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Finance minister says Berlin should support common deposit insurance scheme

Germany’s finance minister has offered hope of a breakthrough in plans to create a full eurozone banking union by ending Berlin’s iron opposition to a common scheme to protect savers’ deposits.

Olaf Scholz said that Europe’s global role would be undermined if it failed to complete the integration of the eurozone’s financial sector. The plan to centralise oversight of eurozone banks was conceived seven years ago in response to the region’s deep sovereign debt crisis.

“The need to deepen and complete European banking union is undeniable. After years of discussion, the deadlock has to end,” Mr Scholz wrote in an opinion article for the FT.

He said that Brexit, which would see the EU losing the City of London — its largest financial centre — also meant it was time for the bloc to promote better integration of its banks.

The European Central Bank and EU chiefs in Brussels have long urged governments to end political divisions over further banking union. They have argued that the project is vital to ensure that bankrupt banks can be safely wound down without the need for large taxpayer bailouts, and to make the eurozone more resilient to economic shocks.

The most surprising element in Mr Scholz’s proposals is his plan for a common EU scheme to shield depositors during a banking collapse. Germany has previously rejected such plans amid public hostility to any perceived attempt to put taxpayers on the hook for shaky banks in other countries.

The reinsurance system would act as a backstop to national funds, helping to ensure that governments can honour their legal obligation to protect deposits of up to €100,000 in the event of a banking collapse.

Accepting some form of common European deposit insurance mechanism was “no small step for a German finance minister”, Mr Scholz wrote.

However, his proposals come with heavy caveats and conditions, which are bound to spark concern in EU member states with weaker finances or fragile banking sectors.

They will also be contentious within Germany. Officials in Berlin emphasised that the initiative — in a so-called non-paper, for discussion only — was Mr Scholz’s alone and had not been co-ordinated with German chancellor Angela Merkel. It remains uncertain whether she will back the plans.

Past efforts to shift the debate in Germany foundered on the opposition of conservatives in Ms Merkel’s Christian Democratic Union, as well as the Sparkassen, or savings banks, which have their own, jealously-guarded deposit insurance scheme.

“Europe will not move closer together by shifting burdens on to others,” Helmut Schleweis, president of the German Association of Savings Banks (DSGV), said in September. “It is not the right moment to communitise deposit insurance schemes.”

However, there have been signs of a change of heart within the German finance ministry as the banking union project stalls.

Mr Scholz said that Brexit and the risk of dependency on China and the US compelled the EU to make headway. 

He has coupled his offer on deposit insurance with tough reform demands to help maintain discipline in bank supervision and resolution, and minimise the risk that Germany could be saddled with the costs of bank failures elsewhere in Europe.

These conditions are likely to be unpopular in many other EU countries, especially those with weaker banking systems such as Italy. 

His demands include amending EU capital rules to remove incentives for banks to buy up large quantities of their home country’s sovereign debt; further action to reduce bad debts in the EU banking system; and the establishment of common European rules on calculating companies’ taxable profits.

Mr Scholz also wants the EU to harmonise bank insolvency law, saying a patchwork of national rules undermines EU attempts to make sure senior creditors share the cost of dealing with bank failures.

We understand that compromises are necessary to complete banking union

The need to deepen and complete European banking union is undeniable. After years of discussion, the deadlock has to end. Therefore, I am calling on the EU to act now to strengthen Europe’s sovereignty in an increasingly competitive world.

Now that the UK, home to London’s capital markets, is on the verge of withdrawing from the bloc, we must make real progress. Being dependent for financial services on either the US or China is not an option. So if Europe does not want to be pushed around on the international stage, it must move forward with key banking union projects, as well as the complementary project of capital markets union.

It is in all our interests to have a fair, well-designed and secure banking union that guarantees stability and enhances growth in all member states, while at the same time protecting taxpayers’ money. We have already accomplished some important steps. We have established single European supervisory bodies and significantly increased capital levels. We have also set up a framework to restructure failing systemically important banks without endangering financial stability or having to use public funds.

However, we are only halfway through this project. European financial markets are still fragmented, and barriers to the free flow of capital and financial liquidity still exist. We have discussed these issues intensively in recent years, to no avail. Now it is time to put together a package to complete the banking union. This has four steps.

