Year: 2017

Latin America’s commodity-driven fortunes

Posted on by Max Tomlin

Despite facing a number of challenges, the macropolitical landscape in Latin America appears to be transforming for the better. As populism gives way to more conventional politics, many of the region’s largest economies are starting to benefit from the pro-business policies of their new, market-driven leaders. This political stability has helped negate investors’ fears, encouraging an influx of foreign investment and driving economic growth across Latin America.

A recent uptick in commodity markets has also improved the region’s economic fortunes, with increasing demand from the US and China driving the prices of essential exports higher. This has provided welcome relief to those finally shaking the devastating effects of the commodity market crash in 2008, which subsequently drove the region into deep recession between 2010 and 2015.

At BCI Asset Management, we believe there are a number of signs to suggest further recovery is on the horizon, and with the right fundamentals already in place, we believe Latin America is the market to watch in the years to come.

Political shifts
The improvement in Latin America’s stock indexes can be widely attributed to the change in the region’s political outlook, with the waning influence of populism providing greater stability to markets across South America. This process started with Argentina in December 2015, as Mauricio Macri, a former businessman and proven market-friendly leader, replaced Cristina Fernández as president.

Since Macri’s election, the Argentine stock market index has soared an impressive 139 percent, and the Argentine market looks set to top the region this year with a return of 27.2 percent in US dollars. Optimism surrounding the new government reforms has driven investor confidence, with the elimination of foreign exchange restrictions and the central bank’s focus on inflation particularly popular among investors.

In Brazil, meanwhile, the impeachment of Dilma Rousseff provided a similar stimulus, acting as a tipping point for the country. Last year, Brazil’s stock market index ranked among the world’s top performing. Since the impeachment, the index is up 23 percent, and we believe there is still further value to be found in the stock market. This success has stemmed from a number of economic reforms implemented by the new president, Michel Temer. To date, Temer’s most notable reforms include a 20-year cap on government expenses, the removal of Petrobras as the sole provider of oil in Brazil, and the introduction of an asset reparation amnesty.

It is clear that greater political certainty has increased investors’ confidence in Latin America’s prominent markets

But Temer’s most important reform is yet to come to fruition: the social security reform, aimed at safeguarding the government’s fiscal balance and limiting public debt growth, still requires approval, but could be crucial to determining the future path of the Brazilian economy. One of the reform’s main aims is to establish a minimum retirement age of 65, replacing the nation’s current requirement of just 20 years’ contribution.

Should the reform be approved, it will represent a massive win ig 1or the market, providing the central bank with leeway to reduce interest rates to between five and 10 percent, as well as drive credit default swaps down.

Peru has also shown signs of political improvement. Elected in July 2016, President Pedro Pablo Kuczynski has put forward an ambitious reform agenda seeking to enhance the country’s competitiveness by transforming the tax system and re-launching a number of mining and infrastructure projects. However, in the short term at least, the effects of the coastal El Niño and ongoing investigations into corruption look set to dampen the country’s progress.

Finally, Chile will be holding its presidential elections in November. Former President Sebastián Piñera is generally leading the polls in the run up to the election and, should he win, his proposals to stimulate economic growth and boost private investment could produce similar results to those witnessed in Argentina and Brazil.

Boosting commodities
With inflows up from $4bn in 2016 to $5bn in 2017, it is clear that greater political certainty has increased investors’ confidence in Latin America’s prominent markets. This additional inflow has predominantly come from passive and active GEM funds choosing to relocate to Latin America in favour of other emerging markets – a clear sign of the region’s growing reputation. With inflows from local and retail investors still relatively low in comparison to more bullish years, we could still see a greater influx of funds in the coming months.

Commodity markets often provide great insight into the strength of Latin American markets, and this has been shown yet again as a recovery in prices has driven trade in all of the region’s economies. Last year, copper prices soared 21 percent (see Fig 1), while iron ore rose an impressive 13 percent. The rise in the price of copper can to a certain extent be attributed to Donald Trump’s election victory, with markets expecting the Republican president would boost infrastructure spending and increase the US’ demand for metal. As the world’s largest producer of copper, Chile would likely be the greatest beneficiary of any increase in demand. And, with the market currently suffering disruptions to supply, the price could rise even higher.

Peru and Brazil also depend heavily on commodities, and have benefited from a recovery in the price of mining materials. The recent resurgence in the price of iron ore has been particularly beneficial, with China continuing to drive demand for high grade iron ore as it seeks to control pollution levels (steel mining consumes less coal when high-grade iron ore is used).

Commodities have also played an important role in shaping the region’s other industries. At the end of the commodities super cycle in 2008, the currencies of the majority of Latin American countries depreciated heavily, making exports more desirable. Since 2012, the Brazilian real has fallen a staggering 55 percent, while the Chilean peso, Peruvian sol and Mexican peso dropped 32, 22 and 36 percent respectively. The renewed demand for commodities is helping to stabilise these local currencies, but they are still some way off the levels recorded during the height of the commodity super cycle. Greater inflows to the region could drive this appreciation in domestic currencies further, leaving room for better returns in terms of US dollars.

The key to Latin America
Nonetheless, it is Chile that provides the greatest indicator of Latin America’s recovery, with the Chilean stock index offering a great vehicle for market exposure in South America. In fact, many Chilean companies have operations spanning the region, with 30 percent of all revenue coming from within Latin America. This revenue comes from a range of sectors too, and includes utilities, consumer staples, retail, telecommunications and real estate.

Furthermore, the Chilean stock market has proved to be one of the best performing markets in Latin America over the past few years, showing an excellent return of 16 percent in US dollars. And this return could be buoyed further by an injection of funds following the conclusion of the nation’s presidential election in November, with current markets only having partially adjusted for the potential return of former President Sebastián Piñera.

If his last election victory is anything to go by – and should Piñera be appointed again – we could see a multiple rerating of Chilean stocks by up to 20 percent. Even without a Piñera victory, the net income reached by Chile in 2016 was close to the level recorded in 2011 during the commodity super cycle.

This was despite corporate taxes rising from 20 to 27 percent in 2014/15. Chilean businesses, therefore, have done remarkably well to defend their return on equity by making efficiency gains in payroll structure, leveraging the benefits of digitalisation and focusing on their core business. Further, there is also momentum in terms of EBITDA and earnings per share growth expectations, with small companies set for growth in the region of 30 percent in 2017.

From a macroeconomic viewpoint, an upturn in private investments and a recovery in the confidence index suggest a recovery in GDP growth in 2017. In April, the consumer confidence index reached its highest level so far for the year, showing a positive trend as a result of the country’s perceived stability over the next five years. The central bank forecasts further GDP growth in 2018, estimating a rise of 2.25-3.25 percent. It is likely these positive growth figures will encourage the central bank to continue with its monetary easing policy, stimulating the equity market further.

In line with these better fundamentals, local pension funds – the main institutional investor in the Chilean market – have reallocated international investments into the local equity market. In the past year, net investments have accumulated close to $2bn, a level not seen since 2012. In March, we also witnessed a slight uptick in investments from retailers. This is significant considering the particularly heavy impact retailers suffered from the downturn in the Chilean market during the recession.

All in all, after an impressive return in the Chilean market, we believe there is enough momentum in earnings and growth perspectives beyond 2018 to boost investor confidence. The strengthening candidacy of Sebastián Piñera will only add to this, fostering domestic demand and private investment. Ultimately, we believe the inflows from both international and local investors will continue into the immediate term, driving growth in Chile and the wider Latin American markets.

NAFTA negotiations will determine Mexico’s position in an uncertain world

Posted on by Max Tomlin

In an effort to deter the Mexican peso’s sharp depreciation, Mexico’s central bank, Banxico, began an aggressive monetary cycle towards the end of 2015. This strategy continues today, with the benchmark rate increasing from three percent in December 2015 to 6.5 percent in March of this year.

In 2016, the Mexican peso had one of its worst years, falling 20 percent against the US dollar and ranking as one of the worst performing currencies worldwide. Fortunately, however, this meant a mild pass-through effect to domestic inflation, which ended close to Banxico’s target inflation rate of three percent.

The outcome of the recent US election was one of the main reasons foreign exchange depreciated, as all asset classes in the country were hit with significant volatility after Trump’s unexpected election victory. The polemical proposals from the Republican candidate had triggered a wave of uncertainty regarding North and South America’s future commercial relationship. It also cast a shadow of doubt over Mexico’s overall role as the US’ southern neighbour and the continued participation of the North American Free Trade Agreement’s (NAFTA) most vulnerable member.

Mexico and Trump
Donald Trump’s election victory sealed what appeared to be the worst case scenario for Mexico. The new president’s proposal to renegotiate NAFTA presented a major risk for a country with a more than 80 percent dependence on US-bound exports. It is important to note Mexico’s important macroeconomic challenges had already put the country under the scope for a possible downgrade by major rating agencies.

The market, therefore, had an immediate risk-off reaction, particularly in the case of the Mexican peso. The start of 2017 also witnessed a sudden and large increase in domestic gasoline and diesel prices, as Mexico’s Ministry of Finance stopped subsidising energy prices. This weakened foreign exchange further and affected consumers nationwide.

In mid-April, inflation was significantly higher than Banxico’s target, with a read of 5.6 percent. We expect these prices to continue to increase, but will also be interested to see how political events affect expectations further. In the meantime, Banxico will be forced to keep raising rates until there are clear signs of inflation returning to target levels.

Donald Trump’s unexpected election victory sealed what appeared to be the worst case scenario for Mexico

This has caused the nominal yield curve to flatten, with the Mexican peso’s volatility forcing the central bank to aggressively hike its rates. Further, we believe the uncertainty of foreign exchange will prevail in the short term, as Mexico and the US head towards NAFTA discussions.

This, along with above average CPI data, favours our underweight strategy on the short end of the curve. Regarding the rest of the nominal yield curve, we prefer the belly to the long end of the curve, as current levels do not price any premium for liquidity or maturity between the 20 to 30 year nodes.

We are, however, more positive about inflation-linked bonds, as we believe the current economic dynamics in Mexico will still support high CPI levels for the rest of this year. We also favour the belly of the curve on the real yield curve, as the very short end volatility does not compensate for inflation carry. Overall, we expect the local currency yield curve to increase by the end of the year, and the long end of the curve (20 to 30 years) to steepen. Inflation linked bonds will also be impacted by this movement, although they will be more resilient than the nominal yield curve.

While higher ex-ante real rates could be worrisome in an economy that is already decelerating, Mexico’s risk premium has come down sharply. That said, uncertainty still remains, particularly in relation to the Trump administration’s foreign policy. Moreover, inflation looks poised to remain high for the short term at least.

This mix could justify higher rates in order to keep a lid on volatility in local financial assets, particularly with the US tightening its belt. It could also represent good ammunition in case of an externally induced slowdown, caused, for example, by a negative outcome in the NAFTA renegotiation.

