When Tim Ellis’ landlord gave him and his 20-something flatmates notice to end their tenancy for a £4,500-a month East London house, they didn’t attempt to argue. Even before moving in the landlord tried to hike the rent last minute, pre-contract. From London via Berlin to Sydney rents are at an all-time high. The search for urban shelter is often costly and exhausting for those seeking opportunity and a place to live.
How will young people put roots down in the future if they can’t afford big cities? Is reform of the global urban rental market possible? Or is this market failure on a simply epic scale? Solutions for change – especially as food, energy and transport inflation bear down while interest rates race higher – look thin on the ground.
Dial back
First, calm down a notch suggests Kath Scanlon, Distinguished Policy Fellow at The London School of Economics and Political Science (LSE). The urban shelter pressures are not spread equally – far from it – she says. “They’re not being felt in Middlesbrough, Hull or Indianapolis. They’re being felt in high-demand, attractive cities like London, Vancouver, San Francisco and Barcelona.”
Perhaps, but the lifeblood of big and attractive cities are usually fed and supported by younger people, particularly in the service economy or public sector. Key workers, in other words. “You’re right,” Scanlon says. “The crisis has implications for when people have children, where school rolls are falling in London.”
So what tools can be deployed? Scanlon doesn’t see the potential for one big intervention that would “solve everything because you are working within the confines of an existing system. We’re not going to sweep away the existing planning system or eliminate the UK Greenbelt.”
Instead she sees potential for more development of Greenbelt land of, say, within 800 metres of existing railway stations “that would provide a couple of million potential homes. If you increased social housing from what is now very small levels that would make a difference.” House price swings are also cyclical, she says, though hopes for wild house price falls among younger home buyers look stillborn: the latest UK government numbers show an annual 5.5 percent price rise in the UK, even if values have fallen one percent since January 2023.
1990s – the decade of demand
Let’s roll back briefly – how did we get here? Dr Chris Foye is a lecturer in housing economics at Henley Business School, University of Reading. He says the seeds for massive affordability pressures in large, well resourced cities were freely sown in the early-1990s.
How the property race boomed
2008 was the year when housing was super-commodified as interest rates fell to support the global economy. Shorn of reliable asset classes to park capital in, institutional investors piled into bricks and mortar.
For rented housing this meant, inevitably, higher rents to satisfy shareholders. But there was a difference this time: large institutional investors, like Blackstone, were switching from investing in offices where people worked to where people lived, like apartment blocks – a big shift.
Residential real estate was valued globally at $326.5trn in 2020, according to Savills, compared to the value of all gold mined at $12.1trn.
Property – along with urbanisation and a rapid drying up of enthusiasm for stocks and gold – was now king.
“That’s when you got agglomeration economies where companies want to be in cities. Networks, the sharing of knowledge, all those things become very important.” A huge surge in employment followed, but only for these highly networked conurbations. You could buy into these cities if the price was affordable, or you could commute. But fast good quality commuting networks are not evenly spread. Even now, some three decades on, some commuting times have deteriorated, says Foye.
A cocktail of zero social housing aspiration – at least as far as the UK goes – and a massive supply-demand imbalance was supercharged in 2008 by cheaper credit from global central banks following the global financial crisis. Rock-bottom interest rates spurred lending – and prices – higher. By late January 2017 the world’s biggest economy was headed by a property developer – President Trump.
So which major Western cities are prioritising lower-cost social housing and a coherent long-term social policy to support it? Not many. Foye says look at Vienna or Helsinki, two cities unconnected by geography but with a long history of strong social housing. Despite big differences, the model is different. In Vienna the government already owns much of the land.
Around 60 percent of Vienna’s 1.8 million residents live in rent-controlled properties. Both cities have a more balanced income distribution, meaning the supply-demand pressures are less – basic economics. Move east to Tokyo, he adds, where rents have generally been kept stable “because Japan produces a huge amount of new housing.” Traditionally Japan has also been a low inflation economy.
To build or not to build?
For many Western cities, you have to build far more social housing, or more housing for lower-income residents. “That way you address the distributional issue and you address the price, or rent, issue,” says Foye.
Such change would mean a doubling or tripling of new supply for some countries. The UK Home Builders Federation (HBF), whose members account for 80 percent of new homes built in England and Wales each year, says under-delivery goes back decades. Some experts believe the UK should be building 300,000 new homes a year, claims HBF spokesperson Steve Turner. “Last year we built around 235,000. That’s a doubling of supply. We were around 120,000 in 2012.”
Some say the government is weakening supply progress, partly through new environmental regulations – more cost, less bottom line developer profit. Supply levels could collapse to near 2012 levels Turner warns, potentially worsening the inter-generational divide between those who own versus those who don’t, or can’t. But this argument pivots also on the UK fixation on home ownership, leaving less room for alternatives – especially for the young – and social housing.
Most new UK social housing is built by the private sector through a cross-funding model. When planning permission is given a local authority may stipulate 20 percent, for example, of new stock as ‘affordable,’ which it will manage.
Seen through a global lens the supply and demand issue looks increasingly pervasive. The right to adequate housing – including affordable housing, not just what the market will bear – is guaranteed by the Universal Declaration of Human Rights, Article 26, including reasonable security of tenure. Good luck with that, many will say.
What about rent controls? French rent rises for unfurnished properties are controlled by an index, the Indice de Référence des Loyers, or IRL. Three-year tenancies are commonplace and the minimum notice is six months. Rent controls in the US, which are increasingly under attack, are decided at state level. But less concentrated industrialisation in developed economies means the draw of lower rents, or rent controls, which in the past let industrialists cap salaries and costs, have less attraction.
The house always wins
Authorities are sensitive to large-scale social housing change because of the in-built education and health services following wind. “There may also be an increase in traffic or pollution, as well as existing infrastructure like water and energy supplies being stretched further,” says Tabitha Cumming from The Lease Extension Company. In the early stages of the pandemic some predicted rents would fall in big cities and that this would persist. For a short while the city was looking almost obsolete. It didn’t happen.
The world is crying out for well-designed homes for those on ordinary wages
So where will young people live in future affordably? A sliver of hope has emerged from the UK Government’s Michael Gove. The levelling up, housing and communities secretary is introducing a ‘fairer deal’ for tenants but it’s small beer compared to the three million social homes UK housing charity Shelter says are needed in the next two decades at a £10bn cost per year.
One outcome is the continued development of more ‘edge cities,’ or a new incarnation of suburbia – cheaper land but urbanish, attracting a skilled and educated labour force. More likely is that the ‘crisis’ will continue to worsen until it reaches critical mass, if it hasn’t happened already.
Meanwhile the world is crying out for well-designed homes for those on ordinary wages. Critics, including some developers, are quick to say the profit isn’t there, but demand is off the map. How might, with some more committed policy and environmental re-tuning, a Carrefour Group or Lidl respond, in comparison?
Although it may not sound feasible from a financial point of view, the declared figures recently released by the securities commission of Zambia show that the capital market still made remarkable gains in the first trading quarter for this year. This, despite the downturn in the world’s economy following the outbreak of Covid-19 in 2020 and the Russia–Ukraine war in 2022. According to Securities and Exchange Commission (SEC) chief executive officer, Philip Chitalu, despite external and internal shocks the Zambia capital market increased its total savings from the equivalent of $3.46bn in 2021 to $3.74bn at the end of the first quarter in March this year.
Positive performance in the face of both external and internal economic factors, together with support from macro-economic and financial market fundamentals, was responsible for the 8.65 percent growth. While the pandemic lockdowns, the war in Ukraine, confusion in the local copper mining industry and other factors have a telling effect on the economy in Zambia, the capital market still shows resilience having recorded significant growth.
Local financial analysts attribute the increase in savings to assumptions by many that the country has a promising economy due to its political stability and abundant natural resources, which tends to attract investors and capital. A growing economy is definitely a good bet for a buoyant capital market due to increased financial activities.
At the same time the increase in share prices for companies listed on the Lusaka Securities Exchange (LuSE) and collective investment schemes assets contributed to the rise in savings. Statistics show that collective investment schemes’ assets under management grew by 18.3 percent to reach $84.5m last year from $71.5m in 2021. In this same period the number of investors increased from 141,538 to 271,631.
The LuSE All Share Index (LASI) went up by 22 percent last year relative to the same period in 2021. On a monthly basis in the first half of last year market increases were noted from January to February where it went up by 7.65 percent. Hence at the end of the second quarter of 2021 LASI was at 6,854 points before reaching 7,342 points at the end of the third quarter in that year. At the end of December 2022 LASI closed at 7,337.79 points leading the SEC chief executive to make an optimistic statement on the future dealings of the capital market. “If the figures are anything to go by then we have a bright future for the capital market in Zambia,” Chitalu said.
A master plan
The growth of the Zambia capital market has so far incentivised the government to seek the participation of commercial banks in the treasury bonds it floats on the LuSE floor. It wants the financial institutions to quote, buy and sell their bond securities on the country’s capital market at all times. When launching the Capital Market Master Plan for 2022, Zambian president Hakainde Hichilema said the plan, once implemented, would contribute to greater transparency for all treasury bill participants and at the same time enhance efficiency in the government bond market.
Hichilema said his government wants to make it compulsory for all commercial banks and other financial institutions in the country to buy and sell their securities on the primary market in order to benefit all participants. This is after realising the crucial role of both the primary and secondary dealerships on the capital market. The government is expected to reduce investment costs and to create a more dynamic liquid market. Although the plan sounds attractive, more so with the advent of electronic trading platforms, banks and other financial institutions have not yet bought into the idea.
On the part of Bank of Zambia the government plan requires completion of the bond yield curve while also determining the benchmark of the rates on a number of securities. It is also vital to assess the country’s current government bonds situation as plans are devised to develop the capital market further. Meanwhile, Zambia is one of the 10 countries in Africa whose capital market is under study by the Africa Trade Barometers, according to Stanbic Bank.
The study will assess that country’s trade openness, access to finance, macro-economic stability, infrastructure development, foreign trade, governance, economic performance and trade financial behaviour.
It is not all plain sailing though. Zambia has considerable financial problems to solve and it would be foolish to pretend otherwise. It has external debt of more than $20bn and has not yet accessed the remaining part of the International Monetary Fund’s loan it badly needs to restructure the economy.
The global digital economy and African Trade Exchange initiatives are expected to have a positive growth bearing on the capital markets of many African countries including Zambia, and for this developing country it is a promising sign for a better and more prosperous future.
Falling oil prices are having a domino effect on the global energy stocks after dropping between six and seven percent, with European goliaths falling by between six and eight percent and US oil corporations falling by five to seven percent. Both the US benchmark and the global benchmark crude oil prices have fallen significantly, reaching their lowest levels since December 2021. The price of the US benchmark dropped by six percent to $67.48 per barrel, the most since July 2012. In a similar vein, the benchmark Brent Crude price fell by almost five percent to a low of $71.46 a barrel.
