International currencies

China wants to make the yuan a central-bank favourite

And it is playing a trump card in order to achieve it

BETWEEN 2004 AND 2012 BNP Paribas helped funnel $30bn into Sudan, Cuba and Iran, all then under American sanctions. It hid its tracks using a network of “satellite” banks and by stripping payment messages of incriminating references.

Whistleblowers tipped off American prosecutors. The bank pleaded guilty, expecting to pay €1.1bn ($1.2bn). It was fined $8.9bn by American authorities in 2014, and the case escalated to a diplomatic row.

BNP immediately fell into line. It moved the division overseeing the security of its dollar transactions from Europe to America, the first foreign bank to do so. A dozen staff lost their jobs and its compliance team was revamped.

There was relief at the bank. It had avoided being permanently banned from clearing dollars, the closest thing to commercial death for international lenders. “Banks create money, and money is a sovereign good,” says Jean Lemierre, BNP’s chairman. “States decide what we can do with it.”

America wields more clout than other states because its money is so central to the system. On international currencies’ three roles—unit of account, medium of exchange and store of value—the greenback ranks high. Most commodity contracts are denominated in it.

The dollar represents half of cross-border interbank claims, a proxy for international payments, and 62% of central-bank reserves. No amount of American goofing seems able to blunt its appeal.

Everyone rushed to buy dollars during the subprime crash, even though Wall Street caused it.

They did it again in March despite America’s bungled response to covid-19.

Minting it

Yet the flattering snapshot masks an ominous process. Aware of the power that issuing an international currency confers, China is on a charm offensive. Cautious to avoid past mistakes, it is advancing methodically. And it is playing a big trump card: opening up its $13trn bond market, which accounts for 51% of all bonds issued by emerging economies. So far, all is going according to plan.

There are three types of benefits to the issuers of a reserve currency. One is reduced transaction costs. Banks can access central-bank liquidity at will. Firms can borrow cheaply overseas and suffer less foreign-exchange risk.

A second, bigger prize is macroeconomic flexibility. To outsiders, dollars are an attractive asset they use for cross-border purposes. Yet, for America, foreign ownership of its notes is like a loan from abroad. Hunger for dollars allows it to finance deficits with its own money instead of forcing its residents to spend less.

That reduces the elemental need to balance the money that comes in with what goes out, freeing America to pursue the monetary and fiscal policy it wants. When the country suffered its first-ever credit-rating downgrade in 2011, investors rushed to buy dollar assets, making it even cheaper for it to borrow.

That autonomy, as well as the world’s dependence on greenbacks, gives it leverage—its third big advantage. America can extract concessions by rewarding allies with vital liquidity while denying it to foes.

Last year three Chinese banks pledged swift compliance when suspected of flouting sanctions against North Korea. Monetary clout grants influence on international regulation: European bankers complain that global capital-adequacy ratios are harsher on them than on Americans.

Being the world’s money master incurs costs, too. Robust demand for the dollar boosts its value relative to others, hurting exporters. The Fed must contend with a growing overhang of liquid debt overseas, which leaves the domestic economy hostage to sudden movements of capital, says Benjamin Cohen of the University of California, Santa Barbara. And there is the duty to bail out the system when necessary.

Such trade-offs explain why rising economies, like Japan and Germany in the 1980s, shied away from turning their fiat into global favourites. Until recently Europe was in that camp. It saw the euro as a tool to build the union but did not care if others adopted it.

Yet that calculus has changed. With America more isolationist, the EU attaches fresh value to monetary autonomy. In 2018 the European Commission started pushing for a stronger international role for the euro.

In that world minting a reserve currency is the ultimate aim. This is because the currency mix of central-bank holdings tends to be highly concentrated—more so than private investors’ portfolios. Becoming an investor darling, however, is a necessary first step.

That requires having large, liquid capital markets and government bonds that are deemed safe assets (these make up the bulk of foreign-exchange reserves). Another requisite is to be widely used in trade, as central banks like to stock up on the cash their country needs to buy imports.

There it helps to have a big economy that is integrated into global markets.

With four oil majors, a convertible currency and a vast cross-border banking system, the EU would seem to be “ready for prime time”, says Karthik Sankaran, a fund manager and currency strategist. Without fiscal union, however, it lacks a supranational, liquid eurobond.

And bonds issued by single members display uneven safeness, because Europe’s weak banks and sovereigns are tightly connected (banks typically hold 15-30% of their home country’s debt). A banking union would help break that “doom loop”, but Brusselites admit the project is “a bit stuck”. The euro’s share of global reserves fell to 20% last year, from 28% in 2009.

