Blain’s Morning Porridge, October 8 2020 – What is the future?

“Acting on you best behaviour, turn your back on Mother Nature..”

Who won the US vice-presidential debate? Was it particularly relevant?  Safe and dull.  The consensus seems to be it was a succession of boring statements rather than watching candidates perform under pressure.  Trump tweeted Harris was a “Gaffe Machine” – meaning 40% of the US electorate now know that to be an irrefutable truth.  Democrats say she aced it with her forensic destruction of the Trump response to Covid. Pence came over as competent – which in Trump world means he is A+. Next…?

One of these two is likely to become US president.. sooner or later.

Of immediate interest, (and boosting y’day’s market) is the way Trump nixed negotiations on further stimulus on Tuesday, and spent yesterday trying to do side deals. Support for airlines was a feature. The airline industry is haemorrhaging money just to stay grounded. Naturally the carriers want to cut costs and job. With flights still 1/3rd of pre-Covid and planes still near empty – Nancy Pelosi is willing to do a deal and pay them to maintain jobs.

Some analysts believe there is value in the air.

After the $50 billion US airlines have already received, the possibility of airport testing regimes, and the suppressed demand of travellers wanting to do business and holidays – many believe the outlook looks enticing as Covid lifts. Airline stock prices scream “cheap”. But the airlines around the globe have been amongst the most active distressed issuers in the debt market, borrowing heavily and at double digit numbers just to stay aloft. While resumed flights might look a buy story – many airlines are going to be crippled with high cost debt.

That might not be a problem if the world returns to pre-Covid normal. The low-cost carriers are best positioned to benefit from a surge, but the wider airline business will not find it easy. The problem will be in aircraft leasing – where many planes just won’t fly again.

The world is changing. Priorities have altered as a result of Covid.. and today’s travellers won’t always set the agenda. Younger travellers want green aircraft – which debt strapped airlines will struggle to provide. Millennials want environment friendly holidays – which will be limited in supply. The buy-airlines case depends on a rapid return to normal. The issue is does normal ever return?

I suspect airlines won’t be on the only sector of the market that still doesn’t understand just how much the Pandemic has altered the future.

Its always about the future…

Some clues to a changing globe are in view. As the World Bank warns of 100 million slipping into poverty as a result of Covid, and the IMF warns about the risks of pulling stimulus too early, there is a very interesting piece in the FT this morning by Gillian Tett on Axa’s survey of what scares people. It is well worth a read for her comments on the Hubris of the West. Pandemic ranked 10th 2-years ago. Today its Pandemic and Climate Change up at the top. Cyber-Warfare is third. 73% of us feel more vulnerable today. But that number is only 25% in China, and their biggest fear is not pandemic, but geopolitical conflict.

There are too many things that scare me about our future to comment on them all.. but my biggest fear is financial meltdown taking society down unless we do some serious fixing of society and wealth. I get more and more worried about aspects of finance. I do think we are reaching some key moments in finance where the consequences of past action are coming due. It might be the unsustainability of the disconnect between financial assets and the real economy. It might be the obscene wealth inequality triggered by the K-Curve Covid recovery.

Or it might be something small that triggers financial fracture – a detail that rips open an enormous hole in the financial system. (Just like ABS and mortgages did in 2007.)

One of these potential holes might be in the loan market. Over the last 10-years we’ve seen burgeoning demand for assets fuel tighter and tighter prices. It’s also led to declining protections on covenant-lite loan documents. That has created deals where holders in the leveraged loan market are now finding themselves “gazumped and dumped” by new lenders who’ve spotted the opportunities buried in flawed documents to come in as super-senior to lenders who thought they were protected in that position.

The result is secured creditors find themselves further and further back in the queue, and losses escalate. Bloomberg cover one aspect in a story about leveraged loans and Oaktree. The risk is such behaviour becomes endemic across markets – deepening distrust and illiquidity. Forget “My Word is My Bond” and look to greed to feed markets – which means they will fizzle and ultimately die – screaming.

I am also deeply concerned the financial markets focus on all the wrong things – which is why it’s time to Take a Pop at Green Bonds

Let me start with a story from long, long ago:

Back when I was an investment banker, we were looking for new ideas, something novel and innovative to make my rather indifferent UK employer stand out at little. I was on a business trip to the Middle East, trying to find out why we were so crap at selling bonds to the local big investment funds. I knew from my previous role at a US bank the Gulf were massive buyers of anything and everything we could originate. 

One of the salesmen told me it was because the funds, especially those controlled by Saudi interests and Arab Family offices, would not by debt because of Sukuk – Islamic law outlawing usury, the charging of interest. They explained the concept of Sukuk bonds – bonds that didn’t break the religious rules outlawing the payment of interest. 

Much work was then done inventing a market. We uncovered Islamic scholars to opine on the deal – you could get very strict interpretations costing lots of charitable donations from scholars in Saudi, or you could pay a less strict “scholar” from a madrassa somewhere in Asia a lot less for something similar. We persuaded leading bond issuers just how important it was to diversify their investor base by tapping up Islamic Investors – digging into the mountains of oil wealth wrapped up in funds controlled by religious Islamic investors. 