While it may be great to pay less for petrol, the market impact goes beyond mere lower consumer prices. Changes in oil prices have a ripple impact on the world economy. Perhaps unsurprisingly, the oil business itself is one of the most significant casualties. Oil companies may suffer greatly if oil prices fall. Because they are selling their oil for less money, they are making less money, which can result in job losses, production reductions, and even bankruptcies. It includes not just the larger oil businesses but also the smaller ones and the nations whose economies significantly rely on oil exports.
Oil prices plunged in the first quarter of the year in response to the collapse of two top US banks, Silicon Valley Bank and Signature Bank. Failure of the banking system is putting investors on the back foot. Hefty estimates for oil demand were quashed by the worry that the effects of this failed bank crisis would spread to the wider financial system. Market analysts at Oanda warned that due to lingering “contagion” risks brought on by the turbulence in the banking sector, the oil market will be “locked in a surplus for most of the first half of the year.”
With the sanctions imposed on Moscow due to the war in Ukraine, the inflation rate in the US has climbed to its highest level in 40 years, predicting an unavoidable recession. To combat this, the Federal Reserve has raised the interest rate to its highest level since 2007. Even while some have predicted that the banking crisis would likely soon come to an end and that the price of oil will recover swiftly, there is nonetheless some concern about the possibility of future interest rate increases. The effects of the interest rate increases are likewise hard to predict and may continue to highlight financial vulnerabilities brought on by excessive debt and stretched asset valuations, as well as in particular financial market areas.
According to a WEF report, “with price changes, there is a shift in profiting between oil producing and oil consuming countries”, so while low oil prices may be seen as difficult for countries that export it, it is manageable. Oil exporting nations are making adjustments to their fiscal and monetary policies in response to falling oil prices to lessen the effects on their economies. This may entail decreasing government expenditure, raising taxes, eliminating subsidies, and putting in place monetary tightening measures like higher interest rates.
Apart from that, US CPI has increased immensely, putting pressure on the economy where the Federal Reserve is already dealing with the rising inflation amid banking crises. The oil market can turn around if the Federal Reserve reduces the interest and inflation rates. But at the moment it seems like the market is either preparing for a future recession or it may be that one or more funds has to raise cash and lower the risk on their books due to concerns over liquidity following the bank failures.
Is there a ray of hope?
But it’s not all doom and gloom. Lower oil prices are also attracting big investors like Warren Buffet who has increased his stake in the oil company Occidental Petroleum (OXY – 0.45 percent). With the most recent acquisitions, Buffett’s company Berkshire Hathaway now has a 22.2 percent share in the business. It has acquired over 200 million shares valued at $12.2bn. It is anticipated that China’s economy will bounce back and this year demand will drive from the Chinese market.
As the largest oil consumer in the world, an increase in demand from China could turn oil around. The International Energy Agency (IEA) anticipates that the oil demand will increase by two million barrels-per-day in 2023. According to the Executive Director of the IEA “With the Chinese economy now recovering, it will have major implications for oil and gas market balances.” The OECD has also raised its forecast for global economic growth from 2.2 percent in November to 2.6 percent this year and 2.9 percent in 2024, an increase of 0.2 percentage points over the previous prediction. However, OECD warned that the recovery is still precarious and that risks are still heavily weighted to the downside despite the upward revision of growth expectations.
For all the positive signs, there is still considerable uncertainty over whether or not oil companies will be able to attract investors’ attention, how well China will recover, the continuing effects of the war in Ukraine and the overall geopolitical climate. For now at least, it’s a waiting game.
Raymond Baker is a man on a mission. Following a long career in business that started in Nigeria during the decolonisation period, he published in 2005 Capitalism’s Achilles Heel, a seminal book on illicit financial flows. Nearly two decades later, things are even bleaker. In his new book Invisible Trillions, Baker, 87, argues that financial secrecy has become a main driver of capitalism, bringing the kleptocracy he witnessed in Africa closer to home. Secrecy, he argues, is not a bug but a feature of the system, breaking the link between supply and demand, ownership and control, value and price. Regulating the maze of shell companies and tax havens used by corporations, criminals and corrupt politicians alike is a chimera. He shares with World Finance his thoughts on how hidden money is eroding democracy and what to do about it.
What sparked your lifelong interest in financial crime?
I have lived in the developing world and watched financial crime and corruption. After a long career in business, I decided that I had to say something about this phenomenon. That still drives my will to make a contribution.
You argue that capitalism has adopted a ‘secrecy motivation.’ What is that?
There wasn’t much secrecy in earlier stages of capitalism. Rich Americans built mansions, but you could see these mansions. Today, many rich Americans have money stashed offshore, and you can’t see that. Secrecy enables money to flow from the bottom to the top in ways that governments find extremely difficult to curtail. Inequality has grown in most countries to the highest levels ever. A major contributor to that is financial secrecy: the ability to make, move and shelter money in ways that cannot be controlled.
What role did decolonisation play?
In the 1950s and 1960s, 48 countries gained independence. The colonial powers wanted to keep extracting wealth from former colonies, so they set up mechanisms facilitating the movement of money out of them. People living in these countries didn’t trust their governments and wanted to get money in foreign accounts. That period contributed to the formation of financial secrecy systems facilitating those two processes.
Did you experience that phenomenon while living in Nigeria in the 1960s?
I once met a British ‘old coaster’ living in West Africa for decades. He was the managing director of a company in Nigeria. When I asked about profits, he looked at me with disdain. He said: “Profits? I’m not trying to earn a profit. I’m just remitting money back to the parent company in the UK!” I was startled, because, being just out of Harvard Business School, I had studied all about profits. Here was someone telling me that the price at which he sold goods was insignificant! He only cared about paying the invoices for what was sent by the parent company.
Today ‘trade misinvoicing’ is a much bigger problem, right?
Corporations have kept these issues under the table for a long time, citing the need for free trade and movement of capital. Every multinational corporation uses abusive transfer pricing to move money, either for tax evasion purposes or to convert into hard currency.
Is the EU doing enough to tackle financial secrecy?
It’s a start-and-stop affair. The UK government had said that it would address beneficial ownership by requiring publicly available registries of who were the owners of companies. That has been delayed. The European Court recently ruled that you can’t require publicly available information on ownership because it’s a matter of privacy, although it should be available to governments and some civil society organisations. But this is trying to have your cake and eat it too.
There is a theory that Brexit was partly driven by a desire to avoid EU rules against financial secrecy. What’s your view?
I never understood why the City supported Brexit, given the risks. Why did the City go along with the beneficial ownership agenda? It was getting a lot of criticism about handling dirty money coming into UK real estate. And the City decided that it needed to clean up its act and supported the beneficial ownership effort. Then Brexit came along and complicated that. We started seeing money move out of the UK and into the Netherlands and Switzerland. I’m not clear whether the City wants to be a player in cleaning up the global financial system or wants to continue to profit from secrecy. The jury’s still out.
In the book, you say that the US is the preferred destination for illicit money. Why is that?
Take shell companies. More were created here than anywhere else. The US has come up with a modest beneficial ownership effort, which still has an enormous number of holes. When money comes into a US bank, this is supposed to check whether it arrived from an illegitimate source. When banks see suspicious money, they file a suspicious activity or currency transaction report. 80,000 such reports are filed on average daily. US banks find a reason to take nearly every dollar they can and just file these reports to shift the responsibility to the government. As long as the US continues to have the world’s biggest trade and budget deficits, it will be tough to change that.
You cover a few success stories in tackling financial secrecy, such as post-9/11 legislation against terrorism financing. Could that serve as a guideline for broader action?
In October 2001, the US passed the ‘Patriot Act,’ which stated that no US financial institution could receive money from foreign shell banks. Also, no financial institution could send to the US money it had received from shell banks. This also applied to wire transfers. That was very effective. Shell banks were wiped out. We also pushed other governments to collaborate on curtailing terrorism financing. We forced the SWIFT system to open its books. So we pushed most of terrorism financing out of the legitimate financial system. This shows what you can do if you have the political will.
Is the war in Ukraine a similar shock that could awaken politicians to the dangers of financial secrecy?
We allowed dirty money to come in. The UK and US real estate sector has been a major recipient of dirty money, including from Russian oligarchs. What does that do to the mentality of Putin who looks at the West and concludes that it will always defend its financial interests? He probably thought he could take over Ukraine without being worried about reactions. So maybe we contributed to his megalomania. If you serve criminals for decades, how do you expect them to respect you? I have watched the West blame ‘those corrupt countries over there’ for half a century. In fact, we have been open to receiving the money they have stolen.
You claim in the book that beyond foreign aid we should focus on the money flowing out of the developing world, notably Africa. Why is that a problem?
Africa is a net creditor to the rest of the world. Instead of richer countries supporting Africa, Africa is supporting them. The equation for economic development has two parts: money coming in, money going out.
The World Bank and the IMF have focused on the money they’re shifting into the developing world. I don’t know how a development economist can devote his life to improving the lives of poor people and ignore money coming out of developing countries. It’s time for the World Bank and the IMF to put this issue on the table.
Secrecy enables money to flow from the bottom to the top in ways that governments find extremely difficult to curtail
How can we ensure global collaboration on financial secrecy?
The argument that these issues need to be addressed globally is a deliberate deterrent to addressing these activities. Countries hide behind the need for global consensus, rather than taking measures themselves. The US passed the Foreign Corrupt Practices Act in 1977, years before Europeans. We led virtually every country to adopt anti-corruption measures. Let’s not let the desire for unanimity become a stumbling block toward forthright action.
Has over-financialisation of the economy contributed to financial secrecy?
The financial sector represents around 20 percent of global GDP. It has been a growing part of the US economy and has contributed to the loss of manufacturing jobs. I would like to see more manufacturing in the US and the financial sector have less sway. Banks should get out of the business of owning corporations.
How can you regulate banks when they have so much corporate activity? We should go back to the Glass-Steagall era when commercial and investment banking were separate. That would be a controversial point for the US Congress to take up. Perhaps the reality would come forward if a large US bank found itself in trouble through some of its corporate investments.
Isn’t the financial services sector too big to fail?
We can regulate the banks better. Following the 2007–08 financial crisis, we passed regulations that improved the health of larger banks. The Trump administration weakened those regulations. Silicon Valley Bank was one of the prime advocates for medium-sized banks being too small to regulate. But then it became too big to fail! You can’t have it both ways. I support higher levels of bank capitalisation, regular stress test reporting and stronger anti-money laundering provisions.
Does the financial secrecy system threaten democracy?
There’s no question about it. The intervening link is inequality, driven by financial secrecy. The financial secrecy system is designed to move money from poor to rich, from criminal to legitimate, from corrupt to respectable. It has driven inequality through the roof. When I graduated from Harvard in 1960, the ratio of senior executive pay to workers’ wages was 20:1; today, it’s more than 350:1.
Financial secrecy has contributed to inequality, and is hurting democracy. No democracy can be strong amidst rising inequality. So controlling financial secrecy is a necessary step towards strengthening democracy.
