Dirty Deals

Documents Show Secret Plans for Elite League of Top Clubs

A coalition that includes FC Bayern Munich spent months working on plans to create a private league of elite teams behind the backs of associations and other teams. By DER SPIEGEL Staff

Bayern Munich CEO Karl-Heinz Rummenigge

The email that could lead to the greatest revolution in the history of European football begins with a completely harmless sentence: "Hi Romano, I would have another interesting issue where we would like to mandate you." The message was sent by Michael Gerlinger on Feb. 3, 2016. Its recipient: the international law firm Cleary Gottlieb.

Gerlinger, 45, heads up the legal department at FC Bayern Munich and is more or less the team's behind-the-scenes brain. He rarely appears in public, but team CEO Karl-Heinz Rummenigge hasn't made an important decision without him in over a decade.

Gerlinger's mail is explosive. It concerned nothing less than the future of European football. In it, Gerlinger instructed the lawyers to examine whether FC Bayern Munich could withdraw from the German league, the Bundesliga, and whether the team would have to allow its players to play for the national team in the future.

The Bundesliga without Bayern Munich? The national team without Mats Hummels, Joshua Kimmich or Manuel Neuer? It seems almost unimaginable.

But in 2016, anything seemed possible. That year marked something of a turning point in the realm of top-level, international football. FIFA, the international football federation, seemed leaderless and aimless after a wave of raids and arrests. The European umbrella association UEFA also saw its president Michel Platini ousted from office because of a multimillion-euro payment by former FIFA boss Joseph Blatter. At the same time, the next TV rights for the Champions League and Europa League were soon to be awarded. Revenues for the two competitions almost tripled between 2007 and 2017 and stood at more than 2.2 billion euros by the latter.

The battle that erupted after Gerlinger's mail for all the European tournament money and for the power in elite-level football could almost have been written by a scriptwriter for "House of Cards." All the sleights of hand, the relentlessness and the backroom conversations can be reconstructed with the help of a data set that the whistleblower platform Football Leaks has made available to DER SPIEGEL and its partners in the international research network European Investigative Collaborations (EIC).

The documents provide a sense for who the actual decision-makers in the football business are. They lay bare just how ruthlessly and shamelessly these individuals amass their power in order to pursue their greed for even more money. They also reveal why national -- and, more recently, international -- competitions have become so predictable, why leagues from the Champions League, to the Bundesliga on down to Italy's Serie A are monotonously won by the same teams over and over again.

That is another reason why football in 2016 faced the challenge of having to completely reposition itself. Not to make things more appealing and exciting for fans, but to continue to produce the lavish profit margins the industry has become used to in recent decades.

To achieve that goal, some clubs have apparently even been willing to betray the traditional cooperation between the clubs and the national leagues, one which has provided the framework for European football for decades. Seven of the world's top clubs have secretly joined forces, all apparently with a single idea in mind: Boredom spells the death of any show, and the only way to combat boredom is to put on an even bigger, glitzier show, the greatest football show on earth. The idea is the creation of a Super League, an elite league of top-level competition reserved exclusively for the top names in European club football. Every game is a top game. That is the secret society's plan.

Today, in November 2018, the Super League idea appears to have fresh impetus: According to the draft of a confidential term sheet that Real Madrid received just a few days ago from a consulting firm, 16 top clubs are to sign a document to establish such a league. According to the document, the league would begin operating in the 2021 season. One of the 16 clubs named in the document is FC Bayern Munich.

The Temptation

Charlie Stillitano has a long resume. When the United States professional soccer league was founded in the 1990s, he signed on as the first general manager of the New York/New Jersey Metro Stars. Later, he demonstrated a nose for big deals -- and has focused his attentions since then on international matches. In 2014, Stillitano organized a match between Manchester United and Real Madrid at Michigan Stadium, an event attended by 109,318 fans -- a record for a soccer game in the U.S. to this day.

A heavyset bald man with horn-rimmed glasses and stubble, Stillitano can often be found in the VIP lounges belonging to Europe's most powerful clubs. José Mourinho, the star trainer at Manchester United, almost reverently refers to Stillitano as "Mr. Zero Mistakes."

According to the Football Leaks documents, Stillitano sent an email to two Real Madrid executives on Dec. 17, 2015: General Director José Ángel Sánchez and the team's head of marketing. He wrote that the current draft for the Super League was attached: "Would it be possible to use your laptops to present this in the meeting this morning? Thanks, Charlie."

Stillitano's draft, marked "strictly private and confidential," offered the following to the Real Madrid executives:

- The 17 teams with the strongest TV presences from England, Spain, Italy, Germany and France would compete permanently in a European league.

- The Bundesliga clubs participating in the league would include Bayern Munich, Borussia Dortmund and Schalke 04.

- The 18th participant would be a team from Portugal, Russia, the Netherlands or Turkey.

- The league would run for 34 weeks, with matches on Tuesdays, Wednesdays and Saturdays.

- There would be a knockout round at the end of the season.

The debate about the introduction of a Super League has been ongoing for more than 30 years and there have been repeated attempts to completely reform European football and create a league for the best of the best. Secret projects with abstruse names like "Gandalf" were devised, and the top chieftains of football, such as then-AC Milan patron Silvio Berlusconi and later Real Madrid President Florentino Pérez, were completely convinced of the idea of an elite league.

But none of the projects came even close to Stillitano's idea. In his presentation, he calculated that each of the top clubs could achieve annual revenues of "500 million euro plus." By way of comparison, Real Madrid, the 2016 Champions League winner, received around 80 million euros from UEFA.

Calculated Disinformation

Several months later, in August 2016, Karl-Heinz Rummenigge made a sensitive statement at a meeting of the European Club Association (ECA). By that time, he had been chairman of the ECA -- the world's largest club alliance, representing the interests of more than 220 teams -- for eight years. According to the minutes of one meeting, Rummenigge said that "the big clubs received big offers to create a super league and that UEFA then called for a meeting with representatives of some of these big clubs a couple of weeks ago with a proposal to keep European club football united."

The message was clear: Unless the big clubs got more money and power from UEFA, they would start their own league.For smaller and midsized clubs, whose interests the ECA is also supposed to protect, such a scenario would be a disaster. UEFA distributes TV revenues to teams playing in the Europa League and Champions League according to a revenue-sharing formula ensuring that smaller teams also get a cut. But if the top clubs were to turn their backs on the UEFA competitions, the other clubs would lose out on millions in revenues. For some of the clubs, such a rearrangement could threaten their very existence.

In 2016, the big clubs found themselves in an excellent position to push through almost all their demands. But how could they have come so far?

The Football Leaks documents clearly show that Rummenigge's negotiating strategy hinged on one tool in particular: calculated disinformation. He only told the respective groups he was speaking to exactly as much as necessary to prevent a backlash. The ECA in particular, along with the league associations, were taken by surprise by the elite clubs' reform plans.

The Secret Society

On Jan. 30, 2016, Real Madrid's General Director Sánchez emailed one of Stillitano's Super League presentations to the club's vice president and noted: "This document needs to be analyzed."

Real Madrid then chose to follow a path that was rather unusual in the world of ego-driven, competitive football: Together with six other top clubs, the Spaniards assembled a kind of task force that would look into the establishment of a Super League. In the months that followed, Real, FC Bayern Munich, Juventus Turin, FC Barcelona, Manchester United, London-based Arsenal FC and AC Milan would go behind the backs of UEFA and the other clubs to work together to also develop an option for leaving the national leagues and their football associations behind entirely.

