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Should zombie companies be feared?



Many investors fret that a corporate “zombiepocalypse” may be one of the thorniest problems the global economy faces in the coming years. But a bombshell paper by the New York Federal Reserve argues that this fear may be overdone. 

Even before the eruption of coronavirus, concerns that a growing horde of walking-dead companies — usually defined as those unable to cover debt-servicing costs from long-run profits — were pervasive. 

Two years ago, the Bank for International Settlements calculated that the share of zombie companies across the 14 big economies it studied had climbed from 2 per cent in the late 1980s to 12 per cent by 2016. The driver was that they stayed undead for longer than in the past, neither recovering nor dying out. The most likely reasons for this were the falls in interest rates that reduced debt repayments and banks being reluctant to pull the plug.

March of the zombie companies

The trend was no accident. In fact, after the 2008 financial crisis, policymakers considered low rates and forbearance absolutely necessary to prevent a mass corporate extinction event that would have caused many more millions of jobs to disappear. In this, the authorities had learnt from the mistakes of history. 

Back in 1929, Treasury secretary Andrew Mellon advocated the mass liquidation of struggling companies to “purge the rottenness out of the system”. Foreshadowing Joseph Schumpeter’s theory of “creative destruction”, he argued this would be the best way to ensure a recovery. Instead, the Mellon Doctrine helped turn the crash of 1929 into the Depression.

Nonetheless, many economists worry that allowing feeble companies to shamble on indefinitely does entail real, longer-term economic costs. The 2018 BIS paper estimated that “zombie companies” are unproductive, invest less and suck up resources that could otherwise be redeployed in more dynamic areas. Even beyond the zombie company phenomenon, economists fretted that rising corporate indebtedness in general stunts the ability of companies to invest.

These fears have been supercharged in the wake of the coronavirus crisis. Of the many legacies the pandemic will leave in its wake, a monstrous corporate debt burden is one of the biggest. 

Line chart of Global non-financial corporate debt as percentage of global GDP (%). showing Global corporate debt level has spiked to new record in 2020

The rise in corporate bankruptcies has so far been surprisingly modest, thanks to the extraordinarily aggressive response from governments and central banks, with the latter alone pumping more than $7tn of stimulus into bond markets, according to the IMF.

But the net result has been that the developed world’s corporate debt burden has climbed from an already record 91 per cent of gross domestic product in 2019 to 102 per cent at the end of September 2020, according to the Institute of International Finance. Although rock-bottom interest rates make this more bearable, economists fret that this debt “overhang” will be a millstone around the neck of the global economy for years to come.

Perhaps not, according to the paper published by the New York Fed this month. Using a database across 17 economies going back to the 19th century, Oscar Jordà, Martin Kornejew, Moritz Schularick and Alan Taylor investigated whether big corporate debt build-ups led to deeper and longer recessions, as is historically the case after booms and busts in household or finance industry debts. 

Their conclusion is counterintuitive. “There is no evidence that corporate debt booms result in deeper declines in investment or output, nor that the economy takes longer to recover than at other times,” the paper says. Nor did the economists find any evidence that big corporate debt overhangs made economies more fragile, and prone to less frequent but bigger downturns. 

Why is this? The NY Fed paper argues that corporate bankruptcy and restructuring regimes are generally much more efficient than those for individuals. Both company owners and creditors are best served with a swift resolution. 

However, when creditors are dispersed and combative, contract enforcement is weak or the legal process cumbersome, it can discourage or delay a speedy restructuring or liquidation. This can nurture more undead companies. “More frictions lead to more under-investment and survival of zombie firms, which can impair aggregate productivity growth and slow down the recovery after recessions,” the economists note.

In other words, policymakers should worry less about low interest rates allowing the number of companies to linger in the twilight zone of survival. Instead, they should focus on ensuring that bankruptcies and restructurings are handled as quickly and efficiently as possible.

Twitter: @robinwigg

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US regulators launch crackdown on Chinese listings




US financial regulation updates

China-based companies will have to disclose more about their structure and contacts with the Chinese government before listing in the US, the Securities and Exchange Commission said on Friday.