First, we need common insolvency and resolution procedures for banks, building on the example of the US Federal Deposit Insurance Corporation. This means making instruments that have proven useful to large banks available to small banks too. This could include bridge banks. Where competition within the single market may be distorted, the Single Resolution Board should be involved. But the Single Resolution Fund would still not apply to non-systemically relevant institutions.

We already have common resolution rules for large, systemically relevant banks in Europe. Smaller banks, however, fall under the different national insolvency laws. A single insolvency framework for banks would reduce frictions. Moreover, it would be a genuinely European solution. We should allow for deeper integration of EU banking groups, while duly taking into account host countries’ interests in fair burden-sharing.

Second, ensuring a stable banking sector means further reducing risks. This means further reducing the number of non-performing loans and tackling the risks associated with sovereign debt. Sovereign bonds are not a risk-free investment and should not be treated as such.

Banks should have to make provision for risks arising from sovereign debt within an appropriate transition period. We should introduce capital requirements reflecting credit and concentration risks from sovereign exposures on banks’ balance sheets in a careful, gradual manner without threatening financial stability. Over time, banks all over Europe would build up more diversified portfolios of sovereign bonds. Doing so would enhance their stability. This approach would help countries with weaker credit ratings.

Third — and this is no small step for a German finance minister — an enhanced banking union framework should include some form of common European deposit insurance mechanism. A European deposit reinsurance scheme would significantly enhance the resilience of national deposit insurance.

However, such a scheme would be subject to certain conditions, one of which is that national responsibility must continue to be a central element. In the case of a bank failure, a three-tier mechanism would apply. First, the resources of the national deposit guarantee scheme would be used. Second, where national capacities have been exhausted, a European deposit insurance fund, administered by the SRB, would provide limited additional liquidity through repayable loans. Third, where additional financing may be necessary, the relevant member state would step in. A limited loss coverage component for the European deposit insurance fund could be considered, once all the elements of the banking union have been fully implemented.

Last but not least, we have to intensify our efforts to prevent arbitrage. Tax law still distorts competition within the EU. This is why Germany, together with France, is calling for the adoption of a common corporate tax base and a minimum effective tax. Progress with banking union must not lead to competition-distorting tax arrangements. We need uniform taxation of banks in the EU.

European policymakers are aware that there is a strong case for further improving the institutional and regulatory framework in order to reduce risks in the European banking sector. So far, we have failed to deliver. Now, taking advantage of the fresh energy supplied by a new European Commission, and with Brexit just around the corner, it is time for a change. Let us redouble our efforts and finish the job. We need to end the deadlock.

The writer is Germany’s minister of finance

The $2 Trillion Question Hanging Over Aramco’s IPO

Risks of investing in the state company have been made clear following September attacks on its oil facilities and a profit decline

The starter’s gun has been fired on Aramco’s initial public offering, but problems that have dogged the oil giant over the past four years remain. Perhaps the most pressing: convincing international investors that the company is worth what it says it is.

For some investors, the risks with Saudi Arabian Oil Co., as Aramco is known, were made clear by a recently disclosed 18% decline in net profit to $68 billion for the nine months ending in September from the same period a year ago. The figures raise questions about the resilience of the world’s most profitable company, as oil price volatility remains high and in the aftermath of recent attacks that briefly slashed its output by about half.

That said, Aramco’s nine-month income exceeded the 2018 net figure posted by Apple Inc., the most profitable publicly traded company.

The financial results were another step in the state-owned oil giant’s preparations for an initial public offering slated for December. The launch comes after nearly four years of delays and received the go-ahead in recent days from Saudi Crown Prince Mohammed bin Salman.

Still, Aramco’s earnings decline highlights the risks money managers face investing in a company whose income largely depends on the price of the underlying commodity. The risk is compounded by Aramco’s state ownership structure. The kingdom’s grip means minority investors will have little influence over Aramco’s operations even after it lists.

Uday Patnaik, head of emerging-market debt at U.K.-based asset manager Legal & General Investment Management Ltd., said if Saudi Arabia ever needed extra funds it could be tempted to tap Aramco.

“Guess where you go if you need some tax money? You go to your quasi-sovereigns,” Mr. Patnaik said, adding that such a move wouldn’t be unusual in an emerging-market economy.