So Europe tinkers around the edges. It sends questionnaires to G20 countries to understand why they do not use euros more often. In March it held a workshop with its eastern neighbours on how to issue euro bonds.

The EU scolds its policy banks for not issuing more debt in euros. But top-down efforts are gaining little traction. “I look around me and everyone uses the dollar. It’s not me, it’s my clients,” says a European bank boss.

Russia has been brasher. Since 2013 its central bank has cut the dollar share of its reserves from 40% to 24%. Today Moscow mostly issues debt in roubles and euros. ING, a bank, reckons 62% of its exports were settled in dollars last year, down from 80% in 2013.

But the push aims to insulate it from American wrath, not make it a currency power. Rosneft, a blacklisted firm that extracts 40% of Russia’s oil, now denominates its contracts in euros.

Going global

China makes no secret of its yearning for a global yuan. Eager to control how much money comes in and out of the country, however, it has long had capital controls in place, which limit how much of the currency outsiders can access.

So its progress has been gradual. In the 2000s it started allowing Hong Kong residents to open deposit accounts in redbacks, creating pools of liquidity outside the Great Wall.

It used the former British colony to test other policies, such as persuading foreign states and firms to issue “dim sum” bonds. Its efforts stalled in 2015, when a loosening of controls, and worries about China’s economy, forced the central bank to dump $1trn in reserves to combat outflows. Controls were tightened. Foreign trade settled in yuan collapsed. Offshore deposits cratered.
 Sceptics say China is dreaming when it talks about internationalisation. But they have not woken up to fresh facts on the ground. Deposits did take a hit in 2015, but they are rising fast again and are now back to over 1trn yuan ($144bn), 20 times their total in 2009. Liquidity has spread: Taiwan has nearly half as much in deposits as Hong Kong. Singapore and London have grown.

A boom in foreign-exchange transactions also suggests growing usage. The daily turnover of FX instruments traded in Hong Kong has more than doubled since 2013, to $107bn. Other hubs have risen: Britain accounts for 37% of all trades; France and America are nearing double-digit shares.

A growing list of offshore investment products are denominated in yuan, which helps raise its profile among investors. Hong Kong now lists exchange-traded funds, equities, gold futures and property investment trusts, says Craig Chan of Nomura, a bank.

But China’s mightiest advances are in the real world, where it uses its vast trade and investment network to fan out its fiat. The Belt and Road helps. Direct investment by Chinese firms into related projects was worth $15bn last year, a quarter of which was in yuan.

China now settles 15% of its foreign trade in the currency, up from 11% in 2015. It has made it easier for its national champions to use the yuan in their transfers to foreign outposts, such as financing flows, capital injections or day-to-day cash management.

China wields particular clout in emerging markets. The number of banks processing yuan payments globally has grown by half since 2017, to 2,214. Most additions have come from Asia, the Middle East and Africa.

Some European countries are also keen, notably France, the region’s dollar-basher in chief. A fifth of its trade with China is settled in yuan, as is 55% of payments between both countries.

Paris actively encourages its banks and businesses to use the redback. A former IMF official says several multinationals have begun pricing deals in yuan to bypass American sanctions.

Beijing is mulling a wider offensive. It has appointed yuan-clearing banks in 25 countries to accompany exporters. It also wants to procure more of its vital imports in redbacks. In 2018 it launched yuan-denominated oil futures in Shanghai.

This helps importers hedge risk while paying in domestic currency, says Stephen Innes of Axicorp, a foreign-exchange provider. They became the third-most widely traded such futures globally in just six months.

Last year HSBC became the first foreign bank to hold margin deposits for foreign traders of iron-ore futures in Dalian, China’s commodities exchange. Vina Cheung, its yuan expert, says the country is “preparing the infrastructure to include overseas investors and traders”. Multinationals are starting to respond: Rio Tinto sold its first yuan iron-ore contract in October.

Crucially for China’s end goal, central banks are also warming up to the yuan. Since its inclusion in the IMF’s special drawing rights, a basket of elite currencies, in 2016, its share of global reserves has risen every quarter, to 2.1% in September.

Natalie Dempster of the World Gold Council, an industry body, reckons some central banks are using gold as a halfway house to buy yuan once capital controls are lifted (they bought a record amount of gold in 2018).

China has signed currency swap agreements with over 60 countries, amounting to half a trillion dollars. Some have pledged to allocate 10% of their stash to the yuan, which would bring its share of reserves to $800bn (from $220bn today).

Two factors could tip them into action.

First, the yuan appears to be influencing exchange-rate fluctuations around the world.

Recent research by IMF scholars finds the “yuan bloc” to account for 30% of global GDP—second only to the dollar, at 40%.

Central banks pick reserve currencies closely tied with their own.