Risks offset by the US election
The Mexican stock exchange has also been affected by Donald Trump’s victory, with its main index, Mexbol, suffering an important correction throughout the fourth quarter of 2016. The universe of listed companies faced several headwinds as a result, with some facing a risk to US-bound exports, while others had increased financial leverage in spiking US dollars. Many were also affected by the local currency weakness, which accelerated expectations of rising inflation and central bank tightening.

However, as Trump’s presidency advanced through its initial weeks, market sentiment experienced a dramatic change. Trump’s tone towards Mexico – as well as his main commercial advisor’s – became softer and sometimes even constructive. Furthermore, the first major reform put to Congress by Trump’s administration failed to succeed, suggesting all of Trump’s campaign promises may not come to fruition.

By the first quarter of 2017, the Mexican peso had started to strengthen, and, with further action from Banxico, the extreme caution towards Mexican equities gradually began to fade. Our belief is the market has been overly complacent with Mexico, setting aside many of the same reasons risk alarms were triggered a few months previously.

The current level for Mexbol implies very challenging growth expectations, which have continued to be disappointing for the past five years. A great deal of this market’s overestimation originated in the erroneous foreign exchange expectations at the beginning of each year. Therefore, Mexican equities have normally become richer as the Mexican peso has weakened, making them as expensive as in other emerging markets.

80%

of Mexican exports are US bound

20%

Decrease in the value of the peso compared to the US dollar in 2016

3%

Banxico’s target inflation rate, 2017

5.6%

Inflation rate in mid-April

On top of this, Mexico will be exposed to a very tight electoral process in 2018, which could bring back an incremental sense of risk as markets respond to political uncertainty. Nevertheless, we see interesting opportunities in the off-index space, as these companies benefit from good internal macroeconomic trends.

Even as risks prevail, Mexico’s macroeconomic balance seems poised for further improvement during 2017; the country’s current account has been adjusting thanks to a boom in non-oil exports. Along with a lower fiscal deficit – helped by a non-recurring income from the central bank’s foreign reserves – it seems buffers are being built despite a negative backdrop. However, uncertainty continues as we await the outcome of the NAFTA renegotiations.

Negotiating NAFTA
If the aftermath of the NAFTA renegotiation is negative, the deterioration in foreign exchange will hardly be enough to sustain the recent acceleration of Mexican exports. Instead, investment will decrease and household consumption will take a defensive detour. Mexico’s public finances will also suffer thanks to shrinking tax revenues.

On the other hand, if the outcome is positive, we believe Mexico’s economy will be in a fairly good position – similar to the situation seen two years ago after the approval of the country’s structural reforms. This binary scenario is highly dependent on political and external factors, which, unfortunately, may depend on Trump’s mood swings.

While we expect volatility as NAFTA negotiations advance, our base scenario is for the two nations to achieve a fair trade deal with no major changes affecting the trade partnership. Fears have diminished as the US’ stance on NAFTA has softened, so we remain optimistic about Mexico’s debt denominated in US dollars. We also believe corporate activity remains in good shape, with credit being hit by external uncertainty rather than fundamentals.

We are also positive on credit, as we have seen yield corrections from historical lows of last year. The strategy favours maturities below three years on the floating rate scheme, as the risk is upside bias in terms of rate hikes. Meanwhile, we remain neutral on corporate debt with fixed coupons, as more repricing is expected following government yield curve corrections.

Overall, Mexico is situated in a very interesting and unique position for the years to come. Uncertainty over its relationship with the US has created a number of significant opportunities for Mexico; presenting a substantial upside potential assuming the outcome of the NAFTA renegotiation isn’t too radical. The relationship between both economies is deep and difficult to untie, which makes us positively biased.

Nonetheless, until this uncertainty dissipates, volatility will continue as market participants assess the risk-reward ratio on the country’s different asset classes. This said, SURA Asset Management’s stand remains one of optimism, and this has been shown by the company’s significant investments in Mexico over the past decade.

China announces SOE restructure as corporate debt continues to mount

Posted on by Max Tomlin

On July 26, a statement published by Beijing authorities revealed all large state-owned enterprises (SOEs) are set to be turned into joint stock or limited liability companies (LLCs) by the end of the year. In doing so, the state hopes to make its key businesses more modern and efficient, while also enabling the establishment of flexible and market-based mechanisms.

So far, around 90 percent of the country’s SOEs have made the move, with positive results. According to the cabinet’s website, those companies that have registered as LLCs or joint-stock companies now have improved management and governance structures.

The restructure will bring China’s SOEs in line with
the corporate governance practices of developed economies around the world

The restructure involves the introduction of a board of directors, bringing China’s SOEs in line with the corporate governance practices of developed economies around the world. Likewise, boards will have key decision-making abilities, including recruitment and wage distribution, while employee salaries will be directly linked to profits and productivity.

Such moves are crucial aspects of China’s strategy to create conglomerates capable of competing in global markets, such as transportation and energy. The restructuring of SOEs is also intended to tackle a looming problem facing the economic giant: debt.

According to the 2017 OECD Economic Survey on China, the country’s public and corporate debt now exceeds 250 percent of its GDP, up from 150 percent prior to the 2008 financial crisis. A particular concern for the state is its level of corporate debt, over 70 percent of which originates from SOEs.

In addition to the much-needed modernisation of China’s SOEs, those found to be uncompetitive will be shut down. This process began earlier in the year, when Governor Zhou Xiaochuan revealed banks would withdraw financial support for unviable firms.

Though there is talk of mixed ownership reforms – which would enable private companies to invest in China’s SOEs – Beijing has pledged to strengthen its leadership in the firms in order to prevent lost assets and ensure stability during this transition.

The restructuring of China’s SOEs is pivotal in the state’s plans to further develop its economy, particularly given the inevitable slowdown in GDP growth. If successful, the shift will also help to tackle China’s mounting corporate debt problem, which is one of the highest among emerging market economies.

Why Europe still needs cash

Posted on by Max Tomlin

Payment systems in Europe are facing upheaval. With the digital revolution offering ever-faster and more convenient means for settling transactions, cash seems – to some – to have no future. But to write off the role of banknotes and coins in the economy would be a mistake.

Non-cash payment options have been proliferating in recent years. Credit cards, online transfers and direct debit payments are already well established. Now, smartphone-enabled digital payment solutions and mobile wallets are also gaining ground. The emergence of potentially disruptive innovations like distributed ledger technologies indicate that further and possibly fundamental change may be on the horizon.

Independent of these new and incipient options, there are a number of studies making the case to abolish cash. Advocates of a cashless society tend to fall into three distinct camps: the first camp, the alchemists, wants to overcome the restrictions that the zero lower bound (ZLB) imposes on monetary policy.

The second, the law and order camp, wants to cancel the primary means of payment for illicit activities. And the third camp, the fintech alliance, anticipates major business opportunities arising from the elimination of the high storage, issuance and handling costs of cash that the financial industry currently faces.

The impact on society
But the arguments for going cashless do not withstand scrutiny. Start with the alchemists’ case: it is true that, in an environment of very low interest rates, the conduct of monetary policy becomes difficult. Yet experience has shown that the effective lower bound is different from the ZLB.

Harming the decent majority in order to punish a misbehaving minority would be like cracking a nut with a sledgehammer – and breaking the table it is on in the process

Indeed, negative interest rates have worked without triggering a flight to cash, especially when combined with outright asset purchases, long-term credit operations (including ‘fixed-rate full allotment’ and ‘targeted’ variants) and forward guidance. As such, negative interest rates should be understood as a specific non-standard monetary policy instrument different from low interest rates.

The law and order camp’s case for banning cash also wilts under scrutiny. By acting as a store of value and a means of payment, cash fulfils an important social function for many law-abiding citizens. Would anyone suggest forbidding private ownership of luxury cars or gems because criminals like them? Harming the decent majority in order to punish a misbehaving minority would be like cracking a nut with a sledgehammer – and breaking the table it is on in the process.

Finally, the fintech alliance promises that, with its innovative digital payment solutions, it can ease the conduct of financial transactions. Customers would no longer need to carry wads of cash or search for ATMs. But it is an open question whether the still highly fragmented digital payment sector will help customers more than the companies offering the payment solutions.

What the people want
There is one more major problem with the arguments for a cashless society: most people, at least in the eurozone, don’t want it. According to an (at the time of writing) unpublished European Central Bank (ECB) survey of 65,000 eurozone residents, almost 80 percent of all point-of-sale transactions are conducted in cash; in terms of value, more than half of all payments are made in cash.

As is often the case in Europe, the differences among member states are pronounced: the share of cash transactions ranges from 42 percent in Finland to 92 percent in Malta. But, overall, the public’s commitment to cash remains strong – and is becoming stronger. In fact, growth in overall demand for cash is outpacing nominal GDP growth. In the last five years, the average annual growth rate of euro banknotes was 4.9 percent by value and 6.2 percent by piece. This rise includes denominations that are predominantly used for transactions, rather than for savings.

These findings confirm the appropriateness of the ECB’s neutral stance on payments, which allows for both cash and cashless payments. This approach is based on four principles: technological safety, efficiency, technological neutrality, and freedom of choice for users of the respective means of payment.

The ECB’s supreme objective is to ensure price stability. To support that objective, it supplies safe central bank liquidity, in the form of both bank-held central bank reserves and banknotes (the latter being the sole notes with the status of legal tender in the eurozone). If Europe were to abolish cash, it would cut off people’s only direct link to central bank money. In a democracy, such a link helps to foster public acceptance of central bank independence, by reinforcing the trust and support of the people in the conduct of effective monetary policymaking.

The ECB will continue to provide banknotes. We will also facilitate the further development of an integrated, innovative and competitive market for retail payment solutions in the eurozone. If, one day, cash is replaced by electronic means of payment, that decision should reflect the will of the people – not the force of lobby groups.

© Project Syndicate 2017

Michael Kors to buy Jimmy Choo for $1.2bn

Posted on by Helen

On July 25, luxury fashion pacesetter Michael Kors announced it has agreed to purchase footwear and accessories specialist Jimmy Choo for $1.2bn. The deal will see Jimmy Choo shareholders receiving 230 pence ($3) per share.

The announcement comes amid lackluster sales results at Michael Kors and a substantial dip in its share price. In May, the company announced it would be closing 125 retail outlets – 15 percent of its stores – amid disappointing sales forecasts.

The acquisition will provide Michael Kors with an opening into the fast-expanding luxury footwear and accessories market

Michael Kors’ decision to unite with Jimmy Choo could bring the company a new set of customers and, perhaps most importantly, the momentum behind the Jimmy Choo brand. Jimmy Choo is now 20 years old and, according to Michael Kors’ press announcement, represents an “empowered sense of glamour” and a “playfully daring spirit”.

The acquisition hopes to tap into more than just this brand image: it is also expected to provide Michael Kors with an opening into the fast-expanding luxury footwear and accessories market. It could also provide an enhanced presence in international markets, with Asia being key focus for future growth.

The merger is expected to boost Jimmy Choo sales to $1bn, as well as create an as yet uncalculated quantity of “long-term operational synergies”, according to the press release.