At Sunday’s launch announcement, Aramco CEO Amin Nasser said he had been meeting investors in New York, London and throughout Saudi Arabia in recent weeks, adding that the firm would further educate investors before publishing an IPO prospectus on Nov. 9.

“We have to explain a lot of things with regard to our strategy going forward,” Mr. Nasser said.

The company’s dividend payout, set at $75 billion annually, makes it attractive to investors seeking steady cash flows akin to a bond, some of the potential investors have said. As such, Aramco’s offering is expected to be largely judged on the dividend yield it would generate for investors—the higher the yield the more appealing the investment but the lower the resulting valuation for Aramco.

Aramco is targeting a valuation of up to $2 trillion and has set a base valuation of around $1.7 trillion, The Wall Street Journal has reported. At those levels, the company would generate a dividend yield of between 3.75% and 4.4%, based on an annual payout of $75 billion. A lower valuation of $1.5 trillion, which some investors have said is more realistic, would raise the yield to 5%. Aramco will face investor pressure to deliver the higher yield, which would bring it in line with dividend yields of already trading energy majors. Royal Dutch Shell PLC, for example, carries a yield of more than 6%, according to FactSet.

“Let the market dynamics...drive the value and what the pricing should be for that IPO,” one equity investor said ahead of the IPO announcement on Sunday.

During investor meetings ahead of the IPO, Aramco is expected to highlight the competitive advantage and diversity of its operations to reassure investors about its ability to meet its dividend commitment. According to Aramco’s IPO presentations, the company’s all-in production costs are between $7.20 and $7.40 a barrel of oil, ranking it among the world’s lowest-cost producers and biggest oil exporters. Further, the company is making moves to expand its gas and chemical production operations to generate additional sources of revenue. In March, Aramco agreed to buy a 70% stake in Saudi Basic Industries Corp., the kingdom’s petrochemicals firm, for $69.1 billion.

Still, some money managers have argued those advantages aren’t enough to justify a lower yield given the risks Aramco faces. The killing last year of dissident Saudi journalist Jamal Khashoggi threatened investor confidence in the kingdom. The CIA concluded Mr. Khashoggi’s death at the hands of Saudi operatives in Istanbul was likely ordered by Prince Mohammed.

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The Crown Prince has said he takes responsibility for the killing because it occurred on his watch, but he denied having prior knowledge of the operation.

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The kingdom has already tried to assure potential investors that the annual dividend is secure, promising that nongovernment shareholders will get preference over the state, receiving their share of the $75 billion payout even if Aramco’s earnings don’t cover the government’s full share as an investor.

Still, Aramco has signaled it may go further to address investor appetite for dividends and the company’s goal of achieving the highest valuation possible. Aramco might raise the initial annual dividend payout by $5 billion to $80 billion, according to an Aramco executive. It could also increase the payout to $100 billion over the short term, according to the executive. That would generate an initial dividend yield of 4%, based on a $2 trillion valuation. At a $100 billion payout on the yield would equate to 5%.

Aramco is betting on broad support for the offering from domestic investors, while hoping to sell about 50% of the issue to international investors, the Journal has reported.

That might not be enough to win over some key global investors.

Following the September attacks on the oil facilities, the company met sovereign-wealth funds in Abu Dhabi, Singapore and Oman among others, according to a senior Saudi official. However, none of the funds committed to buying IPO shares, indicating the pricing was too high even if participation could help them achieve closer business ties with Saudi, according to the official.

Trade tensions between China and the U.S. also threaten potential participation in the offering by China’s sovereign-wealth funds. In November 2017, the U.S. government intervened to stop Aramco’s efforts to sell a stake to a Chinese consortium of state-held entities over concerns the deal would more closely tie together an ally with Beijing.

Assets in money-market accounts are at a decade high, a bullish sign for some investors

Nervous investors have socked $3.4 trillion away in cash. But stocks are rising and their nerves are calming, leading bulls to view the huge cash pile as fuel that could drive markets higher still.

Assets in money-market funds have grown by $1 trillion over the last three years to their highest level in around a decade, according to Lipper data. A variety of factors are fueling the flows, from higher money-market rates to concerns over the health of the 10-year economic expansion and an aging bull market.

