By: Hwan Pyo CHUN, President of Farazad Investments, Inc.
Economic Trend in Asia
The world economy is definitely keeping its eye on the U.S. exit strategy. The unemployment rate in the U.S., which once reached 10% in 2009 when the nation was directly hit by the 2008 financial crisis triggered by the collapse of Lehman Brothers, is now at its four-year low of 7.3% in August 2013. Its GDP growth rate has also been turned around from -2.5% in 2008 to 2.5% as of the second quarter of 2013. The “Quantitative Easing” policy has been the emergency measure to overcome the U.S. financial crisis since 2008; with its economy recovering, however, the U.S. government is now seeking an exit strategy.
Ironically, the U.S. exit strategy—“scaling-back” of its “Quantitative Easing”—is adding extra pressure on the Asian economy which, following the European financial crisis, has already been facing several issues including Japan’s “Abenomics” burdening its neighboring economies, withdrawals of capital taking place in developing countries, and China’s tight money policy coupled with some negative outlooks on the nation’s debt problem. The Asian economy, having been sensitive to the ups and downs of the U.S. counterpart, hopes the U.S. exit strategy will be slowly paced as it will necessarily result in the rise in interest rates and thereby burden corporate and household debts in Asia and have a serious impact on its real economy. Although the U.S.’s possible debt default and other impediments to its economic recovery could force the federal government to hold off on or reconsider scaling back its “Quantitative Easing” policy, the exit plan has become a reality that the global economy—particularly the Asian economy—has to cope with.
Possible Expansion of International Structured Finance Market in Asia
“Structured Finance,” as a financing method, is not a familiar term in Asia except among experts in correspondence finance. Such financing is being done primarily through ABS (Asset Backed Security) issued by governments or corporations and backed by large-scale real estates; but strict requirements for borrowers’ credit rating, complicated business licensing process, and the method’s feasibility structure all make it difficult for most small and mid-size businesses and new companies to utilize it. Under these circumstances, the “structured finance market” in Asia has not yet been vitalized to match the economic scale and potential of Asia.
What if foreign capital evaluates the feasibility of approaching Asia’s real economy through the tool of structured finance? If a country’s capital has a limited access to its own structured finance market, such market is likely to be an unfamiliar territory—more unfamiliar than other economic regions—for foreign capital as well. Therefore, when there is little to no performance record by foreign capital’s structured finance (hereinafter “international structured finance”) in Asia and the market remains unfamiliar to both its own and foreign capital, it might seem premature to discuss the possible expansion of the international structured finance market in Asia.
Where Can We Find a Key to Expanding The International Structured Finance Market?
The Financial Times recently mentioned Korea as “a market to watch” referencing the nation’s huge current account surplus and its strong economic foundation in the midst of Asia’s economic turmoil following the U.S. exit strategy.
After undergoing the financial crises in 1997 (IMF) and in 2008, Korea has constantly strengthened its economic health. While emerging countries in Asia are experiencing withdrawals of capital from stock markets due to their financial crisis, Korea has enjoyed, as of September 13, approximately 4.2 billion USD of net cash inflow. What is worthy of notice is that these capital inflows are from the U.S. with an impending exit strategy—based on its recovering economy—and moreover, this is “long-term investment capital.” The U.S.’s recovering economy is a positive sign for Korea whose economy depends heavily on exports to the U.S. In addition, Korea is strategically expanding its economic boundaries by globalizing its economy through entering into the FTA with the U.S., pursuing FTA’s with the E.U. and China, and seeking to expand the free trade area. The recurring political issue of North Korea’s nuclear program is not to be taken lightly, but it has never affected South Korea’s sovereign credit rating or its real economy. Many indicators, aside from the Financial Times’ explanation, show that in the big picture, Korea has the most potential as the key to expanding the international structured finance market in Asia.
Korea’s Potential as Investor as well as Investment Market
However, there are weak points in Korea’s Economy. Among the problems to be solved are its export-heavy economy susceptible to external factors and the real estate market that has not yet revived.