CEO of Jimmy Choo Pierre Denis commented: “We are convinced that there is so much more that can be delivered in the years ahead… Our two companies share the same vision of style and trend leadership. Our luxury heritage is the foundation of Jimmy Choo and we will continue to bring our brand vision to consumers globally.”

The deal, which has been approved by both boards of directors, is scheduled to close in the final quarter of 2017. Before becoming official, however, it must be approved by Jimmy Choo shareholders, who make up 75 percent of share capital and therefore collectively have the final say.

Elon Musk: shooting for the stars

Posted on by Max Tomlin

“When something is important enough, you do it even if the odds are not in your favour”

Elon Musk

Born in 1971 in Pretoria, Elon Reeve Musk grew up amid the chaos of South African apartheid. As a child, Musk was quiet and had a tendency to drift off into a trance-like state – a habit doctors mistook for hearing problems. He was also an obsessive reader, reading up to 10 hours per day and consuming information at an astonishing rate.

Musk’s geeky, introverted persona contrasted starkly with the popular ‘jocks’ who dominated the adolescent social circles of Pretoria, making him the victim of brutal bullying throughout his childhood.

“He was tossed down a flight of stairs one time and then punched up after that – he spent about a week in hospital – that was fairly common in his younger days. He was sort of like the nerd in the corner in a very masculine, sports-oriented culture – obviously he didn’t really fit in”, said Ashlee Vance, author of Elon Musk: How the Billionaire CEO of SpaceX and Tesla is Shaping Our Future, the only biography of the tech titan that features exclusive interviews with the man himself.

After his parents divorced, Musk – the second of three children – moved in with his father, Errol. Musk has said very little about those years, but a quote from him in Vance’s book simply states: “It was not a happy childhood. It was like misery.” From a very young age, Musk began fantasising about escaping to the US, his oft-dreamt-about land of opportunity.

There are many individuals who are incredibly capable, intelligent and ambitious, but it is difficult to deny Musk is in a league of his own

Using his mother’s Canadian roots to obtain a visa, Musk left for Montreal aged 17 with nothing but $100 to his name, taking what would be the first of the many big risks he would become known for. He spent his first year in Canada working various low-paid jobs before enrolling at Queen’s University. After two years at the college, Musk transferred to the University of Pennsylvania in a bid to open new doors for himself.

Dotcom buzz
Always striving to do better, Musk completed his studies at Penn and decided to pursue a PhD in materials science and physics at Stanford University. Despite the college’s prestige, he was lured away by the scent of the very recent internet boom, dropping out after just two days at Stanford in search of Silicon Valley success. Having interned at several tech companies in the area, Musk was convinced he could capitalise on the new phenomenon.

Together with his brother Kimbal, Musk started his first company, Global Link Information Network, which was later renamed Zip2. The idea behind the start-up was ingenious; many companies were still suspicious of the web and needed help to join this new realm. Zip2 was a map-linked, searchable business directory that helped them to make that leap.

By February 1996, venture capitalists had come calling. Mohr Davidow Ventures’ $3m enabled Musk to go national, while a new strategy helped the company to sell software packages to newspapers, including the Chicago Tribune and The New York Times. In February 1999, Compaq Computer made a surprise $307m cash bid – but by then Musk was already dreaming up his next grand plan.

Revolutionary fintech
Having earned $22m from the Compaq deal, Musk set his sights on an idea that had been brewing ever since he had been an intern at Scotiabank while living in Canada. A firm believer in the web’s potential, Musk was adamant that an internet-based bank could disrupt the global financial market and become wildly successful. And so, a month after Compaq’s announcement, Musk invested $12m of his own money to create X.com.

The move was highly unusual. “For most of the people in Silicon Valley who make it big, a big perk is that there are investors who are willing to give you a lot of money for your next venture – you don’t have to take as much personal risk”, Vance told World Finance. “But [Musk] always wanted to control his companies and really not have anyone to answer to, and so he gambled all of his own money, and the things that he went after were all things that people largely thought were impossible.”

Following much hesitation from investors and various internal issues, X.com secured an injection of cash from Sequoia Capital and finally went live on November 24, 1999. Musk was revolutionary in his strategy, gifting new customers cash rewards and creating peer-to-peer payment systems. In just a couple of months, X.com managed to secure some 200,000 customers – as well as a major rival. This competing firm was called Confinity, the creation of two young entrepreneurs, Max Levchin and Peter Thiel.

After an initial alliance, things soon turned nasty as the two start-ups began to compete ferociously. Having lost millions in a seemingly unwinnable battle, the pair merged in March 2000. With Confinity’s hot new product PayPal and X.com’s cash reserves and sophisticated products, it was a match made in heaven, and the merged company soon raised $100m from the likes of Goldman Sachs and Deutsche Bank. By July 2002, just over a year after the company had been rebranded as PayPal, the board accepted a $1.5bn offer from eBay. As PayPal’s biggest shareholder, Musk walked away with $180m after taxes.

SpaceX’s Falcon 9 launches on a resupply mission to the International Space Station

Into space
But when Musk and his wife embarked on a long overdue honeymoon in September 2000, it not only gave the PayPal board its first chance to oust Musk as CEO, it also resulted in him contracting a near-fatal bout of malaria. Musk responded with a formative move to LA and the rediscovery of one of his favourite subjects: space.

Before eBay’s bid came into play, a series of seminal events saw Musk head down a historic path linked with his childhood passion. From a young age, Musk had dreamed about space, forever romanticised by his favourite book, The Hitchhiker’s Guide to the Galaxy. With a dream team of rocket engineers in place and a $100m investment of his own money, Musk turned his fantasy into reality, creating Space Exploration Technologies – also known as SpaceX – in June 2002. The company’s goal was to make spaceflight 10 times cheaper, and its ultimate vision was to one day colonise Mars.

The reaction was one of incredulity. “No private person had ever created a successful space company – many billionaires had lost huge chunks of money trying”, said Vance. But despite the hoards of naysayers, Musk proceeded, promising that the launch of SpaceX’s first rocket, Falcon 1, would cost $6.9m as opposed to the standard minimum of $30m. After three failed attempts, on September 28 2008, Falcon 1 reached orbit.

NASA promptly signed a $1.6bn contract with SpaceX, marking the first private deal in its history. Musk made history again and again after that point; through SpaceX, he had actually succeeded in making space travel more affordable, opening up a universe of new discoveries and possibilities.

Making boring sexy
For the incredibly driven Musk, one seemingly impossible achievement was not enough. In 2004, the entrepreneur turned his hand to another outlandish project, becoming Chairman of electric car company Tesla Motors. “The electric car had been tried and died several times before”, said Vance. Once again, Musk had set out to achieve what so many others before him had failed to do.

Elon Musk in numbers:

$12m

The amount of his own money Elon Musk invested to create X.com

$47bn

Tesla’s market capitalisation. In comparison, 114-year-old Ford’s cap is $45bn

$1.6bn

The value of NASA’s contract with Musk’s space exploration company, SpaceX

2008

The year Musk’s rocket Falcon 1, constructed by SpaceX, launched successfully

In October 2008, Musk became Tesla’s CEO and invested $70m into the company. Against all odds, this astonishing gamble paid off. Before Musk introduced Tesla’s first vehicle, the Roadster, all electric cars had focused solely on being green. “The cars ended up being boring, and they were slow – they were mediocre”, said Vance. “[Musk] flipped it on its head and said, ‘Let’s make a really sexy car that goes incredibly fast, and make an electric car that’s an object of desire instead of a compromise’.” This approach sparked public interest; suddenly electric cars were cool.

Then came Tesla’s second car, the Model S sedan. Vance explained: “He turned all these things that had been disadvantages for electric cars into advantages.” For example, Musk placed heavy battery packs at the bottom of the car, giving it a very low centre of gravity so it handled well. “They got rid of the engine, because they didn’t need one, and so you have storage in both the front and the back, [creating] what they call the ‘frunk’.” With much less machinery and a lot more space, “you end up with a sedan that goes incredibly fast – as fast as a race car”. Musk also added a large touch screen monitor, essentially turning the car into a computer.

Musk’s ingenuity transformed how electric cars were perceived. “I think that was how he succeeded where other people had failed”, Vance added. Following a string of Car of the Year awards, by April 2017, Tesla had overtaken General Motors as the most valuable car manufacturer in the US – a stunning feat for a technology that up until recently was considered so unappealing.

Incredibly, Musk’s ambitions didn’t stop there. In August 2016, Tesla bought SolarCity, a solar energy services provider that Musk had invested $10m in back in 2003. Today, SolarCity is the largest solar provider in the US. Musk’s other grandiose plans for the coming years include a hyperloop transportation system and underground tunnels that will make traffic jams a thing of the past. Essentially, Musk seems intent upon solving the world’s problems, one (or, indeed, a few) at a time.

A visionary
Naturally, there are many individuals who are incredibly capable, intelligent and ambitious, but it is difficult to deny Musk is in a league of his own. This is best exemplified by the fact he simultaneously heads not one, but two groundbreaking and diverse mega-companies. And while there may be a few others who can – or already have – done this, none have succeeded to quite the same degree as Musk.

Vance explained: “He’s running two giant companies at the same time and he knows everything that is going on with the products; he helps design them, he helps figure out inventions, he is essentially the entire marketing arm for all of his companies. They don’t spend any money on advertising, which is – especially in the automotive industry – very unusual, and then he does the business side too. He does it all, and that’s at two companies… He treats business more as almost a life and death situation, or like war, than a job. And so he is competing on a different level than most people”.

Making a success of two global enterprises, both in markets that were previously considered impossible to conquer, is nothing short of extraordinary. To achieve this astonishing feat, Musk maintains a gruelling schedule. He is strict and stern with his employees, demanding they work as hard and are as razor-sharp as he. Musk sets himself targets and timelines that are laughed at by others, but help push him even harder. But while these factors help forge his incredible success, there is one other that drives him to achieve the impossible: Earth’s Plan B.

“I think he likes money as much as the next person and it certainly allows him to live this very larger-than-life existence that I think he revels in”, noted Vance. “But I think there’s just no question for me that it’s not money that drives him. He [has] a very strange goal: his goal is to create a human colony on Mars, and that really is his overarching life purpose. I think it’s probably silly to a lot of people, [but] pretty much anything that he does fits in line with that. He wants to create this escape plan for the human species in case something goes wrong on Earth. And then you can see Tesla and SolarCity as attempts to fix the Earth in case that doesn’t work out.”

Curriculum Vitae

Born: 1971 |  Education: University of Pennsylvania

1971: Musk was born in the South African city of Pretoria, a sprawling city an hour away from Johannesburg. A studious, quiet child, Musk was badly bullied for years and had an unhappy upbringing.

1989: After years of imagining his escape, Musk set off for Montreal, Canada with only $100. Unsuccessful in tracking down long-lost relatives, Musk worked odd jobs to make ends meet.

1995: Having completed degrees in business and physics at Pennsylvania University, Musk abandoned a PhD at Stanford to head for Silicon Valley and create internet start-up Zip2.