Yet some analysts say the heap of cash shows that investors haven’t grown excessively exuberant despite markets’ double-digit gains this year, and have plenty of money available to buy when lower prices prevail. That is a comforting message to those concerned about an economic slowdown yet wary of betting against a market that has punished doubters during its 10-year run.

“Cash always makes me feel good, both having it and seeing it on the sidelines,” said Michael Farr, president of the money-management firm Farr, Miller & Washington, which is holding twice as much cash as usual. “It keeps things a little bit safer.”

Investors said the rising cash reserves reflect several worries that have become prevalent among money managers over recent months, as flare-ups in the trade war with China and uneven U.S. data sparked bouts of volatility in markets.

Many are concerned that stock prices have climbed to unsustainable levels relative to companies’ earnings at a time when the U.S. economy is slowing. A popular metric pioneered by Nobel Prize-winning economist Robert Shiller shows that valuations remain near two-decade highs, though they have retreated from their heights of early 2018.

Sandy Villere, portfolio manager at the $2 billion Villere Balanced Fund, is keeping 17% of his portfolio as cash, up from the usual 10%. Mr. Villere believes valuations have become stretched and prefers to wait for another dip before jumping in again.

“We don’t have to swing at every pitch,” said Mr. Villere, who added two new stockholdings to his portfolio when markets slid last December. “Right now, we’re struggling to find high quality at reasonable prices.”

Rising yields in money markets have been another key factor. Money-market funds through October offered an average annual return of around 1.6% this year, up from 0.02% in 2011, according to Crane Data. Sweep accounts at brokerages, the main reservoir where these firms hold clients’ cash, paid about 0.2% on average through September.

When interest rates fell in the years after the financial crisis, bank deposits gained market share from money-market funds because the gap between the yields on both had narrowed so much, said Peter Crane, president and publisher of Crane Data.

Money-market rates rose in response to the Fed’s nine interest rate increases since 2015 and have declined in recent months to reflect the central bank’s rate reductions this year.

Higher rates, together with a comparatively high degree of liquidity, has increased money markets’ allure for investors looking to park their cash for a comparatively short period.

Some fund managers have warned investors against being overly cautious in a market that has shrugged off a range of economic and geopolitical worries over the past decade and continues to edge higher. A UBS Global Wealth Management survey of 4,600 wealthy entrepreneurs and investors showed that more than a third raised their cash allocations in the past quarter in response to flaring trade worries.

In total, cash holdings rose a percentage point to 27% of survey respondents’ portfolios at the end of the third quarter from the previous quarter, even as a growing number said they were increasingly optimistic on the global economy and stock performance. The cash allocation is much higher than the percentage recommended by the firm.

“There is a dichotomy in sentiment—investors are holding large cash balances in a wait-and-see mode, even though nearly 50% anticipate higher stock market returns in the next six months,” said Paula Polito, UBS Global Wealth Management’s client strategy officer, in a recent report.

The difference between combined flows into cash and bond funds relative to stocks over the past year is the greatest since 2012, after adjusting for assets under management, according to Goldman Sachs.

In a historical context, however, stock allocations remain large. The firm estimates that investors have about 12% of their portfolios in cash, ranking in just the fifth percentile going back to 1990. By contrast, stock allocations are at roughly 44%—equivalent to the 81st percentile going back the past three decades.

Analysts at Bank of America Merrill Lynch, meanwhile, see the cash pile as an indication that markets have plenty of fuel for more gains.

The bank’s proprietary Cash Rule Indicator, which gives a buy signal on stocks when investors’ cash balances are above their long-term averages, has been in bullish territory for the last 20 months. Fund managers polled in the bank’s latest survey said they are holding an average of 5% of their portfolios in cash. That compares with a 10-year average of 4.6%.

“We take it as an incredibly positive sign on a contrarian basis,” said Jared Woodard, investment strategist at the bank.

Property investor launches campaign to restructure listed real estate lender Urban Exposure

Property investor Robert Tchenguiz has returned to shareholder activism with a campaign to restructure a listed real estate lender in which he owns shares, after years embroiled in litigation over a failed probe by the Serious Fraud Office.