Even though the number of unsold apartments has gradually decreased to reach 75,000 in July 2013, the 6-month-old administration had to come up with strong real estate measures including tax cuts and exceptionally low lending rates, which nevertheless appear to be only partially effective. An interesting fact is that the demand for rentals in Korea stays at a very high level despite the number of unsold homes, due to people’s expectation that home prices may go down; in addition, more and more people in Korea choose to rent rather than buy.
If the unsold homes can be purchased with the help of funds from the international structured finance, if trust companies with reliable credit can be designated to operate leasing projects that are profitable and legally secure, if the projects can retain stability by offering sale on a long-term basis, then lenders can expect high rates of return through the international structured finance; the rate of return can be surprisingly high, if the lender had obtained an ownership interest in the borrower company as consideration for financing. This model can be strategically made applicable to new housing constructions as well as to unsold housing markets.
The new construction market in Korea has complex issues surrounding the acquisition/registration taxes and the regulations prohibiting builders from selling and leasing simultaneously; detailed solutions, which require a long discussion at a later date, are workable in the framework of the above-described model. Korea as an investment market, therefore, is a great potential venue for the convergence of products by the international structured finance. Many insurance companies and investment banks in Korea have had a hard time finding attractive investment opportunities domestically, partially due to the nation’s sluggish real estate market, and they are constantly turning their eyes abroad.
“Pension and Funds Investment Pool” is a government-managed, government-supervised, government-run management committee established in 2001 by the Ministry of Strategy and Finance for the purpose of maintaining a pool of entrusted funds; the committee has a Vice Minister of Strategy and Finance as chairman and a number of experts from the private sector and the government. This pool reflects unique aspects of fund management in Korea, in that the amount of trust continues to grow—from 1.9 trillion KRW in 2001 to 15 trillion KRW in 2012—notwithstanding its fairly low rate of annual return (low to mid 2%) and yet the great majority of the amount is invested in stocks or bonds. These characteristics present important clues for the expansion of the international structured finance market (Korea’s national pension is the third largest in the world, only next to those of Japan and Norway, but 90% is invested in stocks and less than 10% goes to alternative investments—the lowest rate, along with Japan, among major countries operating pension and funds).
Lately, a REITs-based hotel fund was introduced in Seoul: this product, unlike in traditional financing, does not require a certain level of equity ratio from the owner of a business hotel as long as the hotel operator under a master lease provides a minimum revenue guarantee (hereinafter “MRG”), and a trust company becomes an underwriter in this model. One of the hotel funds has already completed its investment and the hotel is operating normally. Of course, this product is not completely independent from the concept of equity; however, since investment funds take care of both equity and residual funds, this product practically allows the developer to proceed with the development with just the “initial capital” to cover expenses for obtaining project ownership, licenses and permits. As the validity of the procured funds relies on the hotel operator’s MRG, the developer can, depending on the MRG, count a big portion of the profits from the real estate development towards the procured amount. This shows the possibility that Korea as an investor can use the tools of international structured finance and create convergence products by combining its capital with foreign capital to mutually reduce each other’s risks.
Possible Expansion of International Structured Finance Market in Asia through Expansion Medium
The foregoing examples are presented to illustrate how Korea, as an investment market for the international structured finance and also as an investor with huge capital, can function as a medium for the expansion of the international structured finance market in Asia. Korea has a solid economic foundation compared to other Asian countries, and has been adopting advanced financial tools in preparation for the opening of its financial market following its FTA’s with the U.S. and the E.U. If the international structured finance develops strategic convergence products in connection with Korea’s unsold homes, business hotels, and alternative investments, and if it also utilizes the potentials of China—despite a few negative factors—and VIP (Vietnam, Indonesia, and the Philippines) whose growth rate has surpassed that of BRIC’s based on their “urbanization, workforce, and resources,” the expansion of the international structured finance market in Asia will be a very possible and probable scenario.
