLenGes FOR BAnksToday, it is fair to say that banks are reverting to their orig-inal purpose which is to serve the public interest. Why, af-ter all, does the financial sector exist? To put it simply: To take the savings of its many small depositors and, by ag-

gregating them and transforming their term structure, to make these funds available for productive investments, while managing the risks that arise from these activities.Many are saying rightly that banks must transform their business models. And much has already been happening here. Banks have massively brought down risks, have de-emphasized or entirely exited certain products and have focused on their core competencies. What is more, they have recognized that, if they want to have long-term client relationships, they must once again act as partners. Together with their business models banks have to be squarely in the mainstream of society.

Over the last 18 months, we have seen eurozone banks re-ducing their balance sheets by 2.9 trillion euros. According to research that RBS published in August this year, how-ever, banks are still too large. At 32 trillion euros, they are still over three times the size of the economy. They need to be leaner and raise more capital. We estimate eurozone banks will have to cut 3.2 trillion euros more in assets over the next 3 – 5 years.

FuturE rElEvaNCE oF sourCEs oF FiNaNCE: rolE aNd importaNCE Rating average (scale 1=highest to 6=lowest importance)

iNtErNal sourCEs oF FiNaNCE (opEratiNg Cash Flow)

vENturE Capital / privatE EquitY

baNk loaNs

govErNmENt FuNdiNg *

boNd issuaNCE

CommErCial loaN providErs

issuaNCE oF sharEs or CoNvErtiblEs

soCial & CommuNitY lENdErs *

* selected by less than 50% of participants

1.2

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D R . I n G R I D h e n G s t e Rw h O I s F I n A n C I n G t h e R e A L e C O n O M y ?

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D R . I n G R I D h e n G s t e Rw h O I s F I n A n C I n G t h e R e A L e C O n O M y ?

source: the Royal Bank of scotland plc.

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So, on the one hand, banks will become leaner and thus fitter. On the other hand, at least some will have to main-tain a certain weight in order to provide the necessary fi-nancing for their corporate clients. Today more than ever, companies need banks that are able to advise and support ever more complex and increasingly international trans-actions and that can deliver the required financing. This means not only delivering know-how and access to the in-ternational capital markets, but also the capacity to lend or syndicate loans. This has not gone away.

key PILLARs OF CORPORAte FInAnCeTo illustrate this point, allow me to share another example from our practical experience. Corporate clients, particu-larly large ones, regularly use syndicated loan facilities, particularly undrawn lines of credit, to improve their credit ratings. This is a form of financing which is simply not available from the capital markets; for this, strong banks are needed.And this story does not just end with well-structured ex-ternal financing. There are also issues like cash manage-ment, liquidity management and international payment systems that are of immense importance, especially for

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companies that do business around the globe. Here too, companies need help to overcome major hurdles; to cite just one current example, I need only mention four letters: SEPA.

Supply-chain financing is another example that is becom-ing increasingly important. Measures to more efficiently manage working capital, for example, by negotiating longer payment terms, have become an essential part of doing business for most companies. But while this finan-cial stretching mechanism has a considerable impact, it can also present new challenges for many companies, par-ticularly in today’s international context. Putting payment systems into place which are fast, reliable and efficient re-quires a strong bank with its own international network. A bank’s network is critical for determining the role it plays in society.

In conclusion, it is fair to say that clients may become less dependent on bank finance because of their strong bal-ance sheet positions and their efforts to diversify their sources of finance. It is also true that alternative sources of funding will become stronger for certain services and products. For instance, it is less possible for banks to fi-nance long-term assets because they are reducing their balance sheets and in light of increased regulation.

For the future of banking, I see a consolidation of and con-centration on core competencies. But we will still have strong banks that will support growth and investment plans of large corporations as well as smaller ones. Banks are here to stay, and for their corporate clients they will remain indispensable providers of financing and access to liquidity. So, in sum, the answer to our question about who is financing today’s real economy is the same as it ever was: the banks, of course!

D R . I n G R I D h e n G s t e Rw h O I s F I n A n C I n G t h e R e A L e C O n O M y ?

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The Spanish economy is emerging from a double dip re-cession that was at its worst in 2012, against the back-ground of the heightening crisis in the euro area. At that moment, our economy was undergoing a severe confi-dence crisis along with strong funding difficulties. Fortunately, we are now in the process of overcoming this difficult episode. Strong measures taken at both the European and domestic levels have contributed to easing financial tensions and correcting the macroeconomic im-balances built up during the years in the run up to the Great Recession.

In the first half of 2013, the pace of contraction of Spanish activity eased significantly. GDP fell in the second quarter by 0.1 percent. Forecasts point to a stabilization of the economy in the second half of this year and to a modest expansion in 2014. The gradual restoration of growth will be based on the continuation of the significant positive contribution from external demand and, more impor-tantly, on a progressive rebalancing of the economy, which will stabilize domestic demand.

The aforementioned recovery in the Spanish economy has proceeded alongside the correction of some of the macro-

economic imbalances accumulated in the previous expan-sion, namely the external imbalance, the high level of lev-erage of households and firms, and the sharp deterioration of public finances. In addition, structural reforms in key areas such as the labor market and the financial sector are contributing to the setting in place of more robust founda-tions for growth looking forward.

CORReCtIOn OF exteRnAL IMBALAnCeOne of the most visible aspects of the rebalancing of the Spanish economy is the adjustment of its external deficit. The imbalances built up during the previous expansionary period gave rise to a very high current account deficit, of up to 10 percent of GDP in 2007. The correction since then has been intense. Indeed, the economy was already in surplus in the second half of 2012, and by the end of this year the external surplus could climb to levels above 2 per-cent of GDP.Part of this adjustment has been cyclical owing to the sharp contraction of domestic demand during the reces-sion. But it has also been caused by the domestic adjust-ment of relative prices and costs. Measured in terms of relative unit labor costs, the Spanish economy has already recovered almost all of the competitiveness lost since the

t h e A u t h O R

Path to Sustainable Recovery in SpainGradual restoration of growth is underway

Luis M. Linde GovernorBanco de España

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beginning of the economic and monetary union (EMU). Improved competitiveness is one of the reasons behind the export share gains that we have observed in all markets, especially outside the euro area.

PRIVAte seCtOR DeLeVeRAGInGDeleveraging in a recessionary environment is necessarily a slow process, due to weak income growth, and must un-fortunately be based mainly on the contraction of lending to the most indebted sectors and firms. The completion of the correction of imbalances will still require further effort from households and firms: the reduction of the high level of accumulated debt that started in 2009 needs to con-

tinue. More time is still required and financial conditions will remain tight for a while. But there are encouraging signals, especially in the case of the financing of the most dynamic export and innovation-oriented sectors.

FIsCAL COnsOLIDAtIOn PROCessAfter the sharp deterioration of public finances during the crisis, the fiscal consolidation effort made since 2010 has achieved remarkable results despite the adverse macroe-conomic circumstances. In 2012, the public deficit was cut by four percentage points of GDP to 6.8 percent of GDP (excluding the one-off impact of the financial assistance for bank restructuring).