2000: An internal coup saw Musk ousted as CEO of PayPal and replaced by co-founder Peter Thiel. Musk continued losing control of the company, but made $180m when it was sold to eBay in 2002.

2010: Two years after Musk succeeded Ze’ev Drori as CEO of Tesla Motors, the company raised $226m in its IPO, making Tesla the first US car firm to go public since Ford in 1956.

2012: SpaceX became the first private company to send spacecraft to the International Space Station. Falcon 9 successfully delivered 1,000lbs of supplies to stationed astronauts.

Why a spike in the global arms trade could represent a new brand of globalisation

Posted on by Max Tomlin

While the post-recession world has seen dented trade volumes and a retreat from globalisation, the global arms industry has managed to buck this trend by exhibiting a relatively sturdy upwards momentum in trade volumes since the early 2000s. According to data from the Stockholm International Peace Research Institute (SIPRI), transfers of major weapons in the period from 2012 to 2016 reached their highest volume for any five-year period since the end of the Cold War, and were up 8.4 percent from between 2007 and 2011.

Patterns seen in the global arms trade provide a window into the state of global conflicts: trade volumes swell with each major war, while trade channels provide a snapshot of a complex web of global alliances. Beyond this, factors like oil prices and economic growth play a critical role by influencing states’ appetite for arms expansion. The recent uptick in volumes of weapons being traded, however, also reflects an increasing proportion of military spending being channelled towards weapons imports, implying weapons are made increasingly for the purpose of being sold abroad.

Illustratively, global military expenditure has largely plateaued since 2009, during which time the volume of international arms transfers has been on an upward streak. Much of this can be explained by demand driven by individual conflicts and threat perceptions in nations without domestic production capacity. For instance, Vietnam, which borders the South China Sea, increased its weapons imports threefold between 2012 and 2016 from the four years prior. Meanwhile, Saudi Arabia, embroiled in an expensive conflict in Yemen, increased its purchases by 212 percent.

Shifts in the way weapons move around the world reflect the changing shape of an increasingly concentrated, technologically advanced and specialised weapons manufacturing industry

Yet conflict itself is just one side of the story. Shifts in the way weapons move around the world also reflect the changing shape of an increasingly concentrated, technologically advanced and specialised weapons manufacturing industry. Between 2012 and 2016, SIPRI identified 57 countries as exporters of major weapons, but the five largest suppliers made up the vast bulk of sales: together, the US, Russia, China, France and Germany were responsible for 74 percent of all arms exports (see Fig 1).

The industry has always been highly concentrated among certain ‘top tier’ suppliers, but figures from SIPRI show this is becoming increasingly the case, with the top five exporters from 2012–16 exporting 8.5 percent more arms than the countries comprising the top five in the previous five-year period.

Indeed, SIPRI’s figures are in part reflective of the weapons industry’s own particular brand of globalisation. Alongside greater volumes of trade, developments over recent years have seen it evolve into an increasingly globally intertwined and hierarchical industry, with multi-domestic firms and international collaborations becoming the norm.

A scissor effect
According to Jennifer Erickson, Assistant Professor of Political Science and International Studies at Boston College: “In some ways, globalisation has characterised – and influenced – the evolution of the global arms trade since the end of the Cold War. In other ways, there is more continuity than you might expect.” One of the key features of the arms industry is that it moves very slowly, with shifts in production capacity or trade relationships taking a long time to concretely materialise.

That being said, the dramatic reduction in funding for defence after the Cold War forced firms in the sector to change their strategy. Erickson explained: “Since governments were spending less on defence procurement, this meant that the global arms market shrank, with significantly more competition among defence companies for their customers. As a result, defence companies were subject to intense economic pressures to consolidate, export and specialise in order to survive.”

The reduction in funding came in combination with growing technology costs required for evermore sophisticated weapons systems, making it increasingly untenable to maintain small scale production lines. Together, these forces created a ‘scissor effect’, whereby the development of integrated global linkages and operations became crucial to survival. This prompted a wave of mergers and acquisitions, which began on a domestic level – but when domestic demand was saturated, firms sought cross-border consolidation. The result is the concentrated and hierarchical sector seen today, with the emergence of defence giants that have consolidated their business through new partners and subsidiaries.

According to Erickson: “Trends in specialisation and hi-tech weapons systems have also meant that, among the advanced industrial democracies, weapons production has become much more interdependent than in the past. Supply chains for a weapon produced in a single country like the United States involve numerous companies, both foreign and domestic.

“As a result, the production of a single weapon can entail a globalised supply chain, even before it might be sold and exported on the global arms market. The production of some weapons might also be completed in multiple countries. The F-35 Joint Strike Fighter, for example, has been a deliberate effort to globalise production among its investor countries.” Therefore, even as the volume of cross-border trade shrank after the Cold War, the scissor effect forged a new global character that persists in the industry today.

An increasingly consolidated and specialised industry can also create added pressure for producers to export, because domestic weapon demand – particularly for European countries – cannot always support large-scale production lines. “Shutting down a production line means that you lose out on capacity, and rebuilding that capacity is über expensive – it is as expensive as building it up from scratch”, said Aude Fleurant, Director of the Arms and Military Expenditure Programme at SIPRI. Often reluctant to forego domestic capacity, countries tend to fall back on exporters to soak up the excess capacity created by large scale production lines. This effect means export competition can be fierce.

The result of this process of globalisation and consolidation is that the industry is morphing into a huge ‘hub and spoke’ model. This has been described by Richard A Bitzinger in his book Towards a Brave New Arms Industry? as consisting of “a few large first-tier firms at the core, serving as centres for excellence for weapons design, development systems and integration, with global supply chains extending out to second-tier states on the periphery”.

Evading the invisible hand
“If you also associate globalisation with free trade, then globalisation does less well in characterising the global arms trade”, Erickson noted. In this sense, the arms sector obeys its own logic, making its particular brand of globalisation distinct from that seen in civilian sectors.

As Fleurant said: “It is the last market for which there [is] no WTO [World Trade Organisation] free trade in position. It is one of the last markets that is protected at the state level – that can be subsidised.” Indeed, the sector gains its divergent character as a result of the WTO’s ‘security exception’: a proviso ensuring activities in the military sphere, including government research and export subsidies, are shielded from challenges under WTO rules. The security exception therefore allows governments to intervene in the market as they wish if it is deemed to be in the interest of national security.

As a result, the trend towards a more globalised weapons industry is markedly different from the globalisation seen in traditional sectors. Instead of trade flows being increasingly dictated by the ‘invisible hand’, a state has free rein to support its domestic weapons industry through tax breaks, subsidies and import restrictions.

Unlike globalisation in traditional sectors, a state has free rein to support its domestic weapons industry through tax breaks, subsidies and import restrictions

While the security exception holds back free trade in its purest sense, it simultaneously has the effect of propping up the sector. For instance, when a WTO ruling deemed Canada’s subsidies to aircraft manufacturer Bombardier to be illegal, the Canadian Government responded by shifting its support to the military arm of the company in order to dodge the ban. As a result, if heightened trade tensions prompt further challenges to be made through the WTO, more countries may utilise this exception by shifting state protectionism to the military sector.

The exception can also encourage greater concentration in the sector, due to the fact that the arms industry is bolstered in those countries with large defense budgets.

Beyond this, there are a number of restrictions and embargoes that will forever hold back the free movement of weapons. However, measures to contain the trade of weaponry are often surprisingly meagre. For instance, the first attempt to regulate the industry at a global level – the UN’s Arms Trade Treaty – has not yet been ratified by China, Russia or the US, which together form the bulk of global sales.

Thomas Friedman famously described globalisation as the “flattening” of the world economy through globalised trade, outsourcing, supply chaining and political liberalisation. Owing to the heavy hand of the state and the ever-present significance of borders in the arms industry, this is one area where the world is certainly not flat. Weapons companies will never quite emulate the freedom of those firms in heavily globalised industries, such as telecommunications or textiles. And yet, the arms sector’s post-Cold War transformation and recent surge in trade volumes illustrate the fact the sector is certainly not immune to the forces of globalisation.

Baiduri Bank launches new online services for Brunei’s businesses

Posted on by World Finance

Bruneians demand sophisticated banking products, says Baiduri Bank CEO Pierre Imhof. They are wealthy, they travel the world, and they expect the same quality and ease of banking at home as overseas. Pierre explains how Baiduri steps up to this challenge: from a series of technological firsts in the retail space, to online merchant services with the highest security available for SMEs and larger corporates.

Click through to the second part of our interview with Pierre, where he discusses Baiduri’s soon-to-open stock exchange.

World Finance: Brunei’s stock exchange is scheduled to open later this year, sparking renewed international interest in the small – but wealthy – island nation. The initiative should help the government’s ongoing efforts to diversify the economy. Joining me is Baiduri Bank’s Pierre Imhof.

How are the diversification efforts going?

Pierre Imhof: The diversification process for the last two years, with the change in oil and gas prices, has become an absolute priority. So the government has intensified their effort for diversification, and banks are playing a major role in this process: mainly targeting SMEs, and secondly the foreign direct investments.

These initiatives are an absolute priority within the Wawasan 2035, which is the government’s long-term development plan to create a nation which is healthy and financially sustainable.

World Finance: How is Baiduri Bank playing a role in that?

Pierre Imhof: We are very eager to finance the short-term needs of companies; we are also very eager to finance some of their long-term needs, to develop their business, to finance a new project, etc.

We know our clients well, the relationship is very personalised. We understand their needs, we are able to proffer solutions which correspond to their needs.

For example, for very small enterprises we have launched a product called MerchantSuite, which is offering to our small clients the possibility to transact online, to receive payments online without having to create their own website.

World Finance: Attracting foreign direct investment, another important role that banks need to play in the diversification efforts; how are you achieving that?

Pierre Imhof: The whole banking system in Brunei is very strong, and Baiduri Bank is no exception. Baiduri Bank has a very strong capital, and this definitely assures foreign direct investors when they come that they will find in Brunei a bank which is able to support them, a range of services which is of good quality, and in which they may put their confidence.

Another element is, banking with the highest level of security is very important for all clients. Baiduri Bank has been the first bank in Brunei to have developed PCI-DSS standard, which is a very high level of security for protecting data.

World Finance: You mentioned the trend towards digital services earlier; what other kinds of additional services are businesses – whether home-grown or coming from overseas – demanding from banks?

Pierre Imhof: We see, as I mentioned, more demand from companies to make their transactions, their transfers, through internet banking.

When they have retail clients, they like to offer services online. And banks behind the scenes are offering the technology to allow these companies to process their payments online.

What I think we’ll see more and more is development of new methods of payments, and we are working in order to offer in the future to our clients these new methods of payment.

World Finance: And what are the latest trends in the retail banking environment in Brunei?

Pierre Imhof: The Brunei retail market is, for banks, quite sophisticated. Bruneians are wealthy. They travel. They know what’s happening all around the world. So we have to be always very advanced in terms of our offer of products in the retail segment.

We are the first bank, many years ago, to offer internet banking services; and mobile banking is an area where we move fast, and where we are developing strongly our presence.