Gary Gensler, the chair of the US corporate and markets regulator, has asked staff to ensure greater transparency from Chinese companies following the controversy surrounding the public offering by the Chinese ride-hailing group Didi Chuxing.

“I have asked staff to seek certain disclosures from offshore issuers associated with China-based operating companies before their registration statements will be declared effective,” Gensler said in a statement.

He added: “I believe these changes will enhance the overall quality of disclosure in registration statements of offshore issuers that have affiliations with China-based operating companies.”

The SEC’s new rules were triggered by Beijing’s announcement earlier this month that it would tighten restrictions on overseas listings, including stricter rules on what happens to the data held by those companies.

The Chinese internet regulator specifically accused Didi, which had raised $4bn with a New York flotation just days earlier, of violating personal data laws, and ordered for its app to be removed from the Chinese app store.

Beijing’s crackdown spooked US investors, sending the company’s shares tumbling almost 50 per cent in recent weeks. They have rallied slightly in the past week, however, jumping 15 per cent in the past two days based on reports that the company is considering going private again just weeks after listing.

The controversy has prompted questions over whether Didi had told investors enough either about the regulatory risks it faced in China, and specifically about its frequent contacts with Chinese regulators in the run-up to the New York offering.

Several US law firms have now filed class action lawsuits against the company on behalf of shareholders, while two members of the Senate banking committee have called for the SEC to investigate the company.

The SEC has not said whether it is undertaking an investigation or intends to do so. However, its new rules unveiled on Friday would require companies to be clearer about the way in which their offerings are structured. Many China-based companies, including Didi, avoid Chinese restrictions on foreign listings by selling their shares via an offshore shell company.

Gensler said on Friday such companies should clearly distinguish what the shell company does from what the China-based operating company does, as well as the exact financial relationship between the two.

“I worry that average investors may not realise that they hold stock in a shell company rather than a China-based operating company,” he said.

He added that companies should say whether they had received or were denied permission from Chinese authorities to list in the US, including whether any initial approval had then be rescinded.

And they will also have to spell out that they could be delisted if they do not allow the US Public Companies Accounting Oversight Board to inspect their accountants three years after listing.

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Wall Street stocks climb as traders look past weak growth data




Equities updates

Stocks on Wall Street rose on Thursday despite weaker than expected US growth data that cemented expectations that the Federal Reserve would maintain its pandemic-era stimulus that has supported financial markets for a year and a half.

The moves followed data showing US gross domestic product grew at an annualised rate of 6.5 per cent in the second quarter, missing the 8.5 per cent rise expected by economists polled by Reuters.

The S&P 500, the blue-chip US share index, closed 0.4 per cent higher after hitting a high on Monday. The tech-heavy Nasdaq Composite index climbed 0.1 per cent, rebounding slightly after notching its worst day in two and a half months earlier in the week.

The dollar index, which measures the US currency against those of peers, fell 0.4 per cent to its weakest level since late June after the GDP numbers.

“Sentiment about the economy has become less optimistic, but that is good for equities, strangely enough,” said Nadège Dufossé, head of cross-asset strategy at fund manager Candriam. “It makes central banks less likely to withdraw support.”

Jay Powell, the Fed chair, said on Wednesday that despite “progress” towards the bank’s goals of full employment and 2 per cent average inflation, there was more “ground to cover” ahead of any tapering of its vast bond-buying programme.

“Last night’s [announcement] was pretty unambiguously hawkish,” said Blake Gwinn, rates strategist at RBC, adding that Powell’s upbeat tone on labour market figures signalled that the Fed could begin tapering its $120bn a month of debt purchases as early as the end of this year.

The yield on the 10-year US Treasury bond, which moves inversely to its price, traded flat at 1.26 per cent.

Line chart of Stoxx Europe 600 index showing European stocks close at another record high

Looking beyond the headline GDP number, some analysts said the health of the US economy was stronger than it first appeared.

