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Editor's Note: Hamish Risk | July 2, 2020
In today’s Macro Briefing Capital Economics explains that whether or not risky assets continue to rise, market dislocations like those seen in March are unlikely in the event of a second wave of coronavirus infections thanks to the massive backstops put in place by global central banks. Meanwhile, the bungling reaction to the pandemic has done little for President Trump’s re-election chances according to Eurasia Group, who now predict a Biden victory that could structurally change the balance of power in Washington and usher in a radical reform agenda. Elsewhere, Tellimer explains where to find value in emerging and frontier markets, while Enodo Economics sounds a warning over the health of the Chinese banking sector amid a pandemic of defaults in the wake of COVID-19. Lastly, we shine a light on the practicalities of ESG data and ratings by looking at how they flag up the vulnerabilities of companies, with Wirecard as our case study, and Integrum ESG as our ratings provider.
corporate governance ESG Wirecard Integrum ESG
1. ESG: How Wirecard investors could have avoided disasterThe FT Moral Money column yesterday highlighted the less than impressive performance of ESG ratings in flagging up the potential fraud that unravelled at Wirecard and took the stock to close to zero. The FT highlighted how Wirecard had earned median-grade ESG ratings from MSCI and Sustainalytics, the two largest and most established providers in the ESG data/ratings market today. The implication was that these firms were well behind the curve in identifying the governance risks that proved so fatal, not just for the company, but for its investors. While this isn’t great PR for MSCI and Sustainalytics, it may not necessarily reflect the market for ESG ratings/scores as a whole. The marketplace for ESG ratings/risk metrics is growing rapidly, with many new entrants. We point to one such new entrant, Integrum ESG, which was founded in 2018 by the former head of European research at Macquarie Bank, Shai Hill. Integrum provides an ESG ratings dashboard, with data harvested from company reports using AI. They also provide sentiment scores derived from 850,000+ news and social media sites which are reviewed by neural-network AI in real time. So how did they do on Wirecard? Firstly they carried a ”D” rating, which is their second-lowest grade on their A-E scale. Secondly they identified that the problem was in governance, and specifically Audit. Their stand-alone governance score was also D, and a poor approach to auditing was clearly highlighted. Furthermore, the Integrum system breaks down the Audit score into component parts, where they had flagged up concerns about the independence of the audit committee and that its external auditors EY, had been in place for too long (10-years). Lastly, Integrum’s sentiment ESG tracker began giving strong negative signals two days before the Wirecard share price took its fatal nosedive on June 17th from 103 euros down as low as 1 euro. If you would like to find out more about Integrum’s ESG dashboard click below to contact the firm.
banks China NPLs Enodo Economics
2. China changes tack on NPLs as Covid defaults worsen its bad-debt headacheDinny McMahon at Enodo Economics has issued a warning over the health of the Chinese banking sector as the coronavirus pandemic increases concerns surrounding non-performing loans (NPLs). She says since 2016, Beijing has been engaged in a slow-moving clean-up of the banking system, with official data showing banks disposed of Rmb5.3 trillion-worth of NPLs. While large in absolute terms, McMahon says it’s difficult to say with any confidence how significant the efforts have been relative to the overall bad debt problem. While officially financial regulators have never acknowledged an NPL ratio higher than 2% in over a decade, she says, the actual level of bad loans is likely far higher. Indeed, last year, McMahon estimated the true extent of credit losses in China is likely to come to 19% of GDP. She says the pandemic has undoubtedly created a wave of additional NPLs, but even before the emergence of Covid-19 slower economic growth was impairing bank asset quality. McMahon breaks down the major channels of NPL disposal, how they are evolving, and what investors can expect in the year ahead. Ultimately, she says, as the burden of distressed debt continues to mount, so will the role of the state in ensuring financial stability.
Emerging markets Equities Technology Tellimer
3. Chasing technology’s tail – EM equity strategy overviewAny active institutional equity fund looking at EM and FM will need staying power in the face of the technology freight train, says Hasnain Malik at Tellimer. He says while the word “unprecedented” has been used widely to describe the world in 2020 the dominant feature of global equity markets looks no different from 2019 or any of the last several years: the substantial outperformance of the largest technology stocks, whether in developed markets or emerging markets, and largely because of the high weights of these technology stocks, the outperformance of developed markets over emerging markets and of emerging markets over frontier markets. Malik has looked at how the large and small emerging markets have progressed over the year to date and assessed them from top-down, equity strategy perspective. Beyond the assumption that everything continues to chase technology, he says Asia looks more appealing than all other regions and India, Indonesia. Pakistan, Philippines, Qatar, and Vietnam are his top markets. The report also outlines which regions and markets look too risky.
regulation US economy US presidential elections Eurasia Group
4. A large democrat majority in the Senate could structurally change the balance of powerPresident Trump politically has had a bad month and is losing to Joe Biden in most vote intention polls and on most questions of who is best positioned to handle key issues for voters, says Eurasia Group’s Jon Lieber. He says given President Donald Trump’s declining popularity over the past month, the odds of a victory for Joe Biden this November have risen to 60%, up from 55%, and a bigger Biden lead makes Democrats more likely to take control of the Senate (55%, up from 50%). A Democratic majority would pursue an aggressive agenda limited primarily to fiscal issues and new regulations—unless they eliminate the filibuster, which is more likely if they control a larger majority of 53 or more seats, according to Lieber. Eliminating the filibuster would allow for the addition of two new Democratic senators from the District of Columbia, he says, which would structurally and permanently swing the balance of power in Congress toward the Democratic coalition, clearing the path towards a significantly more aggressive pro-labour and pro-environment agenda.
central banks Risk assets Capital Economics
5. Market stress likely to remain limited, even if cases riseJonas Goltermann at Capital Economics believes central bank backstops will make a re-run of the March panic in financial markets unlikely, a key assumption underpinning his view that risky assets will recover further ground in the second half of 2020. While equity markets have fallen back a bit over the past three weeks amid worries about the increase in new coronavirus cases in the US and elsewhere, he says, there is little sign of the widespread market dislocations that accompanied the global spread of the pandemic in late February and March. If anything, says Goltermann, strains in core money markets have eased further over the past month, probably in large part thanks to central bank backstops put in place in March, which have reassured investors that even if the prices of risky assets fall, market functioning will be maintained. Although those backstops may be tested if the rise in new coronavirus cases continues and equities tumble further, he thinks that central bank support will continue to keep the global financial system on an even keel. Thus while a major “second wave” in the pandemic is a key downside risk to Goltermann’s generally optimistic forecasts for risky assets, he doesn’t anticipate that it would lead to a repeat of the money market freeze and distressed selling across financial markets that occurred in March.