And in Brunei we have been also the first bank to launch PayWave, this new technology: our clients like to tap, pay, and go.

These are technologies that we are using more and more in Brunei for our retail clients.

World Finance: Pierre, thank you very much.

Pierre Imhof: Thank you.

Brunei’s stock exchange signals more global approach to diversification

Posted on by World Finance

Brunei’s stock exchange is scheduled to open later this year, sparking renewed international interest in the small – but wealthy – island nation. The initiative should help the government’s ongoing efforts to diversify the economy. Baiduri Bank’s Pierre Imhof explains the progress that authorities have made towards launch, and what the stock exchange represents for the future of Brunei.

Watch the rest of our interview with Pierre Imhof here.

World Finance: I’m with Pierre Imhof, CEO of Baiduri Bank, and we’re discussing Bruneian industry.

What’s the latest on the development of the stock exchange?

Pierre Imhof: The authorities are making significant progress, from what I understand, on the technical and the infrastructure aspect of developing a stock exchange. It’s a part of a more global approach that the country has to develop its capital markets activities. There is of course another aspect: if you have a stock exchange you need to have clients, so it’s important also that in parallel it attracts interest by companies to be listed.

World Finance: Brunei is the last ASEAN country to create its own stock exchange; what does it represent for the future of the economy?

Pierre Imhof: Brunei has the means to develop further its capital markets activities. There is already an Islamic product – sukuk, the equivalent of bonds – in Brunei. And I think that the objective is to create a bigger, more developed, and more diversified capital market environment. Which we, of course, support.

World Finance: Pierre, thank you.

Pierre Imhof: Thank you.

Afore XXI Banorte: standardisation key to the success of Mexico’s pension system

Posted on by Max Tomlin

The introduction of the Mexican pension system in 1997 marked an important juncture in the development of the state benefit programme. Drawing inspiration from the pension reforms conducted in Chile during the 1980s, Mexico’s pension plan transformed the traditionally informal, pay-as-you-go contribution system into a fully funded, private and mandatory contribution scheme.

Now, 20 years on, the joint venture between the Mexican Government and the nation’s private pension providers has proved an unprecedented success, providing millions of previously underrepresented Mexicans with a secure future. That said, while the state of Mexico’s benefit system has undoubtedly improved in the decades since the plan’s inception, there is still much to be done.

At the heart of this transformation is Afore XXI Banorte. Formed from a series of mergers between some of Latin America’s largest pension funds, Afore XXI Banorte has continued to work alongside the Mexican Government to improve the current pensions system and ensure Mexicans leaving the workplace can do so with confidence and dignity.

Managing risk 
Published in 2015, the OECD Reviews of Pension Systems report outlined the significant need to increase the mandatory contributions of all Mexican workers in order to ensure benefits exceeded 50 percent of final salary. The report also highlighted the need to standardise a fragmented system that was still suffering after the transition from an ill-defined pay-as-you-go system to a mandatory contribution scheme. Now, in 2017, it is Afore XXI Banorte leading the charge to address these issues.

Afore XXI Banorte currently manages a pension fund in excess of MXN 658bn ($35.1bn) and boasts one of the most diverse portfolios on the market, having taken full advantage of the investment regime that formed its success. Afore XXI Banorte’s risk management and investment committees have been vital to overcoming the hurdles outlined in the OECD report.

Afore XXI Banorte has introduced a number of key changes to ensure customers receive the best returns on their investment

Working in conjunction with the Mexican Government, the committees have established international standards and introduced greater transparency to the fund’s investment practices. Confidence is key to any market and, by leveraging its influence as a leader in the Mexican pension system, Afore XXI Banorte has introduced a number of key changes to ensure customers receive the best returns on their investment.

In 2016, Afore XXI Banorte introduced an internal benchmark and implemented best practice procedures in its external manager selection process for alternative assets. Both moves represented a first for Mexico’s pension fund managers and, after receiving considerable backing from the regulator, established a new standard in pension provision. Technological advances have also improved the fund’s risk management and investment processes, ensuring client contributions continue to gain value at less risk.

Securing the future
These moves have been reinforced by the fund’s decision to refresh its management team. A new CIO joined the team in 2016, as well as two seasoned investment professionals – one Head of Alternative Assets and one Head of Asset Allocation – and new CEO Juan Manuel Valle. With decades of asset management experience between them, Afore XXI Banorte’s new appointments have helped strengthen the fund’s bid to consolidate its position in a fluctuating market.

Valle believes this consolidation will present the greatest challenge to both Afore XXI Banorte and the wider market in the immediate future. This has become particularly evident in the current volatile environment, with the possibility of major structural changes occuring in the international arena. As a result, having a seasoned investment team with a solid process and investment discipline is key in this moment. Coupled with the continuing strain of introducing old pay-as-you-go policies into the new system, this will make strong leadership and transparent business operations a prerequisite to any future success, especially if Mexico’s pension payment scheme is to follow an upward trajectory.

To this effect, Afore XXI Banorte plans to grow its alternative investments portfolio and improve the efficiency of the uncorrelated and higher duration assets it already holds. As the market begins to mature, retaining affiliates will become a primary goal of all pension providers, and the best way to achieve customer loyalty is by providing fantastic service and returns.

While the Mexican pension system still has some way to go to match some of its rivals, the responsible investment, innovation and transparency of fund managers like Afore XXI Banorte will continue to provide an essential driver to the market and help to secure a more positive future for all Mexican workers.

Following China’s debt-paved Silk Road

Posted on by Max Tomlin

When Chinese President Xi Jinping unveiled his cherished Silk Road Economic Belt project in 2013, the scale of his ambition was so vast that it hardly seemed credible. China would rebuild its historic trade route, but this time taking it even further than the Han Dynasty did in 206 BC. Xi’s modern Silk Road would stretch all the way to Europe through central and western Asia. For good measure, there would also be a maritime route connecting China with south-east Asian countries, Africa and Europe.

If anything, the grand plan has gotten even bigger since, embracing much of Latin America and sub-Saharan Africa. Bankrolled by state-controlled lenders, Chinese hydropower contractors are dominating greenfield projects in much of Africa. As such, they appear to have the inside track on bidding for the $5-12bn Grand Inga Dam expansion in the Democratic Republic of Congo – set to be the biggest hydropower contract in the world.

Although China has borne the bulk of the debt, it isn’t funding the Silk Road all by itself. Another financial engine is the Asian Infrastructure Investment Bank (AIIB), although this was admittedly launched by China two years ago with $100bn in authorised capital. The AIIB is steadily building up its war chest, with the help of private sector investment in the shape of pension funds and other sources of capital, through a big-ticket series of public-private partnerships.

The grand plan for a renewed Silk Road has gotten even bigger, embracing much of Latin America and
sub-Saharan Africa

The AIIB, which has 57 member states (the US is not one of them, due to its fears over Chinese ambitions in the region), needs all the funds it can get; it has identified an $8trn backlog of large-scale projects such as toll roads, power plants, seaports and airports. Top of the list is infrastructure in Asia, but the bank has ambitions to expand into other regions later, to the considerable benefit of China. With its current president being Chinese national Jin Liqun, the AIIB is largely controlled by the Asian superpower.

In the pursuit of its ambitions, the AIIB is handing out money like water. In 2016 – its first full year of operations – the bank pumped $1.3bn into nine major infrastructure projects, including ones in Azerbaijan and Oman. And it’s keeping up the pace: in early May, for example, it approved a landmark $160m loan for a power project in the Indian state of Andhra Pradesh under the country’s Power for All initiative. There will be a lot more money where that came from. As AIIB President Jin said: “We expect [this] to be the first of many projects that AIIB invests in India.”

Debt trouble
For 2017, the AIIB has drawn up a long laundry list based on what it calls “cross-border connectivity” – which is another way of saying ‘Silk Road’. On the agenda are roads and rail, ports, energy and telecommunications infrastructure right across central Asia, along with “maritime routes into south-east and south Asia, the Middle East and beyond”.

But the paving of the Silk Road with low-priced debt has got China into trouble in some regions, particularly following the collapse in the price of crude oil. In Latin America, for example, state-owned lenders have been forced to swap infrastructure-funding debt for the supply of oil as recipient countries run out of revenues with which to pay China back.

The policy has also backfired in other locations. As the Oxford Institute for Energy Studies pointed out in a definitive recent report, crisis-hit Venezuela provides a sobering example: in mid-February, China agreed no less than 22 new deals aimed at propping up the South American country’s fast-declining oil industry. Although the ever-hopeful President Nicolás Maduro characterised the deals as heralding “our country’s economic recovery”, it looks more as though China is taking control of its wells and refineries in an infrastructure-for-debt swap.

The situation in several other countries must be making China’s state-guided lenders wish they’d never gotten involved. Ecuador, for example, is struggling to maintain agreed production levels, while in Angola plummeting oil revenues are jeopardising the government’s ability to repay its debts to China. Iran, meanwhile, is not fulfilling China’s hopes either.

In late January, rating agency Fitch expressed its concerns about whether some of these oil loans will ever be honoured, citing the low sovereign rating of several recipient countries. It warned: “The lack of commercial imperatives behind [Silk Road] projects means that it is highly uncertain whether future returns will be sufficient to fully cover repayments to Chinese creditors.”

In other words, unless global crude prices rise by at least 10-20 cents a barrel, many of these loans won’t pay off. And China still hasn’t achieved the energy independence it wanted when it began investing in Latin America. As the Oxford Institute pointed out: “Despite the billions invested in global oil markets, China still relies on Russia, Saudi Arabia, Iraq, Angola, Oman and Iran for two thirds of its imports.”

But with so much capital in play, China can hardly back out now. The Oxford Institute noted: “After investing so heavily, Beijing has few options but to maintain support for these countries in a bid to sustain oil production, at least enough to ensure loan repayment and equity output.” In short, China must pour in good money after the bad.

Brazil is a case in point. In April 2016, the China Development Bank agreed on a fresh $10bn oil loan to help bail out cash-strapped, corruption-ridden Petrobras. But, unlike Venezuela and other recipient countries, at least Petrobras had the oil.

China in Africa
In the meantime, China continues to invest fearlessly in other countries (see Fig 1), particularly in Africa. The lender is typically Exim Bank, whose cheap funding lies behind much of China’s rapid expansion in the region as it gives contractors a price advantage over western competition. According to an OECD report issued in late 2016, in the past five years China has pumped around $13bn into the sub-Saharan energy sector alone in the form of direct loans, buyer/seller credits and foreign direct investment.

$13bn

Amount China has invested in the sub-Saharan energy sector in the past five years

150

Chinese-funded projects have been completed globally in the past five years

56%

Chinese companies’ share of the renewables sector

$8bn

The backlog in large-scale Chinese infrastructure projects

That’s how Chinese contractors built nearly all the new power capacity in the region between 2010 and 2015. More than 150 projects were completed in the past five years, and at least another 50 are under construction or approved. And while dominating in hydropower, Chinese companies cover the entire energy mix including renewables, a sector where they’re responsible for 56 percent of new capacity, among them a 600 MW coal-fired plant in Botswana, the 400 MW Bui Dam in Ghana, a 100 MW diesel-fired power plant in Niger, and a 244 MW wind farm in Northern Cape, South Africa, as well as geothermal projects in Kenya.