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In terms of the structural deficit, the reduction was close to seven percentage points of GDP. This sizable drive is unparalleled in the industrialized countries, although fur-ther efforts will be required to stabilize public debt and to place it on the necessary downward path.

LABOR MARket ReFORMThe most serious repercussions of the crisis have amassed in the labor market, with job destruction on a huge scale and unacceptable rates of unemployment. There was a cy-clical component to this worrying performance but it was also motivated by severe structural distortions in the func-tioning of the labor market. These distortions prevented the necessary adjustment of wage costs, so that the full weight of the adjustment was borne by employment de-struction.

The labor market reform implemented last year has tack-led these problems at their roots, by introducing more

flexible means of hiring and a collective bargaining system more aligned with firms’ needs. Wage settlements now re-flect the required adjustment. The effects of the reform on job creation would probably need some more time to ma-terialize because of the medium-term nature of many of the modifications made. However, recent employment de-velopments have also improved short-term labor pros-pects, meaning the labor market could begin to recover in late 2014.

At the same time, significant steps have been taken to strengthen budgetary discipline and to ensure the sustain-ability of the public pension system. Budget deficit limits have been enshrined in the Spanish Constitution and a new Budgetary Stability Law has been approved, with strict limits that apply to all levels of government. In addi-tion, the creation of a new independent fiscal authority is currently under way.

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FInAnCIAL seCtOR ReFORMIn 2012 a clear roadmap for the restructuring and recapi-talization of the Spanish banking sector was established. The first stage of this process was the identification of banks’ capital needs through a detailed asset quality re-view and a bottom-up stress test. This led to the approval of rigorous restructuring and recapitalization plans, and the recapitalization of banks with capital shortfalls. Finally, their problematic real estate-related exposures were trans-ferred to an asset management company.

In addition to these measures that were aimed at address-ing the specific problems of the most vulnerable institu-tions, several across-the-board actions were taken so as to strengthen the Spanish banking sector as a whole. These measures included the implementation of additional pro-visioning requirements for real estate exposures – intro-duced in the first half of 2012 – and the establishment of a 9 percent minimum core tier 1 capital ratio for all banks. Moreover, a new resolution framework, in line with forth-coming international standards, was introduced and fur-ther transparency requirements were set on real estate ex-posures and restructured and refinanced loans.

These measures, along with other policy action taken at the European and domestic levels, have considerably eased the pressure on Spanish banks and have allayed con-cerns regarding their soundness. Funding conditions have considerably improved, as shown by the significant reduc-tion in borrowing from the Eurosystem. Moreover, the lat-est figures show modest improvements in profitability, in line with the baseline scenario of the stress test conducted in 2012. Pre-provisioning profits, which reflect the in-come-generating capacity of banks, are growing at posi-tive rates and doubtful assets, though increasing, are slow-ing down.

The outlook for Spanish banks remains challenging. In a context marked by slow economic growth, subdued credit demand and low interest rates, interest margins will re-main under pressure. Moreover, doubtful loans will con-tinue rising in the short term, although the resulting effect on provisioning requirements is expected to be below that of recent times. Against this background, banks must con-tinue their efforts to contain costs and improve their effi-ciency. In particular, it is essential that institutions that re-quired recapitalization should comply strictly with their restructuring plans, which envisage significant capacity reductions.

All in all, the situation of Spanish banks is very different from that in 2012. Today, their exposure to the real estate sector is manageable, their loss-absorbing capacity has been considerably reinforced, their balance sheets are more transparent and their funding conditions are clearly more favorable. Of course, as in other countries, signifi-cant challenges remain ahead. But the actions that have been taken have addressed the major structural problems of Spanish banks and they are now better prepared to make a sustainable contribution to economic growth.

LessOns FOR COnFIDenCeSpain has already made a tremendous adjustment effort to rebalance its economy. The progress made is helping to improve internal and external confidence and is already evident in the narrowing of the sovereign spread and in the normalization of external financing conditions. The completion of the adjustments in the real and financial sectors, and of the highly ambitious program of reforms now under way, are the key factors for resuming growth in the near future.

L u I s M . L I n D eP A t h t O s u s t A I n A B L e R e C O V e R y I n s P A I n

the full article is published in the monthly OMFIF Bulletin. Please see www.omfif.org for more details.

photos page 32 © Ander Dylan, kenneth Dedeu / shutterstock.com

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h A R A L D B e n I n k P R e P A R I n G F O R A e u R O P e A n B A n k I n G u n I O n

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Five years after the Lehman Brothers bankruptcy, a Euro-pean banking union seems more urgent than ever. The euro area banking system remains undercapitalized, fragile and fragmented. Without instruments to allocate losses of banks to both shareholders and unsecured creditors, taxpayers in the euro area are likely to bear the burden of losses. Fiscal capacity to cover these losses is limited in the crisis countries. Taxpayers in other EU countries are unwilling to pay for a bill running into hundreds of billions of euros.

A banking union is seen as a remedy. It would create enti-ties for supervision and resolution with authority and ca-pacity to deal with the largest banks, with a minimum de-mand for taxpayer involvement. The ‘too-big-to-fail’ problem would be addressed by the creation of a mecha-nism for resolution that would allocate losses to share-holders as well as unsecured creditors of the banks in a predetermined and predictable order. This ‘bail-in’ mech-anism would alleviate the distortion of risk-taking incen-

tives of banks with access to excessively cheap funding from creditors expecting to be bailed out.

The progress toward a full banking union is slow for rea-sons that are easy to understand and predictable. So far, there is agreement on the Single Supervisory Mechanism (SSM) for the largest 130 – 150 banks – an important first step. But the objectives cannot be achieved without effec-tive resolution mechanisms.

The agreement that the European Central Bank (ECB) will become the single banking supervisor in the middle of 2014 is an important step. The EU’s Recovery and Resolution Directive sets a deadline of 2018 for national resolution mechanisms with bail-in provisions. In the meantime, bail-outs are likely to remain the rule for re-solving large banks in distress. Bail-ins will be ad hoc and politically tainted as in the Cyprus case.

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Preparing for a European Banking UnionSupervision and resolution must go hand in hand

Harald Benink Founding Chairman European Shadow Financial Regulatory Committee

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thRee PhAses OF IMPLeMentAtIOn

The implementation of a banking union can be divided into three partly overlapping phases. The European Shadow Financial Regulatory Committee (ESFRC) con-siders it important to separate these three stages. The first phase involves preparing the ECB as the SSM for most of the banking system in the euro area. A critical as-pect is the so-called Asset Quality Review. The ECB plans to execute this over the next 12 months.The second phase involves creating largely similar na-tional rules for the restructuring and resolution of banks as envisioned in the Recovery and Resolution Directive. Several euro and EU countries lack the appropriate bank resolution procedures and authorities. Implementing this directive, or at the least creating temporary intervention laws for banks allowing bail-in of unsecured creditors, is urgent. The Asset Quality Review may lead to problem banks being identified that must be either resolved (or bailed-out if no bail-in mechanism is in place). The ESFRC argues that this phase should begin before the Asset Quality Review is completed.The third phase calls for a EU-wide or at least euro area-wide resolution regime, consisting of common rules and one common implementing institution. There are sub-stantial disagreements about this phase, which may re-quire a treaty change. Nevertheless, the implementation of the first two phases must be done with the ultimate objec-tives of the Banking Union in mind.