Second, China has opened a fresh breach in its capital controls, and money is streaming in (see chart). In 2017 the country launched Bond Connect, which allows foreigners to invest in onshore bonds through Hong Kong, and scrapped investment quotas. Last year it also authorised international credit-rating agencies.

That, plus rising domestic demand for listed securities, has convinced the world’s most popular index providers to phase Chinese bonds into their benchmarks. This helped draw $60bn of foreign money into government bonds in 2019, a flow that covid-19 has not stopped. Some 1,900 overseas investors are registered to Bond Connect, up from 700 a year ago.

Foreigners now own 3% of China’s bond market, the world’s second-largest, and 8.8% of its government bonds (up from 2.8% in 2015). Their appetite will only rise. Chinese bonds offer good yields and diversification benefits.

Yet they remain on the “very periphery of institutional investors’ portfolios”, says Mark Wiedman of BlackRock, the world’s largest money manager. It is creating a programme to guide clients on how to invest in China.

Future of Our Global Economy

The Beginning of De-Globalization

The corona crisis is changing the global economy. Production security is growing more important than efficiency. Here is what that might look like.

By Alexander Jung

A container ship in Qingdao, China
A container ship in Qingdao, China / SIPA / ZUMA PRESS / ACTION PRESS

Corona is here, and it won't be leaving anytime soon. Which means that hopes for a return to normal are likely to be in vain. Furthermore, everybody has become hyper-aware of the dangers of infection and it is a fear that will stay with us.

Social distancing will continue to guide our personal interactions, restaurants will leave every second table empty, open-plan offices are being divided up and only two, maybe three, people will get into the elevator at a time, and each will be facing a different corner.

Such is our new reality, and such are the changes coming to the world of work. More than that, companies are trying to make themselves more resistant to sudden economic shocks and resilience is the new guiding principle.

Industrial machine producers, of the kind that make a huge contribution to the German economy, have begun shifting priorities from making the supply chain as cheap as possible to making it as secure as possible. Wholesalers have turned to video chats when making large sales rather than flying halfway around the world as they used to. Airlines, meanwhile, find themselves fighting for survival and many have had to take public-sector bailouts.

Indeed, in the foreseeable future -- for months, or perhaps even years -- the state will be the savior of last resort for many companies. It alone has sufficient means at its disposal to battle the pandemic, minimize its economic consequences and prop up entire industries.

And not only is the state in Germany providing emergency aid, cheap loans and economic stimulus, it is also ensuring that the minimum wage is significantly increased for care workers in retirement homes while top executives at companies like Daimler and Lufthansa are voluntarily forgoing their bonuses.

Will It Be More Just?

Such is the new world at the beginning of the 2020s. Its outlines are already taking shape. It will be a world in which security will play a greater role, as will central governments. But will it be more just?

Matthias Horx, a 65-year-old futurologist, dared making an optimistic prediction right at the beginning of the corona crisis, arguing that many things would change for the better. He believes the crisis provides us with an opportunity to slow down the economy, to inject more solidarity into society and to learn to be satisfied with less.

Bazon Brock, however, believes such ideas are nonsense. People never learn the correct lessons from catastrophes, says the 83-year-old art theorist. Following the financial crisis, he points out, banks speculated more than ever. Arguing that crises are opportunities is naïve, he believes.

Either way, in situations such as the one we are currently experiencing, everyone yearns for a return to some form of business as usual. This crisis, though, is leaving us will little choice. It is forcing us to chart a course for a future that seemed impossible just a short time ago.

It was, after all, global mega-trends that made this pandemic possible in the first place: mobility, urbanization, interconnectedness, the worldwide division of labor and the destruction of the environment are all part of it. Which is why everything must now be examined with a critical eye.

This article marks the launch of a DER SPIEGEL series examining the vast changes we are facing. Among those shifts is the move away from globalization and the changes in the worldwide division of labor that entails.

Another is the trillions in debt that will limit the flexibility of both countries and companies for years to come. Technology is likely to become an increasingly prominent feature of our daily lives. And more attention will have to be paid to the pressure heaped on the shoulders of workers and to ideas for making our economic model both fairer and more sustainable.

"Humanity learns only through suffering or persuasion," said the Swiss educator Johann Heinrich Pestalozzi back in 1799. The world after coronavirus provides a chance to combine the two.

From International Efficiency to Regional Stockpiling: Deglobalization

Crisis? What crisis? At agricultural machine manufacturer Grimme, production has continued at all its factories throughout the entire coronavirus shutdown. None of the company's 2,700 employees has been placed in a work furlough program and the only thing that has changed is that the shipping department now works in shifts because of social distancing rules. Otherwise, everything is as it has always been, says Grimme executive Jürgen Feld. "Our philosophy is helping us in these times," he says.