Although there’s some alarm surrounding China’s geopolitical ambitions in the region, generally the OECD approves its role in the region’s hitherto capital-starved energy sector. “China has become an important source of financing in Africa”, the report noted. “Chinese engagement in power covers all primary sources except nuclear, and all sizes of projects, while donors from OECD countries avoid financing large hydropower dams or coal-fired power plants.”

China has certainly picked up the plum contracts. As the OECD added: “The share of greenfield power projects contracted by Chinese companies equals those contracted by companies from the next four largest countries combined: France, Italy, Finland and the United States.”

Building bridges
As well as building infrastructure, on its own doorstep China is busy erecting financial bridges that underpin its wider involvement in Asia’s roaring economy. It started off with Singapore, which sees itself and Shanghai as the financial powerhouses of the Silk Road. The Monetary Authority (MAS), Singapore’s financial watchdog, noted earlier this year: “Both financial centres can work together to develop innovative capital market solutions for infrastructure projects in China, ASEAN and in third countries.”

In the past two years, Singapore has fallen over backwards to help bring Chinese companies into the region, some for the first time as they venture beyond their own borders with President Xi’s encouragement. During this process, MAS has opened a regulatory dialogue that is set to pave the way for nothing less than a “new Asian financial landscape”, as the authority’s Deputy Managing Director Jacqueline Loh described it. She was speaking not long after MAS signed up to participate in China’s interbank foreign exchange market and, in another boost for the growing power of the renminbi, the authority started buying yuan-based assets for Singapore’s official foreign reserves. If this isn’t a seal of approval for China’s ambitions, nothing is.

With China’s vast financial sector encroaching on the borders of the rest of Asia, Jacqueline Loh’s promise of a new Asian financial landscape is no exaggeration. For instance, financial conglomerate Ping An has 109 million core finance customers and an internet user base approaching 300 million, while Tencent – although known as a gaming and social networking site with 800 million active users – is already expanding into finance with vast potential beyond its home base. And then there’s e-commerce giant Alibaba, which has its own global ambitions.

China’s fast-growing fintech industry is also poised on Asia’s doorstep. Of the world’s five biggest fintech firms, three – top-ranked Ant Financial, fourth-ranked Lu.com and fifth-ranked ZhongAn insurance – are based in or near Shanghai.

As the region develops common standards of regulation, firms such as these are bound to push along the Silk Road, where the financial opportunities are off the scale. According to statistics compiled by MAS, the financial system in Asia could reach $200trn by 2030 – this is four times its current size and more than double the projected size of the financial sector in the US.

Children protest China’s presence in Myanmar

Regional nervousness
To put it mildly, not all nations in the region are as sanguine about the Silk Road as Singapore. In fast-developing and resource-rich Myanmar, the reforming administration headed by Aung San Suu Kyi is not nearly as pro-China as the old military regime was, which had long been cultivated by Beijing. As the World Economic Forum pointed out, Myanmar is a new energy frontier lying between China and India, at the very crossroads between east and south Asia – and China wants a piece of it.

At the time of writing, the two countries had finally struck a deal on the much-delayed, $1.5bn, 770km oil pipeline across Myanmar to land-locked Yunnan in south-west China. It had been sitting empty for two years after a standoff between the two countries over what Myanmar saw as highly unfavourable terms that China had tried to railroad through. China sees the pipeline as an important part of the Silk Road project, because it has the capacity to provide five percent of its daily import demand and take the pressure off deliveries made through the contested Malacca Strait.

Eventually though, Myanmar will have to find a way of cooperating with its giant neighbour, just as other nations lying along the route of the Silk Road will. With a population of 54 million compared with China’s 1.35 billion and a threadbare (though improving) economy, Myanmar is in no condition to withstand its partner’s global ambitions. For these reasons, despite their misgivings about China’s occasional strong-arm tactics – for instance, in the hotly disputed, hydrocarbon-rich China Sea – nations such as Singapore, Malaysia and Indonesia are learning to embrace the Silk Road, wherever it may lead.

Turbulent times ahead for commercial airlines as soaring fuel costs leave profits grounded

Posted on by Max Tomlin

In April, a video surfaced online of an incident aboard a United Airlines flight. In the video, a man, David Dao, gets asked to disembark the plane prior to take off at Chicago’s O’Hare International Airport. When he refuses, airport officials violently drag him from the plane. He returns to the aircraft with a bloodied face, due to his head striking an armrest during the scuffle.

A 69-year-old grandfather, Dao reportedly suffered a concussion and lost two teeth in the ordeal, with his lawyer later claiming his injuries would require reconstructive surgery. The graphic video garnered international attention, with many questioning how such an incident had happened. Adding to the chaos, United Airlines CEO Oscar Munoz put out a tone-deaf statement lamenting the need to “re-accommodate” the passenger, while also claiming Dao fuelled the situation by being disruptive. The backlash was swift, and Munoz was forced to go on tour apologising again and again for the ordeal.

While an overreaction by airport officials and a bungled public relations response made the whole episode far worse than it needed to be, much of the public attention was drawn back to what initially caused the chaos: the need for someone to vacate a seat they had paid for.

Overbooking flights is a calculated risk many airlines take. In general, it pays off; the extra tickets sold cover the cost of re-accommodating any passengers when flights are full. This practice is not born out of pure greed: the airline industry is financially challenging, as costs are high and profit margins are often extremely tight (see Fig 1). Overbooking is not just a shrewd way to make extra money; for some, it’s the only way to stay in the skies.

Only recently has the airline industry grown to, in sum, cover its own costs, though many carriers still face an uncertain future. In an industry where ticket prices have entered a race to the bottom and subsidised carriers operate on an uneven playing field, air travel is a difficult sector in which to make money. While the industry is currently entering a period of relative success, a multitude of challenges still remain.

The Airboat Express
The first scheduled commercial flight in history took place on January 1, 1914. Abram Pheil, then Mayor of St Petersburg, Florida, paid $400 (about $10,000 by today’s standards) at auction to take Flying Boat No 43 on a 23-minute jaunt from St Petersburg to Tampa Bay. The plane, built by Thomas Benoist and flown by Tony Jannus, was made out of wood and muslin. “What was impossible yesterday is an accomplishment of today, while tomorrow heralds the unbelievable”, said Percival Fansler, the owner of the plane and operator of the route, at the time.

Though the airline only received a contract to operate for three months, demand stayed high throughout its operation, with Fansler asserting that not once did the plane fly without a passenger. Local businesses also took advantage of flying some limited goods across the bay, if only for the opportunity to advertise the fact that they were transported by the ‘Airboat Express’.

Still, the profitability of the airline industry was already dubious. Local historians recorded that, despite taking in $12,000 in fares over the route’s operation, profits were low due to employee wages, gas, oil and the cost of getting the aeroplane to Florida in the first place. “We have not made much money, but I believe we have proved that the aeroplane can be successfully used as a regular means of transportation and commercial carrier”, Benoist was reported to have said at the time. While passenger interest waned in the months after the initial three-month contract as people left Florida at the end of their holidays, the airline at least proved there was an appetite for air travel.

In the US, the airline industry properly took off in 1925 with the passing of the Air Mail Act. This legislation, which allowed the US postmaster to arrange a contract with private airlines for mail delivery, paved the way for the Air Commerce Act, which regulated the industry and gave the US Secretary of Commerce the power to establish airways, certify aircraft, license pilots and enforce air traffic regulations. In 1930, the Civil Aeronautics Board was established to regulate the industry, including setting routes and standardising passenger fares. In 1958, the Federal Aviation Agency was established to manage safety standards.

Amid these regulations, prices for fares stayed out of reach for many. The Civil Aeronautics Board only approved routes and fares that guaranteed a 12 percent financial return on flights that were 55 percent full. Air travel was largely seen as an industry in need of protection and support from the government; simply having the flights available was an economic driver and, particularly for international routes, a form of soft diplomatic power. Instead of price, airlines began competing with service, offering comically luxurious amenities on board like piano bars and cocktail lounges.

Airlines have scrambled to find other sources of income, such as through on-board food and additional luggage fees

In the mid-1970s, a simplification of the charter rules governing transatlantic flights resulted in the emergence of low-cost international airlines. Laker Airways, owned by British entrepreneur Freddie Laker, created the Skytrain service, offering extraordinarily cheap fares from London to New York. Keen to make air travel in the US more affordable as well, President Jimmy Carter tasked economist Alfred Kahn with devising a plan to bring down the price of a ticket.

Kahn drew up the Airline Deregulation Act of 1978, ushering in free market competition in the industry. Dozens of new players rushed into the market, creating the no-frills airlines that are common today. Many other countries followed suit as greater competition put air travel in reach of the average person.

Earn your wings
While deregulation was a tremendous success in terms of lowering airfares, in the short term, it caused immense pain for carriers. Among the low-cost carriers, competition was fierce. More established businesses, particularly international ‘flag carriers’ that were often state-owned and not concerned with profit, found themselves lowering prices to compete with these new upstarts. Overall, the airline industry has only recently managed to start making money. This reputation is well known – in 2013, Warren Buffett famously described the entire sector as a “death trap for investors”.

Speaking to World Finance, Tim Coombs, Managing Director of Aviation Economics, said that, up until two years ago, the industry at large had not been able to cover its costs of capital. The recent accomplishment has largely been due to the success of US carriers. He explained: “It’s the level of profitability [that] is patchy elsewhere, but the US airlines have been making record amounts of money, which is sort of dragging the overall number up.”

The biggest change to the US airline industry in recent years has been significant consolidation. Since the turn of the millennium, 10 of the US’ major carriers have merged into four: Southwest, Delta, American and United. “So the level of intense competition that we’ve got in other parts of the world isn’t really the case in the US”, Coombs said. “They’ve managed to bring some discipline in terms of pricing, they’re quite disciplined in terms of amount of new capacity they’re adding, and therefore the general oversupply of capacity which is driving down profitability elsewhere doesn’t exist anymore in the US.”

But despite this recent landmark instance of overall profitability, pressures still remain. Coombs said international carriers – particularly those still partially or fully state owned – put pressure on privatised competitors: “You’ve still got some of those carriers in various parts of the world. Arguably, some of the carriers in the Middle East – particularly Etihad and arguably Qatar Airways – are there as instruments of promoting the country. And given they’re government owned, they don’t have the same sort of financial discipline to be profitable. All those sorts of carriers who are operating in the marketplace [have] an impact on those carriers which are trying to be more commercially focused.”

Adding to the challenge is how easy it has become for travellers to find the lowest available ticket price for their trip. With the rise of comparison websites like SkyScanner and TripAdvisor, the average customer rarely looks beyond the cheapest options. “Sadly, as much as I don’t really want to say it, it’s like going into a supermarket and choosing a can of baked beans; you end up buying the cheapest can”, Coombs said. “You don’t really care if you’re flying on Monarch, easyJet, Ryanair, British Airways or Iberia, you just get the cheapest ticket.”