The ECB must have a clear view of banks’ strengths and weaknesses when it takes over responsibility for supervi-sion in 2014. It would be detrimental to the reputation of the ECB in its new supervisory role if a major bank would collapse only shortly after it has taken on its new role. The asset quality review may reveal that many banks are in a worse condition than generally believed. Steps may be needed to write off asset values and/or increase equity capital. Some banks may have to be closed down or re-

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solved in a way that minimizes contagion effects. At pre-sent, the ECB is not in a legal position to request and en-force measures to alleviate such situations. The ESFRC recommends that the ECB should not accept supervision of banks from countries without effective pro-cedures. It lies in banks’ strong interest to be supervized by the ECB. They can be expected to put pressure on national legislatures to act. The ESFRC has argued that the ECB should enter contrac-tual agreements with national authorities for clarifying responsibility between the ECB as the supervisor and the national resolution authorities. These contracts could in-clude early intervention and appropriate actions on the national level to avoid failures. The contracts should in-clude agreements that restructuring and possibly recapi-talization must not amount to bail-outs of shareholders and unsecured creditors but rather follow agreed upon rules for bail-ins.

Finally, we note the asset quality review should not be con-ceived and implemented in a narrow sense. The quality as-sessment should address the viability of a bank’s business model and its governance structure. An important lesson from the Lehman Brothers bank-ruptcy is that great value losses can occur in insolvency proceedings when there are jurisdictional conflicts and the financial institution is opaque. In the case of Lehman Brothers, the bankruptcy of its US entities went relatively smoothly but the bankruptcy of its subsidiaries in several other jurisdictions was costly and time-consuming. The main reason why substantial and unnecessary losses oc-curred was that the legal organization of Lehman Brothers did not resemble its operational and functional organiza-tion.The operations of its legally separate subsidiaries were tightly integrated. Subsidiaries, therefore, found them-selves cash-strapped when the parent went bankrupt; as-sets associated with activities in one subsidiary could be booked in another.

European cross-border banks are generally operating as subsidiaries in host countries in spite of close operational and functional integration. The host country banks oper-ate as de facto branches in spite of being separate legal en-tities under host country jurisdiction.The resolution of a cross-border bank in the EU will en-counter exactly the same problems of Lehman Brothers if responsibility for resolution is entirely a national responsi-bility. The banking union in its complete form represents a remedy for this problem. But until a Single Resolution Mechanism is realized, the Lehman problem will exist.

The jurisdictional conflicts can be minimized with a re-quirement that host country subsidiaries must be opera-tionally separable from a distressed home bank within 24 hours. New Zealand has such a requirement as a part of its Open Resolution Procedures. The ESFRC recommends that the EU implements a ‘separability’ rule for the period before the Single Resolution Mechanism is in place. This rule would require that subsidiaries conduct its important functions within 24 hours after closing as a result of the distress of the home bank. Without such a rule the com-plexity of resolving a cross-border bank may leave author-ities with no choice except a bail-out. Separability includes information and risk-management systems, participation in payment systems, customers’ access to deposits and clarity with respect to the booking and origination of as-sets and claims. Living wills can help prepare resolution authorities but, without a clear separability requirement, jurisdictional conflicts are most likely inevitable.

European finance ministers have held many discussions focused on creating a truly European resolution authority. Unfortunately, urgent questions on the first two phases of implementation of the Banking Union have not been an-swered yet.

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the full article is published in the monthly OMFIF Bulletin. Please see www.omfif.org for more details.

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A x e L s t R O t B e k M A n A G I n G C O M P L e x I t y : h O w t O s u C C e e D I n t O D A y ’ s A u t O M O t I V e B u s I n e s s

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Axel Strotbek Member of the Board of Management, Finance and Organization AUDI AG

“Any car that merely takes you from A to B does not go far enough.” – August Horch

August Horch, the founder of Audi, was not just one of the pioneers of the automobile age. He was also a visionary when it came to recognizing that continued success in the automobile business begins and ends with satisfied cus-tomers – that the journey is just as important as the desti-nation. Meeting and exceeding customers’ wants and needs is still the most important part of the equation for carmakers today. But since the days of August Horch, car buyers – and their expectations – have changed. And so has everything else.

Within just the past decade alone, the automotive industry has been affected by a complex set of business conditions including the global financial crisis, the collapse and re-

bound of the US car industry and increased regulatory pressure to develop eco-friendly vehicles. Managing this complexity will be paramount to succeeding in the highly competitive global automotive business.

MAnAGInG heteROGeneOus AnD DIVeRGInG CustOMeR seGMents No longer reliant on kicking tires down at the local car dealership, consumers of the 21st century are online 24/7 and have instant access to a plethora of choices when they are looking for their next “ride”. Premium car buyers, es-pecially, want a car that has been customized down to the tiniest detail. They want a car that reflects their individual-ity, attitude and passion for driving, something our Italian colleagues at Lamborghini and Ducati call a “bella mac-china”. But what makes a car desirable? The answer varies depending on what market and region we’re looking at.

Managing Complexity: How to Succeed in Today’s Automotive Business

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For example, in China many customers have a preference for long versions of regular models. Their predilection is all about status seeing as successful Chinese business lead-ers can afford to have a chauffeur for their car. Long ver-sions provide more leg room for the passenger in the back seat, thus displaying his or her social standing to everyone else on the road.

Meanwhile, in the United States, which is still the world’s number-one premium car market, the definition of luxury is changing for the next generation of consumers. Experts say that for young Americans, a great Internet connection is often more important than other things. Their top pri-ority is to be “always on” and connected.

Carmakers like Audi have responded by turning the auto-mobile itself into a mobile device – one that is as seam-lessly connected to the Internet as a smartphone or tablet computer. Today, drivers have access to a wide range of online services geared toward their specific requirements. Furthermore, connecting the car with other vehicles and with the surrounding infrastructure makes driving both safer and more enjoyable.

DeVeLOPInG AnD MAnAGInG An eFFICIent PRODuCtIOn netwORkIn order to expand their global reach into markets world-wide, carmakers need to strategically develop their inter-national production network. Audi, for example, is cur-rently expanding from 11 automobile plants today to 14 in 2016, including an all new site in Mexico. Producing on-site in each global region is key to becoming the world’s number-one premium car brand.

In every one of our factories, we have employed the modu-lar production strategy that is used across the Volkswagen Group. It allows us to achieve maximum standardization in products and processes while simultaneously offering our customers the best quality and a high level of differen-tiation.

The beauty behind this modular strategy is that it stream-lines procurement and production. Implementing stand-ardized processes allows Audi to produce different models on the same production line so that we can react very quickly to changing consumer demand. Additionally, us-ing identical parts across different models provides a ma-jor advantage for our procurement department. Utilizing the modular strategy also allows us to remain agile and competitive in terms of innovation, efficiency and financ-ing.

COntenDInG wIth ReGuLAtORy AnD tRADe BARRIeRsThe decision to locate our first North American produc-tion plant in Mexico is a prime example of how carmakers have to navigate a complex tangle of regulatory and trade barriers facing international businesses today.

