ETFs not to blame for market turbulence, says BNY Mellon

Industry will recover with global assets hitting $6tn despite recent outflows

Emma Dunkley

© FT montage

The exchange traded fund industry is being defended from accusations that it helped to cause last month’s global markets turbulence, despite a slump in investor interest and mounting scrutiny of the role played by passive investments.

Jeffrey McCarthy, chief executive of BNY Mellon’s ETF asset servicing business, said the industry would recover from the turmoil, adding: “ETFs do not cause volatility — an ETF is diversified in its investment across a wide variety of securities . . . it’s more the rise of program trading.”

His comments come after the Bank of International Settlements said on Monday that volatility-linked passive funds aggravated the stock market slide in February.

Mr McCarthy said global ETF assets are set to swell to $6tn by the end of the year, up from about $5tn in January.

A number of ETFs were halted in the US in 2015 due to “extreme volatility”, he added, and the incident “spurred looking at trading rules at exchanges . . . sometimes market volatility events can put a spotlight on rules for examination, and that can be positive”.

A handful of “inverse Vix” passive products, including both exchange-traded notes and ETFs, plunged when the volatility index soared to its highest level in two-and-a-half years as stock markets sank.

Mr McCarthy said ETNs “operated and performed how they were supposed to”.

The bulk of passive products tracking the Vix index are exchange-traded notes rather than funds, as the latter typically invests in a broader range of securities.

The scale of investor fright from ETFs was shown by fresh data from ETFGI, an ETP research company. Market volatility sparked the first ETF outflows in two years in February with some $23.5bn being pulled from funds that track US and Canadian equities.

The recent outflows have raised questions over whether the ETF market can continue to expand at the current rapid rate after it breached the $5tn barrier in January.

Mr McCarthy said global asset growth in ETFs will in part be driven by greater retail uptake in Asia over the next few years, which lags behind the more mature US and European markets, and said that he is “bullish” on growth in the region.

A sharper focus on fees paid by investors for funds and other financial products, driven by regulation such as the retail distribution review in the UK and more broadly Mifid II, is set to sweep through Asia at some point, which will drive up assets under management, he said.

Regulation has helped to separate the fees attached to investments and those charged by distributors, including independent financial advisers.

The development has benefited the low costs associated with passive investments such as ETFs, which follow an index up or down at a fraction of the price of actively managed funds run by stockpickers.

The Geopolitics of Britain

By George Friedman

The fundamental problem for Britain has always been continental Europe. The danger to Britain was that a single, powerful entity would arise that could do two things. First, it could ally with the Scottish elite to wage war against England on land. Second, it could build a naval force that could defeat the British navy and land an invading force along the English shore of the Channel. The Romans did this, as did the Normans.

Successive powers arose in Europe that saw an opportunity to defeat England and later Britain.

The Spaniards attempted an invasion in the 16th century; the French in the 19th century; the Germans in the 20th century. Each was defeated by treacherous waters and the Royal Navy.

Many other potential invasions were never launched because the navies didn’t exist. They didn’t exist because of the British grand strategy, the core of which was that the nearest landmass, continental Europe, would always place Britain at a demographic disadvantage in a war. The population of Europe was the base of armies vastly larger than that which Britain could field. Therefore, the central strategy was to prevent such a force from landing in Britain.

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Building a naval force able to challenge the British was enormously expensive. Only a very wealthy country could afford it, but very wealthy countries lacked the appetite. Other countries, seeking to increase their wealth, competed with other aspiring countries, diverting resources to land-based forces and making it impossible to build navies. The fact that the continent was fragmented first between kings and emperors, and later between nation-states, was Britain’s primary line of defense.

The wealthiest nations were constantly fending off attacks from neighbors, while the poorer countries plotted strategies for enhancing their position through war. As a result, there were a succession of great continental powers: Spain, the Netherlands, France and Germany. None was strong enough for long enough to divert resources to taking Britain.

The Grand Strategy

British grand strategy, therefore, is to maintain a large naval force, but beyond that, to do what it can on the European continent to discourage hegemony on the mainland by preventing coalitions from forming, or by fomenting rivalries. In other words, the British grand strategy was constant involvement on the European continent, with the primary goal of diverting any nation focusing on naval development. These actions could involve trade policy, supporting various dynasties or nations, using the ability to blockade, or inserting limited ground forces to support a coalition of forces.