The company was founded in 1861 as the village blacksmith in Damme, southwest of Bremen. These days, it is the world leader in potato harvesting machines. The bright-red behemoths, some of them boasting more than 500 horsepower, dig the potatoes out of the earth before cleaning and sorting them. Eighty percent of the machines are exported, but the vast majority of production takes place in Germany, as it always has.

Grimme has consistently refused to adhere to modern-day management principles, such as the idea that large industrial manufacturers must produce globally and outsource services to remain as flexible and efficient as possible. Damme has frequently examined whether such an approach would work for the company, but has always chosen to go another direction.

The company, if you will, is more old school, preferring to produce as much as it can at home, particularly critical parts like screens and reels. In-house production depth, a reference used by economists to measure how much a company makes itself, is around 85 percent. "We've always been laughed at because of it," says Feld. Now, though, the erstwhile critics have become envious.

Greater Emphasis on Security

Whereas competitors such as Claas and Fendt have been forced to shut down their production lines, Grimme has become something of an avant-garde in the agricultural machinery industry and is indeed setting a trend for the economy as a whole. At the moment, production managers are receiving a rather brutal lesson in how crisis resistant their supply chains are, or aren't.

The results of that lesson can be seen from a survey conducted by the consulting firm EY among 145 companies in Germany. It found that a third of the companies are planning to make changes to their supply chains as a result of the corona crisis, placing greater emphasis on security and less on Price. 

Economist Thomas Straubhaar has never understood why companies insisted on establishing production sites overseas. "Producing cars in China, thus frivolously jeopardizing intellectual property and technical advantages, cannot be considered sustainable," he says.

Straubhaar is in no way a critic of globalization. On the contrary, he points out that free trade and the global division of labor has led to a situation in which more people are doing better than ever before, particularly the Germans.

Straubhaar has, however, observed that globalization is losing momentum. China's price advantage is shrinking, and wages have risen to Eastern European levels in many parts of the country. The pandemic risk has introduced yet another factor to slow the pace, the economist says, and it won't go away soon. "We all know that this won't be the last pandemic."

It is a realization that changes everything. Those who are 45 years old today, the average age in Germany, have never experienced anything else in their adult lives than a world of open borders, free markets and accelerating globalization. It is an era that began three decades ago with the fall of the Berlin Wall.

The Stuff of Dreams

A quarter century later, the rise of populists and protectionists slowed this process. The pandemic then brought it to an end.

The virus has revealed just how vulnerable our economic model is, regardless of how profitable it has been for Germany's export industry. Those companies whose production chains are largely international will face the greatest challenges -- companies such as the sportswear company Adidas, which has an in-house production depth of just 5 percent.

The company is headquartered in Herzogenaurach, near Nuremberg, but pretty much every other aspect of the company is spread out across the globe, including design and product development, but especially production. Finished products are supplied by around 630 companies in 52 countries. For an entire generation of executives, this model was the stuff of dreams. Everybody wanted to be like Adidas.

Some prefer to outsource (Adidas shop in New York) while others make almost everything in-house (such as the agricultural-machinery producer Grimme): Supply chains are only as strong as their weakest link. Some prefer to outsource (Adidas shop in New York) while others make almost everything in-house (such as the agricultural-machinery producer Grimme): Supply chains are only as strong as their weakest link.

But in this crisis, it has become apparent just how fragile such a structure can be. Border closures in Europe have made things much more difficult, Germany's Mechanical Engineering Industry Association has complained, even bringing production completely to a halt in some instances. A survey conducted by the association in mid-April found that 89 percent of companies have experienced clear hindrances to normal business operations. Supply chains, as has once again become apparent, are only as strong as their weakest link.

Indeed, the Fukushima catastrophe in March 2011 demonstrated just how rapidly they can break. Japanese automobile manufacturers were forced to suspend production for several months and suppliers around the world suddenly had an order shortage. Indeed, the indirect effects of the disaster were a hundred times greater than the direct, economic consequences.

The remedy is a strategy that is as old as humanity itself: Stockpiling. The problem, though, is that stockpiling binds capital, which has resulted in the shunning of the practice in favor of extreme efficiency. Now, though, executives seem to be changing their minds. In recent weeks, demand for storage space has skyrocketed. Stockpiling is the new black.

Multiple Supply Sources

Nowhere have the weaknesses of "outsourcing" and "just-in-time" manufacturing become more apparent in Germany than in the pharmaceutical industry. Basic ingredients often come from just a few factories in China and India -- and in early March, India suspended the export of 26 active ingredients and drugs, including paracetamol and the ingredients used to produce antibiotics.