Seven competitors, organized in a cartel-like structure, were now exploring how they could nullify the established competitions. Competitions from which they had done quite well up to that Point.

It was on behalf of this secret society that Bayern Munich's chief legal counsel, Michael Gerlinger, sent his initial email to the law firm of Cleary Gottlieb in February 2016. He received a response only 18 minutes later, with one of the lawyers offering him a phone call. A few hours later, Gerlinger sent another email to the lawyers, this time with a clear assignment.

"As you can see (...), we have basically 3 different break-away options," he wrote, before listing them out: to leave the European competitions or to completely back out of the national leagues and their associations. Gerlinger divided the last point into two scenarios for two differing points in time.

The remainder of the email consisted of questions that were meant to assess the legal implications of such a departure -- questions that challenged the fundamental values of the European football community:

- Could the Super League clubs be held liable for any loss of revenue at UEFA?

- Would the clubs still be required to allow their players to play for national teams after leaving UEFA?

- Could the associations or leagues penalize players for participating in the Super League?

- Could players have their contracts annulled if their club switched to a private Super League?

A meeting of the ECA club alliance took place in Paris just six days after Gerlinger's email, with more than 140 high-ranking representatives of top European football clubs gathering to discuss FIFA, UEFA and a possible reform of the Champions League. According to the minutes of the meeting, ECA Chairman Karl-Heinz Rummenigge stated that the ECA and UEFA were striving for an "evolution of the competitions."To this end, he added, there would be an "exchange of ideas ... at different levels" and a few "informal working groups" would address the issue.

Rummenigge seems to be a true master when it comes to trivializing important information. The fact that he also possesses a high degree of moral flexibility can be seen by his dig against the global association: "FIFA needs a transparent, democratic and efficient structure with a new vision. (...) FIFA, as an umbrella organization, needs to ensure from the top that the basic virtues of football, fair play and seriousness are preserved."

Transparency. Democracy. Fair play. Seriousness.

Even as Rummenigge was spouting his flowery rhetoric, the international law firm was busy examining on behalf of Bayern legal counsel Gerlinger the possibilities for doing away with everything that the ECA was trying to reform.

The lawyers needed about a month for their initial analysis. On March 1, 2016, Bayern Munich received a confidential memorandum that provides a perfect illustration of the ability of top lawyers in modern football to expose every single legal loophole.

In the 23-page document, they enumerated the legal hurdles for the foundation of a Super League. They noted that neither UEFA nor FIFA could seriously penalize the top clubs for withdrawing as this would represent a fundamental violation of "EU competition law." The lawyers then moved on to a so-called Memorandum of Understanding (MoU), which the ECA had signed with UEFA in 2015.They noted, however, that this agreement on objectives was not binding because the MoU, in which the clubs committed themselves to UEFA and its competitions, was not signed by the individual clubs but only by the ECA umbrella association.

The fact that it was Gerlinger himself who had taken a leading role in negotiating this MoU with UEFA -- and received a bonus of 25,000 euros from the ECA for doing so -- makes the double-dealing that much more grotesque.

The international law firm's assessment provided the top clubs with numerous arguments to protect themselves and their players from possible lawsuits by associations, leagues and competing clubs. But the lawyers also anticipated some problems if the clubs were to withdraw from their national associations: On the one hand, the clubs would likely still have to continue to allow players to play for the national team because the World Cup and the European Championship enables players to "increase their value (and salary)." Denying players that opportunity could quickly result in a lawsuit.

On the other hand, Bayern Munich in particular would face a serious problem if it were to withdraw from the Bundesliga. Player contracts in Germany contain a clause that binds them exclusively to the Bundesliga. Should FC Bayern Munich actually take the step of leaving the league, the lawyers argued, the players could possibly terminate their contracts unilaterally and switch to other teams without transfer fees. A nightmare scenario that could result in the loss of hundreds of millions of euros for the team from Munich.

But the Bavarians didn't seem to be particularly deterred. In the following months, they would continue working together with the other conspirators, their expensive lawyers and high-profile investors on a possible solution to the problems.

The Whistleblower

"What do you notice when you read the cartel's documents?" John asks. It's August and he's sitting on a plastic chair in black shorts inside a tiny apartment somewhere in Eastern Europe. There is a large water stain on the ceiling and one of the windows can no longer be closed. John stares at his laptop as a vast number of documents fly across the screen and says: "The clubs are constantly talking about the Super League and how they can market all this shit even better and make even more money. But there's one thing they never talk about: the fans. About the people who made this sport great. What does a league like this, with matches being televised around the world, do with the spectators?"

John learned to love football as a child, and he is troubled by the fact that the sport has become purely a business and entertainment operation. John says he is disgusted by what money has done to football, by all the corruption and talk of tax evasion, and by the many dirty deals made by consultants, players and officials.

About three years ago, John, which is not his real name, had had enough. The young man founded the Football Leaks platform. What began as a home page on which John publicly posted confidential documents such as player contracts, transfer agreements and sponsorship deals, has now become one of the biggest threats to the dark side of football. In February 2016, John decided to turn over a large portion of his documents to DER SPIEGEL. Together with the research network EIC, the newsmagazine has since evaluated huge amounts of data and transformed it into hundreds of stories.

Cristiano Ronaldo and several dozen other top players had to pay millions in fines and back taxes as a result of the revelations, with some of the professionals almost having to do prison time for tax fraud. Furthermore, several additional investigations are underway throughout Europe against players, agents, tax consultants, lawyers and officials, on allegations ranging from corruption and tax fraud to bribery -- and even an accusation of rape.

But that still isn't enough for John.

The whistleblower handed over additional tranches of data to DER SPIEGEL at the beginning of this year. The Football Leaks trove now includes more than 70 million documents and over 3.4 terabytes of information, making it the largest data leak in history. The collection also contains the documents relating to the secret plans for a Super League.

Together with its EIC partners, DER SPIEGEL spent eight months evaluating the data. Around 80 journalists from 15 media outlets worked on exposing all the legal violations and secret deals. They extend across the entire football industry: from the president of FIFA to emirate-owned clubs such as Paris Saint-Germain and Manchester City, to smaller clubs that incorporate foreign youth players like mass-produced goods, either using them to turn a profit or abandoning them. Then there are the player agents, for whom there are apparently no limits at all. The Football Leaks data set also includes information on the topics of doping, betting fraud and racism. DER SPIEGEL and the EIC will publish these stories in the coming weeks.

"All of this has to come to light. The people who truly love football and who constantly pay for it have a right to know how it really works. Football has spun completely out of control. The Super League plans clearly show who has the say in the sport: Rich investors and a few top clubs are bullying everyone else," says John.

Football finds itself facing a crucial question: Who does the sport belong to? The fans who made it great? The clubs that keep it running? Or the associations that are supposed to supervise it?

"Honestly, I don't care if there is a Super League or not. What bothers me is the kind of secret deals that super clubs are making. Everything happens in secret, there's hardly any oversight, and there is no transparency -- and that is the breeding ground for criminal activity," says John.