Can Thematic Investing provide investors with growth opportunities in uncertain times?
New whitepaper from CAMRADATA explores
CAMRADATA’s latest whitepaper on Thematic Investing, considers the role this type of investing can play in asset management and explores trends that can permeate society and traverse sectors. The whitepaper includes insights from guests who attended a virtual roundtable on Thematic Investing hosted by CAMRADATA in November, including representatives from CPR Asset Management, Sarasin & Partners, Impact Investing Institute, PwC, Quilter Cheviot, Scottish Widows and Stonehage Fleming.
Sean Thompson, Managing Director, CAMRADATA said, “In these seminal times, thematic investing has the potential to shape how the future unfolds. Yet running a successful thematic fund is no easy feat – it is a bit like navigating unchartered waters trying to identify the trends and the long-term opportunities.
“Trends such as AI and biotechnology are still in their relative early days, for example, and global economies are undergoing dramatic changes. But mapping out certain trends, identifying potential sustainable returns through a unifying thread that spans multiple sectors, could help future-proof investments. “Our roundtable guests considered current key themes, which themes worked well, and which have not and how thematic investors could identify trends with the potential to offer future growth.”
The guests named themes they currently like which included artificial intelligence, China, climate change, clean energy, automation, evolving consumption, ageing, digitalisation, water, waste management, biodiversity, and board diversity.
After discussing themes that have worked or not, the guests looked at total allocation to themed funds, and whether clients might be blinded by themes to the overall risk exposure in their portfolios.
Key takeaway points were:
- Themes have a habit of coming and going. One guest recognised that automation and robotics, for example, were cyclical, which means that investors will have to think carefully about entry-points.
- It was agreed that the commodities ‘super cycle’ of the 2000s came about with the economic development of China. Many commodities-based products found their way into mainstream investing, but this is unlikely to happen again.
- One guest was surprised by some of the themes that interested their customers; with their research showing that Board Diversity was almost the lowest-ranking concern among the ESG choices they listed.
- There was correlation between environmental impact and social benefits to investing. The theme that concerns the Impact Investing Institute, which is less than two years old, is improved measurement of such relationships.
- In terms of successful themes, one clear winner due to COVID had been digitalisation.
- One theme that has not done so well is the Ageing theme focused on older people travelling and enjoying experiences abroad later in life.
- One guest said their firm used themes for ideas generation, not as a shortcut for portfolio construction. They said themes lead to good ideas, but they then spend at least three months researching a stock, so that the best themes are represented by the best investments.
- The final point was that there are sensitivities for any global investor in allocating to themes, even the biggest one of all, Climate Change.
- But on a positive note, one guest added if all stakeholders can resolve their differences on definitions such as impact and ethical investing, then more capital will be readily transferred into opportunities.
The whitepaper also features two articles from the sponsors offering valuable additional insight. These are:
- CPR Asset Management: ‘Central Banks: leading the path towards Impact Investing’
- Sarasin & Partners: ‘Theme or fad? How to invest for the long term’
To download the Thematic Investing whitepaper, click here
For more information on CAMRADATA visit www.camradata.com
Promises, Promises: Navigating the Reputational Risks of ESG Investment Pledges
By Nir Kossovsky and Denise Williamee, Steel City Re
As the trend towards ESG investment and a low-carbon economy continues, banks are being backed into a reputational corner. Law firms specializing in representing the expanding pool of litigious shareholders are salivating.
On one hand, banks understand the inherent financial risks and challenges involved with making a wholesale move towards a low-carbon economy. The transition to a greener corporate world can’t happen overnight; as long as “brown” assets continue to be profitable, those in bank leadership positions have to balance their green aspirations with their responsibility to shareholders.
On the other hand, while not renewing loans on existing coal mines or fracking sites may improve a bank’s carbon disclosures, it could have social and financial ramifications that disappoint other stakeholders—i.e., causing people to lose their jobs. Still, financial institutions are experiencing pressure from all sides—from ESG investors to social license holders – to divest the fossil fuel industry and adopt drastic “green financing” practices now.
