TheChek News Flow

Brussels initiative is part of European response to fallout from Beijing’s ditching of strict pandemic restrictions

The EU has offered free Covid-19 vaccines to China to help Beijing contain a mass outbreak of the illness following its decision to end strict nationwide pandemic-related restrictions.

The offer was made in recent days ahead of a meeting of EU health ministry officials on Tuesday, said European Commission officials, speaking under the condition of anonymity. The initiative is part of efforts by health commissioner Stella Kyriakides to arrange a European response to the prospect of a wave of infections after Beijing ditched its so-called “zero Covid” policy.

“Commissioner Kyriakides has reached out to her Chinese counterparts to offer solidarity and support, including public health expertise as well as through variant-adapted EU vaccine donations,” said one official. Beijing has yet to respond to the offer, the person added.

China has relied on its domestically produced Sinovac and Sinopharm vaccines and has yet to deploy western vaccines using mRNA technology at large scale. The World Health Organization on December 21 said China’s current vaccination coverage was insufficient.

Its domestic vaccines require three doses to prevent severe illness in vulnerable people.

Two doses only provided 50 per cent protection for people over 60, Dr Mike Ryan, WHO head of health emergencies, told a press conference.

“That’s just not adequate protection in a population as large as the population of China. In such a large population, with so many people in a vulnerable setting, with that coverage, we really have to focus on vaccination.”

Only 40 per cent of over-80s have had three doses, according to WHO data.

By contrast, in the EU, 83 per cent of the adult population is fully vaccinated and more than 1.7bn doses have been delivered. Contracts have been concluded with eight vaccine developers, providing as many as 4.2bn doses.

However EU member states have surplus stocks due to large orders of vaccines under long-term contracts with manufacturers. These could be shipped to China, the EU officials said.

Kyriakides is seeking a meeting with pharmaceutical companies to adjust the contracts within the next few weeks after complaints from member states that they are spending money on drugs that are destroyed.

Meanwhile some EU countries have insisted that travellers arriving from China after January 8, when restrictions are lifted, must provide evidence of a negative Covid test or of their vaccination status.

France, Spain and Italy have all said they would bring in controls as they fear the spread of as yet unidentified new variants. However, Kyriakides has called for co-ordinated action. Member state officials last week opted not to call for China-specific measures since coronavirus is now endemic in the EU. They meet again on Tuesday and there is a meeting of the Integrated Political Crisis Response emergency mechanism on Wednesday.

China’s mission to the EU insisted on Sunday that the country had good vaccination coverage. “More than 3.4bn Covid-19 vaccine doses have been administered on the Chinese mainland, with over 90 per cent of the population fully vaccinated and over 92 per cent of the population received at least one dose,” it said.

It said Chinese tourists did not pose any threat, pointing out that the European Centre for Disease Prevention and Control considered Covid-19 screenings and other measures on travellers from China “unjustified”.

“Tourist destinations across the world can’t wait to welcome Chinese tourists as cross-border travel searches soar in China,” China’s mission to the EU added.

Long-delayed reckoning comes after falling markets hit both management and performance fees last year

Global asset managers are facing a long-delayed reckoning in 2023 as falling assets force them to cut costs and make tough decisions about where to invest for growth.

Revenues were down across the industry last year, after a record 2021, as falling markets across almost all asset classes hit both management and performance fees. In the US, total assets in mutual and exchange traded funds dropped 17 per cent between the start of 2022 and the end of October, the most recent figures available from the Investment Company Institute showed.

At the same time, most money managers are under pressure to find money to upgrade their technology and win new customers. As a result, they are squeezing personnel costs through hiring freezes and bonus cuts in the hope of avoiding mass job losses. Consultants also reported a sharp uptick in requests for advice on “efficiencies”.

“There has been a lot of complacency. A lot of players now really need to get their act together,” said Markus Habbel, a partner at Bain who focuses on the sector. “If you don’t have scale, it is getting tougher.”

While the initial reaction to this past year’s turmoil has largely been generic belt-tightening measures and small across-the-board cuts, industry analysts predict that the coming year will require more strategic decisions.