When Lula da Silva and Alberto Fernández, presidents of Brazil and Argentina respectively, announced last January that the two countries would start preparations to issue a common currency called ‘Sur,’ the reaction was a mix of shock and amusement. “This is insane,” tweeted the former IMF chief economist Olivier Blanchard. Brian Armstrong, CEO of the crypto exchange Coinbase, went one step further, suggesting that Bitcoin might be a better “long-term bet” for the two countries.
A new currency with a long history
The severe backlash, including from local businesses and economists, has pushed the two governments to reframe Sur as a ‘unit of account,’ aimed at facilitating bilateral trade, rather than a fully-fledged currency union. Sur will be used in parallel with national currencies and trade financing will be guaranteed by a common fund, explained the two countries’ finance ministers in a joint press conference. Brazil’s finance minister Fernando Haddad even implied that the plan would only go forward if the currency was partly backed by Argentinian commodities. “It would be a vehicle currency for electronic settlements, without using the US dollar as an intermediary currency,” says Rodrigo Wagner, an economist specialising in currency adoption who teaches at the Adolfo Ibañez Business School, adding: “Unlike initial interpretations, the actual project seems implementable.”
Some hope that a currency union between South America’s two largest economies could lead to closer economic and political integration in the region, following in the steps of the European Union. Trade between South American countries stands at just over 15 percent, compared to 55 percent in the richer and more economically integrated European Union. Lula and Fernández have invited other South American countries to join the fledgling partnership, with little interest so far. “The proposal could gain more traction in the future if it were part of a coherent package for integration,” says Wagner.
If anything, a common currency could facilitate trade and capital flows between the two neighbouring countries. Standing at roughly $28bn in 2022, trade between Brazil and Argentina has stagnated compared to over $40bn just a decade ago, partly because of Argentinians’ inability to purchase Brazilian goods due to a chronic shortage of dollars. “Sur could initially boost trade between the two countries, as Brazilian exporters would have some advantage relative to other exporters, which would charge in hard currency. But that is a classic case of trade diversion, as opposed to trade creation,” argues Alexandre Schwartsman, a Brazilian economist and consultant who has served as Director of International Affairs at the country’s central bank, adding: “At some point, however, when Brazil would want to settle the difference, presumably in hard currency, problems would most likely arise.”
With a thriving manufacturing industry, Brazil could tap into the opportunities offered by the common currency to increase exports to its neighbour. Over the last decade, Brazil has had an annual trade surplus of around $2.4bn with Argentina. However, Argentina would have more to gain from the deal, according to Schwartsman, given its chronic shortage of hard currency: “It would be a major gift to Argentina and some Brazilian exporters, which would be paid regardless of whether Argentina pays its debt. Probably the Brazilian central bank or the treasury would pay exporters and keep the ‘claim’ against Argentina. But there is no major advantage for Brazil.”
Surprisingly enough, the project enjoys support from both sides of the political spectrum in two countries that are deeply divided and have gone through periods of economic and political turmoil. Just four years ago, the previous Brazilian President Jair Bolsonaro proposed a joint currency with Argentina, hastily dubbed ‘peso real.’ The country’s central bank issued a statement clarifying that no such plan was in the pipeline; the following day Bolsonaro insisted, but never mentioned it again.
For the current Brazilian president, who made a surprise comeback to politics and won a third term last winter, the plan is driven by a mix of ideology and geopolitical interests, Schwartsman argues, notably concerns over perceived ‘US imperialism’ and the use of the dollar as a weapon to put pressure on developing countries. Solidarity between the two countries’ leftwing governments might have also played a role. “The announcement was intended to lend some support, mostly moral, to the Argentine government, which is ideologically congruent with Lula’s,” says William Summerhill, an economic historian specialising in Brazil who teaches at UCLA. “It’s a signal of solidarity in the abstract.”
Can it work?
One reason why the announcement has been met with scepticism is the lacklustre history of monetary integration in South America. Previous attempts to create currency unions have failed, although announced with great bombast. A similar plan to launch another Brazilian-Argentine currency called ‘gaucho’ in the 1980s was abandoned amid the economic crisis that engulfed Latin America at the end of the decade. Twenty years later, several South American countries ruled by leftwing governments adopted a virtual currency aimed at facilitating trade; aptly named ‘SUCRE,’ an acronym standing for ‘Unified System for Regional Compensation’ but also ‘sugar’ in French, the project practically never took off.
A common currency could facilitate trade and capital flows between the two neighbouring countries
Even less ambitious plans to create mechanisms to clear export payments, such as the ‘Convênio de Pagamentos e Créditos Recíprocos’ (CCR) arrangement between members of the Latin American Integration Association, have been shelved. The lack of a common currency is not even the main obstacle to economic integration, says Wagner: “A ‘vehicle currency’ is far from being the most binding constraint to boost trade. Cross-border contract enforcement and massively reducing exchange rate controls seem much more relevant.”
History aside, the vast differences between the two economies pose the greatest challenge. For a fully-fledged common currency to work, Argentina and Brazil would have to remove trade barriers, harmonise regulation, and enable free labour and capital flow. The two economies have grown apart over the last two decades, with Argentina’s inflation rate surpassing the 100 percent threshold this year, while Brazil has been enjoying single-digit inflation rates and a stable monetary environment. Argentina has been cut off from global debt markets since its most recent default in 2020 and has imposed foreign exchange and capital controls to prevent its citizens from buying dollars.
The two countries would also have to share a central bank and harmonise interest rates, which were separated by nearly 70 percentage points in the first half of 2023. A monetary union would also require the two governments to guarantee Sur with large holdings in gold or a reserve currency, possibly the dollar. The lack of a mechanism to coordinate money supply and fiscal coordination makes this viable only as a “small-scale, off-the-books special programme in which the value of anything involved is tightly regulated. Something so specific and scaled-down that it would make no difference,” says UCLA’s Summerhill.
Dropping the dollar
One reason why the two countries are eager to go ahead with the plan is to reduce their dependence on the dollar. Argentina and Brazil are major exporters of commodities whose economies are vulnerable to fluctuation in US foreign exchange and interest rates. Argentina’s fateful decision to peg the peso to the US currency in the early 1990s is widely seen as a main contributor to the crisis that engulfed the country in 2001, a political and economic disaster from which it has yet to recover. During his campaign last winter, the Brazilian President Lula proposed a common currency for South America as a means of increasing economic integration in the region and undermining its dependence on the dollar. “Sur was possibly designed to create some momentum behind the idea of delinking from the use of the dollar in transactions and government reserves,” says Summerhill, adding that a new currency for trade is a topic “very hard to escape,” given the dollar’s dominance in the region’s economy; sanctions imposed by the US against Russia and the ensuing disruption to trade served as a stark reminder of that. “Behind any transactions using other currencies, there is a dollar shadow price for the goods involved, which determines the other countries’ exchange rates,” Summerhill says.
Some see ‘Sur’ as part of a broader scheme of the BRICS countries, a group of emerging economies that includes Brazil, Russia, India, China and South Africa, to minimise the influence of the dollar in world finance. In a meeting this May, officials from Brazil and Argentina discussed the prospect of establishing swap mechanisms that would allow exporters to avoid using the dollar for transactions. “BRICS members do not have a concretely expressed ‘plan’ to de-dollarise the global financial system, but individual members have interests in pursuing the use of local currencies in international trade and investment,” says Zongyuan Zoe Liu, a fellow for international political economy at the US think tank Council on Foreign Relations.
As with previous attempts to create currency unions in South America, many experts expect the initiative to fall into oblivion once the initial enthusiasm and political momentum fizzle out. “The interaction of domestic politics within both countries, including widespread and endemic corruption, the rise of populism, and the unstable nature of their respective economy feed into the political cycle, as well as the lack of robust monetary policy experience, do not make a joint currency credible,” says Liu.“It will disappear into the background as a low priority for Brazil,” Summerhill adds. “There are much bigger fish to fry.”
To understand where we are, it’s useful to remind ourselves of the journey taken to get here. The sustainable finance movement can be roughly separated into three eras with unique characteristics, each building on the other. The first such era started roughly around 1990, when the Domini 400 Social Index was launched in the US, one of the first such indices and still going today. This was the ‘pioneering era’ characterised by boutique firms exploring a new concept of investment that better incorporated environmental and social data into investment decisions. This is when the term ‘socially responsible investing’ or SRI was popular and the term ESG had not even been coined yet.
The work of these early pioneers in the 1990s began to diffuse into mainstream finance in the early 2000s. This is when the shift to the second era, the ‘mainstreaming era’ began to take place. This was characterised by the entrance of major financial services and asset management companies into the sustainable finance space. In this phase, we see a shift from SRI to ESG (environmental, social and governance), accompanied with an expansion of what issues are being addressed. This phase sees a growing acquisition of the small boutique SRI players by the big mainstream financial services companies, and it is when we see companies like S&P, Bloomberg, FTSE-Russell, MSCI, Vanguard and Blackrock – to name a few – all enter the sustainable finance space with offerings for mainstream investors. It was also the period that saw the creation of the UN-supported Principles for Responsible Investment, in 2005, and the UN Sustainable Stock Exchanges (SSE) initiative, in 2009. It was a decade that began with the niche and ended with the mass market. This mainstreaming era continued into the 2010s, and continues to this day. Sustainable finance has momentum and continues to grow in size and sophistication.
The age of sustainable finance
By the mid to late 2010s, however, the world was noticeably shifting to the third era of sustainable finance, the era of ‘regulation and standardisation.’ This era is characterised by the codification of sustainable finance practices. The UN Sustainable Development Goals, launched in 2015, created the global policy framework for sustainable development that further fuelled the mainstreaming of sustainable finance. As sustainable finance grew, so did the need for regulation and standardisation. Public markets are like trains and regulation and standardisation are the twin rails they run on.
As sustainable finance grows in size, it was inevitable that more work would need to be done to ensure transparency, stability and investor protection. The start of this era can be traced to events like the creation in 2015 of the now famous TCFD, or Task-force on Climate-related Financial Disclosures, by the Financial Stability Board and in 2018, the creation of the first formal sustainability working groups at IOSCO, the International Organisation of Securities Commissions. National regulators were also getting involved as well as supranational authorities like the EU. It is a period in which the world went from zero markets with mandatory ESG disclosure to more than 30.
This is the era of sustainable finance that we live in today. In the last five years, sustainable finance has benefited from the development of official taxonomies such as the EU Taxonomy on Sustainable Finance, the creation of the IFRS Foundation’s International Sustainability Standards Board (ISSB) consolidating sustainability reporting standards, and the work of the IOSCO Task Force on Sustainable Finance. As Ashley Alder, IOSCO Chair and head of the Hong Kong securities regulator says, “it is of utmost importance that the regulatory community steps up its efforts in ensuring markets contribute positively to sustainability challenges, in a way that secures the integrity of financial markets and the protection of investors.”