He opens a presentation marked "strictly confidential" on his laptop, a document apparently shared among members of the secret society. It shows that in 2016, football earned over $16.7 billion from global TV rights, more than twice as much as American football, the next sport on the list.

"The fans and the federations have to be able to understand what is actually happening with all the money," John says. "Instead, they are left completely in the dark, and in the end, it's just a handful of people who are taking the lion's share."

John opens emails from Michael Gerlinger, calls up ECA reports by Karl-Heinz Rummenigge and scrolls through UEFA contracts. Where does he get all these confidential documents?

Recently, there have been a number of reports claiming that football clubs and law firms may have been hacked, and that someone at Football Leaks may have obtained information using so-called phishing emails.

In John's home country of Portugal, newspapers and television channels have been reporting for months about a case in which leaked data has plunged the country's most popular club, Benfica Lissabon, into a morass of investigations for alleged corruption, gambling manipulation and bribery.

Some media organizations have claimed that Football Leaks is also behind those revelations. John, though, says he has no desire to comment on "all the nonsense that gets printed in some newspaper." He repeatedly stresses that neither he nor any of his comrades-in-arms is a hacker. "We have very good sources and a strong network that provides us with a lot of information," he says.

Whether or not you believe what he says, one thing is true: So far, none of John's documents have turned out to be fake. The stories that have come out of the data he has collected have a high degree of social relevance and have even revealed criminal activities. And the whistleblower has never tried to determine the direction or the tenor of an article. "We do not spare anyone, we don't work on behalf of an intelligence service, association or player agent and we're not paid by anyone," says John. He is unwilling to disclose the names of anyone else working on the project.

He knows that investigations have been launched against Football Leaks in several countries and that football clubs and player agents have hired private detectives to come after him. "The life of a whistleblower is problematic. But, much like Edward Snowden, Chelsea Manning or Julian Assange, we believe in what we are doing and think that this form of disclosure is important to society," says John.

He opens another file, a presentation titled "A Super League Scenario for Top European Football." John says: "Take a closer look at this. In 2016, the associations lost all control over the top clubs in connection with the Super League negotiations. The public hardly learned anything about it, but this power shift will have devastating consequences for football."

The Operation

Charlie Stillitano is nothing if not persistent. In 2016, a few weeks after his meeting with Real Madrid, he visited the five top clubs in the Premier League: Manchester United, Arsenal, Chelsea, Liverpool and Manchester City. The meeting took place at a luxury hotel in London.

Shortly after the meeting, paparazzi photos emerged showing top officials leaving the hotel and the British tabloid Sun ran a cover story under the headline: "Top Secret European Super League Summit Revealed." But aside from the information that the club bosses had met at the hotel and talked to Stillitano about some sort of competition, nothing was revealed.

   Khaldoon Al Mubarak, chairman of Manchester City

Nevertheless, the top English clubs went into panic mode, with their press offices agreeing on statements in an effort to get the situation halfway under control. An adviser to the Arab financiers behind Manchester City also got involved. As the Football Leaks documents show, he wrote the following message to CEO Ferran Soriano: "We need to be very careful moving forward and avoid at all costs the perception of a cartel." Soriano replied by saying that the clubs would have to find a more private venue for future meetings.

Stillitano's presentations continued. In early March, he traveled to Munich and showed his concept to Gerlinger. Stillitano, who referred to the secret society simply as the "Big Seven," explained in his presentation how the withdrawal from the national and international leagues and associations might work. Gerlinger would later ask Stillitano to email him the plan. On March 31, there was to be a meeting of the "Big Seven" club bosses, where Gerlinger also wanted to introduce Stillitano's ideas.

At this meeting, the clubs were much more cautious than their counterparts in England. The leaders of the secret society met in a convention hotel in Zurich, where they used conference rooms booked confidentially in the name of an inconspicuous travel agency. The presentation "A Super League Scenario for Top European Football," the same one which had made such a strong impression on whistleblower John, was now shown to the club presidents. It raised sensitive issues: Should the clubs leave the national leagues completely or only turn their backs on UEFA? And what would UEFA have to offer to prevent them from doing so?

The top executives discussed whether a Super League should be "open, semi-open vs closed" -- in other words, whether teams could qualify for this league or whether there would only be a fixed field of participants without promotions and relegations. And the officials were told that they were losing hundreds of millions of euros due to UEFA's organizational expenses and the revenue-sharing agreement with smaller clubs.

At the end of the presentation, two options were submitted: "revolution" or "evolution." In the case of revolution, there was a need for a "timeframe and parameters for break-away from leagues and federations." A communication plan, a marketing strategy and an independent company would be needed. At the same time, the possibility of "evolution," i.e., staying in the UEFA and the leagues, was to be explored further. Gerlinger, Barcelona director Raúl Sanllehí and Stefano Bertola of Juventus Turin would conduct talks with UEFA about these plans in the weeks that followed.

But there were still a few hurdles to overcome before a meeting with high-ranking members of the European association could take place at the beginning of May.

First, Gerlinger and his co-conspirators headed to the regularly scheduled ECA meeting in Amsterdam. Some of the smaller clubs discussed plans for reforming the European competitions. According to meeting minutes, Raúl Sanllehí explained that UEFA was thinking about introducing a third competition above the Champions League, adding that it would act "as a revenue driver." Rummenigge added that "the big clubs have some ideas on the format."

Not a word was said about a possible withdrawal from the national leagues, and there was no indication that some of the top clubs had already worked out concrete concepts for a private league. In fact, it was even suggested that UEFA itself was promoting the plans for an elite competition.

Indeed, it appears that the sole function of ECA meetings was to reassure small- and medium-sized clubs as a way of keeping them under control.

Conditions for Staying

Six days after the meeting with the clubs, Gerlinger sent out another email to the representatives of the secret society. The first item in the email read: "Creation of a Swiss Company."

Gerlinger explained that there had been a conference call with the international law firm and that they were now thinking about setting up their own company to manage the economic rights of the Super League, should it come to fruition.This company would increase the "pressure" on the association, the email noted. "UEFA is clearly fearing that we market our rights ourselves," Gerlinger wrote. But the establishment of such a company in Switzerland, where FIFA, UEFA and ECA are all based, would be problematic, in part because a Swiss bank account is necessary when setting up a "commercial company." But according to new legislation, Gerlinger explained, the establishment of a company bank account was apparently only possible if the company could also demonstrate that it had "proper real office space and employees with signatory power that are Swiss residents." That, however, would mean additional costs, so the group charged the law firm with searching for other countries to host the company.

The football executives gradually seemed to be realizing that the complete withdrawal from the leagues and associations would require considerably more time and planning.

Meanwhile, though, the secret society was intensifying its talks with UEFA. And because the expectations of the Big Seven had been massively elevated by all the tempting numbers and beautiful presentations, and because UEFA was almost completely in the dark, the ensuing conflagration was inevitable.

In early May, a few members of the Big Seven flew to Budapest for a meeting with senior UEFA officials. Four days later, Bayern Munich sent out an email signed by Rummenigge and his Juventus counterpart, Andrea Agnelli, summing up the Budapest talks. "Not one of the ... expectations were met." According to the two officials, UEFA was obviously not capable of arriving at competent solutions. They argued that the top clubs, "which are unanimously acknowledged as the drivers of the system," were now facing "global threats," making the further development of European competitions "not an option: It is a necessity."