British strategy was an endless kaleidoscope of tactics, constantly shifting relationships and actions designed to secure the homeland by maintaining insecurity on the continent. Britain didn’t create insecurity. That was built into the continental geopolitical system. Britain was successful at taking advantage of and nurturing the insecurity that was already there. Britain was always part of Europe, as for example its participation in the Napoleonic wars and the Congress of Vienna. At the same time, it stood apart from Europe because its geography gave Britain another base on which to stand.

The British Empire came into being as a byproduct of this grand strategy. The various imperial naval powers that came into existence were undermined not by naval force but by land conflicts. Spain, the Netherlands and France all developed navies able to carve out empires. But diversions on the continent limited their ability to expand those empires, and drained their ability to exploit them effectively. The British, united after the early 18th century and impervious to European manipulation, were able to sustain an imperial enterprise that constantly expanded and enriched Britain.

The reality of Europe also facilitated British leadership in the Industrial Revolution. Continental manpower, resources and inventiveness were no less than those of the British. But the British had far greater security for their enterprises, less diversion to military production, and a dynamic and growing empire to support industrialization. As a result, Britain developed another powerful tool for managing the continent: exports of manufactured goods and technologies.

What ultimately undermined the British grand strategy was the unification of Germany and the rise of the United States. German unification created an industrial force that could rival Britain commercially and dominate the continent militarily. In World War I, Britain followed a strategy that flowed from its grand strategy, intervening with ground forces to block Germany from imposing a continental hegemony. The cost to Britain far outweighed expectations. The grand strategy failed Britain by forcing it into a vast land war on the continent, taking away the option of selective involvement and manipulation. Britain had to use main force, which negated its geographic advantage.

Also weakening Britain was the emergence of the United States as a power that could field a million men in Europe and create a naval force that was second only to Britain’s. The truce that ended World War I did not end Britain’s problems; it merely delayed them. Within two decades, a re-emergent Germany once again challenged for European hegemony, and Britain’s survival become dependent on the intervention of the United States. In exchange for U.S. support in World War II, Britain all but gave up its empire when it was forced to abandon almost all of its naval bases in the Western Hemisphere in exchange for lend-lease. Having been trapped twice in the one thing she could not do — a European land war — Britain emerged hostage to the United States, now a junior member of its anti-Soviet coalition.

Crafting a New Strategy

The United States then took on the British role on a global basis. Britain was no longer the chess master, but a piece on the board — an important piece, but one that had lost its room for maneuver. Britain had to craft a new grand strategy out of the wreckage of the old. There was, however, a core that remained in place, which was the doctrine of the balance of power. Now, instead of being the major balancing power among other nations, Britain sought to balance its own power between two more powerful entities: the United States and the Soviet Union.

Because of its new position, Britain did not have the option of isolation. Its economic system required access to markets and products, and its strategic position required leverage on the European continent. So in 1973, Britain joined the European Economic Community, and in 1991 agreed to join the European Union. Britain always resisted full integration into the EU, however. In the era after the collapse of the Soviet Union, there were two poles for British strategy: Europe and the United States. Total dependence on either one could lead to disaster. Europe was led by its old nemesis Germany.

The United States was a nemesis as well. Only by having relations with both could Britain hope to retain room for its own maneuver. The two wanted different things. The EU wanted a defined economic relationship with elements of a political one. The United States was open to economic relationship but particularly wanted British participation in its wars. Britain could satisfy both, cling to both poles and thereby find its own space.

The British Dilemma

The problem that Britain faces now is a European Union that doesn’t resemble what the founders imagined, or what existed 10 years ago. Where it had been seen as becoming a pillar of the international system along with the United States, it has morphed into political discord and uncertainty. The United States also has internal problems that were unexpected, but not of the consequence of Europe’s.

Britain’s problem now is being drawn too deeply into dependency on the United States. Such dependency on any country is rarely in a nation’s interest. What Brexit represents is Britain’s distrust of the viability of the European system and a desire to operate independently of it. That is difficult for Britain to do, so the United States is the pole that attracts, if total independence of all coalitions is not an option — which it is not.