A study compiled by the logistics consulting firm Resilience360, a subsidiary of DHL, warns that the current crisis has shown just how important it is to maintain multiple supply sources. "Overall, the COVID-19 outbreak may be a wakeup call to the pharma industry and governments," the consultants write.

And the industry wouldn't be opposed to bringing elements of production back home, assuming health insurance companies would be willing to pay the added costs. Because a restructuring of pharmaceutical supply chains, it seems obvious, would mean that a package of 20 paracetamol tablets would no longer cost just 1.29 euros ($1.41).

That, indeed, is the flip side of de-globalization: Bringing things home increases security but it raises costs and shrinks profit margins. Still, the price of independence can, perhaps, be minimized -- using technology.

Arburg is a producer of injection molding machines, which their clients use to produce their own products -- including, most recently, face masks. The company is based in Lossburg, a town of 7,500 in the northern Black Forest. It is also the location of the company's only production site, which is rather unusual for a global player employing 3,200 people and generating revenues of 750 million euros.

The company has always wanted to be independent, which is partially a function of its location:

Even just a trip to Stuttgart used to mean a day of travel back in the day. To ensure that production can still be profitable despite the higher salaries that must be paid in Germany, the factory is highly automated.

Industrial robots do all kinds of jobs that used to be taken care of by workers, from mounting parts to welding. Indeed, they can even produce customized machines at prices that are comparable to mass produced pieces.

When it comes to the use of robotics in industrial production, Germany is among the world leaders, behind such countries as Singapore and South Korea. Even mid-sized companies like Arburg are increasingly embracing them.

They can be used around the clock, they don't get sick and they don't have to go on vacation.

They also don't have to stay 1.5 meters away from each other in times of pandemic. In short, they make it possible for production to continue in Germany.

Avoiding the Virtual Pandemic

Should coronavirus end up reversing globalization, in other words, it doesn't necessarily have to be disadvantageous to the export industry. Furthermore, not all products have to be packed into containers and shipped overseas. Globalization these days also refers to the exchange of virtual goods, such as data. And digitalization opens up vast potential to German industry.

Machine manufacturers, for example, can use a so-called "digital twin" to simulate how a particular unit works best before it is produced. Or it can be built on the computer and then produced locally by the customer with the help of a 3-D printer. Or, as is already frequently the case, machines can be serviced remotely, with sensors ordering replacement parts before they break.

Germany's "Hidden Champions," those myriad companies around the country that are leaders in their specific technological fields, are driving the digital transformation forward.

Agricultural machine producer Grimme, for example, has come up with a "digital potato," essentially a potato-sized ball covered in sensors. The farmer places it in his field and then "harvests" it with a Grimme machine. As it makes its way through the harvester, it transmits all kinds of information related to optimal functionality, including potential damage done to real potatoes.

Digitalization will become the answer to globalization," says the economist Thomas Straubhaar, though he says that there is a significant danger to the process -- namely that digital infrastructure and cyberspace are susceptible to attacks. "We have to make sure that the current biological pandemic isn't followed by a virtual pandemic," he warns.

The consequences, he says, could even be worse than the consequences of the corona crisis.

Homes without power, offices with no internet connections, banks lacking the ability to perform transactions: a complete shutdown. It is an eventuality that must be prevented at all costs -- a task that only the state is powerful enough to take on. It's role, in other words, will continue to grow. Even beyond the current crisis.

Have investment funds averted a liquidity crisis?

The $55tn industry has emerged scared and shrunken but largely intact

Siobhan Riding

© AFP via Getty Images

In the third week of March, when the dizzying market swings caused by the coronavirus emergency were at their peak, the eyes of the investment world were fixed on the $3.8tn US money market fund sector.

An investor exodus from US prime institutional funds left portfolio managers scrambling to sell assets, threatening their liquidity profiles and paving the way for fund suspensions.

Yet the investment industry’s worst fear — that the liquidity crunch would spiral into a widespread run on funds as when the Reserve Primary fund “broke the buck” in 2008 — did not materialise due in part to interventions by the US Federal Reserve.

While it is an extreme example, the disaster averted for money market funds mirrors the picture for the wider $55tn asset management industry, which has emerged from the recent market turmoil scared and shrunken but largely intact.

Though many funds have activated emergency liquidity management tools, few have been unable to fulfil redemption requests immediately or been forced to suspend trading. Just 80 funds out of the near-35,000 sold in Europe were suspended in March, despite investment groups being hit by record outflows and precipitous drops in asset prices, according to Fitch Ratings.