Education is key
In this era of standardisation and regulation, education takes on new levels of importance. Market participants need help in keeping up with the now fast pace of developments in sustainable finance. We’ve seen training and capacity building related to climate change and disclosure of climate-related information in particular become a growing focus for stock exchanges. As the linchpin of capital market systems, stock exchanges have their finger on the pulse of market needs. Exchanges’ growing focus on sustainability-related training and capacity building speaks volumes about the demand for knowledge and expertise on this topic.
This rising demand is likely due to the rapid progression of standards, frameworks and guidance being developed, coupled with an expansive demand from both investors and regulators. Stock exchanges have recognised the knowledge gap and are taking action. A key example of this action is related to the launch of the TCFD recommended disclosures. These 11 recommended climate-related financial disclosures and accompanying guidelines set a new global framework for identifying what information investors require to assess and price climate-related risks and opportunities.
Stock exchanges play an important role in supporting listed companies and investors as they overcome challenges related to the identification, management and disclosure of climate-related risks and opportunities. When the FSB launched the TCFD recommendations in 2017, stock exchanges were among the first organisations to support the recommendations publicly. Since then, the number of exchanges supporting the TCFD has continued to grow and training has become the top activity conducted by stock exchanges in support of the TCFD recommendations (see Fig 1).
Since 2021, more than 50 stock exchanges have hosted training for their market specifically on climate-related financial disclosures and the TCFD. Much of this training has been supported by the SSE Academy, the SSE initiative’s education arm focused on the provision of globally consistent and pragmatic training for market participants on the adoption and implementation of sustainable finance practices. Building on the UN SSE initiative’s Model Guidance on Climate Disclosures and the TCFD’s recommendations, the SSE Academy has collaborated with stock exchanges providing interactive training that allows companies to ask experts key questions to overcome hurdles and accelerate their climate-disclosure journeys. Through this training programme, the UN SSE, partnering with the World Bank Group’s International Finance Corporation (IFC) and CDP, has enabled stock exchanges to train over 20,000 market participants from 142 countries through more than 200 hours of training. At least a quarter of the 20,000 participants self-identified as being in a leadership position in their organisation and 35 percent of participants indicated that their organisations were in the process of integrating the TCFD recommendations into reporting practices for the upcoming reporting cycle.
The motivation for participating in training varied slightly by region (see Fig 2), however the main impetus globally for upskilling on this topic was to enhance skill sets pertaining to identifying climate-related risks and opportunities that face organisations. Nearly half of all participants indicated risk and opportunity identification as a motivating factor for joining training. During the training, the second most frequently asked question pertained to conducting scenario analysis as a means of identifying the financial impact that climate-related risks and opportunities organisations will face over the coming years.
At the completion of the training, participants indicated in feedback forms that they wish to receive additional training on a number of topics – the most referenced topics being on conducting climate scenario analysis, ESG standards more broadly, nature-related disclosures, and ongoing developments in climate-related disclosures including developments from the IFRS Foundation’s International Sustainability Standards Board (ISSB).
To address these ongoing capacity building needs, the SSE Academy has partnered with the IFRS Foundation to develop new training on the ISSB’s upcoming standards. The ISSB is set to be the new global standard consolidating existing frameworks for reporting financially-material sustainability factors, with international support from the G7, G20, the International Organisation of Securities Commissions (IOSCO), the Financial Stability Board, African Finance Ministers and Finance Ministers and Central Bank Governors from more than 40 jurisdictions. Based on the structure developed by the TCFD, the ISSB’s initial standards set out both general sustainability-related financial disclosures as well as specific requirements on climate-related financial disclosures. Together with the IFRS Foundation, the SSE Academy will continue to support stock exchanges in their capacity-building activities by providing training on the ISSB’s standards when they are released in the coming months.
One of the oldest questions in finance is how to price options – those financial instruments which give you the right, but not the obligation, to purchase an asset in the future at a set price. For example, suppose that you think that the shares of some company, currently priced at $100, are set to go higher. Rather than purchase the shares at that price, a cheaper alternative is to buy a ‘call’ option which gives you the right to buy them at a certain price, known as the strike, in a year’s time.
Let’s say you choose a strike equal to the current price, and after a year the shares have gone up to $120, then the option allows you to buy them for $100 and sell them immediately for $120 to give a quick $20 profit per share. On the other hand if they have gone down, all you lose is the amount you paid for the option.
The problem then is, what should that option price be? And how does it change if we choose a different strike price, like $90, or $105? The answer is important, not just for individual investors, but for the financial system as a whole, which relies on the accurate pricing of this type of risk.
The nervous market
One of the first to have a theoretical stab at this problem was the French mathematician Louis Bachelier. In his 1905 thesis, he argued that the average return of stocks is zero, because they are as likely to go up as go down. The price of an option therefore depended only on the variability of the stock’s price, which he referred to as its ‘nervousness’ though today we call it the volatility. The more nervous the stock, the more expensive the option, because there is a better chance of it ending up ‘in the money.’
Bachelier’s approach had some problems and received little attention at the time, but some 60 years later the economist Paul Samuelson came across a copy and arranged for a translation. As he later told the BBC, he believed that Bachelier’s work held the key to developing “the perfect formula to evaluate and to price options.”
The Black-Scholes model met with immediate success – and helped kick off an explosive growth in options trading
In 1973, this dream formula was achieved in the form of the Black-Scholes model. Its elegant proof relied on the argument that, by constantly buying and selling options and the underlying stock, one can construct a risk-free portfolio. A consequence was that, as with Bachelier, the expected return of the stock dropped out of the equation – all that mattered for the price calculation was the risk-free rate that could be obtained on something like a Treasury bill.
The Black-Scholes model met with immediate success – and helped kick off an explosive growth in options trading. Samuelson wrote that “one of our most elegant and complex sectors of economic analysis – the modern theory of finance – is confirmed daily by millions of statistical observations.” The Nobel Prize Committee – who awarded Black and Scholes their prize in 1997 – agreed that “thousands of traders and investors now use this formula every day to value stock options in markets throughout the world.” The formula has since been described as “the most successful theory not only in finance, but in all of economics” and even as “the most widely used formula, with embedded probabilities, in human history.”
Which is odd, given that the model is actually far from being the perfect formula that Samuelson envisaged.
Is there something funny?
Part of the appeal of the Black-Scholes model was that it seemed to put option pricing onto a rational basis, by eliminating the need for subjective and uncertain estimates of future growth. This changed the perception of options trading from a form of speculation, to a form of risk management, which made it much more acceptable to people like regulators (in fact it is both).
To accomplish this feat, the Nobel-winning proof relied, as mentioned, on the idea that we can constantly buy and sell options and stocks; however this ignores the bid/ask spread, which is the difference between the seller’s ask price, and the buyer’s bid price. And it also assumes that the volatility can be treated as a constant.
There is an easy way to check these assumptions, which is to look at statistical data. First, it is clear that growth rates do matter, because if you buy call options in something that tends to go up, like the S&P 500 index, then you tend to make money. What counts is not the risk-free interest rate, as assumed by the model, but the actual growth rate.
The second problem is that volatility over a certain period is not constant, but is correlated with the price change over the same period. In fact this effect is partially captured by traders, who adjust the volatility depending on the strike price – a phenomenon known as the ‘volatility smile’ because of its parabolic shape.
Of course it’s no surprise that traditional economics, with its exaggerated emphasis on objectivity and rationality, doesn’t get the joke. So how can we improve the Black-Scholes model given these obvious drawbacks? And why are the markets smiling? We return to that in a future Econoclast.
Standing in the middle of Verkor’s headquarters in Grenoble, Olivier Dufour, the firm’s co-founder, delineates his vision for the future of Europe’s green economy. “Batteries replace oil – it is important not to move from one dependence to another,” he exclaims. Founded just three years ago, Verkor has quickly become one of Europe’s leading low-carbon battery producers. The firm recently partnered with Renault to supply the equivalent of 12 GWh of batteries annually. Through its ‘Ecole de la Batterie’ it will train up to 8,000 employees to meet the sector’s ever-growing needs.
Several EU regulatory initiatives aim to turn the bloc into a battery production leader, yet Europe needs to do much more to rediscover its industrial mojo, Dufour says: “The EU needs to reinforce its regulation to enable rapid scaling up all along the battery supply chain, from mining to recycling. It needs to use all the catalysts in its hands: financing, trade mechanisms, training, permitting and energy prices.”
Showing them the money
The race for battery supremacy is part of a broader industrial realignment, fuelled by a mix of environmental, geopolitical and trade interests. Covid brought to the spotlight the vulnerability of global just-in-time supply chains. Trade tensions have slowed globalisation down. Climate change, an emergency that requires global collaboration but local action, is increasingly seen as an opportunity for developed economies to ‘onshore’ industry.
The first shot was fired last summer when the Biden administration passed the Inflation Reduction Act (IRA), pledging to provide $369bn in tax credits, grants, subsidies and loans to boost US clean-tech manufacturing. The plan has sparked a manufacturing boom, says Jonas Nahm, an energy expert at the Johns Hopkins School of Advanced International Studies: “There are an impressive number of plant announcements, particularly in the battery and electric vehicle sector. It’s also accelerating investments in domestic solar manufacturing and other technologies supported by the bill’s tax provisions and local content requirements.”
Widely believed to be a part of the US strategy to weaken China’s dominance in the green economy, the IRA includes over $60bn dedicated to onshoring incentives (see Fig 1). Currently, around 90 percent of clean-tech manufacturing is located in Asia, with China alone accounting for 85 percent of global solar cell production. However, the bill’s domestic production requirements have irked US allies. Only firms that source parts and materials from the US or its trade partners can benefit, excluding the EU and Japan, which do not have a free trade agreement with the US. The Belgian Prime Minister Alexander De Croo has accused the US of trying to poach European investment: “They are calling firms, in a very aggressive way, to say ‘don’t invest in Europe, we have something better.’”
The makeup of the bill has been the product of a polarised political environment. Many Republicans perceive the energy transition as a nuisance that renders competition with China harder. The Biden administration passed the IRA as a ‘reconciliation bill,’ which only deals with spending and revenue, to frame decarbonisation as an economic issue. The bill has also been criticised by industrial groups, such as the National Association of Manufacturers, because of its 15 percent minimum corporate book-tax, aiming to raise revenue for subsidies and tax breaks. Many of the planned facilities are in Republican states, which could boost support for an energetic climate policy, says Nahm. But political division has affected the bill’s remit, he told World Finance. “It doesn’t include investments in many institutions, like vocational training, that would also be helpful in allowing businesses to respond to these incentives and build up a clean-tech manufacturing sector in the US.”
Many experts question whether the IRA goes far enough to tackle climate change. One flaw is that incentives are carbon intensity-based, with a focus on future clean energy and no accountability for existing emissions, says Sanjay Purswani, a senior knowledge analyst specialising in energy at the Boston Consulting Group, adding that they may not be sufficient to achieve cost parity with fossil fuels.
