Bruce Murphy

A new era of big government has begun and is likely to remain underway for decades to come, according to analysis from the global macro research team at Insight Investment, a global investment manager with more than A$1.3trillion under management^[1].

The team has coined a new term, ‘Neofiscalism’, to define the era which has begun to emerge, under which governments take a more direct and proactive role in economic policy and management through fiscal policy. This is in stark contrast to the current regime under which central banks have been largely able to make monetary policy decisions without political interference, it argues.

Gareth Colesmith, Head of Global Rates and Macro Research at Insight, said: “The neoliberal paradigm of smaller government involvement in the economy is under threat. Longer term trends were already moving in this direction, but emergency policies implemented to deal with the COVID-19 crisis have created a potential tipping point.” 

Five implications for markets, according to Insight’s global macro research team:

1. Bond markets may become Japanese-like for a long period. Relatively low volatility by historical standards could lead to a grab for yield that compresses spreads and flattens yield curves.
2. Inflation could trigger spikes in bond yields if it causes quantitative easing to be tapered. Such opportunities are likely to be attractive entry points, as long as the longer-term expectation is for inflation to return to target following the funding squeeze in the real economy.
3. For sovereigns without full control over the currency they issue in, government effectiveness could be key. Effective governments that are able to raise productivity and trend growth could more swiftly reduce debt/GDP ratios.
4. Identifying governments able to maximize trend growth is likely to become important for equity markets as this will become a key driver of earnings.
5. Corporates with state support could have an advantage during funding droughts.

Bruce Murphy, director of Insight Australia and New Zealand, said: “The COVID-19 crisis has pushed fiscal and monetary policy to extraordinary levels.  While Australia’s debt to GDP levels have historically been far lower than many developed economies, we expect the prolonged lockdown in Victoria will see fiscal deficits materially widen on par with the UK, and our debt to GDP ratio to increase significantly.  We believe higher deficits are here to stay and governments will be forced to maintain fiscal deficits at these levels for a prolonged period of time.”

Read the full paper.

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Joshua Kendall

A record $234bn in green bond issuance was added to the market in 2019, an increase of more than 50% on the $150bn issued in 2018. While issuance in 2018 and 2017 was relatively flat, 2019 saw a significant jump up in issuers joining the market, when compared to previous years. This watershed moment marks a turning point in the depth of opportunities available to investors, according to Insight Investment, a leading asset manager.

The core sectors for these instruments – financials, governments, utilities, energy and industrials – all experienced significant growth in issuance with financials leading the charge, adding more than $78bn in green bonds over the course of the year. Diversity improved with the telecommunication sector now part of the market. The Netherlands issued its inaugural green bond in 2019 and Germany said it intends to issue a green bond later in 2020.

Josh Kendall, senior ESG analyst at Insight Investment, said: “Green bond issuance in 2019 reached record levels, deepening the universe to more than $747bn. This strong momentum in support of climate transition indicates a turning point for investors.  We expect 2020 to be another record year for green bonds with early indications suggesting a total close to $300bn in issuance.”

Bruce Murphy, Insight Investment Director of Australia and New Zealand, said: “We hope to see increased issuance of green bonds from Australian corporates in 2020. Its issuance last year remained largely level with 2018 ($4.5bn in 2019 vs $4.3bn in 2018), which suggests issuers may be missing out on the swell of demand from a global investment community actively seeking diverse and impactful opportunities. A deeper investable universe will help speed the transition to a low carbon economy and hopefully create jobs and boost productivity along the way.”

>Social and sustainable impact bonds issuance increased, adding $35bn in 2019, which, together with green bonds, brought total issuance of impact instruments over the year to almost $300bn ($299.8bn). The market also saw the evolution of new types of impact instruments, for example Enel’s transition bond, which may present a model for further issuance from petroleum companies in 2020.