“Given that this was the worst crash since 1929, it’s extraordinary that the majority of open-ended funds are still operating,” says Julie Patterson, head of asset management, regulatory change at KPMG.

The lack of widespread problems suggests that the regulations governing investment funds
are working as they should do, contradicting longstanding warnings from central banks to the Financial Stability Board that more stringent rules are needed to prevent fund liquidity mismatches.

“The next time the FSB or European Central Bank call for asset managers to be subject to macroprudential supervision because they pose a risk to the financial system, we will be pointing to this crisis and arguing that our industry has proved its resilience so far,” says Tanguy van de Werve, director-general of the European Fund and Asset Management Association.

However, many believe the fund industry’s real test is still to come. Certain sections of the market, notably fixed income funds, came under severe strain in March. Large drops in the price of corporate debt and difficulties valuing some corporate bonds had made it hard for managers to produce a reliable measure of how much money their clients had lost and fulfil redemption requests.

These stresses could have spilled over into much bigger problems if central banks and governments had not intervened to shore up markets. According to calculations by rating agency Fitch, central banks have stumped up a total of $93.8bn to support investment funds since the health crisis began.

“It is reassuring that there were not widespread runs on traditional mutual funds. There were large redemptions and the system didn’t break,” says Tobias Adrian, director of the monetary and capital markets department at the IMF. “But the resilience among investment funds was conditional on massive central bank intervention on a scale we have never seen.”

This was evidenced further last month when India’s central bank launched a Rs500bn ($6.6bn) liquidity infusion for funds in an effort to head off contagion stemming from Franklin Templeton’s suspension of six local bond funds following an investor run.

As the Covid-19 crisis drags on and more companies collapse, it is likely that funds will sustain further hits to their portfolios, triggering a new wave of investor redemptions. The IMF is concerned about how bond fund managers will cope when they run down their cash buffers, which it estimates at 7 per cent on average, although some funds have less.

Adding to the IMF’s fears are the fact that paper-thin interest rates have pushed some fund managers into riskier, less liquid assets over the past decade as they have aggressively pursued yield.

“I wouldn’t exclude that a number of funds that are investing in weaker credit may go bust during this crisis,” says Mr Adrian. “Certain funds exposed to bonds that are defaulting will see redemptions, and they will run out of liquidity eventually.”

Daily bond fund flows

Frank Hespeler, senior financial sector expert at the IMF, says recent price dislocations and the “substantive level of liquidity stress” observed in investment funds point to the presence of a “weak tail of vulnerable funds [which] could grow quite quickly in volume depending on redemptions”.

One way that funds can keep these problems at bay is by deploying liquidity risk management tools. These range from deferring redemption requests, tapping credit lines or “swinging” the price of the fund to pass on the costs associated with high outflows to redeeming investors.

Ms Patterson says that regulators’ authorisation of a broader range of liquidity management tools since the 2008 financial crisis has stood fund managers in good stead. Swing pricing, for example, which has been activated by managers including Fidelity, Amundi, Goldman Sachs Asset Management and BlackRock over the past two months, according to regulatory disclosures, is a relatively recent innovation.

These tools can encourage investors to stay in funds and give fund managers time to reposition their portfolios, enabling them to avoid a fire sale of assets. However, they cannot change the liquidity profile of their funds.

In addition, adoption of liquidity risk management tools varies from manager to manager.

Monique Melis, managing director at regulatory consultancy Duff & Phelps, argues that some managers are “still reticent” to use mechanisms such as redemption gates or notice periods, fearing negative reaction from clients. “No investor is enthusiastic about provisions which delay them recovering their money,” she says.

Another lever fund managers have is liquidity stress tests, which help them integrate liquidity concerns into portfolio construction and make sure they have enough liquid assets to meet a surge in redemption requests.

But Alastair Sewell, head of funds and asset manager ratings for Emea and Apac at Fitch, says there is “a question around how severe a stress fund managers are incorporating into their liquidity risk management and whether [the recent crisis] constitutes a new realm of stress that the existing practices are inadequate to deal with”.

New EU rules on liquidity stress testing are set to be imposed on European investment funds later this year. However, these were formulated before the crisis and do not provide for the unusual market conditions experienced during this period. Olivier Carré, partner at PwC Luxembourg, expects regulators to mandate more detailed stress tests in future based on specific scenarios.

Questions around asset managers’ resilience to liquidity risk also centre on funds’ structure and whether strategies that allow investors to redeem their money on a daily basis should be exposed to less liquid assets.

This debate is already high on regulators’ agendas following the blow-up of UK stockpicker Neil Woodford’s investment business last year, as well as the repeated suspension of several popular UK property funds.

