In its Financial Stability Review of 2 May, the South African Reserve Bank sights the probability of further downgrades to South Africa’s credit ratings. This may weaken the currency and lead to higher borrowing costs. In April the sovereign credit rating was cut to junk (debt “non-investment grade” or “speculative”) by both S&P Global Ratings and Fitch Ratings Ltd. Having South Africa at the 2nd lowest investment grade level, Moody’s prepares to visit the country for review. The catalyst for the downgrades was President Zuma firing Finance Minister Pravin Gordhan at the end of March in a cabinet reshuffle. Since then South Africa’s six-member banks index (incl Standard Bank Group and Barclays Africa Group) has plummeted more than 8%, making it the country’s worst performing stocks of the year. It is feared local banks will increasingly have to battle declining returns and rising bad debts in the year ahead.
On 26 April Switzerland’s second biggest bank Credit Suisse reports a first quarter net income of CHF 596bn, reversing a CHF 302m loss a year earlier. This appears to be part of a trend of European banks getting back on a road of recovery. Credit Suisse CEO Tidjane Thiam among others announced that he intends to raise CHF 14bn through a rights issue – granting shareholders a chance to buy new shares at a discount to the current trading price. This could lift the banks’ ratio of common equity to risk-weighted assets from 11,7% to 13,4%. The CEO is also driving an increasing focus on Asia where Credit Suisse seeks to serve both business and newly rich families through its corporate, investment banking and wealth management services. In the past year its Asian wealth management business has had profits rising by two thirds.
It is reported that capital flows to emerging markets have turned positive for the first time since the 2nd quarter of 2014, having attracted a net US$ 28,6bn in the 1st quarter of 2017. This comes after the Washington DC-based Institute of International Finance (IIF) reported that cross-border portfolio flows in March were at their highest monthly level since January 2015 and broad capital flows to China turned positive in February for the first time in almost three years. The trends appear despite the fact that the US Federal Reserve raised interest rates on 15 March, suggesting that investors were not bothered by what would normally be a negative signal for emerging market assets. The Financial Times signals that, starved of yield in developed markets, investors have rediscovered an appetite for emerging market risk.
On 17 February Kraft Heinz announces a US$ 143bn take-over bid for Unilever, only to be withdrawn two days later after strong pushback from the Unilever chief executive and Board. The potential benefits were questioned by Unilever shareholders, 70% of whom are long-term investors who have held their shares for over 7 years. The failed bid did raise concerns about the group’s structure and profitability. On 22 February Unilever announced it would conduct “a comprehensive review of options available to accelerate delivery of value for the benefit of our shareholders”, after which its share price recovered. Unilever’s profit margins are half those of Kraft Heinz, suggesting that the business could be run more efficiently. It may sell off businesses such as Lipton tea to fund a large acquisition in home and personal care, a domain that currently accounts for 57% of sales.
The World Economic Forum (WEF) publishes its Global Risks Report on 11 January. Based on its Global Risks Perception Survey (GRPS) with feedback from 750 experts, it concludes that rising income and wealth disparity and increasing polarization of societies are 1st and 3d respectively among underlying trends that will determine global developments in the next decade. Among top environmental issues ranking both high-risk and high-likelihood, climate change ranks as 2nd most important underlying trend. Of 12 emerging technologies examined, experts found artificial intelligence and robotics as having the greatest potential benefits, but also the greatest potential negative effects and greatest need for better governance. The findings signal a world undergoing multiple complex transitions towards a lower-carbon future, technological change of unprecedented depth and speed, and new economic and geopolitical balances.
From 26-29 December Japanese conglomerate Toshiba loses almost half its share price value as investors respond to its multibillion dollar writedown warning. The Financial Times reports a loss of trust among investors in a company that since 2015 has shown “slack corporate governance and repeated disclosure failures”. Japanese R&I downgraded Toshiba’s credit rating from BBB minus to BB. The warning signaled impairment losses on part of its Westinghouse nuclear business in the US that could result in a writedown of $2,3 billion. Investors continue to question if Toshiba has adequately addressed standards of oversight and decision-making. Accounting irregularities exposed in 2015 suggested Toshiba falsely inflated its profits by $1.3bn over seven years. Japan’s $1.3tn Government Pension Investment Fund — largest investor in the world — announced it was suing Toshiba for damages over the scandal.