This is the British dilemma. The German geopolitical imperative for expansion and the American need to dominate the North Atlantic have taken the old geopolitical reality and radically shifted its grand strategy. Europe is moving toward its historic disunity and class hostility. But Britain is not in a position to manipulate that for its own security. The North Atlantic is no longer Britain’s path to an empire. Depending on Europe is difficult. Relying on the United States is possible, but the U.S. is likely to once again exact a price. What that price is, however, is unclear. The only other alternative is for Britain to try to lead an alternative economic block out of the train wreck of Europe. As Europe’s second-largest economy, this is not an impossibility.

But in the end, Britain is an island, and Scotland is restless. The Germans are united and not altogether predictable. The U.S. is both friendly and avaricious, and its tastes are fickle.

Finding a balance between Europe, however fragmented, and the United States might seem to be best option, but geopolitics tends to force unexpected choices on countries. Who in 1900 would have thought that Britain would be facing the choice it is facing today. Only those who understood what Germany was and what the United States was going to become.

When Shall We Overcome?

Joseph E. Stiglitz

 Black Lives Matter counter protestors at the Unite the Right rally

NEW YORK – In 1967, riots erupted in cities throughout the United States, from Newark, New Jersey, to Detroit and Minneapolis in the Midwest – all two years after the Watts neighborhood of Los Angeles exploded in violence. In response, President Lyndon B. Johnson appointed a commission, headed by Illinois Governor Otto Kerner, to investigate the causes and propose measures to address them. Fifty years ago, the National Advisory Commission on Civil Disorders (more widely known as the Kerner Commission), issued its report, providing a stark account of the conditions in America that had led to the disorders.

The Kerner Commission described a country in which African-Americans faced systematic discrimination, suffered from inadequate education and housing, and lacked access to economic opportunities. For them, there was no American dream. The root cause was “the racial attitude and behavior of white Americans toward black Americans. Race prejudice has shaped our history decisively; it now threatens to affect our future.”

I was part of a group convened by the Eisenhower Foundation to assess what progress had been made in the subsequent half-century. Sadly, the Kerner Commission report’s most famous line – “Our Nation is moving toward two societies, one black, one white – separate and unequal” – still rings true.

The just-published book based on our efforts, Healing Our Divided Society: Investing in America Fifty Years After the Kerner Report, edited by Fred Harris and Alan Curtis, makes for bleak reading. As I wrote in my chapter, “Some problematic areas identified in the Kerner Report have gotten better (participation in politics and government by black Americans – symbolized by the election of a black president), some have stayed the same (education and employment disparities), and some have gotten worse (wealth and income inequality).” Other chapters discuss one of the most disturbing aspects of America’s racial inequality: inequality in securing access to justice, reinforced by a system of mass incarceration largely targeted at African-Americans.

There is no doubt that the civil rights movement of a half-century ago made a difference. A variety of overt forms of discrimination were made illegal. Societal norms changed. But rooting out deep-seated and institutional racism has proven difficult. Worse, President Donald Trump has exploited this racism and fanned the flames of bigotry.

The core message of the new report reflects the great insight of the civil rights leader Martin Luther King, Jr.: achieving economic justice for African-Americans cannot be separated from achieving economic opportunities for all Americans. King called his August 1963 march on Washington, which I joined and at which he delivered his ringing, unforgettable “I Have a Dream” speech, a march for jobs and freedom. And yet the economic divide in the US has grown much wider, with devastating effects on those without a college education, a group that includes almost three-quarters of African-Americans.

Beyond this, discrimination is rampant, if often hidden. America’s financial sector targeted African-Americans for exploitation, especially in the years before the financial crisis, selling them volatile products with high fees that could, and did, explode. Thousands lost their homes, and in the end, the disparity in wealth, already large, increased even more. One leading bank, Wells Fargo, paid huge fines for charging higher interest rates to African-American and Latino borrowers; but no one was really held accountable for the many other abuses. Almost a half-century after the enactment of anti-discrimination laws, racism, greed, and market power still work together to the disadvantage of African-Americans.