There are very few countries that are so well integrated into so many free-trade agreements: In total, Mexico has trade and tariff agreements with more than 40 countries. Securing access to this attractive location, however,

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required Audi to comply with laws stipulating that a cer-tain percentage of the parts used in our local manufactur-ing operations have to be sourced from domestic suppli-ers. To ensure both full compliance with local production requirements and consistent quality and supply of parts across regions, Audi convinced many of its key suppliers to establish production bases in Mexico. Perhaps the most significant challenge facing our industry is the need to tackle the issue of CO2 emissions. And while there is overall consensus among consumers, govern-ments and car executives for the need to find viable solu-tions to reducing emissions produced by the billion-plus vehicles on the planet, there is little agreement on the global standards. The European Union, for example, has

set ambitious emissions targets for 2020: an average of 95 grams of CO2 produced per kilometer. But elsewhere, binding standards vary wildly, sometimes even within one country – as is the case in the US, where standards in California are tougher than those in the rest of the country. Meanwhile, the Audi credo, Vorsprung durch Technik, is executed each and every day. We have consistently re-duced the CO2 emissions of our cars, for example by mak-ing them more lightweight with each successive model generation and by improving the efficiency of our engines through cylinder-on-demand technologies, for example. With the development of alternative drive technologies, Audi has pursued a strategy of evolution, not revolution. New technological solutions are designed to fit into pre-

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existing Audi models, giving us more flexibility with pro-duction. Our guiding principle as we develop new tech-nologies is that the pleasure of driving an Audi should not be sacrificed in favor of eco-friendliness. And we have ac-complished that goal with our A3 e-tron plug-in hybrid: It can be driven in all-electric mode and emission free for up to 50 kilometers. For longer journeys, drivers can rely on one of the most fuel-efficient and powerful combustion motors currently available in a car of this size.

The Audi A3 g-tron can be driven with zero emissions be-cause Audi is using CO2 and regenerative electricity to produce e-gas. This synthetic methane can be fed directly into the natural gas network and supplied through natural gas filling stations. Driving with Audi e-gas is close to be-ing climate neutral as the same amount of CO2 produced while driving was previously captured in the e-gas pro-duction process.

LOOkInG AheAD tO the MOBILIty OF tOMORROwDesigning new cars to be totally emission free will not be the only issue that we will have to tackle as we shape the mobility of the future. Carmakers will also need to address traffic congestion, road safety and hassle-free mobility. Sometime down the road, piloted driving will help to ad-dress these issues – it is just one of many future technolo-gies we are currently working on today. This brings us back full circle to where we began, namely to a focus on our customers and what they will expect from us in the future. At Audi, we believe the automobile will remain a key element in a wide range of mobility op-tions. Some of the technology that science fiction pre-dicted has already come to pass – take the talking car, for example. And some of the advances are still pure fantasy at this time. While we may not be able to predict exactly what the car of the future will look like, we do know that Audi will continue to play a leading role in shaping it.

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Lehman is five years behind us. Much of the state support for the banking sector has been paid back, but the periph-eral nations in Europe are challenged by strong centrifugal monetary forces and the “crisis” seems to be an ongoing theme.How should the corporate world adjust to the new, chal-lenging environment? What lessons did, can and should we draw from the last five years? How can we best prepare for any unknown unknowns in the future?“Debt” and “leverage” were magical words in the past. Some organizations were proposing a more aggressive use of leverage to bolster shareholder return and to align the stakeholder interests along the optimization of share-holder value. What went wrong? Debt itself cannot be the issue. The creation of modern corporations has been a motor for unparalleled wealth creation for nations as well as for individuals. Debt as a concept was an important catalyzer to this success story. It is not the instrument, it is the amounts.We have seen the abundant dosage of debt capital entering corporate balance sheets. We had excesses like “covenant light” loans, “payment-in-kind” financing and fully debt-financed dividends to aggressively alter the equity-to-debt profile of a corporation. We have also seen a financial sec-

tor suck away the best and brightest of each and every gen-eration, industrial Goliaths like the United Kingdom be-come a shadow of their industrial past and a competitive model in the financial sector that separated the success factors.One of the key issues in our competitive economic world is that we have lost sight of the purpose of a corporation. If you work for an alternative fund manager, “excessive” risk taking may be necessary so that only the fittest ideas sur-vive and selection waltzes over the weaker ones. A corpo-ration has a much wider scope. The shareholder should bethe key stakeholder to optimize the firm to, but the corpo-ration has also a clear responsibility toward customers, suppliers, its own people, financing partners and society; therefore, corporate survival by way of a more leveled ap-proach versus risk is mandatory.For explanatory purposes, a company can be separated into its business and the financing of that business, so that we reach – like some rating agencies – a business risk pro-file and a financial risk profile. There have been frequent articles about management boards that deal with steering-on-sight and expecting the unexpected since the inception of the financial crisis. There is certainly some merit in these hints, but, in the

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How to Recover from the Economic Goldilocks Hangover

Prof. Dr. A. Stefan Kirsten Chief Financial OfficerDeutsche Annington Immobilien

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end, reducing the speed of a business endangers its com-petitiveness. The best companies have reduced their busi-nesses to their best understood core, shed peripheral risk, but have not taken out any speed. The de-risking of corpo-rations through their respective business is consequently limited.The other lever is the financial risk of a firm, so the only logical answer has to be to de-risk the business financially. In finance, this means diversification of sources, tapping different pools of liquidity, being utterly reliable toward all stakeholders, transparent and to a good measure conserv-ative. Let us keep in mind that “conservare” as a Latin verb means to keep, maintain and preserve something, not to lose it.In practice, the instruments have to be applied as early as possible. Financial risk has a lot to do with liquidity, debt, cost of financing and access to all sorts of capital. The first

step has to be the adequate debt-to-equity ratio. Here, fi-nancial risk perceptions are influenced by fashions. In 2007, a German housing company with less than an 80 percent loan-to-value ratio (LTV) was perceived as back-dated and under-levered. Currently, LTV levels above 60 percent are considered highly risky. Please bear in mind that a LTV level of 60 percent means that you still get all your debt if you have to sell a property with a 40 percent discount to tested fair market values. So, the first step is to aggressively de-lever the corporation to a target zone. This target zone is usually defined by the external corporate rating or at least by your successful competition. Equity and debt are two very different animals. They can be seen both as calls and puts respectively on the assets of the company. The importance of adequate equity cannot be underestimated. Asset-intensive industries like utili-ties, mining or real estate are very sensitive to those issues.