On 8 November Donald Trump surprisingly wins the US presidential election. He wins 306 electoral votes and Hillary Clinton 232, but gets only 46,2% of the popular vote versus Clinton’s 48,3%. Election polls and investors expected Clinton to win. In the initial market shock reaction Dow futures fall 800 points and the S&P 500 by 5%. European stocks fall and Japan’s Nikkei stock exchange closes 5.4% lower. But within a day markets digest the result and some sectors start to focus on possible opportunities. The Dow industrials move up to their best week since 2011. Based on his election promises, infrastructure and traditional energy sectors are optimistic. So is finance, expecting deregulation. Yet his positions on climate, trade and migration leave clean energy, manufacturing and ICT sectors nervous. Amidst market uncertainty, the value of the US dollar surges with post-election expectations of reflation in the US.
On 5 October the climate convention (UNFCCC) secretariat states that the threshold for entry into force of the Paris Agreement was achieved. This follows receipt of instruments of ratification of the EU and Canada. The Paris Agreement consequently enters into force a month later on 4 November. The speed at which countries ratified the agreement was unprecedented in international treaty-making history. To enter into force, at least 55 countries accounting for at least 55% of global GHG emissions were required. National action plans will now formally become Nationally Determined Contributions (NDCs). On 25 October the International Energy Agency (IEA) reports that renewables have overtaken coal as world’s largest source of power capacity. With falling costs of renewable supplies, the IEA revised its 5-year forecast to suggest renewables’ capacity will grow 13% more than estimated in 2015.
On 6 September the Financial Times reports that most banks today deliver a return on equity (RoE) of only 5% – 10%. This is far from the high point in bank returns during years before the financial crisis of 2008 onwards. A decade earlier for example HSBC made a RoE of 17% and Goldman Sachs 25% – 30%. Non-Nordic European banks’ profitability appears to be undermined by high provisions. Average non-performing loan ratios at 6% (21% in Italy) are about three times US and Japanese levels. Furthermore, fast-digitising, branch-closing Nordic banks operate at a cost-income ratio of 46%, some 10-15 percentage points below the rest of Europe. Europe’s banks trade at 10 times their forecast 2017 earnings and 0.8 times their book value, compared to US banks which trade at 11 times earnings and 1.0 times their book value.
From 5-21 August 2016 Rio de Janeiro hosts the Summer Olympic Games. The costs of hosting the Games include sports-related costs and broader infrastructure-related costs. The sports-related costs of Rio 2016 was estimated to be US$ 4.6 billion, some 51% over budget. With broader costs added, the overall cost was estimated at US$ 12 billion – of which the greater contribution came from the private sector. The costs compare with the previous summer games in London at US$ 15 billion and Sochi winter games at US$ 21.9 billion. The Olympics reportedly have the highest average cost overrun of any type of mega-project. Overall costs include operations costs (during the event including security), venue construction / renovation costs, and infrastructure costs. Estimated externalities, both costs and benefits, remain the subject of much debate.
In July 2016 global corporations assess the material consequences of Brexit. Analysis published by The Economist (9 July) highlights the likely implications for diverse industries. These include European multinationals with investments in an economy that holds some 7% of world FDI. Worries about different regulations applying in the UK versus EU affect especially industries such as ICT (transnational data transfer), airlines (open continental operations), manufacturing (cars, aircraft, etc), energy (cross-border electricity investment and trade), pharma (patents systems) and chemicals (EU REACH framework). These include industries using the UK as an export hub, whose investment planning for the next two years and after faces the additional complication of currency fluctuations (GBP versus Euro). Germany’s BASF for example runs 10 plants in the UK and about 80% of what it produces there is exported to Europe.