The two club representatives wrote that they would agree to remain in the Champions League, but the following conditions should be fulfilled:

- the league would only include 24 teams in the future;

- clubs that had been extremely successful in the past should be rewarded with additional spots in the tournament;

- some European competition matches should be held on weekends and more matches must be scheduled for time slots convenient for broadcast in more TV markets worldwide;

- and the clubs had to be given the power to organize and control the competition together with UEFA.

What Rummenigge and Agnelli were demanding was nothing less than a vast shift of power and revenue in favor of the top clubs. One might also say: It was a betrayal of the over 200 smaller and midsized clubs that Karl-Heinz Rummenigge also represented as head of the European Club Association.

Not surprisingly, UEFA expressed shock in its response, complaining that the meeting had been called merely as "a first face-to-face" among senior executives on the issue and that there had been "no clearly defined objective" prior to the discussion. No decisions at all could be made under these circumstances, UEFA wrote, adding: "We would be grateful if you could inform us about the group of clubs that you represent." UEFA then explained how democratic processes in European football actually work and that there are a variety of committees within which such decisions are taken.

The email was UEFA's last serious attempt to push back against the dominance of the top clubs. In the ensuing weeks, the secret society's plans to withdraw from UEFA competitions became increasingly concrete. The clubs' lawyers were checking into whether they could set up their company in Brussels or London. Club executives reached agreement on a format for the Super League. And they also developed a formula for revenue distribution.

The threats issued by the top clubs come extremely close to blackmail. And the method proved to be effective.

UEFA was increasingly seeking to deepen communication with the leading promoters of the secret league. There were informal discussions, a so-called "handshake" meeting was arranged between UEFA representatives and important members of the Big Seven, and Gerlinger and his associates traveled to the organization's headquarters in Nyon, Switzerland. Subsequently, UEFA submitted initial offers that were extremely accommodating of the top clubs. The reform process was now truly getting underway.

Rummenigge presented the new plans at the ECA meeting in Monaco on Aug. 25, 2016. He said an agreement had been reached for 32 teams to participate in the Champions League. Rummenigge admitted that "communication amongst the clubs had not been ideal." But from his perspective, UEFA was to blame because it had "wanted to keep the discussions highly confidential." Rummenigge also said that the association had asked the top clubs to jointly manage the current allocation of rights. Starting in 2017, however, UEFA had promised to work on a serious reform of European football, which would then be implemented with the new rights period, starting in 2021.

A critical examination of Rummenigge's comments to the ECA, though, suffices to conclude that there is more to the story.

The solution found with UEFA will be beneficial primarily to the top clubs. Thanks to the new regulations, they will receive more money than ever before. The tradition clause alone, which allots greater revenues to those clubs that have found success in the last 10 years in the Champions League and Europa League, will generate over 30 million euros for FC Bayern starting with the 2018/19 Champions League season -- money that is guaranteed even before the club had even played its first game.

Furthermore, the reform will increase the monetary prize owed to the winner of each Champions League match, which also only benefits the top teams. It translates into less money available to the second-tier Europa League and less money in the revenue-sharing pot -- and a growing gap between top clubs and the rest. The impact will be even greater in the national leagues, where real competition will become virtually impossible with such a vast financial gap between the top and bottom teams.

But in the future, that may not even matter.

Because the top clubs got something else as well. Their representatives will occupy four of the director slots in a joint company with UEFA. This means the secret society's three negotiators, Gerlinger, Sanllehí and Bertola, will become part of this body, and over the course of the next three years, they will be able to examine all of UEFA's balance sheets, sponsorship deals and broadcast-rights agreements along with the administrative, organizational and operational costs of UEFA competitions. They will, in short, learn everything they need to know to organize their own competition. Priceless knowledge.

"This is a big mistake by UEFA and we oppose that," wrote Lars-Christer Olsson one day after the ECA meeting. A native of Sweden, Olsson is president of the European Professional Football Leagues (EPFL), an association tasked with protecting the interests of 35 national leagues, including the Bundesliga. According to Olsson, the joint company established by UEFA and ECA is "a first step towards a private super league in Europe." Bundesliga head Christian Seifert was also surprised by the reform plans. He said he was seeing the plans for the first time.

A few days later, the secretary general of the EPFL sent out a 10-page memo intended to provide a "legal and political overview of the current situation." In the memo, the EPFL took an even more drastic view of the reform of the European leagues than Olsson had before: "These amendments were the result of the pressure and threat posed by the top clubs which have been in position to profit from the power vacuum at UEFA and impose their reform with the help of UEFA apparatchiks."

Eleven Founders

It's early October and Michael Gerlinger, the chief legal counsel for FC Bayern, is sitting in his office at team headquarters in Munich. His desk is covered with documents, the shelves behind him are packed with binders. Gerlinger says his primary concern throughout the negotiations was the clubs' self-determination. It was an important achievement, he says, and the cooperation with UEFA in the joint company is "outstanding."

And what about the plans to leave the Bundesliga? It was an option that was looked into, says Gerlinger, because the teams had to be prepared for all eventualities. But no one was truly serious about the idea, and it was soon "completely off the table," Gerlinger says. The attorney goes on to say that the Super League is "quite a different possibility." It would involve "brands" playing against each other, leading to a new level of commercialization in football. FC Bayern would naturally have to be part of something like that, since it wants to be one of the five best teams in the world. But Karl-Heinz Rummenigge, he says, was clearly uncomfortable with the idea of such a privately organized competition. Rummenigge was also the one, Gerlinger says, who said that they should come to terms with UEFA.

Is the Super League dead? It is at least "as far away as ever." Discussions with UEFA are currently underway for formats starting in 2024, he says. There is no reason "to be afraid" of a Super League. Says Gerlinger.

In Spain, however, there are those who apparently have a different view.

On the night of Oct. 22, Real Madrid received an email with the subject line: "Draft of an Agreement of the 16." It was addressed to club president Florentino Pérez. The message was from Madrid-based Key Capital Partners, which advises corporations working on huge projects.

A document was attached to the email -- the draft of a 13-page "binding term sheet" of 11 European top clubs for the establishment of a Super League. If everything proceeds in accordance with the "binding term sheet," the Champions League will cease to exist as of 2021. Instead, the continent's 11 most important clubs will break away from UEFA and found a new elite class called the "European Super League." The 11 "founders" would not be at risk of relegation and would be guaranteed membership for 20 years. Another five clubs will be included as "initial guests," so that the new league would consist of 16 teams.

The project, the document states, is subject to the utmost secrecy. According to the draft, the date for the signature of the 16 club representatives under the "binding term sheet" is set for November 2018, but the specific day has been kept open.

The 11 clubs listed as "founders" of the European Super League -- the ones that would apparently not face relegation -- are Real Madrid, FC Barcelona, Manchester United, Juventus Turin, FC Chelsea, FC Arsenal, Paris Saint-Germain, Manchester City, FC Liverpool, AC Milan -- and Bayern Munich. All seven clubs in the secret society are represented. The five "initial guests," according to the document, would be Atlético Madrid, Borussia Dortmund, Olympique Marseille, Inter Milan and AS Roma.

The 11 founding clubs, according to the document, would register a company in Spain to market, organize and execute the European Super League under its full control. The competition would have two phases: a group round and a knockout round. A second league under the European Super League would possibly also be established.