Kendall said: “The overall growth in impact instruments is encouraging but in too many instances we are finding that the targets set out by issuers lack conviction and ambition. We want to see far more attention paid to the quality of the underlying propositions. Insight has awarded ‘green flag’ status to only 27% of the more than 120 impact bonds we have reviewed. This is because the market still struggles with transparency reporting and a clear demonstration of positive impact.”

Insight Investment manages A$30 billion for Australian investors and A$1.2 trillion globally^[1].

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[1] Figures shown in USD. All data sourced from Bloomberg.

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Cat Bonds are risk-linked securities designed to protect insurers against the risks of potential catastrophe events, with IAG’s deal being the first to offer protection against all natural peril risks in Australia and New Zealand.

This is IAG’s first Cat Bond, issued through Orchard ILS Pte Ltd., a Singapore-registered special purpose vehicle (SPV). The transaction provides IAG AUD 75 million of protection, forming part of its aggregate sideways cover, which in total provides protection of AUD 475 million excess of AUD 375 million. Orchard ILS Pte Ltd. adds a new element to IAG’s risk transfer program and diversifies its suite of available reinsurance solutions.

“We were well positioned to support IAG’s Cat Bond given BNY Mellon’s reach,” said Kenneth Cheong, Managing Director of Corporate Trust, Asia Pacific, BNY Mellon. “This deal saw our experts working with various parties on the global transaction, with teams involved from New York, Sydney, and Singapore.”

“IAG has had a reinsurance presence in Singapore for more than a decade,” added BNY Mellon’s Cheong. “With BNY Mellon’s technical and servicing support, this Cat Bond issuance is a significant milestone in the development of Singapore’s insurance-linked securities (ILS) market. IAG’s deal will be one for the books as the first deal to take advantage of Singapore’s brand new ILS laws.”

Singapore’s financial sector, with the support of its proactive regulators, once again delivered cutting-edge capital market solutions. This deal highlights the potential of the ILS market in the region, and is aligned with the city-state’s efforts to establish itself as a global hub for Asian risk transfer.

Singapore has taken steps to establish itself as an ILS domicile. As part of these efforts, the Monetary Authority of Singapore (MAS) introduced an ILS grant scheme in February 2018. The grant scheme, which was developed in consultation with industry experts including GC Securities and IAG, funds upfront ILS bond issuance costs.

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The facility arrangement will fund construction of Australia’s first thermal Waste-to-Energy (W2E) power generation facility in Kwinana, Western Australia. The transaction closed on October 18, 2018.

When complete, the facility will process up to 400,000 tonnes of household, commercial and industrial waste a year and generate 36MW of baseload power to be exported to the grid.

A consortium of energy and services companies will design, construct, and operate the facility.

As Facility Agent and Security Trustee in a project finance facility, BNY Mellon is able to act as an independent third-party agent and service provider, without conflicts of interest in carrying out fiduciary duties in the transaction.

“We are pleased to be furthering Environmental, Social and Governance (ESG) goals in Western Australia with our agent and trustee support in the financing of this project,” said Sonia Chaliha, Global Head of Business Development for Corporate Trust, BNY Mellon.

“ESG goals align to our broader goals as a company, as well as contributing to the supply of cleaner and greener energy.”

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Building on an award-winning proof of concept developed in a 24-hour hackathon by BNY Mellon’s Singapore Innovation Center team, Deutsche Bank and BNY Mellon jointly deployed a chatbot-to-chatbot communication solution that replaces previously manual responses to status updates on their securities trades. Using these new chatbots, trade settlement status queries for the Hong Kong market are now available to both organizations using Symphony, a widely used financial markets messaging platform. This significantly reduces the manual effort required to query status updates, improving both speed and accuracy.

This unique collaboration began at BNY Mellon’s Innovation Center in Singapore in November 2017 following a successful prototype built and introduced by the BNY Mellon Singapore Innovation Center team as part of the company’s Technology Leadership Forum’s hackathon.

