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Central banks and climate change: all hot air

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Sovereign wealth funds, state investment vehicles that collectively have over $8tn in assets under management, appear obvious candidates to spearhead investment into climate-friendly assets. Most have long-term investment horizons, and all work in the interests of nation states that would need to spend big to mitigate the impact of global warming.

Some recognise this. Norges Bank Investment Management, or NBIM, which somewhat ironically derives its wealth from Norway’s vast oil supplies and which is touted as the world’s largest sovereign wealth fund, has made ESG goals a core part of its investment strategy. Increasingly it pays to go green. Global SWF, a data platform that tracks over 400 sovereign wealth funds and public pension funds, notes in a report out earlier this year that Australia’s Future Fund has “along with a sound investment strategy, historically yielded excellent results” and made money “in both rising and falling markets”.

It may not always be the case that going green makes short term gains —— a lot of the assets in certain parts of the ESG sphere may now be overvalued. But, combine the dangers of being stuck with stranded assets with the reasons we’ve listed for the official sector going green, and what strikes us as odd is that the stance of NBIM and the Future Fund is not replicated across the board. When broadened out to include all of the top 100 funds, Global SWF finds just 35 of them have an ESG report:

For those who follow the world of official sector asset management, this might not come as much of a surprise. Despite their capacity to set the agenda, the official sector has often been too conservative to do so and tended to follow the herd —— even when such decisions have run counter to the interests of the state they represent. During the global financial crisis, for instance, reserve managers pulled $500bn-worth of dollar liquidity at a time when their counterparts in central banks were struggling to cope with a lack of greenback funding.

Central bank reserve managers, which are responsible for north of $12tn in reserves, have traditionally had a different set of responsibilities to sovereign wealth funds. Traditionally tasked with stabilising volatile movements in their domestic currencies, which can spook investors and exporters, they hold assets that are liquid enough to sell quickly so that, in the event of turmoil, they can intervene in FX markets. They are primed for preventing crisis and therefore not so focused on the longer-term.

Some within the field are calling on reserve managers in central banks to change their tune.

At the start of this week Gary Smith of Sovereign Focus and John Nugée of Laburnum Consulting issued a joint paper that argues reserve managers ought to consider climate change enough of an emergency to make investments in technologies that will lower carbon emissions a priority:

The Paris agreement includes commitments to both cut climate-altering emissions, and continually revisit and strengthen those commitments. It is an ongoing promise. Whilst the long-term arguments for a renewable energy transition are indisputable, there will be near-term financial costs associated with the transition. The capital investment required in the rollout of solar and wind energy projects and in re-equipping households to enable the switch to green energy will require large scale funds, and will require them now.

This is the argument for mobilising all sources of national wealth to finance a green transition. Martin Luther King in his seminal 1963 speech addressed what he termed “the Urgency of Now”, and it is a phrase being used with increased frequency and vigour in the climate change debate. Now is the time to act as every year without action makes the task of restoring global climate equilibrium more difficult.

Sovereign Wealth Funds are a clear source of funding for this task, and according to the financial think-tank OMFIF, have assets under management of around $8.5 trillion. However in the current twin crises it is our view that FX reserves should also be considered as part of the solution: and at around $14 trillion take the total firepower available in national wealth accounts to a number that equates to almost 20 per cent of global GDP. This is a sizeable war chest that should not be idle at this critical moment.

Is this set to happen? The optimist in us would note that central banks have stepped up the rhetoric on fighting climate change. Even the Fed, a laggard in this area, signed up to the Network for Greening the Financial System.

Yet, so far, this has been mostly talk. And, as mentioned earlier, the official sector is not known for leading the charge. We hope we’re wrong, but we fear we may be waiting a while long for them to put their money where its mouth is.



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Saudis agree oil deal with Pakistan to counter Iran influence

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Saudi Arabia has agreed to restart oil aid to Pakistan worth at least $1.5bn annually in July, according to officials in Islamabad, as Riyadh works to counter Iran’s influence in the region.

Riyadh demanded that Pakistan repay a $3bn loan last year after Islamabad pressured Saudi Arabia to criticise India’s nullification of Kashmir’s special status.

But the acrimony between the two longtime allies has eased after Imran Khan, the prime minister, met Saudi Crown Prince Mohammed bin Salman in May.

News of the oil deal with Pakistan comes as Saudi Arabia embarks on a diplomatic push with the US and Qatar to build a front against Iran, said analysts. Riyadh lifted a three-year blockade of Qatar in January in what experts said was an attempt to curry favour with the newly elected Joe Biden.

Pakistan had shifted closer to Saudi Arabia’s regional rivals Iran and Turkey, which, along with Malaysia, have sought to establish a Muslim bloc to rival the Saudi-led Organisation of Islamic Cooperation.