US President Joe Biden
Delays in the bill’s implementation may also dampen its immediate benefits. “The IRA gives the industry a long-term horizon to point to with tax credits, but is also introducing uncertainty with the delays in guidance,” says Cassidy DeLine, CEO of Linea Energy, a US power producer, adding: “You have manufacturers who are planning to build domestic manufacturing facilities, but we don’t have the guidance on what will enable equipment to actually qualify. The more stringent the requirements are, the more likely it is that fewer of the announced domestic factories actually get built.”
Potential costs have also raised concerns, given that its open-ended budget could increase demand for green subsidies. Goldman Sachs estimates that the bill could cost up to $1.2trn, but also spur over $3trn in private investments. However, researchers at the US think-tank Brookings Institution estimate that IRA incentives will be less costly than climate-related damages, while helping the US achieve emissions reductions of up to 42 percent by 2030, up to 11 percent lower than without the bill. US solar and wind power could be the cheapest in the world by 2030, courtesy of the IRA, according to Credit Suisse.
French Prime Minister Emmanuel Macron and ProLogium CEO Vincent Yang
Europe fights back
In a truly European fashion, the EU has taken its time to respond. Its post-Covid recovery fund made available €724bn to member states, a third dedicated to green projects. The French president Emmanuel Macron has been touting his vision for a ‘sovereign’ Europe leading the fourth industrial revolution.
The war in Ukraine highlighted the dangers of dependence on a single energy provider, argues Eleonore Soubeyran, an energy policy analyst at LSE. But it was the IRA that stressed the need for a new industrial policy. This March, the European Commission presented its proposal for the Net Zero Industry Act (NZIA), delineating a plan that will mobilise the bloc’s full firepower to kick-start a European clean-tech revolution. The scheme will enable member states to loosen regulatory constraints to green investment, in some cases even overriding environmental concerns.
Permits for large plants producing net-zero technologies will be granted within just one year. An example of the potential gains came this May when the Swedish start-up Northvolt announced that it will build its third battery factory in Germany instead of the US, after Berlin pledged generous state support. The plan’s goal is to raise domestic clean-tech production to 40 percent by 2030, a major increase from present levels; currently, just 10 percent of solar panels used in Europe are produced locally. “The 40 percent target lacks clarity over what more the EU could do if current measures do not deliver. This is a possible risk, given the ambitious nature of the target,” says Danae Kyriakopoulou, policy fellow at the LSE’s Grantham Research Institute on Climate Change and the Environment.
Growing anxiety in Brussels over the IRA’s impact on European industry has been the main driver behind the plan. According to one insider, it was drafted in less than a month. “It hasn’t gone through the full political cycle and the usual refining necessary to reach consensus in the EU. It’s a rushed, improvised response to the IRA, so it doesn’t amount to anything similar to it,” says Ignacio Velasco, a researcher at 3EG, a climate change think tank. To alleviate tensions, the EU and the US have a taskforce to discuss the thorniest subjects. Negotiations have already borne fruit, including US concessions on electric vehicles (EVs) and critical minerals.
Several European firms have criticised the NZIA, warning that it does not match IRA investment incentives. However, the EU’s approach is constrained by the bloc’s institutional setup. “The EU has limited fiscal capacity, because it doesn’t have a large federal budget. It can’t throw money at the problem, which is what the US has done. Only member states can do that,” says Velasco. The Commission also had to strike a balance between large and smaller economies, with the latter fearing that lax subsidy rules would allow rich countries to favour their companies. In 2022, German and French firms received nearly 80 percent of EU state aid. Forthcoming negotiations about the bloc’s Stability and Growth Pact could change that mindset. Margrethe Vestager, the well-respected competition commissioner, has suggested establishing a ‘collective European fund,’ financed with joint debt, to turbo charge green investment. However, a move towards fiscal federalism will take time, says a source that has been following EU negotiations: “That’s bigger than climate change – it’s about the nature of the EU. It will not happen overnight as a response to US policy.”
Critics also point to a protectionist focus that marks a return to the EU’s Keynesian roots, notably industrial planning. Some warn that the plan could set the green transition back by making it more expensive. “While excessively depending on one exporter is not sustainable, as we saw with Russia and gas, it does not excuse incentivising across-the-board inefficient import substitution,” says the LSE’s Kyriakopoulou.
The first carbon tariff system
Carbon taxes are also becoming a top priority of the global green agenda. Partly pushed by rising carbon prices, the European Commission laid out last December its Carbon Border Adjustment Mechanism (CBAM), effectively the world’s first carbon tariff system, to be put on trial this October. The scheme will replace the ‘free allocation’ component of the EU’s domestic emissions trading system (ETS), which helps producers bid for emission allowances. The CBAM will enable member states to tax carbon-intensive imports, including steel, iron, cement and fertilisers, with importers having to obtain emissions certificates based on EU carbon prices.
Bread and batteries
No other industry is more emblematic of the scramble for green profits than electric vehicle batteries. China currently holds 78 percent of the world’s EV battery manufacturing capacity, with Chinese battery makers CATL and BYD alone accounting for half of the global market. Both the IRA and the NZIA aim to change that.
The IRA requires at least 50 percent of battery components to be manufactured or assembled in North America, increasing to 100 percent by 2029. The plan has delivered results, with Michigan emerging as a new battery powerhouse, courtesy of Ford’s $3.5bn planned battery plant using technology from CATL and another $2.4bn battery plant being built by a subsidiary of Gotion, a Chinese firm. Tesla, Volkswagen and Norway’s Freyr Battery have also recently picked US locations to build battery factories.
In Europe, the NZIA offers regulatory incentives aiming to mitigate energy disruption and improve investment costs for battery projects. Taiwanese battery maker ProLogium has highlighted this shift in European policy as a reason for choosing France to build a €5.2bn plant.
However, many analysts are pessimistic that the programme will make a difference. “It will be very hard, probably impossible, to build something akin to the enormous, synergetic industrial ecosystem China has spent more than a decade building in the battery and EV sectors, at least when it comes to scale, and thus price,” says Nis Grünberg, a Chinese energy policy expert from the think tank MERICS.
Verkor’s Dufour, whose firm has a €1bn gigafactory in Dunkirk in the pipeline, confesses that US states have tried to lure his firm to invest in the country, offering a mix of IRA and local benefits. The EU has set a goal of achieving 90 percent battery self-supply by 2030, based on projected needs of 550 GWh, but this pales compared to US and Chinese plans, he says: “This goal is not ambitious for batteries. The industry foresees a need for 1,000 GWh by 2030, meaning that half of the batteries will have to be imported if the EU target is reached. It should be 100 percent or more, which is achievable if the EU creates the right conditions.”
Through the new system, EU policymakers hope to tackle ‘carbon leakage’ – when manufacturers relocate their production outside Europe to avoid domestic carbon taxes. Another goal is to push third countries to improve their environmental standards, creating a level playing field for European manufacturers. Critics, however, point to a lack of ambition, given that the Commission’s initial proposal was watered down by member states. “The phase-out is so slow and long that it will practically not be effective this decade, and after that it could be too late for the climate,” says Agnese Ruggiero from Carbon Market Watch, a Brussels-based environmental group.
Complexity is another challenge. The EU will need to make tough choices on which goods and sectors the CBAM will cover and grapple with technical challenges around the price adjustment methodology, taking into account other carbon pricing systems, such as that of South Korea. “Theoretically, CBAM is a better solution because it offers better environmental efficiency incentives, if designed correctly.
That’s why it hadn’t been implemented in the first place, because it is way more complex,” says Patrick Peichert from Frontier Economics, a consultancy. Loopholes may persist, notably ‘resource shuffling,’ which allows producers to shift products based on the level of each country’s environmental standards. “The result would be that countries implementing a CBAM would lose domestic market share, while global emissions would not change,” says Roberta Pierfederici, a policy analyst at the LSE’s Grantham Research Institute.
EU manufacturers have criticised the scheme for failing to cover exports, leaving them to battle global competition without any support.
One reason for this omission is to make the scheme compliant with WTO rules, which effectively require carbon tariffs to exclude export rebates and have a clear environmental focus. For many developing countries, however, the CBAM constitutes a protectionist measure that will disadvantage their exporters; many have no carbon-measuring systems in place. India is planning to challenge the system at the WTO, while other countries have begun negotiations with Brussels, requesting potential waivers. To alleviate these fears, the EU has committed to provide climate finance to developing countries.
The CBAM is even less popular with Chinese and US policymakers, who have argued that it penalises their producers. The EU has retorted that the scheme just extends rules that already apply within the bloc. “Europe is entitled to its own import rules, just like with food safety standards,” says Carbon Market Watch’s Ruggiero. One way it might gain some acceptance is the adoption of similar policies by other economic superpowers. China is expected to incorporate carbon pricing into its emission trade system, possibly even tracking the full-lifecycle carbon footprint for all traded goods, while politicians and economists have also lobbied the Biden administration to establish a US carbon tariff system.
Lithium battery Industrial Park in China
A WTO crisis
The increasing role of climate concerns in trade disputes has prompted suggestions that, like many other international organisations, the World Trade Organisation (WTO) should have a climate-orientated mandate. “There is a general recognition that WTO rules are not up to the challenge of climate change,” says Soubeyran from LSE. But the overlap of climate and national security makes that more difficult, especially after the US lost a string of cases where it tried to justify erecting trade barriers by invoking national security concerns. Disputes between the US and China on a number of issues, as well as sporadic friction with the EU, have diminished the organisation into a shadow of its former self. Its main dispute settlement mechanism has been paralysed, with the US refusing to appoint new members to the relevant appellate body.
A case in point is the IRA’s clash with WTO trade rules, notably its domestic content provisions. “From an environmental perspective, you can’t justify excluding some members and not others. That is very hard to defend at the WTO,” says a source familiar with the operation of the body. China’s commerce ministry has said that the bill possibly violates WTO rules concerning discriminatory subsidies, while South Korea is considering filing a complaint on the grounds that the law even breaches a bilateral free trade deal. For the US though, that horse has bolted, says the source: “The IRA falls into a wider pattern of US behaviour: it doesn’t care about the WTO anymore. In their internal political and legislative dialogue, it isn’t relevant anymore.”
The emergence of green industrial policies has raised concerns that the global economy is entering a phase of protectionism. Canada has warned that a subsidy race would hurt everybody. In the UK, the Labour party, which is expected to win the general election next year, has made an IRA-like £28bn green investment programme its flagship policy. Emerging economies would pay the price of a global race to the bottom, warns the LSE’s Pierfederici: “US and EU subsidies could decrease green foreign direct investment in developing economies that do not have the same capacity to subsidise their green sectors, exacerbating the North-South divide and resulting in a significant increase in demand for critical minerals, many of which are geographically concentrated in developing countries.”
All eyes are on China, the country accused of starting the protectionist race. Given its green tech lead, the Chinese government is expected to deploy a carrot-and-stick strategy to ensure its producers stay competitive. Ironically, China is getting a taste of its own medicine, but it will not back down, says Alex Wang, an expert on Chinese energy regulation who teaches at UCLA: “It may double-down on support for green industries to maintain the global supply chain dominance it has built over the last two decades. China looks to expand its clean technology business in the global South, as Chinese companies face increased resistance in the US and Europe.”