“We are pleased that our new chatbots can now automate a part of the trade process that previously demanded considerable manual effort. The speed and timeliness of the response were paramount to the client’s experience when this process was in use. Our solution now creates a more efficient way to exchange this information and allows our clients to put their resources to use in greater value-added areas that would ultimately improve efficiency and profitability.” said Hani Kablawi, Chief Executive Officer of BNY Mellon’s Global Asset Servicing business. “We are looking forward to extending the chatbots into markets other than Hong Kong in the coming year.”

Deutsche Bank worked with BNY Mellon to integrate their chatbot into BNY Mellon’s implementation with HCL Technologies as Deutsche Bank’s technology partner. A process that used to previously take up to three minutes for a single trade will now be handled in bulk by the chatbots in real-time, allowing both organizations the ability to significantly reduce effort by the client servicing and operation teams, allowing them to focus on providing an even better client experience.

John Gibbons, Head of Global Transaction Banking at Deutsche Bank, said: “We are delighted to be partnering with BNY Mellon on this innovative idea, which we took to market so quickly. Working in close collaboration, we created a ‘joint ecosystem’ where our institutions share information to deliver seamlessly for the benefit of the end-client.”

Jeslyn Tan, Deputy Head of Global Product Management, Securities Services at Deutsche Bank, said: “What’s different here is the collaborative approach we took to resolve a real speed and accuracy need for our clients. When we first brainstormed the issue, it was immediately obvious that for a truly business-enabling experience, a fully integrated solution in the form of chatbot connectivity was required between both institutions.”

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Natalie Wallder

BNY Mellon is the first triparty agent to provide collateral services for securities settled through Hong Kong (HK) Stock Connect, supporting growing cross-border trade volumes into and out of China.

The bespoke solution expands the range of eligible collateral available to investors, just as international interest in Stock Connect gathers steam.

Beginning June 1, 2018, China A-shares listed on the Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE) will be included in relevant MSCI indices, including the MSCI Emerging Markets Index, for the first time.

The addition of these equities to the indices will significantly increase portfolio allocations to China A shares. MSCI predicts that the inclusion of China-A shares will drive an initial flow of around US$20 billion to shift and track the China A-shares market.

“BNY Mellon Markets is always looking for ways to increase liquidity for our clients. Our Stock Connect solution does just that, by unlocking the ability to utilize these assets as collateral, bank and broker dealer clients now have an additional avenue to finance inventory and reduce funding costs via tri-party collateral management, “said Natalie Wallder, head of Collateral Management, Asia Pacific for BNY Mellon.

The tri-party arrangement for Stock Connect securities was a collaboration between various parts of BNY Mellon including Markets, Asset Servicing and Pershing, with each one involved at different stages of the investment lifecycle.

While triparty solutions are commonly available in most major markets, such a service did not exist for China A-shares prior to BNY Mellon’s offering. This was because collateralizing SSE and SZSE A-shares required considerable adjustments to collateralization models to integrate with local legal and market infrastructure.

BNY Mellon’s triparty collateral service enables portfolio utilization of China A-shares held through HK Stock Connect for market participants.

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However, we are yet to see a detailed roadmap to Eurozone fiscal and political union and further policy action from the ECB is likely in an attempt to boosts the European Stability Mechanism’s (ESM) effectiveness.

“We view the measures taken at the EU Summit last week in Brussels as a significant step forward in stabilising European financial markets,” says Murphy.

“These measures should go a long way towards breaking the negative feedback loop between banks and sovereigns and be supportive of risky assets in the near term. However, they do not solve the problems of excessive debt and weak economic growth that are likely to continue to weigh on the Eurozone. More will be needed to permanently bring down funding costs for sovereigns to more sustainable levels,” he adds.