“The temptation is to take a little bit off everything. In reality it doesn’t move the dial,” said Julia Hobart, partner in the wealth and asset management practice at Oliver Wyman. “Managers will need to decide what they will and won’t focus on. Big structural changes will need to be made to take costs out of the business.”

Jeremy Taylor, who heads Lazard Asset Management’s UK-based business, added: “What does an asset manager do as revenues go down? You tend to do less of what hasn’t worked over the past three to five years and put greater scrutiny on things that haven’t grown . . . you don’t give up on any scale product.”

In fact, the stronger asset managers are keen to press for gains while their weaker rivals are making cuts. “We continue to invest through the market cycle into long-running trends that are strategic priorities for us, including sustainable investing, alternatives, active management and exchange traded funds,” said Patrick Thomson, chief executive for Europe at JPMorgan Asset Management. “If you invest significantly into those trends through a downturn, it puts you at an advantage where others may have to cut back.”

Many asset managers are hopeful that bond funds, which saw big price drops and massive outflows as interest rates rose, will start to recover in 2023. “This is a mixed blessing for asset managers because you’re going to see flows come out of other higher-margin asset classes to lower-margin fixed income,” said Tom Mills, who analyses the sector for Jefferies, the boutique bank.

Some asset managers also predict the downturn will accelerate the shift by clients from traditional mutual funds and brokerage accounts to newer ways of investing, including ETFs, separately managed accounts and model portfolios.

“Whenever there are super shocks in the market, people make big changes to their portfolios. This is when people do deferred maintenance,” said Martin Small, who heads BlackRock’s US wealth advisory business and is the incoming chief financial officer. “In US retail markets, there is a move from brokerage accounts to fee-based advisory, that means more model portfolios and more ETFs.”

Asset managers spent 2021 and early 2022 snapping up providers that specialised in private markets and alternative investments, but dealmaking largely dried up amid the market turmoil. Share prices in the sector are sharply down: the S&P Composite 1500 Asset Managers index has dropped 23 per cent since the start of the year. Sellers are reluctant to accept those prices and potential buyers are not willing to pay more.

Philipp Koch, head of McKinsey’s European asset management practice, thinks continued pressure on costs might change the calculus, particularly in the second half of 2023. “Some players may conclude their business models are no longer sustainable and entertain more creative solutions for consolidation and M&A,” he said. “Most asset managers were on the buyer side . . . there were very few sellers — that might change.”

The pressures may simply be too much for some longtime players. “Whenever there’s a downturn, if it is a deep downturn, the players with weak hands get flushed out,” said Cyrus Taraporevala, who just stepped down as chief executive of State Street Global Advisors. “That’s just normal.”

Lower demand for risky corporate debt could threaten companies’ ability to refinance

The biggest buyers of US junk loans are expected to shrink their exposure to the $1.4tn market in 2023, as the Federal Reserve’s campaign of interest rate rises sparks rating downgrades and defaults.

Collateralised loan obligation vehicles own roughly two-thirds of America’s low-grade corporate loans — but may be forced to reduce their exposure because of credit downgrades, which could unsettle the markets and make it harder for companies to obtain financing.

CLOs, which package up such loans into various risk categories before selling the slices on to investors, have performed well during tough economic times, but analysts say mechanisms designed to protect investors holding higher-quality tranches could reduce the vehicles’ appetite for loans to risky, highly-indebted borrowers.

US CLO issuance ballooned during the depths of the pandemic, reaching an unprecedented $183bn in 2021 as near-zero borrowing costs sparked a broader explosion of capital market activity. Even as the Fed tightened monetary policy last year to tackle inflation and other parts of the global fixed-income market stuttered, CLOs raised a further $126bn — the third-largest annual figure on record, according to data from Refinitiv.

But CLOs have caps on how much very low-grade debt they can hold, with a typical threshold of 7.5 per cent for so-called “CCC” buckets containing highly risky loans carrying ratings near the bottom of the quality spectrum.