P R O F . D R . A . s t e F A n k I R s t e nh O w t O R e C O V e R F R O M t h e e C O n O M I C G O L D I L O C k s h A n G O V e R

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Equity has no tenor and, therefore, no refinancing risk. Investing a new dose of equity into the company improves its risk profile and competitiveness considerably. The total WACC declines, even with more equity due to an altered risk perception in the market. Once this is achieved, the corporation should have access to a variety of capital markets with straight equity, equity-linked as well as debt, secured and unsecured. Not all sources fit to all businesses, but if in doubt, a good dose of simple cash keeps the next crisis at bay. The respective fi-nance departments now have to apply the instruments, check availability of funds and their respective cost.It may be necessary to apply some instruments even if they are inefficient from a cost perspective, just to make a name in the particular market niche. Here a lot of financial and especially banking relationships are built on trust. Trust is a deeply underestimated concept, especially in crisis times. It does not imply blindness in the business balance of a transaction, but, instead, trust marks the clear under-standing of the parties involved that the world is not an Excel spreadsheet, and that human beings have to help each other in difficult circumstances. Maintaining good, long lasting relationships with partners is a paramount task for all management levels. Short term, opportunistic optimization breaks down in crisis times!After choosing the right instruments in the right mix, the strategy needs to be implemented. Here, any organization has to decide about make-or-buy-decisions. The degree of integration in a corporate finance department may go from having one person as a contact to the banking world right up to one’s own banking license for the finance de-partment; everything should be evaluated. History is only an indicator; true rebuild is driven by future demand, not by historical structures. This organizational metamorpho-sis needs close supervision by the company’s top manage-ment. How do the financing counterparts react? Let us keep in mind that financial institutions are besieged and battered in the current environment. Sensitive (over-)reactions are

not uncommon to specific requests. The finance depart-ments of the corporation should bear this in mind when dealing with their respective counterparts. Banks, as well as companies should try to be as transparent as possible with each other in difficult times and should exhibit a will-ingness to separate relationships if strategies are not com-patible. This saves resources on both sides. A constant, confidence-building relationship between all parties at C-level is a must to ensure trust, efficiency and mutual success.One last word about de-risking financially: The corporate treasury department’s primary goal is to maintain ade-quate liquidity at any given point in time. This is as easily forgotten as the key goal of an airline to bring you safely from A to B; it is not about legroom or inflight entertain-ment! This overarching goal calls for prudent steps with valid plan Bs at any given point in time; true plan Bs are also real, doable, but by sheer implication weaker than plan A. The financial health of a corporation is daily, diligent work, but not a miracle.

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Stefan Klebert Chief Executive OfficerSchuler AG

Experts say that by 2015 the global demand for carbon fiber-reinforced plastics will have risen to around 100,000 tons per year, which is almost twice as much as in 2011. This depends to a certain extent on the outcome of BMW’s electric city car “i3”. It is the first car made of carbon-fiber composites that does not carry price tags well into six fig-ures. Instead, it costs about as much as the company’s 3 Series models. If it proves to be a success, many other manufacturers will start producing cars made of carbon parts, and the demand will increase.

The more rigid a material is means less of it is needed to achieve the desired level of stability thus reducing weight. In comparison to conventional steel, carbon parts can re-duce weight by some 60 percent. Electric vehicles need these kinds of lightweight body parts because they can help offset heavy batteries. However, all of our cars need to slim down because from one generation to the next a few kilograms are added with the increase in on-board elec-tronics and safety-related technologies. And a weight sav-

ing of 100 kilograms can reduce fuel consumption by 0.3 to 0.6 liters per 100 kilometers. The car body accounts for 40 percent of its total weight, and the potential savings are considerable.

Schuler is the global market leader in metal and plastic forming equipment. The company recognized this trend long ago and constructed its first presses for the process-ing of carbon fiber-reinforced plastics as early as 1998. Here, carbon fiber mats are placed in a die, filled with resin and hardened by applying heat and the pressure of the press. There are currently several CFRP presses in opera-tion that are supplied by Schuler. They are mainly used to produce roofs and bumpers for certain sports models such as the BMW M3. The National Composites Centre in Bristol, which is part of the British government’s strategy to facilitate the widespread industrial exploitation of com-posites, recently placed an order for another Schuler press. It is thought to be the flagship item in a line to develop the rapid manufacturing of large composite components.

Slimming Solutions and Driving Performances Challenges in automotive lightweight design

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However, automotive lightweight design is not just about composite and carbon parts; it is just as much about high-strength steels. The percentage of these materials will rise considerably over the short term. By 2015, the majority of parts in car manufacturing will be made of high-strength steels. The reasons for this are twofold: First, the goal is to achieve lightweight cars. Secondly, these steels are highly rigid and they react ideally in crashes. This type of steel can also be used for safety components, such as bumper supports or B-pillar reinforcements. Aluminum and mag-nesium as well as hot-formed steels will also gain in im-portance, leaving mild steels behind.

Yet, forming high-strength steels requires special produc-tion measures. Here, Schuler can take full advantage of its ServoDirect Technology, because the slide movement can be individually adapted for the forming process.

But the benefits of hot forming are huge, too. Not only is the weight of the individual part reduced and the tensile strength increased, the required press force is also much lower. At the same time, hot forming offers greater flexi-bility for part design than cold forming.

According to market studies and research done by Schuler, the number of hot-formed parts produced annually worldwide will increase from about 200 million this year to 500 million in 2015. By the end of 2013, 195 lines will be in operation around the globe; 60 of these lines will be de-livered by Schuler. By 2015, there will be close to 300 lines in operation around the globe.

Hot forming has come a long way. The automotive indus-try started to use the process in the early 1980s when it was first patented for a Swedish company. The first safety part

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was a side impact beam used in the Saab 9000. There is a variety of other parts that can be produced in this way such as bumpers, A- and B-pillars, cross beams and dash panels.

With the launch of its new Golf, Volkswagen succeeded for the first time in reversing the trend toward heavy-weight cars. This was made possible by strictly adhering to lightweight construction methods, especially press hard-ening. The proportion of these parts increased from six to 28 percent. Thus, the weight of the car body was reduced by 23 kilograms.

Hydroforming is a rather special forming process. Here, tube and pre-forms are expanded from the inside out by means of a liquid working medium in a closed die. This method makes it possible to manufacture hollow compo-nents with a complex external shape and especially favora-ble strength properties. Hydroformed parts can be used for roof frames and frame structures and can also be found in the Ford Fusion/Mondeo platforms as well as in the pe-rimeter frame around the Harley Davidson V-Rod.

We are experiencing a renaissance with hydroforming. A number of vehicle concepts are currently being devel-oped in the US that involve the use of hydroformed parts made from high-strength materials in the passenger cell. Schuler’s competence center in Canton, Michigan pro-cesses orders from car manufacturers and their suppliers for lines based on the economical global die and stand-ardization process. This process commoditizes hydrofor-med components, making the process more cost effective than ever before. The global standardization of the com-ponent and die design delivers flexibility to produce con-sistent body-in-white parts by tier hydroformers any-where.

Aluminum has almost become a classic for lightweight construction, but it is being used more and more in mod-ern vehicle designs. If every car body part were produced using this material, from the hood and fenders through to the doors and luggage compartment lid or tailgate, the car would weigh up to 40 kilograms less. And thanks to its unique energy absorption ability, it can save lives in colli-sions. Schuler’s mechanical and hydraulic press lines can be used for both steel and aluminum sheet metal. In order to move aluminum blanks quickly, negative pressure is used for suction because aluminum is non-magnetic.

We don’t yet know whether high-strength steels, alu-minum or carbon composites will win the race. In our opinion, future cars will consist of all these materials. The task will be to identify the right place for the right mate-rial.