From this second group, the best teams at the end of the season could play a series of matches in an effort to win promotion to the Super League, but only against clubs that are "initial guests." The plans are explicitly based on Euroleague Basketball, which is not completely impermeable so as not to violate European competition law.

The document also lists the possible ownership stakes that would be held by the individual clubs in the joint European Super League company, with Real Madrid holding 18.77 percent, Barcelona 17.61 percent and Manchester United 12.58 percent. Bayern Munich would be the fourth largest shareholder at 8.29 percent.

There isn't a single mention of UEFA in the entire draft contract.

When contacted, Real Madrid, the company Key Capital Partners and Borussia Dortmund CEO Hans-Joachim Watzke all declined to comment on the concrete document in question. But the fact that discussions about the Super League are currently ongoing, said Watzke, "is clear, and I also believe that a few of Europe's large clubs are clearly working on it." Still, the BVB boss says, such plans are apparently "not very concrete" yet.

He says that also has to do with the decisive question: Should the Super League take place in addition to, or instead of, the Bundesliga, Germany's top league? "That is the firewall," says Watzke. "For as long as I carry responsibility around here, BVB will not leave the Bundesliga." Beyond that, though, Borussia has to "keep all its options open." Because if a Super League ever became a reality, "that couldn't happen without BVB."

Michael Gerlinger and Karl-Heinz Rummenigge had the FC Bayern Munich media director respond on their behalf to written requests for comment on the new Super League plans and on the agreements made by members of the secret society. The club, he wrote, was aware of "neither the existence nor the content" of the term sheet draft. Furthermore, he added, Bayern Munich "as a matter of policy, does not comment on confidential discussions."

China v America

The end of engagement

How the world’s two superpowers have become rivals

FOR THE past quarter century America’s approach to China has been founded on a belief in convergence. Political and economic integration would not just make China wealthier, they would also make it more liberal, pluralistic and democratic. There were crises, such as a face-off in the Taiwan Strait in 1996 or the downing of a spy-plane in 2001. But America cleaved to the conviction that, with the right incentives, China would eventually join the world order as a “responsible stakeholder”.

Today convergence is dead. America has come to see China as a strategic rival—a malevolent actor and a rule-breaker. The Trump administration accuses it of interfering in America’s culture and politics, of stealing intellectual property and trading unfairly, and of seeking not just leadership in Asia, but also global dominance. It condemns China’s record on human rights at home and an aggressive expansion abroad. This month Mike Pence, the vice-president, warned that China was engaged in a “whole-of-government” offensive. His speech sounded ominously like an early bugle-call in a new cold war.

Do not presume that Mr Pence and his boss, President Donald Trump, are alone. Democrats and Republicans are vying to outdo each other in bashing China. Not since the late 1940s has the mood among American businessfolk, diplomats and the armed forces swung so rapidly behind the idea that the United States faces a new ideological and strategic rival.

At the same time, China is undergoing its own change of heart. Chinese strategists have long suspected that America has secretly wanted to block their country’s rise. That is partly why China sought to minimise confrontation by “hiding its strengths and biding its time”. For many Chinese the financial crisis of 2008 swept aside the need for humility. It set America back while China thrived. President Xi Jinping has since promoted his “Chinese Dream” of a nation that stands tall in the world. Many Chinese see America as a hypocrite that commits all the sins it accuses China of. The time to hide and bide is over.

This is deeply alarming. According to thinkers such as Graham Allison of Harvard University, history shows how hegemons like the United States and rising powers like China can become locked into a cycle of belligerent rivalry.

America fears that time is on China’s side. The Chinese economy is growing more than twice as fast as America’s and the state is pouring money into advanced technology, such as artificial intelligence, quantum computing and biotech. Action that is merely daunting today—to stem the illegal acquisition of intellectual property, say, or to challenge China in the South China Sea—may be impossible tomorrow. Like it or not, the new norms governing how the superpowers will treat each other are being established now. Once expectations have been set, changing them again will be hard. For the sake of mankind, China and America need to come to a peaceful understanding. But how?

Mr Trump and his administration have got three things right. The first is that America needs to be strong. It has toughened the rules on takeovers, to give more weight to national security. It has extradited an alleged Chinese intelligence officer from Belgium. It has increased military spending (though the extra money going to Europe still dwarfs that going to the Pacific). And it has just boosted foreign aid in order to counter lavish Chinese investment abroad (see article).

Mr Trump is also right that America needs to reset expectations about Chinese behaviour. Today’s trading system fails to prevent China’s state-backed firms from blurring the line between commercial interests and the national interest. Government money subsidises and protects companies as they buy up dual-use technology or skew international markets. China has used its state-directed commercial clout in smaller countries to influence foreign policy in, say, the European Union. The West needs transparency about the funding of political parties, think-tanks and university departments.

Third, Mr Trump’s unique ability to signal his disregard for conventional wisdom seems to have been effective. He is not subtle or consistent, but as with Canadian and Mexican trade, American bullying can lead to dealmaking. China will not be so easily pushed around—its economy depends less on exports to America than Canada’s and Mexico’s do and Mr Xi cannot afford meekly to disavow his Chinese Dream in front of his people. Yet Mr Trump’s willingness to disrupt and offend has already wrong-footed China’s leaders, who thought they could count on America being unwilling to rock the boat.

For what comes next, however, Mr Trump needs a strategy, not just tactics. A starting point must be to promote America’s values. Mr Trump acts as if he believes that might is right. He shows a cynical disdain for the values America enshrined in global institutions after the second world war. If he follows that course America will be diminished as an idea and as a moral and political force. When America competes with China as a guardian of a rules-based order, it starts from a position of strength. But any Western democracy that enters a ruthless race to the bottom with China will—and should—lose.

The strategy should leave room for China to rise peacefully—which inevitably also means allowing China to extend its influence. That is partly because a zero-sum attempt at containment is likely to lead to conflict. But it is also because America and China need to co-operate despite their rivalry. The two countries are more commercially intertwined than America and the Soviet Union ever were. And they share responsibilities including—even if Mr Trump denies it—the environment and security interests, such as the Korean peninsula.

And America’s strategy must include the asset that separates it most clearly from China: alliances. In trade, for example, Mr Trump should work with the EU and Japan to press China to change. In defence Mr Trump should not only abandon his alliance-bashing but bolster old friends, like Japan and Australia, while nurturing new ones, like India and Vietnam. Alliances are America’s best source of protection against the advantage China will reap from its increasing economic and military power.

Perhaps it was inevitable that China and America would end up rivals. It is not inevitable that rivalry must lead to war.

Emerging Markets Roundtable: Today’s Pain Could Be Tomorrow’s Gain

By Reshma Kapadia 

Emerging Markets Roundtable: Today’s Pain Could Be Tomorrow’s Gain
Eddie Guy

Emerging markets have had a terrible, horrible, no good, very bad year. In other words, the stocks have sold off sharply, and the currencies have been hammered as U.S. interest rates rise and China’s growth slows. The benchmark MSCI Emerging Markets index is 23% below its January high, after rising 34% last year. China’s Shanghai Composite index has fallen 35%. Turkey’s lira has lost 37%, and the pain could spread.