Against a backdrop of higher borrowing costs sparked by Fed rate rises and fears of recession, analysts are warning that those limits will be breached. When these protective switches are tripped, cash flows to investors holding the riskiest CLO tranches, known as “equity”, can sometimes be cut off, redirecting payments to investors higher up the pecking order.

Such a situation could also potentially curb demand for fresh leveraged lending just as many riskier borrowers start to think about how to refinance themselves after a burst of debt issuance during the cheap money days of the Covid crisis.

“Leveraged loans, the underlying collateral in CLOs, are expected to face increased stress, as interest costs are rising and earnings are likely to drop simultaneously,” analysts at Barclays wrote in December. “In our view, issuers will likely face cash flow pressure, eventually resulting in rising downgrades and defaults.”

For some CLOs, that would mean an uncomfortable overflow of CCC buckets and a desire to reduce exposure to corporate borrowers at risk of downgrade.

“We’re not talking about breaching the 7.5 per cent threshold by just a little bit,” said Steve Caprio, head of European and US credit strategy at Deutsche Bank Research. “We’re talking about CCCs potentially going as high as 12 to 15 per cent in the worst-case scenario.”

Analysts at Bank of America expect CCC buckets to increase to “8-10 per cent in a stress and potentially even 15 per cent in a severe stress scenario”, noting that the peak Covid CCC concentration in CLOs was 10 per cent.

Swiss bank UBS also believes “a surge in leveraged loan credit deterioration should increase CCC holdings in CLOs to [about] 15 per cent, drying up demand from CLOs”.

Caprio added that it would be “difficult to entice a new investor” to wade into the lowlier-rated CLO tranches when the risk of having regular payments turned off is “actually quite elevated”.

CLOs’ risk exposure varies, and many managers have built up protection against overflowing low-grade debt buckets. The share of CCC-rated loans in CLO portfolios has fallen to around 4 per cent, Barclays said. “Thanks to CLO managers’ active trading, defaulted assets in CLO portfolio has always been lower than the broader leveraged loan default rate.” 

“There’s a lot of cushion before it really is a problematic dynamic for CLOs,” said Jeff Stroll, chief investment officer at Post Advisory Group.

Stroll added that to reach a situation where cash flows are diverted from the riskiest CLO tranches there would need to be “a lot of downgrades”. “In our deals, we’d probably have to see close to 20 per cent CCC baskets.”

Still, “there has been this kind of sentiment shift you can feel towards proactively trying to manage this as best as possible”, he said.

Concerns about overflows of low-quality loans in CLOs were “probably more valid for pre-Covid and especially vintages from the 2016 commodity crisis”, said Rishad Ahluwalia at JPMorgan. “The CCC ratios in the last two to three years of CLOs are a lot lower than the average.”

Ahluwalia said CLOs are now also buying fewer loans from the ratings category just above CCC out of concerns that if they are downgraded, they will move down a notch and count against the threshold.

Anticipating “very, very elevated” downgrade rates for B and B-minus rated loans into CCC buckets, Caprio concurred that CLO managers “will probably try to avert the problem” of breaching 7.5 per cent thresholds by reducing their demand for loans ranked just above this level.

But “that in and of itself, before the problem emerges, will actually cause some issues within the loan market”.

The pace of CLO issuance has slowed in recent months, while leveraged loan sales were last year just over a third of what they were in 2021. Even at the top of CLOs’ capital structures, demand has weakened.

“The US big banks have really pulled back” from the top AAA tranches of CLO debt this year, Stroll said, “and have basically been out of the market for a host of reasons”. That “buyer base on the AAAs is just much, much smaller and so the ability to get transactions done is much more difficult”.

Many corporate borrowers refinanced and issued new loans when interest rates were low, loading up on cash and pushing out debt maturities. However, “it is critical to note the majority of US and EU loan demand originates from CLO managers”, Deutsche Bank said in a report last month.

“CLO formation depends on the availability of investors to buy tranches ranging from AAA-rated to B-rated credit quality. And that demand for BBB-rated tranches and below in particular will be severely tested in the next recession.”