Coombs said that, in this case, the airline with the lowest overhead costs is at a huge advantage. “If you are in the fortunate position of being Ryanair and have a cost base which is 20, 30, as much as 50 percent lower than your competition, then you can be price leader and still make money, whereas everybody else has to follow your prices.”

All of this has had a tremendous impact on prices. After adjusting for inflation, the average price for a domestic US airfare has fallen 50 percent between 1978 and 2011. “If you look at what’s happened to ticket prices in real terms, they’ve declined by about two percent per annum forever, or at least going back as far as the Second World War”, Coombs said.

“The airlines have become more and more efficient, partly driven by technology, because the aircraft are more efficient these days. Lower fuel burn, better aerodynamics, the airlines become more efficient because of computerisation and every time the airline makes a gain in terms of productivity, or cost of production, that always gets passed on to the passenger.”

He continued: “I’m an old guy. When I was growing up, an airfare to Rome was £500, and now you can get it for £50. Ryanair’s average fare is €46 one way – that was absolutely unthinkable 20 years ago.”

All this has meant airlines have scrambled to find other sources of income. On-board food and additional luggage fees add directly to incoming dollars per passenger, while many airlines bundle insurance, car hire and hotel package deals with tickets as well. These additional revenue streams are a necessity for many carriers.

According to Bloomberg, Cathay Pacific currently needs to sell 124 percent of its available tickets in order to turn a profit. While the airline is currently ranked third in the world for its load factor, calculated as passenger traffic as a percentage of available seats (see Fig 2), this is an obviously impossible task. Meanwhile, Australian carrier Qantas’ air miles loyalty scheme is its division with the highest operating profit margin; it sells miles to credit card companies and supermarkets, which they then pass onto their customers.

In November 2016, Ryanair CEO Michael O’Leary speculated that his airline could potentially give away tickets for free, as it generated enough revenue from these additional services alone. While Coombs said this is not going to happen, it does underscore how much prices have fallen, and how important these extra services are to an airline’s profitability.

Demonstrators protest United Airlines’ treatment of passenger David Dao

What’s in a name?
Since decades of data have taught airlines that certain percentages of passengers are not going to turn up for their flights, overbooking in order to secure that small amount of additional income is common. These predictions are as detailed as individual days and routes. It’s a calculated risk, but the extra income generated from additional ticket sales more than makes up for the compensation given to those passengers unable to board.

$29.8bn

Forecasted industry profits for 2017

$35.6bn

The airline industry’s profits in 2015

$124bn

The airline industry’s estimated fuel bill in 2016

1958

The year the US Federal Aviation Agency was established

50%

The drop in price of an average domestic US flight between 1978 and 2011

While the negative press generated by United’s recent overbooking incident may temporarily change buying habits, Coombs said it’s unlikely to have a long-term effect based on how price sensitive travellers tend to be: “The remarkable thing is, and we’ve done a lot of analysis on this, [passengers] won’t pay very much more to go and fly on another carrier. We’re talking €10 more. If you’re confronted with paying twice as much more to go on another carrier people will sort of say, ‘alright, we don’t like flying on Ryanair, but I’m not willing to go and pay twice as much to go and fly on someone else’.”

Despite some stability in the market at the moment, airlines still face a multitude of challenges in areas well beyond their control: airports often hold local monopolies, making drafting a competitive contract hard, while Airbus and Boeing hold a duopoly on large aircraft sales and, due to international ownership regulations, many airlines are unable to merge with struggling rivals. Coombs said: “The price of oil, GDP, wars, disaster events, currency, Brexit – there’s a list as long as your arm of things which potentially put a dent in your profit stability, which are outside of your control to some extent.”

As has already happened in the US, the global airline industry can expect to see more consolidation in the future. As the effects of deregulation are still playing out, the sector is on a course to correction – albeit slowly. “In theory, we are ending up in an industry that should be behaving like a normal industry does and making returns for shareholders, but I think we’re looking at something that’s going to take decades rather than years, unfortunately”, Coombs said.

In an industry under this much pressure, more bankruptcies may become the norm. With competition still fierce, practices like overbooking flights will continue to be a necessity. But things may be looking up: in February, Warren Buffett changed his tune on airlines, buying into American Airlines, United, Delta and Southwest. “It’s true that the airlines had a bad 20th century”, he said in an interview with CNBC. “They’re like the Chicago Cubs. And they got that bad century out of the way, I hope.”

Emergency exits:

History is littered with the relics of airlines, large and small, that have declared bankruptcy. As well as offering temporary respite from financial trouble, bankruptcies also give airlines the opportunity to renegotiate old and often very generous employee contracts. But while some recover, many are forced to shut down operations after being unable to save themselves.

Here, World Finance outlines some of the airlines experiencing the most turbulence:

Ansett Australia

Established in 1935, Ansett was once Australia’s second-largest airline behind Qantas. It was extremely successful in the 1980s, but it struggled to compete with a number of new start-up airlines that emerged around 2000. It paid millions to become the official partner airline of the 2000 Sydney Olympic Games – a deal widely regarded as a poor decision. Maintenance irregularities later grounded its fleet of Boeing 767s, costing the company AUD 1.3m ($970,500) for every day they were out of action. It entered voluntary administration in 2001.

Alitalia 

In May 2017, for the second time in 10 years, Italian airline Alitalia entered administration. Its first bankruptcy filing saw it privatised and relaunched in 2008, but it has since struggled to compete with the many low cost carriers operating across Europe. Its market share has shrunk, and the recent threat of terrorism on the continent also appears to have reduced passenger counts. Its workers recently voted against a restructuring that would see wage cuts and job losses, and at the time of publication its future remains in doubt.

United Airlines

Then the world’s number two airline, United filed for bankruptcy in 2002 after losing $4bn over the previous two years. Despite operating around 20 percent of all US flights, a slumping economy and falling passenger counts after the September 11 terrorist attacks took their toll. The airline emerged from bankruptcy in 2006 (a record amount of time) with 30 percent fewer employees, 20 percent fewer aeroplanes and 20 percent lower operating costs. In 2010, it underwent a $3bn merger with Continental.

Silverjet

Alongside MaxJet and Eos, Silverjet was part of a group of business-class-only carriers that emerged during the mid-2000s. The company boasted it would be the first carbon neutral airline in the world, and its first flight from London to New York took off in 2007. Despite some initial success, including the expansion of its service to include a Dubai route, by 2008 it had suspended all flights thanks to a doubling in air passenger duty, pressure from rivals and the collapse of a £12.7m ($16.5m) emergency funding deal.

Malaysia Airlines 

Malaysia Airlines suffered two tragedies in 2014: the disappearance of flight MH370, and the shooting down of flight MH17. While these two incidents prompted many customers to avoid the airline, the company had already been posting losses for some time due to strong competition. It was renationalised in August 2014 and Christoph Mueller, famous for orchestrating several airline turnarounds, was appointed CEO in May 2015. In June that year he announced 6,000 job cuts; “We are technically bankrupt”, he said at the time.

Where US manufacturing jobs really went

Posted on by Max Tomlin

In the two decades from 1979 to 1999, the number of manufacturing jobs in the United States drifted downward, from 19 million to 17 million. But over the next decade, between 1999 and 2009, the number plummeted to 12 million. That more dramatic decline has given rise to the idea that the US economy suddenly stopped working – at least for blue-collar males – at the turn of the century.

But it is wrong to suggest that all was well in manufacturing before 1999. Manufacturing jobs were being destroyed in those earlier decades, too. But the lost jobs in one region and sector were generally being replaced – in absolute terms, if not as a share of the labour force – by new jobs in another region or sector.

Operation relocation
Consider the career of my grandfather, William Walcott Lord, who was born in New England early in the 20th century. In 1933, his Lord Brothers Shoe Company in Brockton, Massachusetts was facing imminent bankruptcy. So he relocated his operations to South Paris, Maine, where wages were lower.

The Brockton workers were devastated by this move, and by the widespread destruction of relatively high-paying blue-collar factory jobs across southern New England. But in the aggregate statistics, their loss was offset by a bonanza for the rural workers of South Paris, who went from slaving away in near-subsistence agriculture to holding a seemingly steady job in a shoe factory.

The South Paris workers’ good fortune lasted for just 14 years. After World War II, the Lord brothers feared that depression could return, so they liquidated their enterprise and split up. One of the three brothers moved to York, Maine; another moved to Boston. My grandfather went to Lakeland, Florida – halfway between Tampa Bay and Orlando – where he speculated in real estate and pursued non-residential construction.

Again, the aggregate statistics didn’t change much. There were fewer workers making boots and shoes, but more workers manufacturing chemicals, constructing buildings and operating the turnkey at the Wellman-Lord Construction Company’s Florida-based phosphate processing plants and other factories.

In terms of domestic employment, the Wellman-Lord Construction Company had the same net factor impact as Lord Brothers in Brockton. The workers were different people in different places, but their level of education and training was the same.

Lost manufacturing jobs in one region are generally
being replaced by new jobs in another region or sector

Churning jobs
So, during the supposedly stable post-war period, manufacturing (and construction) jobs actually moved en masse from the northeast and midwest to the Sun Belt. Those job losses were as painful for New Englanders and Midwesterners then as the more recent job losses are for workers today.

During the 2000s, American blue-collar jobs were churned more than they were destroyed. Until 2006, the number of manufacturing jobs decreased while construction jobs increased. And in 2006 and 2007, losses of residential construction jobs were offset by an increase in blue-collar jobs supporting business investment and exports. It was not until the post-2008 Great Recession that blue-collar jobs began to be lost more than churned.

Because there is always some degree of churn, a more accurate perspective on what has happened is gained by looking at blue-collar jobs as a share of total employment, rather than at the absolute number of manufacturing workers at any given time. In fact, there was an extremely large and powerful long-run decline in the share of manufacturing jobs between World War II and now. This gives the lie to the meme that manufacturing was stable for a long time, and then suddenly collapsed when China started making gains.

A question of trade
In 1943, 38 percent of America’s nonfarm labour force was in manufacturing, owing to high demand for bombs and tanks at the time. After the war, the normal share of nonfarm workers in manufacturing was around 30 percent.

Had the US been a normal post-war industrial powerhouse like Germany or Japan, technological innovation would have brought that share down from 30 percent to around 12 percent. Instead, it has declined to 8.6 percent. Much of the decline, to 9.2 percent, is attributable to dysfunctional macroeconomic policies, which, since Ronald Reagan’s presidency, have turned the US into a savings-deficit country, rather than a savings-surplus country.

As a rich country, the US should be financing industrialisation and development around the world, so that emerging countries can purchase US manufacturing exports. Instead, the US has assumed various unproductive roles, becoming the world’s money launderer, political risk insurer and money holder of last resort. For developing countries, large dollar assets mean never having to call for a lifeline from the International Monetary Fund.