Growth numbers below the surface showed that consumer spending had surged, “while the negatives in the report were from inventory drawdown, presumably from supply shortages”, said Matt Peron, director of research and portfolio manager at Janus Henderson Investors.

“This implies that the economy, and hence earnings which have also been very strong so far for Q2, will continue for some time,” he added. “The economy is back above pre-pandemic levels, and earnings are sure to follow, which should continue to support equity prices.”

Those upbeat earnings helped propel European stocks to another high on Thursday, with results from Switzerland-based chipmaker STMicroelectronics and the French manufacturer Société Bic helping lift bourses.

The region-wide Stoxx Europe 600 benchmark closed up 0.5 per cent to a new record, while London’s FTSE 100 gained 0.9 per cent and Frankfurt’s Xetra Dax ended the session 0.5 per cent higher.

In Asia, market sentiment was also boosted by a move from Chinese officials to soothe nerves over regulatory clampdowns on the nation’s tech and education sectors.

Beijing officials held a call with global investors, Wall Street banks and Chinese financial groups on Wednesday night in an attempt to calm nerves, as fears spread of a more far-reaching clampdown. Hong Kong’s Hang Seng rose 3.3 per cent on Thursday, although it was still down more than 8 per cent so far this month. The CSI 300 index of mainland Chinese stocks rose 1.9 per cent.

Brent crude, the global oil benchmark, gained 1.4 per cent to $76.09 a barrel.

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Man Group posts tenfold gain in performance fees




Man Group PLC updates

Man Group, the world’s largest listed hedge fund manager, reported first-half performance fees 10 times higher than a year ago, in the latest sign of the industry’s robust rebound from the coronavirus pandemic.

Strong commodity and equity markets helped take performance fees at the London-based company to $284m in the six months to June, up from $29m a year before when March’s huge market falls hit many fund returns, and the highest level since at least 2015. Performance fee profits were 50 per cent above broker consensus forecasts.

Man also posted $600m of net client inflows in the three months to June, its fourth consecutive quarter of inflows, although the figure was lower than analysts had expected. However, $6bn of investment gains in the second quarter helped lift assets under management to a record high of $135.3bn.

Column chart of Half-yearly performance fees ($) showing Man Group cashes in on market rebound

Man’s results highlight how strongly the $4tn hedge fund industry has bounced back after a turbulent 18 months for markets, including a huge sell-off last spring, as well as sharp market rotations and retail investor-driven rallies in meme stocks that some funds were betting against.

Last year, hedge funds, which have long been criticised for mediocre returns and high fees, made 11.8 per cent on average, according to data group HFR, their best calendar year of gains since 2009 in the wake of the financial crisis.

Investors have taken notice. After three years of net outflows, the industry has posted $18.4bn of inflows in the first half of this year.

Chief financial officer Mark Jones said the hedge fund industry was now benefiting from a tailwind after strong gains last year. “You saw hedge funds deliver exactly what clients wanted,” he told the Financial Times.

“Clients need new sources of return,” he added. They “are trying to reduce their bond exposure, and most have as much equity exposure as they can stomach”.

This year Man has made strong gains at its computer-driven unit Man AHL, named after 1980s founders Mike Adam, David Harding and Martin Lueck, which tracks trends and other patterns in markets.

Its $4.6bn AHL Evolution fund, which bets on trends in close to 800 niche markets, has gained 10.2 per cent so far this year and contributed $129m of the performance fees in the first half. The fund is shut to new money but Jones said that late last year it opened briefly to new investment, raising $1bn in a week.

Man’s first-half profits before tax came in at $323m, well above analysts’ forecasts. The company also said it would buy back a further $100m of shares in addition to the $100m announced last September. Broker Shore Capital said the company had posted “blowout” figures.

Man’s shares rose 2.4 per cent to 196 pence, their highest level in three years.

Last month, Man announced that chief investment officer and industry veteran Sandy Rattray would leave the company. Meanwhile, Jones is set to step down from the board and take on the role of deputy chief executive, overseeing the computer-driven AHL and Numeric units.

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