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R A L P h h e u w I n G t h e V A L u e O F C O n t I n u O u s G L O B A L P R O C e s s I M P R O V e M e n t

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Ralph Heuwing Chief Financial Officer, Dürr AG

Dimitri Belobokov Partner, Stern Stewart & Co.

Dürr’s shares have skyrocketed in recent years. How much of that was due to the fantasy of the capital markets and how much is based on fundamental drivers?Since the beginning of 2007 our share price has increased by almost 400 percent. Since the low point of the 2009 cri-sis, it has risen by a factor of 14. While this is obviously an exceptional stock performance, the share price only mir-rored the strong earnings improvements that we were able to realize as a result of the comprehensive transformation we undertook at Dürr. Of course, this was helped along with the positive market development. Two key drivers led to these results: margin expansion based on significant operational improvements, in particular process improve-ment, and strong top-line growth coming from emerging markets, innovation and service.

How would you weigh the levers process improvement and organic growth against each other?A positive market environment that offers growth oppor-tunities always helps. But I would say that over the last five years, 60 percent of our performance actually came from process improvement and other operational measures. It has been a very comprehensive effort, a continuous jour-ney that has touched all aspects of value creation. It has mobilized the whole company and brought about signifi-cant efficiency and productivity gains.

Was the process improvement campaign initially triggered by perceived internal inefficiencies or by an external shock event?Before its transformation Dürr was a much more decen-tralized organization. All around the world similar things were done in many different ways, using different systems and tools. That is why efficiency levels and, maybe even

Interview: The Value of Continuous Global Process Improvement In an interview, Dimitri Belobokov and Dürr’s CFO Ralph Heuwing talk about the importance of continuous process improvement and how it was implemented across the 8,000 people strong organization of the automotive equipment supplier.

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more importantly, quality and reliability in our business processes varied a lot between entities. Overall, the situa-tion was not satisfactory. 2004 and 2005 were difficult years that saw the culmination of many negative external and internal developments that led to a change in top management with Ralf Dieter taking charge as CEO. He initiated a change program called “Focus” that restored our financial health by disposing of several businesses, re-structuring our operations and regaining customer trust. When I came on board in early 2007, the tough cuts had been made and we turned our attention to the longer-term, sustained improvements. We believed that a strong harmonization of products, processes and systems would generate a step-change in performance: Product harmoni-zation leads to higher economies of scale and more relia-bility while process harmonization leads to fewer mistakes and higher productivity. It is also the basis for global col-laboration. Systems harmonization reduces complexity and maintenance costs. In essence, what we wanted to es-tablish was a reliable, high-performance execution system.

What were the main action fields? We developed a process model of our business with all the core and supporting processes. For each process we ana-lyzed weaknesses and unnecessary interfaces, but also identified the differences between our business units and our geographic entities. We identified and agreed on best practices and redesigned our ERP system template to re-flect those in the workflows. This happened first in Germany and over a period of three years all around the world. One of the success factors was the nomination of global process owners and global key users who were given the responsibility of owning the process that in-cluded describing it, optimizing it and automating it to the extent possible. The global rollout meant a significant ef-fort in terms of mindset changes and required intensive communication and training.

How did you maintain the right focus and cope with the complexity of this program?Initially it was quite tough to build and keep up momen-tum because change efforts conflicted with operational priorities. We actually called the program “FOCUS” in or-der to draw the focus of management toward this change. The program was driven by the management board and progress was monitored in bi-weekly and later in monthly reviews. The installation of a cross-functional CPI team (continuous process improvement) that reported directly to the global business unit heads was very helpful. The team was professionally trained in process improvements and was able to focus on the change outside of day-to-day operational responsibilities. We also installed a business process team in the IT department in order to ensure proper business understanding in IT and to establish one-on-one relationships between process owners and IT pro-cess consultants. It’s clear to me that the program could have easily died without being a recurring item on man-agement’s agenda.

R A L P h h e u w I n G t h e V A L u e O F C O n t I n u O u s G L O B A L P R O C e s s I M P R O V e M e n t

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Did you ever quantify the results on the bottom line? Could you provide a few concrete examples?Yes, we did. We quantified the payback of our investments in a globally harmonized IT structure that had a payback period of less than three years. But the impact was in fact much more profound. EBIT margin levels moved from a historic range of 0-4 percent to a higher and narrower range of 6-8 percent. As I said earlier, a large part of this increase can be attributed to efficiency gains and execu-tion reliability. Take for example the margin deviation in the project business that narrowed significantly. Or, for that matter, the engineering phase in a turnkey paint shop project that was shortened by almost 50 percent. We also generated significant savings in purchasing by combining volumes across projects thanks to a higher degree of standardization.

You just mentioned the communication aspect of such a transformation. What was your story?Communication was an explicit project stream within the transformation program. We informed about progress, setbacks and successes through our intranet and employee magazine, but also in management and business unit meetings that made the change an integral part of our management agenda. We also found out about what our staff thought of the program and saw a high level of identi-fication. People understood that we needed to change and were supportive despite the additional workload and dis-ruption that it entailed. The collective experience of the 2005 crisis clearly played a pivotal role in getting the buy-in among our employees.

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Quite often process harmonization is only popular in the Board and in some central departments. In the operating units and regions people tend to softly curse the “centralists”. How did you avoid or overcome resistance?I don’t think this is true of Dürr. In fact, for us process im-provement has always been closely linked to business exe-cution on the ground and less to headquarters planning. We demonstrated in our German operations that these improvements paid off. Sure, our colleagues in interna-tional operations were initially rather skeptical, claiming

for instance that their legal and tax system required pro-cesses to be different, but our teams were able to overcome this by separating country-specific process items from the generic template. After the first few rollouts, most regions actually wanted to be next in line. What remains a chal-lenge is the integrated process view. For example, engi-neering needs to enter data that logistics or finance require later on to efficiently perform their tasks. To enhance this understanding we run so-called integration workshops in our local operations.

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But do you think it is possible to harmonize without install-ing someone centrally either at the corporate or divisional level who is in charge of the respective process?You need central governance, otherwise you have chaos. We implemented this on the divisional level with global business process owners who decided on the structure of the process and what needs to be improved. But you also need a link into the global organization with key global and local users being the operational experts who train their colleagues and collect and escalate process problems.

What exactly is the role of IT? Is it possible to create a perfect process with an imperfect system? And does a perfect IT sys-tem automatically lead to a perfect process?For successful implementation, the role of IT can hardly be overestimated. In fact, it is key in today’s environment, both in a positive and in a negative sense. Executed well, IT-based workflows provide a great way of harmonizing, accelerating and improving business processes while dis-tributed, heterogeneous and fragmented legacy systems can be a great barrier to improving processes. Dürr in-vested double-digit millions in its IT infrastructure and application landscape to reap the benefits of process im-provement.