The rest of the decline in the share of manufacturing jobs, from 9.2 percent to 8.6 percent, stems from changing trade patterns, primarily owing to the rise of China. The North American Free Trade Agreement, contrary to what US President Donald Trump has claimed, contributed almost nothing to manufacturing’s decline. In fact, all of those “bad trade deals” have helped other sectors of the American economy make substantial gains; as those sectors have grown, the share of jobs in manufacturing has fallen by only 0.1 percent.

In this era of fake news, astroturf social movements, and misleading anecdotes, it is imperative for anyone who cares about our collective future to get the numbers right, and to get the right numbers into the public sphere. As the Republican Party’s first president, Abraham Lincoln, put it in his ‘house divided’ speech: “If we could first know where we are, and whither we are tending, we could then better judge what to do
and how to do it.”

© Project Syndicate 2017

Project Finance Deals of the Year 2017

Posted on by Helen

Last year, Tiwi-MakBan, a Philippines-based geothermal energy project, launched with the first ever green bond issuance in the Asia-Pacific region. The project, backed in part by the Asian Development Bank, will carry out the rehabilitation of two of the biggest geothermal facilities in the world, creating 390 MW of clean renewable power for the Luzon grid.

The scheme will play a key role in meeting the nation’s rapidly growing energy needs, and has created an important precedent for the use of green bonds in the region. The venture is a classic case of how certain projects in the sector are driving ahead in spite of challenges, while turning towards more green investments and finding new and innovative ways to tap into private funds.

Despite uncertainty caused by global political events and persistently low commodity prices, the past year has seen the conclusion of a wide array of impressive projects and deals. World Finance looks to recognise those who have shown versatility and vision in the face of persistent challenges in the sector.

As always, the project finance sector is dictated by the march of technology, the twists and turns of commodity prices, and influential political events

The immense task of drawing up a project and carrying it through to completion requires remarkable leadership and ambition, ultimately forming vital pieces of infrastructure that are the bedrock of economies all over the globe.

The Project Finance Deals of the Year celebrate those that stand out for breaking new ground and driving forward with the biggest and most exciting projects, and provides a comprehensive list of the most noteworthy projects and deals that have taken place in the sector over the past year.

Project pursuit
This year, the need for large scale infrastructure investments has dominated headlines. For one, the Asian Development Bank estimated that developing Asia must invest $1.7trn per year in infrastructure until 2030 in order to maintain its growth momentum, tackle poverty and respond to the issue of climate change. Even assuming fiscal reform could fill part of this investment gap, the bank said private sector investment would have to increase “dramatically”. More specifically, the bank estimated that, for the private sector to fill the gap, it would have to increase investments fourfold from $63bn to as high as $250bn per year over the period from 2016 to 2020.

Furthermore, the McKinsey Global Institute released a report assessing the worldwide need for increased infrastructure investment. The report estimated that, from 2016 to 2030, the world must invest an average of $3.3trn a year in economic infrastructure in order to support expected rates of growth. Simultaneously, governments around the world – including those in the US, Indonesia and India – have underscored the need for sizeable infrastructure and energy investments in order to stimulate economic growth and jobs.

A state of flux
Despite a clear demand for a greater number of projects, the sector continues to be squeezed by the ongoing dip in commodity prices. While prices have begun to pick up for certain commodities, the aftermath of the persistent slump is still being felt through tighter liquidity availability for projects and lower project returns. Furthermore, a lacklustre global recovery is exacerbating such concerns.

Another crucial issue being faced is the considerable political uncertainty weighing on decision makers. This is particularly the case in Europe, where a busy calendar of elections has prompted fears of potentially destabilising political shifts. Meanwhile, Brexit negotiations are underway, leaving a lot up in the air for the region.

Donald Trump’s election victory has triggered further uncertainties in the US, and the lengthy process of translating campaign promises into policy is still ongoing. In particular, several important policy choices regarding energy and infrastructure are still being clarified, which will inevitably have substantial ripple effects for the project finance industry.

Indeed, the global project finance sector has seen a somewhat tentative start to 2017 compared with recent years. According to data from Thomson Reuters, the sector saw 162 deals worth a total of $43.3bn during the first quarter of 2017, marking a 19.4 percent decline from the same time last year. The sector has been particularly slow in the US, with the lowest first quarter recorded since 2013. Volumes were also low for the Europe, Middle East and Africa region, where project finance totalled $17.0bn, down 45.9 percent year-on-year. In contrast, the Asia-Pacific region has succeeded in bucking this trend, with volumes increasing 55.9 percent from last year.

While the volume of project loans declined overall, the past year saw a promising resurgence of bond financing. In fact, project bond issuance actually increased by $8.3bn, bringing the total volume to $43.6bn. This momentum is a positive sign that the sector is diversifying to find new ways to tackle the ongoing disconnect between the investors seeking opportunities and the projects that need their capital. By creating a better functioning market, enhanced bond issuance has the potential to bring a huge injection of funding to the project finance space by unlocking cash from investors, such as insurers, pension funds and sovereign wealth funds.

In particular, the project bond market is being driven forward by the US, which completed $13.6bn in bond volume last year, up from $10.8bn in the previous year. Green bond issuance has also blossomed in China over the past year, which looks set to continue to provide extra liquidity for the renewables sector in the future. Likewise, bond activity has surged forward in Mexico, where reforms surrounding bond issuance are setting the conditions for fresh project opportunities.

Adapting to stay ahead
As always, the project finance sector is dictated by the march of technology, the twists and turns of commodity prices, and influential political events. While the sector has been dented by the low commodity prices seen over recent years, this has come alongside new opportunities in the renewables space.

Markets have continued to shift towards greener energy sources, spurred by technological advances and improved efficiency across a number of renewable sectors. Looking ahead, the need to push forward and adjust to a shifting regulatory setting will present both challenges and opportunities in the sector.

Faced with a landscape clouded by many obstacles, the brightest players in the sector are capturing the best opportunities, while rapidly adapting to those events that shape the markets. The World Finance Project Finance Deals of the Year 2017 celebrate those projects that exemplify the best of the sector with the most forward-thinking and exciting projects.

World Finance Project Finance Deals of the Year 2017

PPP Deal of the Year
Eskisehir City Hospital Healthcare PPP Project

IPP Deal of the Year
Central Java Independent Power Plant

Project Bond Deal of the Year
Elazig Hospital PPP Bond

Power Deal of the Year
Asağı Kaleköy Hydro Power Plant

Oil & Gas Deal of the Year
Fermaca

Airport Deal of the Year
New International Airport for Mexico City

Road Deal of the Year
Santana-Mocoa-Neiva Highway

Rail Deal of the Year
Melbourne HCMT

Healthcare Deal of the Year
Konya Karatay Integrated Healthcare Campus

Social Deal of the Year
Galataport Project

Afore XXI Banorte: we must set the path for the future of Mexico pensions

Posted on by World Finance

2017 marks 20 years since Mexico reformed its pension system in line with World Bank recommendations. Twenty years ago there were no institutional investors; no asset managers. Today the country’s largest Afore is XXI Banorte, with assets under management worth $35bn. The business has worked hard to ensure its investors are focused on long-term targets, and embedded transparency in its investment process. CEO Juan Manuel Valle Pereña and CIO Sergio Mendez Centeno discuss the ambitions and philosophy of the company, and how Afore XXI Banorte became the first pensions provider to pass the Mexican regulator’s new benchmarking process.

World Finance: You’ve been leading Mexico’s pensions industry since 2014; how have you been maintaining your lead?

Juan Manuel Valle Pereña: It is important to put in context that before the pension system reform, there were no institutional investors in Mexico. There were no asset managers. So in the work we have been doing, it’s not only something that we have to do, because we are the largest – we have to be the ones setting the path towards the future.

One of the first challenges is to be able to put together a team that understands the long-term strategy behind asset management. We have to educate the people saving that the long-term strategy is what they should expect to look after. And that there’s no better alternative for them in the longer term than investing their resources through the pension system.

World Finance: You were the first Afore to gain approval from the pension regulator’s new benchmarking process. Can you talk me through this idea? What was the motivation behind it?

Sergio Mendez Centeno: Having a benchmark, the funds have a guideline. Let me put it that way, you know: a target, from which you cannot be distracted, and you can put your goals in the long-term.

The benchmark comes from an exercise; in the case of Afore XXI Banorte, we hired external advisors in order to create this benchmark, that comes from an optimisation process. Utilising the full investment regime, which allows us to invest from fixed-income locally, to alternatives abroad and locally. And we used capital market assumptions in order to find the right portfolio, the right benchmark, the right guideline.

So right now we have this guideline, that includes also our investment philosophy, and includes the way that we assess risk. And it’s key to be transparent. The benchmark helps you in order to do that, because you don’t have to lose your long-term target because of short-term risk.

So we are always in touch with the people who want to have information, in order to give them transparency. And to explain how the portfolio’s working.

World Finance: On the subject of transparency, as you expanded your alternative investments portfolio, you really embedded transparency into that process. Tell me more.

Sergio Mendez Centeno: Our targets are well known. We explain to everyone in the market, we’re saying: what are we looking for? And what are the strategies that we are trying to build in order to create the alternative portfolios.

So, the manager goes onto the internet, and then they file all the information there. All the things that are required, in order to be accepted.

Then the analyst starts the process. And they start discussions with the manager, doing background checks, how the manager’s doing, how much money, what is the pipeline?

Then, we have legal, we have compliance, we have CEO, CIO. We have analysts discussing if that is the right manager to give money to in order to create the alternative strategies that we are looking for.

So at the end, what we do is, we obtain the authorisation from the investment community to say, yes: this is the right strategy, this is the right manager, this is the right amount of money that we want to give to the manager. So now we can proceed to invest with them.

World Finance: So tell me more about your investment philosophy.

Sergio Mendez Centeno: First we need to fully use the investment regime. That is important. Because it you utilise the investment regime that goes from fixed-income to alternatives, you will have a very good long-term diversification.

After that is to assess which part of the investment cycle we are in. Internationally, because we have a portfolio that allows international investments. Then, finding the right vehicle, in order to better capitalise.

So, the investment philosophy at the end is very macro-oriented. And it’s something that will be exactly the same in an expansionary cycle, as in down cycles.

World Finance: And looking ahead, what challenges do you need to overcome?

Juan Manuel Valle Pereña: The first one is the consolidation of the team. In the structure, in the way we work, and in the people, in the individuals – although they have a lot of experience, they have not been working together for a long time. So, you need to consolidate that team for everything to work perfectly.

Second: we need to take full advantage of what the investment regime allows us. Particularly in our investments abroad, and in alternatives. So we are undertaking now a new mandate on US equities, and also commodities. So during the year we should go out and look for the best managers, in both cases.

I think voluntary savings is a key element. Today we mostly deal with mandatory contributions. And that’s a challenge. People in many countries are not having enough resources for their retirement: we have to make them understand that they need to save. So, voluntary savings is a key element for everyone.

World Finance: Juan Manuel, Sergio: thank you.

Juan Manuel Valle Pereña: Thank you very much, Paul.

Sergio Mendez Centeno: Thank you.