There are, however, several reasons for hope. First, our understanding of discrimination is far better. Back then, the Nobel laureate economist Gary Becker could write that in a competitive market, discrimination was impossible; the market would bid up the wage of anyone who was underpaid. Today, we understand that the market is rife with imperfections – including imperfections of information and competition – that provide ample opportunity for discrimination and exploitation.

Moreover, we now recognize that the US is paying a high price for inequality, and an especially high price for its racial inequality. A society marked by such divisions will not be a beacon to the world, and its economy will not flourish. The real strength of the US is not its military power but its soft power, which has been badly eroded not just by Trump, but also by persistent racial discrimination. Everyone will lose if it is not addressed.2

The most promising sign is the outpouring of activism, especially from young people, who realize that it is high time that the US lives up to its ideals, so nobly expressed in its Declaration of Independence, that all men are created equal. A century and a half after the abolition of slavery, the legacy of that system lingers. It took a century to enact legislation ensuring equal rights; but today, Republican-controlled courts and politicians often renege on that commitment.1

As I concluded my chapter, “An alternative world is possible. But 50 years of struggle has shown us how difficult it is to achieve that alternative vision.” Further progress will require determination, sustained by the faith expressed in the immortal words of the spiritual that became the hymn of the civil rights movement: “We shall overcome.”

Joseph E. Stiglitz, a Nobel laureate in economics, is University Professor at Columbia University and Chief Economist at the Roosevelt Institute. His most recent book is Globalization and Its Discontents Revisited: Anti-Globalization in the Era of Trump.

Trump’s Tariffs Could Start a Real War

by Nick Giambruno

Trump’s steel and aluminum tariffs may set his epitaph in stone… “Herbert Hoover II.”

History remembers Hoover as one of the worst American presidents.

Like Trump, he was a rich international businessman. He was also a political outsider. Hoover hadn’t held public office before his 1929 inauguration. And, like Trump, Hoover faced intense pressure from struggling American workers.

In 1930, he signed the Smoot-Hawley Tariff Act into law, raising tariffs on thousands of imported goods to record levels. This kicked off a tariff war, reducing American exports by half. It was a crushing blow to the American economy.

Nearly a century later, Trump seems determined to make the same mistakes…

Trump Started This Trade War Last Summer

Trump placed tariffs on steel and aluminum last week. China, of course, is the world’s largest producer of both.

The mainstream press called the tariffs “unexpected.” But they didn’t come out of nowhere.

Last month, I told readers of my advisory, Crisis Investing, that steel and aluminum tariffs were likely.

In fact, I’ve been pounding the table about a trade war—specifically a trade war with China—since September.

Frankly, I think Trump fired the first shot in this trade war last summer, when his administration launched an investigation against China using Section 301 of the Trade Act of 1974.

This rarely used provision allows Trump to “take all appropriate action... to obtain removal of any [trade] practice that is unjustified, unreasonable, or discriminatory, and that burdens or restricts U.S. commerce.”

Traditionally, World Trade Organization (WTO) members, including China and the US, have settled trade disputes through it. But Trump, using Section 301, has taken a unilateral approach.

The Financial Times describes it like this:

Under the 301 statute, which has not been widely used since the 1995 creation of the WTO, the US would in effect act as judge, jury and executioner on any grievance that it identifies.

No doubt, the investigation will ultimately show that China is pursuing unfair trade practices.

This will give Trump all the justification he needs to further escalate his war.

A Record Trade Deficit With China

The investigation was the start of a major pushback against China.

Trump even said, “This is just the beginning, I want to tell you that. This is just the beginning.” He wasn’t bluffing.

In January, Trump fired another shot. He slapped tariffs on imported solar panels and washing machines. China is by far the largest producer of solar panels.

After that, in his first State of the Union address, Trump said that previous trade deals have “sacrificed our prosperity and shipped away our companies, our jobs and our wealth,” and that the “era of economic surrender is totally over.”

Then embarrassment hit…

In February, the Commerce Department announced that the US had realized its largest ever trade deficit with China during Trump’s first year in office. (He’d repeatedly promised to shrink the deficit.)

Trump sees the trade deficit as an economic scorecard between the US and China. Now, with a record high deficit, he has another convenient excuse to escalate the trade war.