We then launched the first Sukuk bonds which were exactly like any other bond except we called them Sukuk and they had an scholar’s opinion that qualified them. The bonds would yield a couple of basis points more than a normal bond. As I expected our salesmen failed to sell the bonds to any “Islamic” funds in the Gulf, but we found a ready market for them among European real money funds who judged them good value because they carried a bit of additional spread. While an issuer might launch a 4.5% normal bond, their Sukuk bond might yield 4.53%.

Skip forward nearly 20 years and let’s talk about Green Bonds.

I am a massive believer in ESG investment principals. They are a screaming statement of the blindingly obvious. You would be daft if you invested in anything other than sustainable companies with strong moral compasses which are run by competent management.  It’s so basic and fundamental I see no point in saying it – which is why I usually spit in the eye of anyone trying to sell me an ESG bond…

If bankers are marketing something as ESG – what are they hiding?

Don’t even get me started on Green bonds…

There is a really extraordinary article about Green Bonds in yesterday’s Torygraphclaiming Green Gilts (UK government bonds) will solve everything wrong with the UK. Its naïve in the extreme.

It was written by Conservative MP, Gareth Davies who entered the Commons last year as MP for Grantham and Stamford. He now sits on the Finance Committee. Before tumbling into the nest of vipers called Westminster, he was head of responsible investment solutions at Columbia Threadneedle – and a well-known Green Bond prophet. (I don’t know him…)

Given his background in finance I’m a bit surprised by the Panglossian tone of the article. He is a passionate proponent of a Green Infrastructure Revolution, Green Jobs, and wants to fund it all with Green Bonds. He tears into the UK Debt Management Office for not already issuing Green Gilts by the skip-full. He sagely comments:

The UK Government should issue Sovereign Green Gilts to fund capital investment in infrastructure, creating new jobs, technology and transport…. Issuing Green bonds could be the tonic for all our ills – it will fight climate change, it will raise capital … and might also lower the cost of our debt.

He goes on to suggest we can magic up the funding of: “…manifesto commitments including £1 bln fro electric vehicle charging stations, £800 mm for carbon capture, £350 on cycling infrastructure, and the £640 mm nature for climate fund to support planting 30 million trees a year.” 

And we can do all that by calling bonds green? Who is going to buy them… oh yes, the same people who already buy gilts? Or the people who would buy almost zero-yield gilts called green if they offered something extra… Like the ability of funds that buy green bonds to tell all the savers, investors and pensioners invested in them that they are so much better than anyone else because they are Green Gilts rather than nasty Red, White and Blue ones…

Christ on the proverbial handcart…. The French are issuing €27 bln of Green bonds to finance new nuclear power stations. Every other European nation is joining the Green bond revolution.

The writer is a MP so he must know. (US readers – sceptical sarcasm alert.) He writes that green bonds green bonds would be a cost-effective way to fight climate change, grow our economy, build jobs, and position London at the centre of green finance. He claims Green Gilts are “a tried and tested solution” even though none have been issued…

Now it’s fair to claim Green German Bunds do yield slightly less than conventional bunds – because so many funds reckoned they are good way to demonstrate they pay lip service to Green bonds. I bet many of the same funds also bought Boeing bonds – a company that has comprehensively failed every single ESG test.

And just what qualifies a bond as Green. Well.. nothing.. except saying its green and will be used for vaguely green purposes… like.. anything green.

The bottom line is calling a bond green will not change anything. Politics will change the way governments respond to climate change – and electorates will demand that response across every aspect of government…. Not just the things governments claim bonds were issued to fund… (There is an issue called hypothecation – basically Treasury can’t issue gilts for specific purposes – but I guess the old War Bonds suggests that’s not an issue.)

The UK government is already on the green case and all the initiatives Mr Davies says can be funded via Green Gilts are already being funded by… Gilts.

What Green Bonds do is stick a big bright meaningless label on a bond. What global issuers should be doing is demonstrating they aren’t about labels, but adapting every aspect of the Environmental, Social and Governance on a continuous basis to respond to the changing demands of our stakeholder society..

And if anyone wants to do a debate on Green Bonds as a Morning Porridge Webinar – I shall be delighted!

Seven Things too Read Today

City AM – Be Brave Mr Sunak and keep Spending

Property Chronicle – Boosted and Bent Out of Shape

Kerrang An Open Letter to Rishi Sunak by Lou Reynolds

(We don’t see enough financial commentary from the Heavy Metal World…)

BBerg – The infected President’s ill-advised trip to Bedminster

FT – Donald Trump’s faults are more libertarian than authoritarian

FT – Shift in European equity market belies old economy tropes

WSJ – European Union Moves Closer to Common Debt Issuance

Out of time, and back to the day job…

Bill Blain

Shard Capital