So far, its response has been meek. One reason, argues Nis Grünberg, an expert on Chinese energy policy from the think tank Mercator Institute for China Studies (MERICS), is that it already has IRA-like state aid measures in place. But a more aggressive stance should be expected, he says, as China could weaponise green tech in its disputes with the US and adopt offensive and defensive trade policy instruments such as export restrictions, localisation requirements, and foreign direct investment screening to retaliate. A first warning was given last February when Chinese authorities published a draft law suggesting that the country could impose strict export controls on solar manufacturing technology.
In search of a new balance
In April 2022, a report co-authored by the WTO, the OECD, the IMF and the World Bank warned about the dangers of climate subsidies. But with climate change already serving as a fig leaf for protectionism, the knives are out. Multilateralism is dead when it’s most needed to tackle a global emergency, while state support – ‘green’ Keynesianism – is becoming the new norm. Subsidies incentivising a switch to less efficient producers may be counterproductive, but are also reducing our addiction to fossil fuels, says the LSE’s Kyriakopoulou: “Such measures are partly correcting market failures and implicit inefficient fossil fuel subsidies that already come at a huge cost to taxpayers. The IMF has estimated that fossil fuel subsidies cost almost $6trn in 2020.”
The EU has committed to provide climate finance to developing countries
The original sin, according to Andre Sapir, an economist at the Brussels-based think tank Bruegel, may lie in the Paris Agreement: “It only defined the objectives and left the instruments to reach them unclear, letting countries choose their own policies. It was inevitable that this could create friction in industrial policy.” Currently, no forum exists to ensure international collaboration on the crucial overlap of climate and industrial policy.
Optimists argue that tensions highlight the increasing importance of the green economy, which has finally become a legitimate growth strategy. Oddly enough, protectionism might be bad for the world economy, but good for the planet, says Pierfederici: “In the long-term, competition could lead to a reduction in the cost of green tech, thus contributing to the climate goals.” For the time being, pessimism prevails. “It will get worse before it gets better. Eventually they will realise that protectionism is costly for everyone,” Sapir says. “But it will take time.”
In many ways, 2023 has been a bombshell year for activist investing. In January, US activist short-seller Hindenburg Research sent shockwaves through the business world when it accused India’s Adani Group of a “brazen stock manipulation and accounting fraud scheme” which it labelled the “biggest con in corporate history.” Hindenburg’s campaign against Adani resulted in a whopping $108bn being wiped off the company’s market value in a matter of days. Gautam Adani, the billionaire industrialist who founded the company, denies the allegations, but that didn’t stop him from plunging down Forbes’s real-time billionaires list from the world’s third-richest person to 24th, as of the time of writing.
Campaigns by activist investors, who purchase minority stakes in companies to drive strategic changes, have been on the rise since around 2017. While Adani’s fall grabbed the most headlines so far this year, plenty of other activist campaigns have rocked corporate boardrooms, from HSBC, where activist Ken Lui is calling for a break-up of the bank, to Bayer, where investor Jeff Ubben is reportedly pressuring the business to oust the CEO, to BP, where climate activists filed a resolution urging the company to set tougher emissions targets. In fact, 2022 was a record-breaking year for shareholder activism, and 2023 is expected to see similar levels of boardroom battles.
The activist landscape
The impact of activist shareholders is growing around the world. A tidal wave of campaigns, which began in the US in the age of ‘corporate raiders,’ has gained mainstream attraction in Europe and Asia. On a mission to pursue strong financial returns and strategic accountability, investors are increasingly butting up against company executives they see as underperforming.
It’s Europe that is seeing the lion’s share of new activist campaigns this year
In the first quarter of 2023, 69 new activist campaigns were started globally, which represents the second-highest quarter of activity since 2019, according to data from Lazard’s Capital Markets Advisory team. The increase in activity can be traced back to a new trend in activist investing: ‘swarming.’ This tactic is used when new campaigns are held at companies that had already been targeted by activists recently, and has affected the likes of Salesforce, Disney, Bayer and Japan’s Seven & i. In fact, 36 percent of the campaigns in the first quarter of 2023 were linked to the ‘swarming’ phenomenon, and 13 percent of targets were subject to multiple new campaigns in this quarter alone.
In 2022, activists were buoyed by tumbling markets that gave them clear sights on how companies could be pushed to improve their margins. According to the Shareholder Activism Annual Review by Insightia, 929 companies were publicly targeted by new campaigns in 2022, up six percent from 2021 and mostly driven by the US, Korea and Japan. “The outlook for activism in the US is perhaps the best in years, despite an extended run of defeats in 2022’s marquee campaigns,” the report said.
But despite this, it’s Europe that is seeing the lion’s share of new campaigns this year. According to Lazard’s data, there was a 34 percent decline in campaign activity in the US in the first quarter of the year, breaking an eight-year trend. At the same time, 21 new campaigns were started in Europe, making the first quarter of 2023 the busiest first quarter on record. European campaigns accounted for 30 percent of all global activity, though they were heavily concentrated in the UK and Germany. “What that tells us is that activist funds are looking at Europe as a new frontier,” said George Casey, global managing partner at law firm Shearman & Sterling.
In the US, Be Your Own Activist, a report by Deloitte, highlights that US activist investors have in recent years been looking toward Europe as a more attractive market. Specifically, activists have their sights set on larger companies that offer greater potential for growth and returns. What’s more, Insightia’s annual review noted that “an assertive local activism scene” in Europe was “every bit as exciting as in North America.” While Europe is expected to continue moving towards the US model of activism, which will only make it a more attractive market, there is still a difference in approach. In the US, it is common for new board seats to be won by activists through settlements, whereas in Europe, proxy contests are still popular.
“In the US, the view of both corporates and advisors has evolved over the last 15 years,” Casey said. “Very often in the past, the advice would have been to take a strong stand and fight through a proxy contest, but in the US that has evolved, and the advice now is to listen to shareholders and understand their views. If they would like to advance nominees to the board who are experienced and reputable, these days the advice is to engage and consider.”
Casey continued: “I suspect that in Europe, the trend is a little bit behind. There is still a desire to put on a strong stand. So, I would not be surprised if it arrives towards more engagement and settlements over time.”
Asia-Pacific (APAC) is another growing market for activist investing. Companies based in APAC targeted by activists accounted for 19 percent of campaigns in the first quarter of 2023. Typically, these campaigns have been “overwhelmingly concentrated” in Japan, Lazard’s report noted, but this year has seen a wider range affected, including South Korean and Australian targets. The broadening interest followed a “bumper” year for campaigns in Asia in 2022, Insightia’s report said.
The landscape for activist investors is evolving, but there is another shift taking place in the world of shareholder activism that is just as significant. While many activist campaigns are focused on improving a business from a financial standpoint, another area under increasing scrutiny is a business’s environmental, social and governance (ESG) strategy.
Bringing ESG issues to the boardroom
Broadly, there are two types of activism shareholders are pursuing: operational financial activism and ESG-related activism. The former is made up of activists targeting companies for financial returns by asking for specific operational changes, be that looking at a company’s financial performance and driving change in the way they operate or pushing the company to sell one of its lines of business.
On the other side is a trend for ESG and anti-ESG related activism that has been growing since around 2020 (see Fig 1). “While ESG as such has been increasingly important to investors, corporations and activists for over a decade, in the last four or five years in particular, many corporations have become much more socially active while others have found themselves under pressure to take public positions on environmental and social issues that they would not have previously spoken publicly about,” explained Lara Aryani, partner at Shearman & Sterling.
Indeed, issues like climate change and diversity have seen increasing public pressure, and regulatory changes that have required companies to consider them more fully. “A lot of companies felt that they needed to take a position on these issues of public importance. And so I think companies are more vocal about issues that are social or environmental in nature,” Aryani said.
While boardrooms debate where to declare their position on social and environmental issues, campaigners see shareholder activism as a new option for driving change. “The recent success of a number of ESG activist campaigns coincided with these shifting investor and corporate priorities, and this energised shareholder activism on a range of ESG issues,” Aryani said. “This was particularly the case on climate change activism, which seemed to be seeing some success in corporate action even while congressional reform on these issues seemed to have stalled.” BP faced activist demands in April to set tougher climate targets. Although the resolution was rejected by shareholders, it received more support than it had in 2022.
As ESG demands grow, anti-ESG backlash is also finding its way to the boardroom. With social and environmental issues gaining prominence, there are a growing number of individuals who believe the corporate boardroom is not the place for these discussions. Because of their ties to political issues, many of these campaigns have hit headlines despite the trend still being in its infancy.
“There has been a reaction to the growing popularity of ESG, in the form of ‘anti-ESG’ activism that is comprised of both shareholder activists and certain politicians,” Aryani said. “Though anti-ESG has received a lot of press, it is still somewhat nascent, and so people are watching to see the extent to which those efforts will impact corporate and regulatory action in a meaningful way.”
While businesses may need to take a wait-and-see approach on the anti-ESG trend, it’s important that they consider both sides of the debate when planning their approach to handling activist investors.
In the sight lines
With these two forms of shareholder activism in mind, zeroing in on the trends in both the companies being targeted and the demands being made tells us more about the state of shareholder activism today and what we can expect to see in the years to come.
In 2020, activist campaigns that were focused on mergers and acquisitions (M&A) were the most common, making up 41 percent of the total new campaigns at large companies during the period, according to Lazard’s data, which was in line with levels seen in the previous years.
However, with financial markets having taken a nosedive, Insightia’s report found that activists have “been forced to be more judicious about calls to sell the company in recent years.” Few experts believe that dealmaking will be a prominent trend this year or until markets even out. The decline of the M&A market is to blame for a decrease in the number of campaigns focused on M&A and on capital allocation, the team at law firm White & Case said in a recent report. Instead, established activists and new funds alike are pursuing more campaigns focused on ESG and corporate strategies.
While Lazard’s data backed up the trend of fewer activists calling for industry consolidation or full company sales, M&A-related demands remained popular in Europe, emerging in 57 percent of all campaigns, which was above the historical average. This was driven by a surge in calls for divestitures, the asset management firm said.
With ESG-related campaigns picking up speed, there’s a particular focus on those centred on environmental issues. The rumblings were there in 2020, with new London-based hedge fund Bluebell Capital Partners announcing a ‘One Share ESG Campaign,’ through which it would buy one share of a company in order to challenge its ESG practices. In 2022, the small activist investor took on BlackRock, the world’s largest asset manager, accusing it of greenwashing in its ESG strategy. ESG-focused activist investor Engine No.1 also found success electing three directors to the board of ExxonMobil, which received significant support from institutional investors.
Board representation remains a goal of many activist campaigns
In 2022, there was a “significant increase” in the number of environmental and social (E&S) proposals that were put to a vote, a report by Shearman & Sterling said, but this was likely influenced by a new regulation from the Securities and Exchange Commission (SEC) which made it harder for companies to exclude E&S proposals from proxy statements. While the number of proposals increased year-on-year, the number of approved E&S proposals actually fell from 38 in 2021 to 32 in 2022.