One Promise Trump Can Keep

During his campaign, Trump threatened a 45% tariff on Chinese goods entering the US.

He also said China was sucking “the blood out of the United States” and “we can’t continue to allow China to rape our country, and that’s what they’re doing.”

Getting tough with China on trade is a campaign promise Trump can actually keep. Legally, he doesn’t need anyone’s cooperation, as he demonstrated last week.

It also caters to his base, which believes China is largely responsible for the loss of middle class jobs.

And, as I’ll explain shortly, the new tariffs are part of a much larger and genuinely dangerous conflict with China…

How the American Dream Slipped Off to China

China is displacing the US as the #1 world power.

Its GDP is on track to double compared to US GDP by 2030. In other words, China’s economy will soon be twice as large as America’s.

China has already surpassed the US in more ways than you’d think.

For the first time in modern history, Asia is richer than Europe in terms of private wealth. It will also be richer than North America within the next two years.

China is driving this shift.

The Chinese are some of the most aggressive savers in the world. They save more than 30% of their disposable income.

This is a big reason why more than 700 million Chinese people—the equivalent of nearly twice the entire US population—have risen out of poverty over the past couple of decades.

On top of that, China graduates four times as many STEM students (science, technology, engineering, and mathematics) as the US. And that doesn’t even include the Chinese students enrolled in US universities.

This is a powerful trend in motion. And trends in motion tend to stay in motion, unless something bigger stops them.

In this case, that trend stopper could be a war.

The Biggest Player in World History

There’s a 75% chance the US and China will go to war. That’s according to Graham Allison, a professor at Harvard.

Allison looked at the structural stresses that a rising global power creates when it challenges the ruling power. He studied 16 such cases. In 12 of them, the result was war.

This dynamic played out between Athens and Sparta. It played out between Germany and Britain. And today, it’s playing out between China and the US.

Lee Kuan Yew, the former leader of Singapore, put it this way:

The size of China’s displacement of the world balance is such that the world must find a new balance.

It is not possible to pretend that this is just another big player. This is the biggest player in the history of the world.

Military conflict between the US and China is not inevitable. But if history is any guide, there’s an excellent chance—say, 75%—that the US and China will go to war in the not so distant future.

The US government knows this. Steve Bannon, previously one of Trump’s closest advisers, said, “We’re going to war in the South China Sea… no doubt.”

As China overtakes the US, one or a combination of these three things will happen:

1. The US will do nothing. Current trends will continue. China will displace it as the most powerful country in the world.

2. The US and China will go to war (the traditional kind with troops and bombs).

3. The current economic battle between the US and China will escalate into an all-out economic war.

A full-blown economic war is the most likely and most imminent outcome here. I think it’s almost inevitable under President Trump.

China Won’t Cower in the Corner

Trump knows his supporters are passionate about trade and strongly anti-China. It’s a big reason why he won the election and could be reelected. I don’t see him backing down here.

That said, the Chinese have effective ways to retaliate.

They could dump Treasuries. They could limit imports from the US and reduce exports, like iPhones, to the US. They could also harass US companies operating in China.

China could also restrict access to rare earth elements (REEs). It has a virtual monopoly on REEs, which are absolutely essential to advanced electronics and military equipment. Think electronic cars, flat-screen TVs, drones, and fighter jets.

At this point, a full-scale economic war is pretty much baked into the cake. And as we’ve seen in the past week, it’s also imminent.

Unfortunately, this probably won’t end well for Trump or the US.

As Chinese commerce minister Zhong Shan said on Sunday, “There are no winners in a trade war. It will only bring disaster to China and the United States and the world.”

From Switzerland To Singapore: The World’s Top Tax Havens


The UK-based Tax Justice Network’s new Financial Secrecy Index estimates that the ultra-wealthy are hiding up to $32 trillion in tax havens around the world, and while Switzerland gets the top spot on the new list, the U.S. is a not-so-distant second.

Not even major global scandals such as the Panama and Paradise papers have been able to slow the rise of the bigger and better tax havens, as global industry growth has billion-dollar asset owners looking for the ultimate haven to stow away gains.

These are the top 10 tax havens in 2018, according to FSI:

#1 Switzerland

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Switzerland, a global leader in asset management cornering 28 percent of the market share, is holding an estimated $6.5 trillion, more than half of which comes from abroad.