In a referendum on 23 June, 52% of the British voting population decides that the United Kingdom should leave the European Union. The historical vote sends shockwaves through financial markets world-wide. Broader economic consequences for the UK will unfold in coming years. The immediate impacts hit in particular British financial institutions as well as housing and travel companies as a weak Pound is expected to leave British consumers holding back on spending. EasyJet is one of the first to announce a profit warning, as it expects its revenue in the second half of the financial year to fall by a “mid single-digit percentage”. It starts a formal process to move its headquarters to continental Europe. Foreign investment banks take steps to move staff from London to other European financial centres. The Brexit vote also impacts current merges & acquisitions.
On 2 May federal prosecutors in Brazil announce that they will seek R$155bn (US$44bn) in damages from BHP Billiton and Vale, which operate the iron miner Samarco as 50/50 joint venture. This follows one of Brazil’s biggest environmental disasters ever in November 2015 when a Samarco wastewater tailings dam burst. It among others left 17 people dead and over 500 homeless. The local state and federal governments have already settled with the two companies for US$3bn-6bn. In response to the announcement, BHP’s shares fell 6% in London and 9% in Australia. Vale’s shares fell 5.5% in Brazil. The two groups lost US$7.6bn in value. Considering Vale’s smaller market capitalization, it lost US$1.5bn in value compared to BHP’s loss of US$6.1bn. Yet as FT Lex pointed out, formally each “owns” half of the liability for the disaster.
On 3 April 2016 news breaks on the Panama Papers, a leak of 11.5m files from the database of Mossack Fonseca (world 4th biggest offshore law firm). Leaked a year earlier to the Süddeutsche Zeitung, over 400 journalists world-wide analysed the documents for the International Consortium of Investigative Journalists. Its revelations about offshore accounts for tax evasion purposes imply hundreds of politicians, business and sports people. It also puts the spotlight on banks, such as France’s Societe Generale which was an active user of the law firm to set up offshore shell companies. In response the IMF head calls tax avoidance a global risk. The Obama Administration launches new measures (incl stricter “customer due diligence” rules for banks). Measures proposed by the EU Commission require companies with annual turnover over €750m to annually publish country-level data (incl profits, tax, employees, net turnovers).
On 10 March the ECB announces a cut in its deposit rate to minus 0.4%. Aimed at boosting the Eurozone economy, the move is highly material to the profitability and share value of banks. The ECB also decides against introducing a tiered deposit rate structure, a system of multiple rates used in Switzerland and Japan to encourage lending to companies while also punishing banks that hold too much cash. On complaints by banks that negative interest rates hurt profitability, a senior ECB official argue that banks should revisit their business models and invest more in efficiency through digital technologies. Some criticize the continuation of negative rates, arguing that negative indirect effects overshadow the initial impacts of seeking to tax excess deposits or in effect offering to pay banks to lend. Avoiding too much risk by lending more, banks may respond by charging more for lending (e.g. mortgages) and charging higher fees.
On 2 February Larry Fink, CEO of the world’s largest asset management firm BlackRock, sends a letter to the CEOs of the S&P 500 in which he attacks market short-termism. He asks every CEO to “lay out for shareholders each year a strategic framework for long-term value creation”, one reviewed by board members. It raises the time dimension of materiality. He challenges companies to educate their investors, explaining how with long-term plans they are adapting to technological disruption or geopolitical events, where they are investing and how they are developing talent. This follows meetings convened by Warren Buffett and JPMorgan Chase on the topic of longer-term investment priorities with BlackRock, Fidelity, Vanguard and Capital Group. In a supportive letter to the Financial Times, the CFA Institute agrees that the issue is not quarterly reporting as such but rather the type of information disclosed.
On 14 January the World Economic Forum (WEF) publishes its Global Risks Report. From survey feedback of 750 respondents, the two greatest global risks in terms of impact and likelihood are “Failure of climate change mitigation and adaptation” and “Large-scale involuntary migration”. Migration is a higher concern among short-term (18 months) risks, whereas the resource-related issues of climate, water and food dominate the top five risks with a long-term (next 10 years) perspective. Feedback from over 13000 business respondents to the WEF’s 2015 Executive Opinion Survey show a striking contrast: the relative absence of environmental risks and longer term issues among their top concerns for doing business. In developed economies, their top concerns are economic risks such as asset bubbles and fiscal crisis. In developing ones, it is unemployment, underemployment and energy price shocks.