Does “harmonized” always mean “more efficient”? Where are the limits of harmonization?I already mentioned our rather decentralized structure be-fore the transformation. Harmonization doesn’t need to be an end in itself; it should always bring scalability and operating leverage as well as de-risking the business. In our experience, harmonization can yield great benefits in all operating and execution aspects. Nevertheless, there are limits when it comes to customer needs, competitive differentiation and innovation. For example, different cus-tomer segments may require different process features, such as spare part delivery times or escalation mecha-nisms in case of problems. On a more philosophical note,

innovation sometimes requires breaking the rules. Therefore, senior management has to use its judgment when setting the right level of rigor.

How did you ensure that the efficiency gains last longer than the last report about their successful implementation?Standard business processes need to be hard-wired in IT-based workflows. Besides training and rewards, this is one of the most reliable ways of ensuring sustainable change.

In your experience, what needs to be done to graft a process efficiency DNA to the organization?One of the most valuable things is a so-called “lessons learned session” after every project, initiative or program: What went well? What needs to be improved? When this becomes routine, it makes the discussions less political and more constructive. And this is where permanent im-provements begin. The other factor is transparency about process efficiency and its improvements. Regular KPI re-ports provide the basis for discussions on new targets and what is needed to get there.

What is the role of the CFO in this challenge?The process improvement program was clearly initiated by the CEO, Ralf Dieter. My role was to push the IT har-monization and global rollout and to set up a process of continuous improvement. And, of course, the CFO’s role is to provide financial transparency and continuous persis-tence.

Are there any other personal “lessons learned” from the pro-cess optimization initiative at Dürr?Being a former consultant myself, I must say that I had to revisit my views on 80:20. In process optimization, I learned that going for the last mile really pays off. The last 20 percent may be the difference between a good process and a great process.

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The Stern Stewart Institute Annual Summit 2013 Review: What the Future Holds For Us

R e V I e w O F t h e D I s C u s s I O n sh e L D A t t h e A n n u A L s u M M I t O F t h e s t e R n s t e w A R t I n s t I t u t eA t s C h L O s s e L M A u I n s e P t e M B e R 2 0 1 3

More than five years have passed since the beginning of the financial crisis. We witnessed a world economy in shock and a subsequent recovery in 2010 and 2011. Even though the crisis is far from over, it is time to direct our attention to the future. Mistakes that were made in the past must not be pushed to the back of our minds, but focusing on what challenges us next is equally as important. That is why this year’s Annual Summit of the Stern Stewart Institute that convened at Schloss Elmau 19 – 22 September had a particularly varied agenda, ranging from the finan-cial market and family businesses to energy, defense and demographics.

the BAnkInG systeM – when wILL the IMPACt OF the euRO CRIsIs weAken? It is interesting to note that even though there is still a lot of debate going on concerning the impact of the euro crisis on the banking sector, there is a clear-cut division in opin-ion: 50% of the participants hold that the recent crisis led

to a fundamental rethinking of banks’ business models, whereas the other half does not think so.This uncertainty is only partly reflected in the opinion on the future development of the banking sector. A mere 22 percent of our participants believe that we face a stronger role of the investment banking, but a majority (57%) thinks that retail/private banking will grow more impor-tant than it is today (see fig. 1).

figurE 1

has the recent euro crisis led to a fundamental rethinking of banks‘ business models?

50%

50%

yEs

no

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If you are looking for signs of recovery from the financial crisis, you will perhaps find it in the result of our next question. What we see is that there is a visible shift in the attitude toward the splitting up of banks in retail/corpo-rate and investment banking. Whereas in 2012, 61 percent answered favorably and declared it “urgently necessary” to split up the banks, this figure dropped sharply to 42 per-cent, while 34 percent think the splitting up does not make sense (2012: 13%; see fig. 2).

Nevertheless, there is a rather broad consensus that the stability that has not yet returned to the banking sector will be crucial to a more favorable development of the GDP in the next years (with only 10% disagreeing and 1% strongly disagreeing).With regard to the future relevance of the banks, it has been argued in the ensuing discussion that even though the banks will become weaker in terms of profits, they will remain stronger in terms of relevance for the companies. It has also been said that banking is still a business where size matters. All in all, the general expectation tends to be that we will see a further consolidation of the banking sector in the years to come. As far as the entrepreneurial side is con-cerned, the tough competition between banks and the re-sulting low margins were referred to. As favorable as this may seem for companies with reasonable ratings, it has to be seen that the consequences that the banking system has to expect, as regards this competition, will intensify.

stRAteGy – hOw DO we PRePARe FOR the “unknOwn unknOwns”?Given the still relatively high measure of uncertainty that we just stated, it may come as surprise that the majority of participants look 5 years or more ahead, as far as strategic planning in their companies is concerned (45% = 5 yrs; 12% = more than 7 yrs; see fig. 3). This result can only be explained by noticing that when faced with gloomy macro-economic perspectives, strategic planning tends to gain in importance rather than the opposite. This observa-tion is confirmed when looking at the next question: A remarkable 91 percent of the participants hold that uncer-tainty forces entrepreneurship and does not prevent it.

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figurE 2

will we face a stronger or weaker banking sector in the near future?

stro

Ng

Erw

EakE

r

44% 57%

22%

56% 43%78%

figurE 3

theory tells us that the strategy defines the course of action; however, each day brings an incessant stream of surprises.how many years do you primarily look ahead regarding strategy discussion within your company?

5%

39%

45%

11%

12 months 2-3 years 5 years 7 years

figurE 4

what are you preparing your organization for during the next 12 months?

2012

2013

stROnG uPswInG

sLIGht uPswInG

utMOst FLexIBILIty FOR BOth

sLIGht DOwntuRn

stROnG DOwntuRn

3%

35%

37%

21%

4%

4%

12%

40%

34%

10%

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As for the actual outlook of the economic development we see a considerably more optimistic view than we did 12 months ago: While in 2012 only 16 percent of the partici-pants expected a slight (12%) or strong (4%) upswing, this year these answers were given by more than twice as many (35% = slight, and 3% = strong upswing; see fig. 4). The ensuing panel discussion turned on the general chal-lenges of successfully managing cycles. After noting that there are relatively few changes, particularly notable trends in coping with business cycles include: a change in communicational policies, i.e. more traveling and direct interaction between board and sites; a more urgent need to adapt the culture and agility of the companies to a perma-nently changing business environment; a requirement of using more crowd-sourcing approaches to handle risk and uncertainty; one participant mentioned three require-ments for effectively managing volatilities: a) having a portfolio, b) applying contractual strategies and c) having world class technology. Especially the last requirement mentioned seems worth noting, as another participant underlined the need to reach the top position in a market, because, especially in a downturn, given an ongoing de-mand, clients will turn to the market leader.

CentRAL BAnks – DO we exPeCt tOO MuCh OF theM?Coming back to the euro crisis, the panelists discussed the role of the central banks and the performance they showed so far in preventing the worst consequences of the euro crisis.While the general assessment of their performance so far is a surprisingly positive one (with 72% answering rather positive and 9% very positive; see fig. 5), many discussants pointed out that one must not expect too much of the cen-tral banks. The underlying assumption was that we should give up the illusion of an apolitical central bank, but never-theless urge the governments to minimize interferences with the work of the central banks. The thesis warned against overloading the institutes with

too many tasks like solving unemployment, inflation and growth issues. Instead they should focus on the money supply in general and in the long-term inflation targets in particular, a view that was shared by the panelists, just like the conviction that the greatest danger in turbulences is to act with yesterday’s logic.Even though the independence of the central banks was questioned by several panelists, one participant pointed out that there might be yet another twist to the relation between the European governments and the ECB, notic-ing that it could well serve as a scapegoat once the next sizeable problem occurs.Concerning the further political integration of the EMU, a clear majority of the participants (45% over 19%; see fig. 6) expect a stronger political integration in the member states as a reaction to the current situation.