“While volatility is likely to persist in financial markets, the steps taken at the summit, combined with evidence of more supportive policy shifts from major central banks, give us confidence to increase the amount of risk we are willing to take, in particular in areas like corporate credit and emerging markets where valuations are attractive and fundamentals remain solid,” says Murphy.

Plans afoot
The following proposals have been made and will be considered by national governments:

The European Stability Mechanism (ESM) can be used to recapitalise banks directly

“This provision attacks the most contentious aspect of Eurozone policy coordination: explicit debt mutualisation,” explains Murphy.

“Core Eurozone countries have been reluctant to use the ESM as a direct bank recapitalisation tool because the liabilities within the banking system can be large, thus rendering them politically untenable. Yet, if handled properly – we are scant on details for the moment – this could break the financial links between banks and sovereigns, thereby freeing up sovereigns to focus on credible macroeconomic reform,” he adds.

“It is possible that this provision can be extended retrospectively to previous bank recapitalisations in Ireland, Portugal, Greece, and Spain. Furthermore, in reading the statement, we do not believe that this will require full ratification of the treaty by national parliaments. Nevertheless, the ESM itself still needs to be ratified by the parliaments of the majority of Eurozone governments.”

Establish a single supervisory mechanism for the banks in the Eurozone, which should involve the European Central Bank (ECB)

“We believe that this is a positive step in preventing future crises. However, critical measures to prevent inter-regional contagion are still missing, such as pan-European deposit guarantees.”

He continues, “The fact that the ECB is involved suggests that these regulatory efforts will pertain solely to the 17 countries participating in the monetary union, rather than the 27 members of the European Union as a whole.”

The Spanish bank recapitalisation will be financed through the European Financial Stability Facility (EFSF) and transferred to the ESM without assuming senior status

“The Spanish bank bailout will move from the EFSF onto the balance sheet of the ESM when it becomes functional, but the ESM will not hold senior status on the Spanish loan programme,” says Murphy.

“At this time, this provision is specific to the Spanish recapitalisation programme only,” he adds.

Establish a €120 billion fund for immediate growth measures. These measures will be financed via the European Investment Bank (€60 billion), the EU budget (€55 billion), and the new Project Bond issuance (€5 billion)

“The European Commission has pushed for growth financing for investment projects and jobs. While the amount is small and does nothing to alter the near-term outlook for the region as a whole – these funds represent just 1.3% of 2011 Eurozone nominal GDP – it could be helpful to the smaller programme countries,” explains Murphy.

“On balance, we believe that material progress has been made on breaking the financial link between the sovereigns and their banks, but there are few signs of a detailed roadmap to fiscal and political union.”

He continues, “We expect further easing from the ECB in response to this positive Summit outcome in order to provide the national governments time to implement the new measures related to the ESM’s expanded capabilities and create a new regulator. Our view is that these measures are a step forward in stabilising European financial markets and welcome this demonstration of policy coordination.”

10 July 2012

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“Markets reacted negatively to a wide range of disappointing macroeconomic data in May, and we believe that there will be more negative data to come,” says Jason Pidcock, manager of the Newton Asian Income Fund from Newton, part of BNY Mellon Asset Management.

“For this reason, we are likely to maintain our relatively cautious outlook for the rest of the year, despite the increasing number of high-quality companies available at attractive valuations.

“We are particularly aware of the problems in China, where the efforts of 2009 and 2010 to stimulate growth are beginning to have an adverse impact upon the economy; our Chinese exposure is very selective,” he adds.

“There’s no doubt that a significant economic slowdown in China would affect the whole region but we do not expect growth to collapse.”

Pidcock continues, “Growth remains strong and we expect this to continue. Furthermore, we believe that the concerns over China’s economic growth are broadly priced into markets and we would describe our view of the country as cautious rather bearish.

“We think that its economy is likely to plateau from here, with GDP numbers unlikely to fall below 7%. The economy is in the process of rebalancing and this might not happen quickly or smoothly. As such, further interest rate cuts and fiscal stimulus are likely, although these measures are unlikely to be as aggressive as they were in 2008.”