Mr Tchenguiz on Tuesday said his company, R20 Advisory, had built up a 12.6 per cent stake in Urban Exposure and had written to its board proposing to restructure it as a listed debt fund.

“UK plc is riddled with these types of companies where they sell mixed messages, and mixed messages are not what the investor base wants,” Mr Tchenguiz said. “This is a prelude to a much bigger one I’m working on.”

Before the financial crisis Mr Tchenguiz was one of the UK’s most aggressive activist investors, intervening in companies such as the pub group Mitchells & Butlers and supermarket J Sainsbury before the lending behind many of his stakes collapsed in the crisis.

He and his brother Vincent Tchenguiz were arrested in 2011 in a Serious Fraud Office investigation into the Icelandic bank Kaupthing, prompting years of litigation that lowered the brothers’ profile as investors.

The SFO later dropped its investigation into the brothers, and in 2014 it apologised to the pair and paid them £4.5m in damages. Related lawsuits continued until last year, however, when Robert Tchenguiz dropped a legal case against accountancy firm Grant Thornton and several other defendants, after reaching an agreement with Kaupthing.

He said at that time that he hoped to rebuild his business interests. But he now operates separately from his brother, who has amassed a biotechnology portfolio and owns billions of pounds of residential freeholds.

This year Robert Tchenguiz expressed support for an activist campaign being waged by the US fund Coast Capital at First Group, the rail and bus company, in which he also owns shares.

Listed on London’s Aim in 2018, Urban Exposure lends to residential property developments in the UK from its own balance sheet and manages loans financed by third parties, such as the private equity giant KKR.

It trades at a discount to net asset value of 25 per cent, Mr Tchenguiz said. Shares traded at 57.8p each when markets closed on Tuesday.

Mr Tchenguiz said: “The guy who wants exposure to the debt [issued by Urban Exposure] currently has to take a risk on the management.”

R20 proposes carving out the management company from Urban Exposure, saving what it said would be £12m-£13m a year. It said the management company would be majority-owned and controlled by Urban Exposure.

R20 said the group should pay a dividend of 30p a share, worth a total of £47.5m, and should also issue 100m new shares at 35p to improve liquidity in the stock. It said it would underwrite 57 per cent of those shares and had identified a broker for the rest.

The group said the new structure would mirror that of publicly traded debt funds such as Starwood European Finance.

Urban Exposure said: “The board of Urban Exposure notes the announcement by R20 Advisory Limited . . . [it] will evaluate the proposal from R20 and will issue a further statement if and when appropriate.”

Trade wars, Brexit and car sector woes signal brink of technical recession

Germany’s top economic advisers have slashed their growth forecast for Europe’s largest economy, while warning that the country is suffering from global structural shifts, such as growing trade protectionism and digital disruption of traditional industries.

The Council of Economic Experts’ annual report, which it will submit to parliament on Wednesday, will make grim reading in Berlin. The council has cut its growth forecast for this year from 0.8 to 0.5 per cent and for next year from 1.7 to 0.9 per cent.

Adjusted for extra working days, the government-appointed council is expecting only flat growth of 0.5 per cent in the German economy next year. The report requires an official response from the government in the next few weeks.

Germany has averaged 2 per cent growth in the past five years. But its economy has slowed sharply and is now on the brink of a technical recession — defined as two consecutive quarters of contraction — after shrinking by 0.1 per cent in the three months to June.

Third-quarter gross domestic product figures for Germany are due on November 14 and many economists expect another slight shrinkage.

The export-focused economy has been hit by the US-China trade war, uncertainty over Brexit and a sharp decline in the car industry, which has been disrupted by new emissions rules and the shift to electric vehicles.

The council said the slowdown made it unwise for the government to maintain its commitment to a balanced budget approach — known as the schwarze Null, or black zero — as it could prevent Berlin from using fiscal policy to stimulate and rebalance the economy.

It concluded that it would be sufficient to maintain the separate debt brake — a more flexible rule that is anchored in Germany’s constitution and requires the federal government to keep its structural deficit at less than 0.35 per cent of GDP.

However, this issue split the council, with two of its five members writing a minority view that the constitutional debt brake should also be rewritten to give added flexibility in a downturn.