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figurE 5

how do you see the role and effectiveness of central banks during the fiancial crisis up until now?

2% 17%

72%

9%

very negative rather negative rather positive very positive

figurE 6

Are we going to have a stronger political integration within eMu member states in the future or rather move toward less intensive co-operation models?

19%

36%

45%

Less intensive co- operation / integration models

no chance Also stronger political integration besides monetary integration

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GOVeRnAnCe – DeAth OF entRe- PReneuRIAL thInkInG?The next panel addressed the question of whether the growing power of governance is equivalent to the death of entrepreneurial thinking. In the keynote speech it was ar-gued that governance must never be something to rely on instead of entrepreneurial thinking and acting, because being an entrepreneur means the willingness to put one’s own career at risk, which cannot be achieved by the extrin-sic motivation in the form of governance rules. As far as global developments are concerned, the speaker pointed to the constantly growing problem that we are not playing on a leveled field with the emerging markets playing by different rules.Given this analysis, which was shared by several panelists (“Management should be guided by the thought: ‘Would you do this if it was your own company?’“), one result of our poll was all the more surprising: a considerable major-ity of participants expressed their opinion that among CEOs a higher focus is put on doing things right (i.e. act-ing in accordance with governance and other constraints) compared to doing the right things, a view that is decid-edly confirmed by yet another answer: 85 percent find that in the last 10 years things in general have shifted in favor of “doing things right” (see fig. 7).However, it would be simplistic and wrong to conclude that governance generally is seen as a hindrance to innova-

tion, creativity and entrepreneurship. It’s just something to always keep in mind while focusing on doing the right things. Integrity will always remain more important than governance. Similarly, crises are not generally seen as neg-ative, but, as one panelist put it, as a potential catalyst for creating new opportunities and a sense of urgency.

the ReBIRth OF FunCtIOnAL exCeLLenCe – PROs AnD COns OF the ssCTwo topics dominated the panel that dealt with the func-tional excellence – that quickly became obvious – on the one hand Shared Service Centers and their role and func-tions within the company and on the other hand, the pros and cons of more centralization.As far as the SSC are concerned it was made clear that they can be very useful instruments indeed, as long as some conditions are met: first, it has to be guaranteed that they lead to synergies and are not established for the sake of standardization; second, once, the SSC is operational and working, it has to be regularly (annually or bi-annually) benchmarked and thereby prove that is still is cost-effi-cient compared to external solutions (also in terms of the price/performance ratio), not at least because the set-up of the SSC is a common decision of the corporate center and businesses, which implies an obligation to contract.

figurE 7

Looking 10 years back, have things shifted more in favor of “doing things right“?

85% 15%

yEs

no

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figurE 8

In a restructuring phase, it is beneficial to take a more centralized approach.

YEs

No

85%

15%

Comments (selection): “Depends on the potential of the units“ “Depends on the homogeneity of the business model“ “Depends on the restructuring situation, I can well imagine that decentralization is sometimes key for a successful restructuring“ “Central objectives: yes, central micro-management: no, as it is too slow“

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Centralization in the company can be a good thing, for ex-ample in a restructuring phase: 85 percent of the partici-pants think that a more centralized approach can be ben-eficial in this situation (see fig. 8). But here too some pre-requisites have to be fulfilled: centralization cannot be an end in itself, but has to have a clear purpose. Objectives might be centralized, but centralizing the micro-manage-ment could prove fatal as it slows processes and creates potential sources of error within the company’s structure. And, last but not least, an important statement made by one of the panelists: a good strategy is worthless in case of a poor implementation.

eneRGy stRAteGy – when wILL RenewABLes FInALLy tAke OVeR?At the end, we returned to the global level, talking about one of the topics that will be key for all economies and for prosperity in general: the energy strategy in the 21st cen-tury. The thesis maintained that new projects will affect the prices for energy particularly in Asia and that will lead to a much stronger decrease of energy prices in Asia and, therefore, to higher competitiveness compared to Western economies. These developments coincide, as far as Asia is concerned, with a lower dependency on the Middle East,

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which subsequently will also alter the geo-political power balances in the decades to come (an overwhelming major-ity of the participants think that Asia will be the only re-gion with a strong increase in geopolitical power within 10 years; see fig. 9). According to the keynote speaker, lower prices in Europe can be expected in 10 to 20 years – after the depreciation of renewables is over. At the same time, he voiced his concern that until then it has to be made sure

that our utilities and the new industry of renewables are still in working order by then. The times of nuclear energy are gone, as the capital is tied-up for too long (up to 90 years), while technology cycles tend to lead to ever more frequent innovations and changes every 10 to 15 years. The over-subsidization of renewables is described as an obstacle for innovation and new technologies, even though more efficient and cleaner carbon technology would be more than welcome, given the ecological impact that cannot be neglected. There is no need for additional energy, because costs and the resulting competitiveness are still the most important variables. But even when leaving aside the potential impact of the development of energy prices, it seems that the anticipated striving for energy supply and energy security is cause for concern: a mere 10 percent of the participants do not be-lieve that this development will increase the danger of po-litical tensions (see fig. 10). It remains to be seen which consequences a potential self-sufficiency of the US would have in the years to come (expected by 55% of the partici-pants as soon as within the next 5 years). Several partici-pants expressed their concern that the EU has to put more emphasis on securing the energy supply to Europe, and pointed also to its significance for the industrial competi-tiveness. Summarising the debate very poignantly, another panelist listed three take-aways: 1. to get rid of coal; 2. move from gas to renewables; and 3. do not forget innova-tion and technology. The same panelist granted that the experiment undertaken by Germany is something that only Germany can afford right now.

figurE 9

how would you rank the changes in geo-strategic power of the follow-ing regions, 10 years from now?

EuropE

stroNg iNCrEasE stroNg dECliNE

us

asia

middlE East

figurE 10

will the strive for energy supply and energy security increase the danger of political tensions going forward?

46% 44%

10%

yesto a very high degree

yesto a small extent

nO

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Editorialof The Stern Stewart Institute’s Periodical

9th Edition, December 2013Published half-yearly

Board of EditorsMarkus Pertl Gerhard Nenning

Chief EditorGerhard Nenning

Editorial ProductionAnja Deucker

Design Production and ArtworkKW Neun Grafikagentur

PrintingIndustrie-Druck Haas

The opinions, beliefs, and viewpoints expressed by the various authors in this publication do not necessarily reflect the opinions, beliefs, and viewpoints of the editorial staff or of The Stern Stewart Institute. The publisher accepts no responsibility for errors, omissions, or the consequences thereof.

The Stern Stewart Institute e.V.Salvatorplatz 480333 MunichGermany

T +49 89 242071 0F +49 89 242071 11

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