Khan has developed a strong rapport with President Recep Tayyip Erdogan, encouraging Pakistanis to watch the Turkish historical television series Dirilis Ertugrul (Ertugrul’s Resurrection) for its depiction of Islamic values.

Ali Shihabi, a Saudi commentator familiar with the leadership’s thinking, said that “bad blood” had accumulated between Riyadh and Islamabad, but recent bilateral meetings had “cleared the air” and reset relations to the extent that oil credit payments would restart soon.

A senior Pakistan government official said: “Our relations with Saudi Arabia have recovered from [a downturn] earlier. Saudi Arabia’s support will come through deferred payments [on oil] and the Saudis are looking to resume their investment plans in Pakistan.”

The Saudi offer is less than half of the previous oil facility of $3.4bn, which was put on hold when ties frayed.

But Fahad Rauf, head of equity research at Ismail Iqbal Securities in Karachi, said: “Any amount of dollars helps because time and again we face a current account crisis. And with these prices north of $70 a barrel anything helps.”

Pakistan’s foreign reserves were more than $16bn in June compared with about $7bn in 2019 before it entered its $6bn IMF programme.

Robin Mills at consultancy Qamar Energy said: “Saudi Arabia and Pakistan are allies, but their relationship has always been rocky. And the Pakistan-Iran relationship is better than you might think.”

Mills said that the timing of the Saudi gesture was “interesting” given that Iran was preparing to step up oil exports with the US considering easing sanctions.

“The Saudis are on a bridge-building mission more generally. They have sought to mend fences with the US and there is also the resumption of relations with Qatar,” he said.

Ahmed Rashid, an author of books on Afghanistan, Pakistan and the Taliban, said that there were a variety of factors that might have spurred Riyadh to restart the oil facility.

It may be “partially linked to the American need for bases” to launch counter-terrorism attacks in Afghanistan from Pakistan, he said, but added that its priority was probably to prevent Islamabad from falling under Tehran’s influence.

Rashid pointed out that Pakistan was caught between China, which has invested billions of dollars in infrastructure projects, and the US.

“Pakistan has to play it carefully, it is dependent on China for the Belt and Road, dependent on the west for loans,” said Rashi. “This is a very complex game.”

Anjli Raval in London and Simeon Kerr in Dubai



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Digital euro will protect consumer privacy, ECB executive pledges

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The introduction of a digital euro would boost consumers’ privacy and protect the eurozone from the “threat” of competing cryptocurrencies that could undermine the bloc’s monetary sovereignty, according to the central banker overseeing its development.

Fabio Panetta, an executive board member at the European Central Bank, told the Financial Times that one of the project’s key aims was to combat the spread of digital coins created by other nations and companies.

“If the central bank gets involved in digital payments, privacy is going to be better protected . . . because we are not like private companies,” he said. “We have no commercial interest in storing, managing, let alone abusing, data of users.”

“Of course there is the potential threat that could come from others issuing a digital means of payment . . . If people do want to pay digitally and we do not offer them a digital means of payment, somebody [else] would do that.”

He contrasted the digital euro — an electronic version of cash issued by the central bank — with “unstable coins” such as Diem, Facebook’s planned digital currency which would let users send money as easily as text messages.

The ECB’s recent consultation on a digital euro found that people’s greatest concern was that it would erode their privacy. But Panetta said the central bank had tested ways to separate people’s identities from their payment details. “The payment will go through, but nobody in the payment chain would have access to all the information,” he said. 

The central bank has also tested “offline payments for small amounts, in which no data is recorded outside the wallets of payer and payee”, he said; transfers of up to €70 or €100 could be done using a Bluetooth link between devices. 

Chart showing expected post-pandemic payment behaviour in the eurozone

“For very small amounts, we could permit really anonymous payments, but in general, confidentiality and privacy are different from anonymity,” Panetta said, adding that some checks would be needed on most transactions to avoid money laundering, terrorism finance or tax evasion.

“A payment can be reconstructed [after the event] if the police want to assess whether there’s been any illicit activity,” he said.

Nearly two-thirds of the world’s central banks are running practical experiments on whether to launch digital currencies, according to the Bank for International Settlements.

But commercial banks worry that central bank digital currencies could erode their deposits, especially in a crisis. Morgan Stanley estimated as much as €837bn, or 8 per cent of eurozone bank deposits, could switch to digital euros.

It could also crowd out cash, some critics have argued; more than half of German households surveyed recently by the Bundesbank expressed scepticism about a digital euro and frequent cash users were the most dubious.

Panetta said a digital euro would lead to “a fundamental change in the way in which payments, the financial system and society at large will function”, for example by being “programmable” to allow automated payments, such as road tolls or in a cinema.

But he said the ECB was determined to make sure the digital euro did not undermine the commercial banking system, replace cash, crowd out innovation or become a shadow currency in smaller countries.

To achieve this, it is planning to either cap the amount anyone can hold at €3,000 each or impose “disincentivising remuneration” above that threshold, Panetta said.