“While the decline in the number of successful E&S proposals seems incongruent with the increasing support by both activists and institutional investors for E&S initiatives, this is likely due to the fact that a significant number of proposals, particularly those relating to climate change, prescribed specific actions to be taken by the company, in contrast with the historically more successful types of proposals – E&S and otherwise – that contained more general recommendations or enhanced disclosure,” the report said.
White & Case also identified greater scrutiny of ESG campaigns as a trend to watch this year. Large institutional shareholders, including BlackRock, began to scrutinise campaigns more carefully, and their success depended largely on whether there was an economic case for them.
Beyond the ESG debate, another trend taking shape is campaigns that target large businesses. “Due in large part to activist campaigns, such as Engine No.1’s successful proxy contest against ExxonMobil in 2021 and Third Point’s successful campaign against Walt Disney in 2022, there will likely be a surge of activist campaigns targeting S&P 500 companies,” White & Case said in their report. “These campaigns have demonstrated that size alone is not a defence to a well-funded, thoughtful activist attack.” Indeed, Lazard’s data shows that this trend is well underway, with global targets with market capitalisations greater than $50bn representing 16 percent of unique companies targeted in the first quarter, the highest share on record. This trend was identified in both the US, which logged its third consecutive quarter of elevated levels of mega-cap focus, and Europe, which also saw a spike.
These strategic trends aside, which sectors are in the firing lines? Technology firms continue to be one of the most frequently targeted sectors by activists, according to White & Case, with software, services and the internet likely to be the targeted subsectors. Industrials will also be in focus, with engineering and construction machinery expected to be in activists’ sight lines.
A changing regulatory environment
Board representation remains a goal of many activist campaigns, but the majority of board seats obtained are now through settlement agreements rather than proxy contests. One reason behind this change is new regulations that are reshaping the shareholder activism landscape. In the US, activist campaigns are facing new universal proxy rules, which are expected to have a significant impact on the industry. Universal proxy rules adopted by the SEC in November 2021 will, experts predict, make it easier for activists to get one or two nominees elected to boards, though it could make it harder to elect a majority. The new rules are also expected to make proxy contests easier and more affordable, which will encourage smaller activists with fewer resources.
These changes, Insightia’s report said, “sent a jolt through the industry as advisers try to model how the greater choice available to investors will influence voting decisions.” According to data from Insightia’s Activism module, settlements have risen compared with last year since the rules came into effect in September. Lazard’s early look at the effects of the universal proxy rule found that activists have demonstrated the same apparent appetite for board changes at US companies, but there has been a “significant shift” to smaller activist slates nominated at US companies. Activists secured 43 board seats in the period from September 2022 to March 2023, 98 percent of which were through settlements.
Technology firms continue to be one of the most frequently targeted sectors by activists
As activist investing spreads around the world, flashy headlines of boardroom battles abound. But the most common advice for executives dealing with shareholder activism is to hear them out. “What often happens, which in the past people did not necessarily pay attention to, is that the activist may be raising the kind of issues that institutional shareholders may be thinking about as well,” Casey warned. “And so if the activist strikes a chord on a particular issue with the concerns that institutional shareholders have, then in a proxy contest, institutions will support the activist.”
“The number one recommendation would be to engage, to listen, understand the positions, see if there is something in what the activist is saying that actually may be useful for the company. And discuss. If you disagree, then it’s better to explain it in a way where you are engaged, as opposed to just rejecting a particular position but without explaining your own point of view,” Casey said.
As shareholder activism campaigns are seen more as an eventuality and investors are open to supporting them, it seems the new era of activism will be less about standing against activists and more about unexpected partnerships.
As the evidence has shown in the months since, they are not as safe as we all thought. In the bigger picture the global financial system is under stress and in some regions is in turmoil, partly because of post-Covid inflation.
“Financial stability risks have increased rapidly as the resilience of the global financial system has been tested by higher inflation and fragmentation risks,” warned the International Monetary Fund in its latest Global Financial Stability Report issued in April 2023.
Some of the most vulnerable banks are in the smaller emerging economies where debt is high and the ability to repay is in decline. But overall the IMF sees a more desperate banking environment triggered by rising geo-political risks, unsustainable levels of debt, rising inflation and interest rates, and tighter money. Meantime it was a close-run thing, far closer than anybody was prepared to admit in those fraught few days of March. As Swiss Finance Minister Karin Keller-Sutter conceded in Washington in April, the lightning-quick, forced takeover of Credit Suisse by rival UBS “had helped to avoid a national crisis.”
And that’s just in Switzerland. The president of Switzerland’s central bank, Thomas Jordan, said the takeover had prevented Credit Suisse from becoming “the first domino in a systemic crisis.”
A systemic crisis! The immediate aftermath of the collapse of Credit Suisse and SVB revealed cracks in the system that must be rapidly repaired. As the news of the problems with the two banks broke, tremors ran through the entire finance sectors of Europe, the UK and the US. There were signs of distress through much of the financial sector in America, where two others banks collapsed in a classic example of contagion.
It’s not so much the failure of one bank that worries regulators; it’s the risk of contagion. It may seem unlikely that the failure of a second-tier bank like SVB on the other side of the world would further destabilise Credit Suisse, but that’s exactly what happened. Spooked by events in Silicon Valley, more depositors pulled their funds from the Swiss giant and accelerated its demise.
Although the Swiss authorities get full marks for moving quickly and decisively, their observations are not exactly reassuring given the enormous time and effort invested in the supposed avoidance of another banking crisis like 2008. In the US ordinary depositors were so jittery that the US Fed was clearly worried about other runs. “It appeared that contagion from SVB’s failure could be far-reaching and cause damage to the broader banking system,” the Fed’s Michael Barr, vice-chairman of supervision, told the House of Representatives. “The prospect of uninsured depositors not being able to access their funds could prompt depositors to question the overall safety and soundness of US commercial banks.”
Reckless behaviour?
As we shall see, both banks somehow slipped the leash of responsible risk-averse management that regulators imposed on them in the wake of 2008 but in the meantime the inevitable question is: have the global giants returned to the reckless behaviour that precipitated the financial crisis?
Shortly after the Credit Suisse panic, French and German authorities reportedly raided five giant banks over potential money laundering and tax evasion on behalf of wealthy clients, highly illegal activities that had brought down the wrath of regulators following the post-2008 revelations of egregious behaviour.
The question has special significance because the reforms put in place over the last 15 years were supposed to render banking shocks a thing of the past. With the Bank of International Settlements in Basle drawing up the principles and details of the reforms, national regulators had ordered a whole swathe of measures that among others separated investment from deposit banking, boosted capital ratios and liquidity, sheeted home responsibility onto specific senior executives, eliminated sky-high undeserved bonuses and, above all, ensured a tottering institution could collapse without triggering a house of cards, as happened in 2008. In short, no bank could be allowed to become ‘too big to fail.’
Simultaneously, regulators subjected the giant institutions – the systemically important institutions (G-Sibs) to much closer scrutiny that was, it should be said, often resented by the bankers themselves.
Yet in spite of all this regulation 49-year-old Silicon Valley Bank failed in just 24 hours after what the US Federal Reserve described as “a devastating and unexpected run by its uninsured depositors” while once-mighty Credit Suisse was bundled into USB, its supposed rival, with indecent haste before it failed. It turned out Swiss regulators had been worried about the viability of Credit Suisse for a while. Of these failures, Credit Suisse was by far the most disturbing.
Founded in 1856 to finance Swiss railroads, it could claim 2022 revenues of nearly $17bn and assets of $592bn. It was Switzerland’s second-biggest bank and until about a year ago it had been considered impregnable. Troublesome, but still impregnable. The Swiss banking system has always prided itself on its robustness, reliability and high reputation. The main regulator FINMA is one of the most respected anywhere. Yet the Swiss government had to stump up $122bn in a hurry to underpin the rescue of Credit Suisse. That’s also against the new rules because the failure of even a G-Sib is not supposed to cost taxpayers anything.
Meantime in the US there was no question of a takeover of SVB, even at the point of a gun. The Federal Deposit Insurance Corporation, which is charged with maintaining stability and confidence in the financial system, followed the book or, as central bankers say, the ‘hierarchy.’ The FDIC quickly guaranteed all the insured deposits of SVB and Signature Bank, another federally supervised institution that went under because of a run on deposits in the wake of the general nervousness. Senior management was cleared out overnight, something the US Fed has no compunction about doing, and troubleshooting regulators moved in to sort out the mess.
Most importantly, the Fed headed off the nightmare of further runs on other banks by guaranteeing as much liquidity as they might need for up to a year. Meantime equity and other liability holders in SVB lost their investments, as the post-2008 hierarchy requires.
Speculation and repercussions
The repercussions from these failures, different though they are, are many. In the case of a genuinely global institution like Credit Suisse with activities in the US, Europe, Middle-East and elsewhere, they are of course much greater. In fact, they will run on for years. Already there is speculation about the ability of UBS, with total assets of $1.1trn and revenues of $34.6bn, to absorb its rival, partly because of the dubious nature of the latter’s assets. In theory the takeover creates an institution with $5trn in assets, but nobody is yet sure how much the assets of Credit Suisse will have to be written down.
Vice Chair of the Fed Reserve Michael Barr
The red ink is already spilling. The investments of Credit Suisse shareholders have taken a hit and FINMA will value its tier-one bonds at exactly nothing. Stockholders have taken a bath, also following the post-2008 rules to the letter. UBS will pay $3.3bn for Credit Suisse, a pittance compared with its pre-failure value.
So what happened that wasn’t supposed to happen? To take the US first, reading between the lines the US Fed was surprised by the collapse of Silicon Valley Bank. Called before the House of Representatives’ Committee on Financial Services, Supervisor Barr explained that the bank was fatally wounded because of management’s failure to handle liquidity risk, which is incidentally its biggest responsibility, and that the run did the rest. Subsequent media reports say that management was focused too much on growth rather than stability and that, when internal stress tests revealed problems, they were ignored.
But why the run and why its immediate effect? It’s clear that the Fed is confused and a little shame-faced about it all. “SVB’s failure demands a thorough review of what happened including the Federal Reserve’s oversight of the bank,” said Barr. That review should become compulsory reading in the banking world because it will be a salutary lesson.
But it is already known that SVB had a concentrated business model and that its customers were mainly involved in the technology and venture capital sector, which is potentially immensely profitable but high-risk. Although the bank had been around for more than four decades, it had grown quickly in the last few years, tripling its assets in the three years up to 2022 at a time when the tech sector was booming. That should have triggered concerns. Some of the biggest failures on both sides of the Atlantic before 2008 were institutions that had grown rapidly, like Royal Bank of Scotland.