Look South East…
“We are more optimistic about much of South East Asia and countries such as The Philippines, Thailand, Singapore and Malaysia. Indeed, this view was reinforced on a recent Newton visit to the region; growth in these areas seems to be holding up well, with Thailand and The Philippines, in particular, benefiting from falling commodity prices.

“Though dependent upon these lower costs, we would expect these countries to be relatively immune to a Chinese slowdown, in part, because they have not undergone a credit boom so there is no reliance upon rising property prices to fuel growth but also because they still boast robust domestic consumption,” Pidcock adds.

3 July 2012

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“The key to the global economic outlook is whether the resolution of the European financial stresses evolves in an orderly, semi-orderly or disorderly way,” Hoey states.  “We expect a semi-orderly pattern, which should be consistent with a global slowdown at a subdued pace rather than a full-scale global recession.”

Hoey regards the global economy as fundamentally recuperative after the Great Recession, but vulnerable to shocks since private sector deleveraging and fiscal consolidation in developed countries is not yet complete.

“Our interpretation is that the U.S. is ‘short-funding’ a persistent U.S. budget deficit rather than financing it by the sale of long-term bonds to the private sector,” Hoey says.  “We view the sale of new bonds by the Treasury followed by Federal Reserve purchases of Treasury bonds in the secondary market as the Federal government selling bonds to itself.  After all, the profits of the Fed flow to the Treasury.  At some point in the future, persistent deficits will need to be funded by increased sale (net of Fed purchases) of long-term Treasury bonds to the private sector.” 

“The Federal Reserve has now taken responsibility for the yield on long-term Treasury bonds, some 60 years after it won its independence from the need to support the long-term Treasury market,” Hoey concludes.

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“The worst case would be a mild brief recession, but we are more likely to experience a low-growth recession over the next three to six months,” he said.  “While the worst of the current downdraft likely is behind us, it is difficult to determine the exact market bottom for these types of corrections.”

Malvey characterized the current environment as an aftershock to the Great Recession, and noted that anxiety about a second economic dip after a primary recession has long been common. Typically, such concerns and negative market reaction about a possible secondary recession tend to dissipate within three months as a result of negative news exhaustion, markets finding an equilibrium state, and the emergence of attractive equities and credit debt after their decline to discounted valuations, he said.  Malvey also noted that risky assets tend to rally before the end of recessions.

The current market volatility has been sparked by a combination of catalysts, including anxiety about a potential U.S. default arising from the spirited Washington debate over raising the U.S. debt ceiling, the ensuing downgrade of the U.S. by S&P from AAA to AA+, the threat of European contagion, and growing evidence of global economic growth deceleration.   Taking a long view, these developments mark the first step in a major political and economic course adjustment for the United States and Europe, according to Malvey. The anemic post-recession recovery and the pronounced market volatility indicate that both the U.S. and portion of Europe are on an unsustainable path due to reduction in potential economic growth, aging demographics, and rising entitlements, he said.

“This will be a long journey,” he said. “Additional difficult decisions will be required in coming years along the road to fiscal rectitude.  Adding to the difficulties in the U.S. is the concern about whether the new congressional super committee can agree to further deficit cuts in December 2011 without the enactment of draconian automatic triggers.”  Malvey also said that many market observers are questioning the advisability of federal government spending cuts in a high-unemployment, near recession environment.

Regarding the sovereign issues in Europe, Malvey said, “It remains to be seen if the European Union, International Monetary Fund and the European Central Bank can shore up the capital markets and prevent the issues in the weaker European economies from spreading.”

Concluding in looking at the current low-interest environment, Malvey noted that dividend-paying equities could become increasingly attractive.  He added that the unresolved European debt issues could drive the dollar higher against the euro in the short run, although he expects the dollar to continue to decline against most other currencies over the medium term.

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