The attraction is a low tax base coupled with a top-notch banking system.

Switzerland is the ‘grandfather’ of global tax havens, and the world leader in cross-border asset management.

As FSI notes: “…the Swiss will exchange information with rich countries if they have to, but will continue offering citizens of poorer countries the opportunity to evade their taxpaying responsibilities.”

And it’s more secretive than the No 2 tax haven…

#2 The Unites States of America

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The U.S. is on a tear on the competition for the top tax haven spot, rising for the third time in five years, and now capturing the number two slot. In 2015, the U.S. was in third place, and in 2013, it was in sixth.

Between 2015 and 2018, U.S. market share of global offshore financial services rose 14 percent, from 19.6 percent to 22.3 percent.

Delaware, Nevada and Wyoming are the most aggressive tax havens, often described as ‘captured states’.

When it comes specifically to offshore financial services, then, the U.S. now has the largest market share, rivalled only by the City of London, according to FSI, which notes that foreign country elites use the U.S. “as a bolt-hole for looted wealth”.

The baggage is piling up. Take the Delaware tax haven, for instance. It’s housing a company in “good standing” that is used for trafficking children for sex but can’t be shut down because it doesn’t have a physical presence in the state, according to Quartz.

#3 Cayman Islands

Third place go to this overseas territory of the United Kingdom, holding $1.4 trillion in assets managed through 200 banks. With more than 95,000 companies registered, this country is the world leader in terms of hosting investment funds. 

It’s a lot more “upmarket” today than it used to be in its heyday as a hotspot for drug smuggling and money-laundering. Now it deals with some of the world’s biggest banks, corporations and hedge funds.

On the FSI secrecy index, it ranks a 71, right between Switzerland and the U.S.

#4 Hong Kong

While one of the newer tax haven’s—it’s already hit fourth place and is managing some $2.1 trillion in assets (as of the close of 2015), along with $470 billion in private banking assets. It helps that it’s home to the third-largest stock exchange in Asia.

And when it comes to ultra-high-net-worth individuals, Hong Kong leads the pack, with 15.3 per 100,000 households.

The attraction is that companies incorporated in Hong Kong pay tax only on profits sourced in Hong Kong and the tax rate is currently at 16.5 percent. So in all likelihood, they’re paying zero taxes.  

In terms of secrecy, it ranks 71 alongside Cayman.

#5 Singapore

This country is the favorite offshore center servicing Southeast Asia (as opposed to Hong Kong, which caters to China and North Asia).

As of the end of 2015, Singapore was estimated to be holding $1.8 trillion in assets under management, 80 percent of which originated outside of the country.

It has a secrecy ranking of 67.

#6 Luxembourg

This is a tiny state in the European Union that packs a massive tax haven punch. Despite its size, it is said to control 12 percent of the global market share for offshore financial services. The FSI estimates that its 143 banks are managing assets of around $800 billion.

Luxembourg has a secrecy ranking of 58.

#7 Germany

Major tax loopholes and lax enforcement have bumped Germany to number seven on the FSI’s list, despite being one of the world’s biggest economies and not intentionally focusing on global financial services. It corners about 5 percent of market share in the sector, and ranks 59 in terms of secrecy.

#8 Taiwán

This is the first year Taiwan has made the Top 10 list, bumping off Lebanon, which now sits in 8th place.

Beijing’s “One China” policy is largely responsible for Taiwan’s ascendancy on the tax haven scene because it managed to fly under everyone’s radar, not participating in International Monetary Fund (IMF) statistics thanks to Chinese pressure.

And no one’s entirely sure how much offshore money is flowing through here.

#9 United Arab Emirate of Dubai

Dubai, servicing massive regional oil wealth, gets the highest secrecy rating of them all, at 84.

Its offshore facilities are exceedingly complex and offers a low-tax environment and lax enforcement.

It’s also recently been the target of an EU tax haven blacklist.

#10 Guernsey

This small tax haven jurisdiction in the English Channel has risen seven places on the list since 2015, and accounts  for 0.5 percent of the global trade in offshore financial services. Essentially, this is nothing more than a ‘captured state’ with a high secrecy rating of 72.