Yet, the latest washout obscures the long-term attraction of these markets: Not only does 83% of the world’s population live in emerging markets, but almost half of this population is middle-class, and new industries catering to these hungry consumers are creating just the sort of change and growth investors crave. With emerging-market stocks trading at steep discounts to U.S. equities, now is the time to start bargain hunting, or at least drawing up a shopping list.
To assist in both efforts and assess the broader outlook, Barron’s recently assembled a roundtable composed of four investors active in global markets since the late 1990s, when emerging markets had one of their most painful crises. Our panelists are Ruchir Sharma, head of emerging markets and chief global strategist at Morgan Stanley Investment Management; Justin Leverenz, manager of the $35 billion Oppenheimer Developing Markets fund (ticker: ODMAX), the largest actively managed equity fund in the category; Richard Sneller, co-manager of the $1.9 billion Baillie Gifford Emerging Markets Growthfund (BGEHX), which has outperformed 96% of its peers over the past three years; and Laura Geritz, who built a strong investment record at Wasatch Advisors investing in frontier and smaller markets, and launched Rondure Global Advisors in 2016. Geritz runs the firm and also manages the Rondure New World(RNWOX) fund, with about $120 million of assets.

While this erudite foursome thinks the recent selloff isn’t over, panelists note that many developing countries are in better shape than investors have assumed. Even China, which reported third-quarter economic growth of 6.5% on Friday, the weakest rate in nearly a decade, still has plenty of gas in the tank.

Barron’s: What is ailing emerging markets this year?

Ruchir Sharma: Emerging markets have been working out the excesses after a decade of breakneck growth—whether it’s fiscal excesses in Brazil, monetary excesses in places like Turkey, or debt excesses in China. The workout has been going on for five or six years, but got everyone’s attention this year because of the strength of the U.S. dollar and rising U.S. interest rates.

Justin Leverenz: Rising rates bring capital back into the U.S. That puts vulnerable countries, such as Turkey, in an especially bad position. Its economy has grown by 3.5 times in local currency since the financial crisis, largely because of an increasing dependence on credit borrowed from foreign investors. Other factors include China’s slowing economy and idiosyncratic circumstances such as Brazil’s presidential election [the second round of voting occurs on Oct. 28] and questions about whether the victor will push through needed [pension and other] reforms. Then there’s the rise in oil prices, which hurts countries without oil production, such as India, Turkey, and Indonesia.

Laura Geritz: The slowdown in China started the panic this year, and rising U.S. rates compounded it. Complacency about the dollar’s value caused other countries to take balance-sheet risk, issuing dollar-denominated debt. There is just too much debt.

Richard Sneller: For some perspective, about 24 months ago, emerging markets were at levels about 15% lower than today’s.

Are they returning to those lows, or rebounding? 

Leverenz: Emerging market equities look reasonably good. That doesn’t mean they wouldn’t go along with a big pullback in the U.S. or developed markets, but I don’t see current problems causing contagion. Most countries have flexible currencies, and fiscal balances aren’t a big problem. If problems worsen, the impact would be manifested in emerging market bonds, which skew heavily toward Eastern Europe, Africa, and Latin America. Asia accounts for 70% of equity managers’ investments.

Geritz: Valuations were down to 10-year average multiples [of earnings] in early October. Investors have been pulling their money from frontier and smaller emerging market countries. Higher-quality stocks have finally started taking a hit, which is what I want to see before getting excited. The selloff might have a bit more to go before stocks bottom.

Sharma: The valuation gap between the U.S. and the rest of the world hasn’t been this wide since the late 1990s. Valuations are telling you that emerging markets are the place to be for the next five to seven year. The question is whether there is one more leg down. China is the only thing big enough to cause that—and the one thing I worry about.
Richard Sneller

Richard Sneller Philip Vukelich 

What worries you most about China? 

Sharma: No country in history has taken on as much debt as China did over the past decade. We’ve been told it’s OK because it is internally owned and the Chinese can keep managing it. But this is the first time that U.S. and Chinese interest rates have converged. In the past, whenever China had a slowdown, it could offset it by levering up some part of the economy to stimulate growth. As interest rates rise in the U.S., China can no longer ease monetary policy without the risk that people take their money out of the country—even with capital controls.

Leverenz: I’m not concerned about China. Growth will slip due to external challenges, slower credit growth, and the country’s focus on deleveraging, as well as more cautiousness about local government spending. But the economy can grow sustainably at 5%, compounded, for the next five years. That is still 30% to 40% of worldwide growth, making China the single biggest engine of growth behind the U.S. China has rebalanced its economy away from exports toward domestic consumption in a remarkable way that doesn’t get coverage. A decade ago, China had an enormous current account surplus, which has evaporated.

Has the market adjusted to a 5% growth rate? That is well below levels of the past 10 years, and below this year’s estimated 6.6%.

Leverenz: I don’t know. The Hang Seng index is down 15% this year, and China’s A shares are down 28%. Debt isn’t an enormous problem. The fundamental problem for China is that it saves too much. China also has fiscal capacity like no other nation on Earth—a low fiscal deficit relative to GDP, and huge reserves of assets to bail out banks. if needed.

Sharma: But over the past decade, debt has increased massively, and the savings rate is the same as in 2008. What can justify that? That is my issue.
Laura Geritz.

Laura Geritz. Philip Vukelich 

China recently reduced the amount of reserves banks need to hold, and gave exporters larger rebates. Is that stimulus a concern for investors? 

Leverenz: Any stimulus will proceed in dribs and drabs, but the credit taps are unlikely to be opened wide since that would go against the country’s need to rebalance its economy and clean up its financial sector. Without the ability to launch big stimulus packages as in the past, China might implement reforms focused on redistribution of the economy, targeting the hundreds of millions of people living in urban areas who don’t have access to health care and education.

Sharma: Data suggest a slowdown is under way, and the extent of it may be more than what is widely believed. Most emerging markets in this circumstance would be raising rates. But if China is really concerned that the trade war is hurting its growth engine, it might lean toward more stimulus. That’s the risk for the next year because it would increase the risk of capital flight.

What is the best way for investors to navigate China and other emerging markets now?

Geritz: We see a lot of emerging market companies with net cash on their balance sheets. That’s different from the past. Take Yum China Holdings [YUMC]. At Yum! Brands[YUM], the U.S. company, net debt is about three times Ebitda [earnings before interest, taxes, depreciation, and amortization]. Yum China has net cash. There is a lot of potential for it to borrow and follow the U.S. business’ route to prosperity: Issue debt and buy back shares. And the stock is cheap.

Sneller: The average price/earnings ratio of our top 10 stocks is slightly below that of the past decade. They are cheap because growth is improving for many of these companies, including China’s Ping An Insurance Group [2318.Hong Kong], India’s HDFC Bank[HDB], and Samsung Electronics[005930.Korea].

Sharma: Outside of the megacap technology stocks and the biggest countries, everything has been pulverized and neglected. Many of these companies have good growth prospects. China, Korea, and Taiwan make up about 60% of the emerging markets index, while countries such as Poland, the Philippines, and Turkey account for about 1% each. I’m willing to bet that isn’t going to be the case in five or 10 years, so my best idea is to sell megacaps and buy everything else in terms of smaller countries and smaller companies. There’s an opportunity in companies in Southeast Asia and Eastern Europe, for example.