To alleviate these pressures, banks are pledging greener financing initiatives. Almost every large global bank has made some sort of commitment. Goldman Sachs, for example, announced they would spend $750 billion on sustainable finance over the next decade. Bank of America pledged $300 billion.
Bank boards and executives likely don’t fully appreciate the reputational risks posed by the aspirational statements they’re making. They are making promises and raising expectations without the operational or governance systems in place to ensure those expectations will actually be met. Overpromising and increasing the risk of angering and disappointing stakeholders is the very definition of reputational risk.
Banks are in a unique position: integral to every aspect of our economy, well-known brands that work hard to build and retain the trust of their customers and the general public while operating in an environment of intense scrutiny by politicians and regulators at every level of government. Satisfying all the stakeholders calling for greener policies while fulfilling their responsibility to their shareholders is a demanding balancing act fraught with risk. The Business Roundtable pledge, led by JP Morgan Chase CEO Jamie Dimon, and elevating employees, communities, and the environment as stakeholders, was an attempt to strike that balance. Already, though, that pledge is being dismissed by politicians like Senator Elizabeth Warren, who characterized it as an “empty publicity stunt.”
The price of missing expectations is costly, and bank executives and board members could find themselves in a legal hot seat. Federal securities lawsuit filings alleging reputation harm from missed expectations are up 60% over last year, the third year of a rising trend.
This trend stems from SEC regulation S-K that calls for more human capital disclosures, and the Caremark decision that sets the bar for most securities litigation and makes board oversight of mission-critical corporate operations a test of the duty of loyalty. Other cases, like In Re Signet, have made ESG-like pronouncements—historically “immaterial corporate puffery”—now potentially material in the securities arena.
For example, directors’ duty of loyalty were successfully questioned in alleged failures of innovation (In Re Clovis Oncology, Inc., board failure to protect the firm’s reputation for pharmacologic innovation); safety (Marchand v. Blue Bell Creameries, board failure to protect the company’s reputation for food safety); and environmental sustainability (Inter-Marketing Group USA, Inc. v. Armstrong, board failure to protect the firm’s reputation for oil pipeline-related environmental protection).
In other words, aspirational pledges are now being considered by courts with the full weight of a material public disclosure. As wealth managers chase ESG-informed investing and capital markets chase ‘green underwriting’, the plaintiff’s bar chases boards and executives making pledges that appear to be no more than aspirational marketing.
The only way to strike a balance and mitigate these risks is through a robust Enterprise Risk Management (ERM) strategy that’s centered around understanding who your key stakeholders are, what their interests are, and ultimately, what their expectations are. Coincidentally, it is also one of the three key behaviors the world’s largest asset management firm, Blackrock, is demanding of all investee companies in 2021 thus communicating the type of authenticity to its slogan “beyond investing,” that BP failed to accomplish with similar sloganeering a decade ago.
Banks need to create a central intelligence unit with board level oversight to comb through every aspect of the organization to identify stakeholder interests, potential risks and/or exposures. Pledges and communications should be informed by a rigorous and honest self-assessment of the institution’s public filings and operational capacity. Overpromising is costly. ESG pledges must be rooted in achievable goals that a bank’s leadership are confident their institutions can reasonably execute on an operational level. Banks also need to consider transferring or financing risks using the broad range of conventional and parametric insurance products currently available.
Enterprise risk management, when executed properly, will fulfill ESG commitments, reassure stakeholder groups and give marketers, counsel, and investment as well as government relations professionals an authentic story to tell about strong corporate governance. ERM focused on reputational intelligence will provide confidence to ESG funds, institutional investors, bond raters, and government officials alike.
The popularity of ESG investment and chasing ESG ratings is not going to go away, and stakeholder pressures will continue to mount. Investors doubled the size of the ESG sector this year, putting $27.4 billion into ETFs traded in U.S. markets. According to a recent survey conducted by Bank of America relating to ‘Gen Z’—which is just entering the workforce—80% take ESG into account when making their investment decisions.