The ECB’s governing council will meet next month to decide whether to push ahead with the preparations and Panetta said it could be ready for use in about five years’ time. 

The central bank will also complete its new oversight framework for private digital currencies and crypto asset providers by the end of this year, he said.

Chart showing average amount of cash in the wallet at the beginning of the day, by country

Crypto assets such as bitcoin are “very dangerous animals” that are “largely used for criminal activities” and consume “a huge amount of energy”, Panetta warned. 

So-called stablecoins such as Diem are meant to be safer as they are backed by fiat currency reserves, but Panetta said the potential volatility of those reserves created “an inherent instability in the function of these coins — and for this reason they are still unstable coins”.

Regulating and supervising crypto assets is hard “because there is no responsible legal entity,” he said. “It is decentralised. They could be in China. They could be in Switzerland or in South America . . . But to the extent that intermediaries are involved in the supply of those crypto assets, then we would have regulation and oversight in place.”

The digital euro should be made available in limited amounts for tourists visiting Europe, Panetta said, but the ECB would “have to reflect very carefully on access, and up to which limit, for foreign users”. 

Major central banks are in talks to ensure their digital currencies are kept “interoperable”, Panetta said, as this would help to “make cross-border payments more efficient and much cheaper”.



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SEC aims to stop insiders dumping stock before the bad news hits

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It seems the great trading edge enjoyed by corporate insiders is knowing when to sell. That makes sense. There are many brokers and business-TV guests with stock buying tips, but few who will urge you to sell now, before the bad news comes out.

But we are probably coming to the end of a great couple of decades for legalised insider trading in America. This boom really started with a 2002 “reform”, the Securities and Exchange Commission’s adoption of Rule 10b5-1. This provided a means for senior executives or board members to sell their shares without making themselves vulnerable to charges of acting on “material non public information”.

New SEC chief Gary Gensler has called for reform of the rule, telling a Wall Street Journal conference that it led to “real cracks in our insider-trading regime”.

The rule was issued, as is customary with major reforms, in the wake of a series of giant corporate scandals — in this case those that came to light after the dotcom crash of 2000-2001. You know, pump earnings, goose the stock, dump your shares. Never again.

To qualify for protection under 10b5-1, covered insiders could no longer sell their companies’ shares at will. They have to enter into a (non-binding) contract, or plan, that instructs a third party to execute trades on their behalf according to a written plan, based on value, timing, number of shares, and so on. The stock sales under these plans would then be disclosed to the SEC and then the general public.

At the time, this seemed like a reasonable way to ensure market transparency while allowing insiders to sell shares to make tax payments, buy houses, or cover school tuition. Plans + disclosure + aligned interests = good.

In practice, Rule 10b5-1 has turned out to be a “get out of jail free” card for opportunistic timing of stock sales using insider information. It is also probably a good object lesson for why $4,000/hour lawyers are a better value than $400/hour lawyers.

To begin with, you, the insider, must follow a plan, detailed in a SEC Form 144, which you adopt at a time when you are not in possession of material non-public information. That would include, for example, certain knowledge that the next earnings announcement will be disappointing for the public shareholders.

Ah, but while you have to establish the plan with, say, your broker or family lawyer, you can modify or cancel the plan at will, in private. And you are not required to inform the SEC or the public that the plan is in place. Even better, there is no minimum number of transactions, so you can use it to make one big sale.

And you can file your plan (when you are ready) on a paper form, rather than in an easily accessed online filing. Until the pandemic, the 10b5-1s were only available for a limited time in the SEC’s Reading Room. It is possible, even likely, that an insider’s pre-filed plan might become general knowledge only after their stock sale has already been executed by his broker.

Mostly the insiders appear to be getting out before bad news is disclosed.

Daniel Taylor, a Wharton School associate professor and director of the Wharton Forensic Analytics Lab, has co-authored a series of studies on data combed from the 10b5-1 filings. He says “the sellers’ outperformance (in timing trades) comes from avoidance of risk”.

According to one of his studies, sales executed in the first 30 days of plan adoption are associated with the stocks underperforming others in their industry by 2.5 percentage points over the following six months.

Sales made 30 to 60 days after a plan adoption foreshadow 1.5 points of underperformance by the insiders’ companies. The sell-off effect was consistent over the 2016-2020 period covered by the study. The insider advantage disappears if sales are made under plans that are at least 60 days old.

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As Taylor (and others) see it, the policy lesson is clear: insiders should be required to wait for at least two months after filing their plans publicly before their stock sales can be executed. Oh, and those plans should be filed in easily accessible electronic form, so insiders’ lessened commitment to their companies becomes obvious before the bad news.

The odds favour the SEC’s adoption of such changes.

The next frontier, Taylor says, is to limit insiders’ use of privileged information about competitors, suppliers, customers and the like. That “shadow trading” is probably a bigger rip-off than insider selling.

 



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