The council’s report is the latest sign of a growing backlash in Germany against the black zero commitment that was enshrined in last year’s coalition treaty between Angela Merkel’s Christian Democrats and the Social Democratic party of finance minister Olaf Scholz.

Germany has had a budget surplus since 2014 that last year reached a record of €59.2bn, or 1.7 per cent of GDP.

The council urged the government to raise infrastructure spending and cut taxes — echoing recent calls by Christine Lagarde, the new European Central Bank president, for the country to increase public sector spending.

German government investment has already been growing by 6 per cent annually for the past three years and officials say Berlin is limited in its ability to do more because of overcapacity in the construction industry and planning approval bottlenecks. But the council said Germany should make it easier for foreign construction companies to operate in the country and speed up the planning process.

The council also said Berlin should scrap the solidarity tax that it has levied on households and businesses since the country’s unification to pay for investment in the former East Germany.

Widening focus of protests highlights stasis of sector out of step with the times

One reason Hong Kong protesters have turned their focus so quickly from a controversial extradition law to income inequality is simmering anger at the cost of housing in the world’s least affordable market by far.

A target of their resentment is the territory’s property tycoons, who with the help of a pliant local government have for years kept housing supply far lower than demand, amassing land holdings but developing them at a rate that ensured rising prices.

That formula is now at risk, with even Beijing starting to criticise the most prominent developers. But while neighbouring Shenzhen gives rise to some of the world’s most innovative companies, helping its economy eclipse that of the former British colony, few of the Hong Kong businesses are trying to adapt to tomorrow’s world.

In seminars on the “Greater Bay Area”, the megaproject to create a vast business and innovation hub by linking southern Chinese cities with a combined population of 70m, they have little more to offer than their capability in providing buildings for incubators — although there are not many Hong Kong start-ups to occupy them.

An exception is Nan Fung, which is putting its success on the line by forging an entirely new path for itself.

Property was not always the only route to prosperity in the city. When millions of immigrants arrived in the wake of the 1949 Communist victory in the Chinese civil war, the wealthiest of the new residents were industrialists from the eastern cities of Shanghai and Ningbo. These manufacturers transformed the colony’s economy, building the city’s fortunes along with their own. Among them was Chen Din Hwa, who fled to Hong Kong in 1949, established a series of textile mills and five years later founded Nan Fung.

The textile mills were shuttered just over a decade ago, long after they became uneconomic, in part because Mr Chen was reluctant to move his operations to the mainland as costs rose in his adopted home. Some of the buildings that housed the operations have been turned into a museum and a centre to encourage technological innovation in fashion. And the company is now known primarily as a property group.

Nan Fung is one of a group of developers that has been marginalised over time as the biggest, including Cheung Kong, Henderson Land, New World Development and Sun Hung Kai became ever more dominant.

Now the third generation of the family is trying to change the group’s identity for the third time by using its capital to buy into the entirely new field of life sciences.

“We started thinking about what should be next,” says Vincent Cheung, the Nan Fung managing director and chief operating officer who is spearheading the shift. It initially spent $1.5bn acquiring expertise, first investing in funds five years ago and then establishing its own venture capital funds in 2017. Nan Fung has invested in 45 companies and 27 funds to date, as well as its own funds operating out of Shanghai and San Francisco.

The dramatic switch in focus came after the family decided to bring in an outsider as chairman, hiring Antony Leung, whose career has included stints as a banker, finance secretary in the Hong Kong government and, most recently, chairman of Blackstone’s China operations.

It was Mr Leung who recommended that Nan Fung change course. “China was an entirely clean slate,” Mr Cheung says. “But AI and big data give China a competitive advantage.”

Nan Fung increasingly resembles US private equity firms such as Bain Capital whose founders embrace philanthropy, writing huge cheques to life sciences, but also invest through their family offices and make biotech part of their core buyout businesses. It helps that the DH Chen foundation, Nan Fung’s largest shareholder, is not listed

“Especially in young volatile markets like China, you need long-term, patient capital,” says Peter Bisgaard, who is in charge of the business’s US portfolio. “If the market dips, you need ample reserves.”

Eight of Nan Fung’s portfolio companies have already gone public, he adds. Whether biotech will be as profitable as property remains to be seen — but at least Nan Fung is now focusing on a public good.