Experts warn of market volatility as trading volumes of gold, oil, silver and copper have surged

Growing numbers of retail investors are being drawn into commodity trading after two consecutive years of bumper returns, despite concerns that they could suffer huge losses or disrupt the complex and volatile markets.

Retail trading volumes in commodity futures and the largest commodity-focused investment funds surged in 2022. But while activity has been spurred by commodities’ much better recent record than that of stocks and bonds, some market participants and analysts have voiced fears about retail traders wading in to a highly volatile market dominated by specialised players.

Daily average trading volumes in CME’s micro contracts for gold, crude oil, silver and copper — which it uses as a proxy for retail activity — were up 93 per cent year on year as of the end of November.

Trading volumes in Invesco’s $6bn PDBC ETF — the largest broad-based commodities fund which is popular with retail investors — jumped more than 60 per cent and were almost three times as high as in 2020. Volumes across its broader suite of commodities funds climbed 50 per cent.

“We got everyone’s attention last year because people were nervous about inflation,” said Kathy Kriskey, commodities ETF strategist at Invesco. “And then after the invasion of Ukraine, that’s when people started focusing on geopolitical risk [too].”

The burst of trading activity came as the S&P GSCI index of raw materials prices jumped almost 9 per cent last year as the war in Ukraine restricted supplies, drawing a stark contrast to the more than $30tn in losses for equities and bonds.

Commodities have been the best-performing major asset class for each of the past two years, according to Bank of America, and were one of just two asset classes to make gains in 2022 alongside cash. Commodity-focused companies were also the only subsector of the US stock market to advance, with the S&P 500 energy sub-index advancing 54 per cent as of December 21.

However, while full-year returns have been strong, commodity trading remains risky, with markets liable to extreme swings that can catch retail investors off guard. In April 2020, for example, the main US oil contract traded below zero for the first time. Many retail traders and platforms had not considered the possibility of negative prices, and the retail brokerage IBKR lost $88mn covering margin calls for customers caught out by the price collapse.

Trabue Bland, senior vice-president for futures exchanges at Intercontinental Exchange, cautioned at a recent industry conference that “these are very sophisticated markets where you can lose . . . whatever you put up with your [broker] in a matter of minutes”.

Besides the risks for retail traders themselves, Bland said he was also concerned about the impact they could have on other market participants, from airlines to farmers.

“People rely on us for those prices. Building retail products around something that people are making multibillion decisions on . . . is not something you should do lightly. People don’t want to see betting on what is essentially their livelihoods,” he said.

Modern indices such as Invesco’s have updated their strategies to avoid some of the problems that afflicted early commodities funds, which sometimes lost money even when prices rose due to quirks in the pricing of futures contracts.

“We’ve made a huge effort to educate the investor base because . . . either people have never touched commodities and don’t understand them, or they knew them 10 years ago,” said Kriskey at Invesco.

She stressed that “you don’t need a lot for [commodities] to be impactful in your portfolio . . . we talk a lot about a 5 per cent exposure, we don’t want investors coming in and saying ‘I’m 15 per cent commodities’”.

Some companies have encouraged riskier bets. Hong Kong-based fund provider CSOP Asset Management announced late last year it would start offering retail traders leveraged exposure to an index of large oil and gas stocks. Leverage allows investors to multiply their potential gains, but can also quickly erase capital when share prices fall.

ProShares, one of the most popular tactical ETF providers with retail investors, operates eight funds giving leveraged exposure to commodity futures. Its leveraged short exposure natural gas ETF is down more than 93 per cent since the start of the year.

Exchange traded products offering inverse exposure to oil and gas have been hard hit, down almost 90 per cent since the start of the year as prices have risen because of the Ukraine war, according to Morningstar.

“Commodities can spike or crash without investors being prepared, more so than equities,” said Todd Rosenbluth, head of research at VettaFi. He said retail investors deserved to have the same options available to institutional investors. “But is it good for everyday investors to have exposure, and to have to manage the roll costs and volatility that come with commodities? That’s a fair question.”