Geritz: I agree. For the past year, the smaller the size, the worse the performance. Fundamentals have been fine for a lot of small-caps, yet companies such as Aramex [ARMX.UAE], the FedEx of the Middle East, and Philippine Seven[SEVN.Philippines], which runs 7-Elevens, have been left in the dust as investors in small-cap and frontier markets sell what has done better to meet redemptions. 
Justin Leverenz
Justin Leverenz Philip Vukelich 

How does the current trade conflict affect emerging markets?

Sneller: In the 20th century, the competition was between Europe and the U.S. In the 1950s and 1960s, the battle was around space between the U.S. and the Soviet Union. Now China has arrived on the scene. It’s not about trade. The core issue, as Russian President Vladimir Putin said, is that he who wins artificial intelligence, wins the world. Protecting intellectual property lies at the heart of what is going on.

Leverenz: About 20% to 30% of the incoming undergraduates at top U.S. schools are Chinese, as are about half those in U.S. graduate schools in life sciences, physics, and math. China has the world’s most significant pool of intellectual talent; it has a lot of capital and a lot of data—whether in ride-sharing with DiDi, commercial data with Alibaba Group Holding[BABA], or transactional data with Alibaba’s Alipay. Data is the fundamental ingredient in artificial intelligence and algorithms. China is going to be a formidable competitor, and there are some wonderful opportunities to invest in, including Alibaba, arguably one of the most audacious companies on the planet. But the U.S. can’t permit the rise of China as an equal, and Beijing doesn’t have the domestic political capacity to make significant concessions, so this tension is going to be a permanent state of affairs.

Geritz: Among the Asian countries, Vietnam has the highest dependence on exports. Everyone there cites China as their biggest risk. If China’s currency weakens, Vietnam will devalue its currency to make its exports more competitive. But over the long run, manufacturers will want to diversify their production to Vietnam to minimize the trade risk. That’s one reason why I’m bullish on Vietnam.

Sharma: An era of de-globalization is a challenge for emerging markets because their mantra for success has always been to export their way to prosperity. Vietnam is a classic example. But it is going to be much more difficult because borders won’t be as open for goods and services, capital, or migration. Even in technology, we are seeing walls come up around countries.

Let’s switch to India, where the economy has struggled in recent years. Is it poised to recover?

Geritz: On the ground, things feel like they are picking up after two weak monsoon seasons, a tax overhaul, and de-monetization hurt growth. But the stock market has had a big run as investors have left China and shifted to India because its domestically oriented economy makes it less vulnerable to trade tensions and its debt to gross domestic product is low. Also, there are a lot of skeletal-looking buildings on Mumbai’s skyline—the kind you saw during the Asian financial crisis that began in 1997 in Indonesia and Thailand when funding dried up. There might be some problems ahead.

Sharma: We are all conditioned to think about how markets reflect economic fundamentals, but it can be the other way, and that is what we are seeing in India. Everyone had been excited about the economy recovering, but now the situation is changing because of financial developments that have taken place as rates rise in the U.S. 
Ruchir Sharma
Ruchir Sharma Philip Vukelich 

Are you referring to the pressure on the rupee, which caused India’s central bank to raise rates?

Sharma: That’s the concern. We are seeing some signs [of stress] emerging.

Sneller: People haven’t fully appreciated two significant transformational changes in India over the past three or four years. The first is that Prime Minister Narendra Modi has made lots of little changes that are bringing about action. For example, three years ago, three miles of expressway were being constructed each day. Today, it is 30 miles. Five years ago, the government wasn’t building any rural houses; now, it is building two million a year. The other change: 24 months ago, India had one of the world’s worst mobile networks. Today, it has one of the biggest, most efficient, carrying more data every day than the entirety of U.S. networks.

How can investors benefit from those changes?

Sneller: Reliance Industries[RIL.India], which started out making polyester yarn, became the biggest refinery in the world and has taken outrageous bets—most recently in mobile telephony and now, e-commerce. There are 250 million Reliance Jio [network] users, consuming six hours of phone time each day. We haven’t yet started to understand what those on-the-ground changes might mean for India’s growth over the next five, 10, or 20 years.

Leverenz: I own less in India today than in the 14 years I have been at Oppenheimer because it is overowned and overvalued. There is also this misperception that India is the next China. There is no next China—and India will never in my lifetime be even close to China. It has a big but extraordinarily poor population, and despite Modi’s efforts, it can’t make the fundamental changes that are needed.

Is Latin America becoming more attractive to investors? Mexico and Brazil have had important elections. 

Leverenz: I am more interested in Mexico. I suspect that President-elect Andrés Manuel López Obrador’s [leftist] government, elected this summer, is going to be more pragmatic than expected, and Mexican stocks are as cheap as they have been in 20 years. My fund has a large position in Femsa [ Fomento Económico Mexicano; FMX]; half of the value of the company is Coca-Cola Femsa[KOF], but Femsa also owns the convenience-store chain Oxxo, which is expanding into small pharmacies. Oxxo could become the biggest logistics company in Mexico, using its convenience stores for package delivery and using its warehousing, fulfillment, and trucking operations. That is in embryonic stages but could be a big opportunity over the next five to 10 years.

Geritz: Brazilian valuations are middling; Mexico looks better. Wal-Mart de Mexico[WMMVY] has a great balance sheet, dominates the market with a valuable network of brands, and has scale that makes others compete on price. It provides protection if the U.S. stays strong and other emerging markets don’t spring back immediately. One reservation: It is seeing abnormally strong same-store sales due to remittances from U.S. workers back home. I worry about what happens if the U.S. economy slows. You might get a better price for the stock if the market sells off. We own it; long run, it is a great company and quality compounder.

Pro-business candidate Jair Bolsonaro won the first round of presidential elections in Brazil. What is the outlook for Brazil? 

Sneller: If Bolsonaro wins the runoff election, new possibilities emerge. I have one stock idea in a universally hated category: Petrobras[ Petróleo Brasileiro; PBR].

Leverenz: That’s the boldest statement we have heard so far—the most highly indebted company on Earth, and with huge governance problems.

Sneller: People haven’t fully appreciated the scale and growth potential of its sub-salt oil discoveries, which went from producing almost nothing 20 years ago to producing two million barrels of oil a day. For the first time in its history, Petrobras becomes a serious exporter of oil. And companies are making more profits per barrel at $80 a barrel now than four or five years ago at $105 to $110 a barrel because they have cut costs. It is a hugely profitable time, even for Petrobras.

Do you favor any other energy stocks?

Leverenz: Novatek[NVTK.Russia] is one of the few Russian companies I would invest in. Its management is arguably the best globally. Novatek transformed from a scrappy exploration-and-production company five years ago to the second-largest domestic gas producer. It got creative with technology and discovered condensate, essentially a wet gas that is more profitable than domestic gas. They just started shipping liquefied natural gas. We are at the beginning of a massive LNG revolution as China and other parts of North Asia want a reliable, economic source of clean energy.

Sticking with contrarian ideas, is it time to invest in Turkey?