The stress experienced by products such as high-yield bond funds in March provides fresh ammunition to policymakers seeking to ensure funds’ redemption terms are aligned with the liquidity of their underlying assets.

The IMF wants policymakers to force bond fund managers to comply with eligibility criteria based on credit quality and liquidity metrics before adding assets to their portfolios. It also recommends that asset managers are required to match the redemption period of their funds to the liquidity profile of their portfolios better to mitigate the potential for fire sales.

“The issue of fund liquidity was already a regulatory priority and the recent market turmoil has only served to underscore it,” says Sean Tuffy, head of market and regulatory intelligence at Citigroup. “Hard questions will be asked about the need for daily liquidity for all fund types.”

Before this overhaul can happen, however, policymakers will want to see how well investment funds withstand the rest of the crisis. The IMF’s Mr Adrian predicts there will be a “weeding out of badly run mutual funds from well-run mutual funds”.

What is less clear, however, is whether vulnerable funds will go bust in an orderly fashion or whether they trigger a run on the wider fund industry, creating contagion effects across the global financial system. The answer to this question will determine the direction of asset management regulation for years to come.

FTfm Suspensions gather pace in Europe The sharp market correction led to a spike in fund suspensions in Mar 2020 ($bn)

*Several funds subsequently reopened or were liquidated, although the majority remain suspended

The next stage of covid-19

Lifting lockdowns: the when, why and how

They are blunt instruments that can cause immense harm. Time to be more discriminating

Since china locked down the city of Wuhan on January 23rd, over a third of the world’s population has at one time or another been shut away at home. It is hard to think of any policy ever having been imposed so widely with such little preparation or debate.

But then closing down society was not a thought-out response, so much as a desperate measure for a desperate time. It has slowed the pandemic, but at a terrible price. As they seek to put lockdowns behind them, governments are not thinking hard enough about the costs and benefits of what comes next.

Although social distancing may have to be sustained for months or years, lockdowns can only ever be temporary. That is because it is becoming clear how costly they are, especially in poor countries. Part of the price is economic. Goldman Sachs this week predicted that India’s gdp would fall in the second quarter at an annualised quarterly rate of 45%, and would rebound by 20% in the third quarter if lockdowns were lifted. Absa, a bank, reckons South Africa’s economy could shrink at an annualised rate of 23.5% in the second quarter.

The poorest are hit very hard, because they have nothing to fall back on. In sub-Saharan Africa an individual in the lowest income quintile has only a 4% chance of receiving social assistance from the government in normal times. The combination of covid-19 and lockdowns could drive up to 420m people into absolute poverty—defined as having to live on less than $1.90 a day. That would increase the total by two-thirds and set back progress against penury by a decade (see article).

The consequences will be far-reaching. Hunger permanently stunts children. Lockdowns that block normal services cost lives. The World Health Organisation has warned that covid-19 threatens vaccination programmes. If they stop in Africa, 140 children could die for each covid death averted.

A three-month lockdown, followed by a ten-month interruption of tuberculosis treatment, could cause 1.4m deaths in 2020-25. It is the same for malaria and aids. The longer lockdowns continue, the likelier it is that they will cost more lives than they save.

The picture in rich countries is less dramatic, but still worrying. America’s unemployment rate increased from 3.5% in February to 14.7% in April. In Britain a third of new graduates had a job offer withdrawn or delayed. Bond markets in America are signalling a wave of defaults, especially in hospitality, raw materials, carmaking and utilities.

The scarring in the labour market could last for years. Rich-world services are vulnerable, too.

One study concluded that delaying cancer consultations in England by six months would offset 40% of the life-years gained from treating an equivalent number of covid-19 patients. Vaccination rates have fallen, risking outbreaks of diseases like measles.

Lifting lockdowns risks a second wave. Iran reopened in April to save the economy, but last week designated the capital, Tehran, and eight provinces as “red zones”, because the virus is spreading there again. Some American states, such as Georgia, that never suppressed the initial outbreak will soon find whether they lifted lockdowns too hastily. Some African countries are going ahead even though their case loads are rising.

To limit the risk requires an epidemiological approach that focuses on the places and people most likely to spread the disease. An example is care homes, which in Canada have seen 80% of all the country’s deaths even though they house only 1% of the population. In Sweden refugees turn out to be high-risk, perhaps because several generations may be packed into a household. So are security guards, who are often elderly and are exposed to many people in their work (see article).

For this approach to succeed at scale, you need data from tests to provide a fine-grained picture of how the disease spreads. Testing let Germany rapidly spot that it had a problem in its slaughterhouses, where the virus persists longer than expected on cold surfaces. Likewise, South Korea identified a super-spreader in Seoul’s gay bars. Without testing, a country is blind.