On 12 December governments at COP 21 finalise a new agreement following the 1997 Kyoto Protocol. Fossil fuel producers play down its significance. Others describe it as historic. Richard Branson speaks of a “Paris effect” that will ensure the economy of the future is clean energy driven. The pact implies a science-based net zero emissions target for the 2nd half of this century. Bloomberg reports SolarCity CEO Lyndon Rive saying that “companies with business models threatened by a low-carbon world need to re-focus, fast“. The Stowe Global Coal Index (stock performance of 26 major producers) lost almost 60% of its value in 2015. The Paris agreement obliges every country to set out what it is going to do about its GHG emissions every five years, starting 2020. Every five years governments will experience intense public scrutiny of their climate plans. It also aims to keep global temperature rises to “well below” 2°C.
On 4 November the New York State Attorney-General sends a subpoena to ExxonMobil requesting financial records and other documentation for an investigation on whether the company misled investors and the public about climate change risks and how it could affect ExxonMobil. The Attorney-General’s office has broad powers to initiate financial fraud cases because of New York state’s Martin Act (1921). The Financial Times reports that it is inquiring into whether ExxonMobil made adequate disclosures to investors about the risks involved, its climate change impact disclosures to the SEC and possible consumer fraud considering its marketing, advertising and communications regarding climate change. The inquiry covers activities since the 1970s. CERES commented: “It’s not a crime to be a climate skeptic. But it is a crime to lie to investors, and to materially underestimate the risks.”
Thomson Reuters Launches an online, multimedia report entitled “Seven Reasons the World will be Sustainable”. It profiles the challenge for the Global 500 to take on carbon pricing. It also quotes the Global Sustainable Investment Review, highlighting that the global sustainable investment market has grown from $13.3 trillion in 2012 to $21.4 trillion in 2014, representing 30.2% of professionally managed assets in developed regions. In an interview Mercer’s Head of Responsible Investment (RI) says one of the main factors driving this growth is rising acknowledgement of the performance benefit associated with RI techniques. The evolution of ESG integration is showing the value that “nonfinancial” factors unlock. More research demonstrates that companies performing well on “material sustainability issues” outperform peers in terms of historical return measures, states Mercer’s Alex Bernhardt.
In September 2015 US regulators found Volkswagen guilty of intentionally falsifying emissions data. It catalyzed much debate on VW, the car manufacturing industry and test standards in Europe to limit air polluting NOx emissions. While consumer reaction worldwide did not immediately show a dramatic impact on sales revenues, investors made their displeasure clear. VW shares fell 70% over the following month. The company was removed from the Dow Jones Sustainability Indices (DJSI) by October and the FTSE4Good Index by December. In mid-November Union Investment, Germany’s third largest asset manager, called for the company to replace its new CEO and chairman. Volkswagen has budgeted $7.3 billion to mitigate fallout, including the prospect of vehicle buybacks. Commentators noted how an environmental or “extra-financial” issue became material overnight. (On broader industry fallout see FT.)
After the Black Monday China stock market crash of 24 August, Apple’s shares dropped 10% as investors were concerned about its exposure to the Chinese market. Later that day Apple CEO Tim Cook took the unprecedented step of replying to an email of the TV host of the CNBC show Mad Money. He indicated that Apple has continued to see strong sales growth for its business in China during July and August. After this feedback went public on the TV show, Apple recovered US$ 78 billion of its lost market value. Considering SEC rules on fair disclosure, a BBC correspondent commented: “as the email did not contain any numbers, I suppose Apple could argue that the information was not material, and that (TV host) Jim Cramer is not a stock analyst”. The incident illustrates the impact of different disclosure venues – for example a press release versus a statutory report – on investor decision-making.