Leverenz: I don’t think so. Turkey needs a massive recession for many years, to pare its debt and deal with its fiscal imbalances. I don’t think it is politically possible to go through that sort of protracted pain.  
Sharma: The market value of the MSCI Turkey index has shrunk so much that it is only as big as the 150th-largest U.S. company. But it is hard to make a case when there are so many similar situations with better fundamentals. For example, the combined market value of three of the largest Southeast Asia economies—Indonesia, Malaysia, and the Philippines—is the same as Apple ’s[AAPL] $1 trillion market value. The last time I saw such anomalies in small- to mid-cap stocks was in the late 1990s.

What are the danger signs emerging markets investors ought to watch for now?

Geritz: Greater-than-expected inflation that pushes interest rates higher. It would be hard in that scenario to make a case for owning many stocks anywhere in the world, when holding cash in the U.S. would get you 3% to 4%.

Sharma: One thing I’m watching is the renminbi/dollar exchange rate. Everyone is watching the 7.0 [yuan]-to-the-dollar level. The Chinese currency could weaken beyond that, but it’s the speed and circumstances around any weakening that will be important. Hopefully, China can contain [the situation] with capital controls, and has a slowdown rather than something more sinister. But that is the risk that keeps me awake.

Geritz: It used to be that if the U.S. sneezed, the world caught a cold. But China is such a large economy now that it impacts not just other emerging markets, such as Vietnam, but everyone. A slowdown in Chinese consumption—signs of which we are beginning to see—would impact global companies like Nike[NKE] or Adidas[ADS.Germany], while a slowdown in Chinese tourism would slow the growth of Japanese companies we own.

U.S. Banks Make Hay of European Trading Rules

Goldman Sachs and Morgan Stanley gain from consolidation in equities trading

By Paul J. Davies

No banker likes new regulations, but European investment bank chiefs will feel more aggrieved than normal this year.

The reason? A set of rules for securities trading that came into force in January appears to be handing U.S. banks a big competitive advantage.

Goldman Sachsand Morgan Stanley both highlighted the benefits to their equities trading revenue during third-quarter earnings calls. The cost to European banks will become apparent when they start reporting from Wednesday.

Goldman, Morgan Stanley and JPMorganare the world leaders in trading equities, which has been the bright spot for investment banks this year. The equities business has increasingly become a game where bigger is better: It is highly automated and requires heavy investment in software and algorithms that help investors make their trades faster and at lower costs.

The biggest U.S. players already had an advantage. But the new European rules, known as the second Market in Financial Instruments Directive, or Mifid II, have had the unintended consequence of giving U.S. banks another leg up.

These rules expose the actual fee for making a stock trade because they have forced banks to disaggregate other equity services, such as stock research. Previously all brokerage costs were swept into an ill-defined commission. For equity fund managers, the ever-growing competitive pressure from super-cheap passive funds has made trading costs a big focus.

As the new European rules took effect, many fund managers talked about cutting back on the number of brokers they would use. The latest results suggest they have been following through on this promise. “Mifid II is an important driver of something that’s happening across the system, which is consolidation in the top three scale players,” Goldman Chief Financial Officer Marty Chavez told investors Tuesday. "We’ve seen, especially in Europe but also globally, market share concentrating in the top three.”

Goldman Sachs’ Marty Chavez in 2016.
Goldman Sachs’ Marty Chavez in 2016. Photo: Simon Dawson/Bloomberg News 

Equities trading has been good for U.S. banks this year as bouts of volatility have prompted more buying, selling and hedging activity among clients. Altogether, revenue is up 18% over the first nine months for the big five compared with the same period last year.

U.S. banks were already taking market share in the first half. European banks’ equities revenue was up less than 12% in dollar terms from the first half of 2017, compared with 23% growth for U.S. banks.

Some European players have been doing better than others. Barclays ’sfirst-half equity-trading revenue was up almost 40% year-over-year in dollar terms; BNP Paribasand UBSalso saw strong growth. Deutsche Bankwas the big loser.

New equity sales by companies raising money help to drive other equity trading. In another bad sign for European banks, equity fundraising and related activity was down 51% in the third quarter versus the same period last year in Europe, compared to a 5% rise in the Americas, according to Refinitiv.

It is getting harder to succeed in stock trading for European companies—and regulators really haven’t helped.

Fact and Fiction in the Khashoggi Affair

The journalist’s killing could call into question the U.S.-Saudi alliance.

By George Friedman

Yesterday, my colleague Xander Snyder wrote an excellent piece that placed the Khashoggi affair into the broader context of Saudi-Turkish-U.S. relations. I recommend reading it in full, but the short version is this: The United States needs Saudi Arabia for a variety of reasons, foremost of which is to prevent Iran from expanding its power any more than it already has. This will probably trump the short-term hysteria that the assassination has engendered.

There are, however, a few points on which I would like to elaborate. The first is the victim himself. Jamal Khashoggi was high-born and well-connected. He was the nephew of Adnan Khashoggi, a prominent and powerful arms dealer in the 1980s. He used to work for Turki al-Faisal, the former head of Saudi intelligence. Before 9/11, he conducted an interview with Osama bin Laden, someone who didn’t do interviews often. He went on to become a crusading journalist resolutely opposed to the Saudi government. I don’t know that his opposition to Riyadh is what caused his death. I do know that many journalists write critically of Crown Prince Mohammad bin Salman every day, and most are not (allegedly) tortured, murdered and dismembered in a consulate in Turkey.

The next point relates to Mohammad bin Salman, someone who has made a lot of enemies at such a young age. He effectively rules the country but is not technically its king. He came to power by jumping the lines of succession in a bloodless coup. To some Saudis, he is a radical reformer who wants to overhaul the economy, let women drive, and so on. To others, he hasn’t gone nearly far enough. Khashoggi certainly falls into the latter camp. But here again, there are many Saudi reformist expatriates who do not die gruesome deaths.

The most important point, one that I have often written about, concerns the dynamics of the Middle East. After the Islamic State retreated, Iran began to consolidate its power in Iraq, Syria, Lebanon and Yemen. To counter its expansion, the U.S. is leading an anti-Iranian coalition that includes Israel, Saudi Arabia, the United Arab Emirates and others. Washington is, moreover, applying substantial economic pressure on Iran at a time when Iran is already in economic disarray. Given that pressure, Iran is being weakened at home, and we would expect it to be weakened in its westward push as well.

Still, for Saudi Arabia, participating in the alliance is not without its drawbacks. A public alignment between Israel and Saudi Arabia would, of course, frighten Iran, but it would also enrage some of the conservatives in Saudi Arabia. (The fact that the Saudis have aligned with Israel before, albeit quietly, does not mean that they would not lash out if MBS did so again publicly. Plausible deniability must always be maintained.)

And so, Khashoggi’s alleged death, regardless of who would have killed him or why, creates a strategic problem. The countries that seek to contain Iran require close coordination, most importantly between the U.S. and Saudi Arabia. Now there is pressure on Washington to end this very coordination. There is some pressure on MBS, too, since relations with the U.S. are a cornerstone of Saudi national security, necessary as to resist its archrival Iran. In short, if the alliance between the U.S. and Saudi Arabia collapses, so too do the alliances against Iran.

There is much we at GPF don’t know about the killing of Jamal Khashoggi. There is probably much we never will know. It’s not our business to label MBS a noble reformer or a deranged murderer. We traffic in facts, and so what we know is this: Whatever happened in the consulate in Turkey has put in place a sequence of events that could upend the U.S.-Saudi alliance. Whether it actually does, given everyone’s shared interests, is another matter entirely.