Armed with data, governments can continuously refine their policies. Some are universal. Masks were once thought ineffective, but in fact help stop the spread of the disease. Like handwashing, they are cheap and do not impose hidden costs.

However, closing schools harms children and stops parents from working. In contrast with flu, it turns out, the benefits to health are not especially great. Schools should reopen, under conditions that lower the risk to teachers and vulnerable pupils.

As a rule, the balance of costs and benefits favours narrow local policies over blanket national ones. In Britain agency workers carry the virus between care homes: they should work at only one. Gibraltar has a Golden Hour, when open spaces are set aside for the over-70s to exercise while everyone else stays at home.

Stockholm is moving vulnerable people into their own flats. Liberty University, run by Jerry Falwell, a supporter of President Donald Trump, was condemned for keeping its campus open. But thanks to social distancing, it has logged no cases of covid-19.

Poor countries will not be able to afford all these approaches. However, Vietnam and the Indian state of Kerala have shown that good primary-health systems can devise and disseminate sensible adaptations. Poor countries have more experience of infectious diseases than rich ones. Epidemiologists talk of “smart containment” that all can practise.

Rwanda has put foot-operated handwashing stations in busy places such as bus depots. Slums need clean water for handwashing and to cut queues. Local leaders can spread health messages and designate areas where suspected cases can be isolated.

Markets must remain open, but limit social contact. If people can earn some money, millions who would otherwise go hungry could feed themselves.

The emergency phase of the pandemic is drawing to a close. Too many governments failed to spot what was coming, but then did what they could. In the much longer second phase they will have no such excuse. They must identify groups at risk; devise and enact policies for them; explain these so that vulnerable people change their behaviour without becoming scapegoats; provide vital infrastructure; and be ready to adapt as new data come in.

This will sort countries where the government works from those where it does not. The stakes could not be higher.

How Dollar Distress Migrated to Asia

The Fed’s dollar swap figures show that Asia has taken over as the likely axis of future dollar-denominated blowups

By Mike Bird

Many Asian central banks leaned on the Fed’s dollar swap lines in April. / Photo: Paul Yeung/Bloomberg News .

Foreign central banks binged on the Federal Reserve’s dollar swap lines in April, just as they did during the global financial crisis. But there’s been a major change: This time, the action is concentrated in Asia, not Europe.

Figures released Thursday by the Fed, running to May 5, confirm again that Japan has been by a distance the largest user of the swaps. So far, 46% of the $791.09 billion in lending has been to the Bank of Japan.

That’s a huge contrast to the global financial crisis, when the European Central Bank accounted for almost 80% of the roughly $10 trillion in short-term credit extended from 2007 to 2010.

The main growth in Asia comes from Japan, but it isn’t alone: The Monetary Authority of Singapore and Bank of Korea respectively account for 2.4% and 2.5% of the total lending this time, compared with less than 0.5% apiece between 2007 and 2010.

Since the double whammy of the financial crisis and euro crisis, many banks have retreated from global lending with burned fingers. That is true particularly in Europe: cross-border lending by the U.K., French, German, Dutch, Italian and Spanish banks combined has declined by around 30% since the end of 2007.

Meanwhile, Asia has stepped into the breach. Japan’s cross-border lending has almost doubled in the same period. South Korea and Taiwan’s smaller volumes have more than doubled. China didn’t report its data to the Bank for International Settlements back in 2007, but its cross-border lending has risen 50% since it began publishing figures at the end of 2015.

It’s not only in banking that Asia has grown in size and importance: Insurers have gorged on dollar-denominated corporate debt, particularly in Taiwan, but also in Japan and South Korea.

As the gravity of the dollar’s global use has migrated, it likely follows that pockets of stress do, too.

The dog that hasn’t yet barked is the Fed’s FIMA repo facility. The outstanding balance of the facility once again registers at zero.

That makes some sense. While central bank swap lines can actually be considerably cheaper than market funding, the Fed’s repo facility charges a premium which typically exceeds market interest rates. The facility is designed to be used only in times of genuine distress.

But it’s worth noting which places have already begun arranging a line with the Fed: Bank Indonesia has an as yet unused $60 billion arrangement.

The Hong Kong Monetary Authority announced its own $10 billion facility.

There’s no news on Taiwan’s potential use of the facility, but with large dollar reserves and no access to the Fed’s dollar swap lines, it could be a future beneficiary.

If the facility is tapped in the future, it will likely be by major commodity exporters, East Asian economies with ample reserves but large dollar exposures, or both.

So keep an eye on Asia for moments of dollar-related vulnerability, particularly if the Fed judges that markets are calm enough to begin gradually withdrawing emergency support measures.