Bank leadership that is striving to attain the correct balance between stakeholders and shareholders need to lean more into the “governance” portion of the ESG equation; pledges backed by enterprise risk management are the strongest pledges you can make.
ESG – Bubble or Bandwagon?
By Josh Gregory, Founder of Sugi
Isaac Newton was a successful investor, but he lost a fortune (£15m in today’s money) in the South Sea Bubble of 1720. When asked about his misadventure, he supposedly replied that he ‘could calculate the motions of the heavenly stars, but not the madness of people’ (presumably, himself included).
The rise and fall of South Sea stock was one of the earliest and largest instances of a market bubble and crash. Three hundred years later, we’re facing another massive investing trend: sustainable investing. In the last year or so, almost every investment institution has jumped on the sustainability bandwagon.
It’s now arguably more notable to find an asset manager who hasn’t committed to sustainable, ethical, responsible, impact and/or ESG (environmental, social and governance) investing than one who has. The numbers are telling: in August 2020, assets in global ESG exchange traded funds and products topped $100 billion (£73 billion) globally.
Demand for sustainable investments has been bolstered by two main factors. Firstly, with climate change firmly on the global agenda and all eyes watching the Biden administration’s transition to power (and the subsequent climate change policy that will follow), ‘greening up’ has never been more of a priority for businesses and individuals. This includes the investment industry, with both retail and institutional investors increasingly demanding that their money has a positive impact on our planet.
Secondly, since the start of the COVID-19 pandemic reports have continually claimed that ESG funds are outperforming ‘traditional’ investments. No longer is going green cited as a ‘nice to have’; rather, these reports demonstrate the value and resilience of ESG funds to the investor community, increasing demand. Surely, this can only be a good thing? Yes, but only if investors know what they’re buying.
It’s no secret that ESG investing suffers from complexity, lack of transparency and a lack of any universal standard. Fundamentally, this is why we created Sugi – a new platform enabling retail investors to track the environmental impact of their investment portfolios using clear and objective carbon impact data.
Today, ESG terms can lawfully be used to label pretty much anything. Ultimately, this means that the ESG label is not a guarantee of good practice. In fact, an ESG rating is a financial risk metric – the scores calculate the extent to which ESG issues affect a company’s economic value. Many investors, even institutional investors, don’t know how to decipher this. The scores themselves are designed to be used in tandem with portfolio dashboards and other data to make financial decisions. This effectively means that the scores on their own without any context are not of much use to anyone.
This has led to a glut of greenwashing in the sector, where investment products are described as green, ethical or sustainable, but the description is unsubstantiated. And while the top financial performance of ESG funds seems uncontroversial, those digging a little deeper may be surprised at what they find. Many ESG funds are heavily weighted in favour of technology companies, which typically have low carbon emissions. These stocks skyrocketed in 2020 but it’s important to note the context. It was largely due to the COVID-19 lockdowns and had nothing to do with the stocks’ ESG credentials.
The EU, the UK and the US are all working on their own strict definitions of ESG. This should, in theory, go some way to clarify what investors are getting when they choose an ESG or sustainable investment product. However, this will take a while to implement and there will still not be a globally recognised definition or standard.
It would seem many people are pouring money into investments when they don’t know what they’re buying. That’s nothing new. But underneath the ESG label lies something meaningful, worthwhile and, above all, valuable for the world in which we live – environmental, social and governance best practice.
The question remains though, is it a bubble? A bubble exists if ESG investments are over-valued (i.e. over-bought). Right now, ESG funds may be in bubble territory because many of the underlying stocks that make up the funds are themselves in a bubble. But does that make ESG a bubble? If it is, when do we call it?
Historically, all bubbles –whether they be tulips, canals, railways or the internet – no-one knows. And if I knew now, I’d be sunning in the South Seas rather than writing this blog!
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