FINMA Chair Marlene Amstad
And then the pandemic intervened. To boost yield and profits, explains the Fed, SVB invested the proceeds of fast-growing deposits in longer-term securities with better rates, but it did so without having the essential expertise: “The bank did not effectively manage the interest rate risk of those securities or develop effective interest rate risk measurement tools, models, and metrics.”
Nor did the bank manage the risks inherent in its liabilities, the other side of the coin. Here senior executives fell into the classic trap – overseeing a mismatch of liabilities and assets. Or rather, some of them did. Subsequent media reports show there were serious misgivings among some staff about their boss’s decisions. The nub of SVB’s problems was that the technology sector which it served cannot normally rely on robust operating revenues and has to keep cash deposits in the bank to meet payroll and operational expenses. But those cash deposits can also be withdrawn at will and, in fact, often are.
Belatedly SVB realised it wasn’t sufficiently liquid and, on March 8, was forced to announce that it had realised a $1.8bn loss in a sale of securities but that it planned to raise capital the following week. That was a red alert to its clients and some of the smartest people in America took a close look at their bank’s balance sheet. “They did not like what they saw,” said Barr in the kind of candid assessment that is standard practice in the US.
In an alarming example of how precarious the position of a seemingly well-funded bank can be, the clients pulled more than $40bn from SVB in just one day, on March 9. Other depositors immediately followed suit and the very next day SVB failed. Within three days SVB had gone under because of the nightmare of every regulator and banker, an unstoppable run by depositors that recalled the events of the Great Crash of the 1930s when people lined up outside the doors of thousands of institutions to withdraw their cash.
Steady deterioration
While the demise of SVB is a case of incompetent management and, as the US Fed admits in so many words, supervisory failures, the story of Credit Suisse looks very much like an inept management aided and abetted by a regulator hamstrung by politicians. FINMA issued more than 100 red flags to the bank about its various failings during its steady deterioration, although the public knew nothing about them because the regulator is not permitted to release them, unlike in the US and UK.
In a textbook example of how a munificently rewarded C-suite made one blunder after another, Credit Suisse was on the way down as early as 2021, largely because of $10bn in losses of client funds that had been invested in the massively indebted British supply chain financer, Greensill Capital, and $5.5bn invested in US hedge fund Archegos Capital Management.
Both failed in 2021 in an illustration of how interconnected the global finance sector is. Although several other lenders lost heavily in these collapses, Credit Suisse had taken the biggest plunge and suffered the most. These mistakes were “unacceptable,” confessed the bank’s former CEO Thomas Gottstein at the time. At the time of writing it was considered unlikely that Credit Suisse would recover much of its capital in Greensill and probably none in Archegos.
These catastrophes followed several years in which Credit Suisse plunged recklessly into investment banking, a notoriously fickle activity that had brought down US institutions in 2008 such as Lehman Brothers. Wealthy clients took fright at these huge write-downs and fled with their money, the share price declined and the bank’s credibility, surely any institution’s prime asset, collapsed. “The finger of blame points to the bank’s leadership,” concludes an analysis in Swiss Info, a publication of the Swiss Broadcasting Corporation.
Events rapidly took a turn for the worse. Swiss authorities moved in a new management team in October 2022 and tried to steady the ship, principally by tidying up the troublesome investment bank business. “The bank will build on its leading wealth management and Swiss Bank franchises,” it promised in a return to its roots. FINMA approved of this spring clean – “a step in the right direction towards risk reduction,” said the chairwoman of the board, Marlene Amstead, at the time.
But it was too little much too late. In the same month the bank experienced a run on client funds of unprecedented proportions even by world standards. In the fourth quarter outflows hit the gigantic sum of nearly $155bn and, although Credit Suisse managed to scrape through once again, the writing was on the wall (see Fig 1).
Going or gone
The two events have brought to the fore the issue of ‘too big to fail’ that concerns systemically important institutions. One of the most important consequences of the reforms following the financial crisis, it’s an international standard with two parts. Either the bank is a ‘going concern’ and can be somehow rescued or it’s a ‘gone concern’ and is heading for a decent burial. Adopted around the world, the standard defines a ‘going’ bank as one that has sufficient capital to cover losses from current business while a ‘gone’ bank requires it to have sufficient capital that allows it to be restructured or liquidated.
In terms of the viability of the giant, global institutions the takeover of Credit Suisse is the first real-life test of the ‘gone’ part of ‘too big to fail.’ It is a case study that has aroused intense interest around the world and there is not a single banking authority anywhere that is not following it. So far FINMA’s Amstead believes Switzerland did the right thing in what was a collective solution involving taxpayer’s money, government, regulators and central bank, and the acquiescence of UBS.
Having helped Credit Suisse ride through earlier crises, FINMA was now faced with the even more difficult issue of how to shut it down. There were four options, she explained. The bank could be allowed to fail in what is known as ‘resolution,’ a declaration of bankruptcy with what would have been interminable legal and other issues, a temporary takeover by the state that would hopefully lead to reforms and an eventual buyer, and the forced takeover that was finally adopted.
But ultimately, there’s no escaping from the fact that Credit Suisse was not allowed to fail because of the high risk that it might trigger a financial crisis. So does that mean that the entire architecture of ‘too big to fail’ will have to be rebuilt in the light of the debacle?
Regulatory failures
Regulators always have to share some of the blame in a bank failure and, to be fair, they are usually willing to acknowledge their responsibility. In the run-up to the Great Financial Crisis, for instance, the Bank of England pursued a policy of trust in management dubbed ‘regulation-lite’ that was rapidly abandoned in the ensuing carnage.
In the case of SVB, its supervision had been moved to a new team after the bank was classified as a higher-risk ‘large and foreign banking organisation,’ a category reserved for institutions with assets of $100bn–$250bn. That’s still a few steps below the most heavily supervised category of a G-Sib, but any institution with up to a quarter trillion dollars of assets must be regarded as significant.
Almost immediately the new team became worried about the competence of management and issued a rating of ‘deficient-1’ for its enterprise-wide governance and controls. As late as November 2022, supervisors sat down with the management and warned them about emerging risks, particularly in terms of interest rates and liquidity, in which lurk some of the most recognised dangers for a bank’s overall integrity. They also expressed their concerns about the impact of rising interest rates on the financial condition of SVB as well as other banks.
But the supervisors certainly did not expect it to fail, or so fast. The relationship between banks and regulators can be a tense one. While it is important to remember that most banks abide by the rules and are anxious to comply with supervisors’ recommendations, some have to be brought to judgement. In most instances of recalcitrant banks the regulators get their way because they can unleash their big weapon – enforcement through court procedures. In Switzerland, FINMA conducts an average 40 enforcement proceedings a year, most of which never see the light of day. Apart from actual enforcement, FINMA carries out 600–700 investigations a year, which require its investigators to knock on doors the equivalent of two or three times a day “to clarify possible violations,” as FINMA puts it. Faced with the evidence, in nine out of 10 cases the bank takes corrective measures, but the big problem arises when they refuse to do so, as did Credit Suisse.
As FINMA makes clear, it is rare for institutions to defy, ignore or otherwise fail to respond to investigations and multiple rulings. Thus the case of Credit Suisse has raised an issue which Swiss authorities are debating behind closed doors. Clearly, no country can tolerate an institution that rides roughshod over the regulator and here Switzerland was unusually weak. The Bank of England, US Fed and many other central bankers have more freedom to tell it like it is, for instance by naming names. “As the events surrounding Credit Suisse show, our instruments reach their limits in extreme cases,” explains Amstead, who clearly wants to be handed more powers. “It is therefore worth considering an extension.”
But of course that’s up to the politicians and they have traditionally resisted handing FINMA the authority it needs. The authority cannot even impose a fine, something that happens routinely in France, UK and the US, among other countries. As we see, Switzerland’s politicians have shot themselves in the foot. Astonishingly, even after Credit Suisse had been tied into UBS, the country’s parliament voted after a long debate that, in so many words, it was the wrong thing to do.
Fit for purpose
On the bright side lessons are being learned. The Fed is in the middle of much soul-searching about the effectiveness and power of supervisors. Essentially, in a wide-ranging internal review it is asking whether the regulatory regime is fit for purpose. “Once risks are identified, can supervisors distinguish risks that pose a material threat to a bank’s safety and soundness? Do supervisors have the tools to mitigate threats to safety and soundness?” asks Supervisor Barr, who told the House of Representatives that “the failure of SVB illustrates the need to move forward with our work to improve the resilience of the banking system.”
In short, perhaps supervisors must get tough before it’s too late. Meantime though, the US Fed wants to apply the Basel III reforms to smaller banks like SVB, the idea being they have a bigger cushion for absorbing losses rather like the G-Sibs. And in another move that will be closely watched by the entire financial sector, the Fed plans a whole new panoply of stress tests that capture a much wider range of risks and uncovers channels for contagion. In itself, that is an admission that the current stress-testing technologies just don’t cut it.
The fear about contagion is that it is often irrational – in the modern banking system insured depositors get their money out – but fear spreads without reason. One little-known weakness in the post-2008 global banking system is the rise of fintech, the upstart sector that is determined to eat the big boys’ lunch. Nimbler, cheaper and often more customer-friendly, they have weakened the giants’ hold on the financial landscape. One result is that there are fewer banks in the US, to take just one jurisdiction. As US Fed governor Michelle Bowman explained recently, “de novo [new] bank formation has essentially stagnated for the past decade during a time when financial services have rapidly evolved.”
This matters because new banks are by definition smaller, more conservative and, surprisingly, often safer. The smallest banks often sail through a crisis while their bigger rivals struggle, explains Governor Bowman: “As we have seen over time, they often outperform larger banks during periods of stress like the pandemic and during the 2008 financial crisis.”
Also, they look after their customers better, notably small business, during hard times. If nothing else, that may precipitate a flight by depositors away from the giants. Looking ahead, current levels of bank capital probably won’t be seen as sufficient. They certainly weren’t in the run-up to the Great Financial Crisis, as regulators acknowledge, and the latest scare is prompting a rethink.
The consequences of inadequately capitalised banks run deep. For instance, the 2008 crisis with its banking failures triggered the deepest and longest recession since the Great Depression of the 1930s. In America, the world’s wealthiest – and most banked – country, employment collapsed and took six years to recover; six million individuals and families lost their homes to foreclosures; and over 10 million people fell into poverty. The effects are still being felt today, as the research shows.
Although the return of the much-feared run on deposits is causing central banks concerns, on the bright side nobody is saying that the global banking sector is about to implode. “We’re in a very different place and I really don’t see this as the beginnings of a systemic financial crisis,” Bank of England governor Andrew Bailey said in a post-Credit Suisse debate.
No central banker would of course ever say anything different, but there’s no doubt that the tremors caused by the collapse of SVB and Credit Suisse have exposed cracks in the system that must now be repaired.
Taking to the stage at the Chinese Communist Party Congress in October 2022, President Xi Jinping was met by rapturous applause. The week-long event ushered in a new era for both Xi and for China, handing the veteran politician a further five years as head of the ruling party. With the removal of the two-term limit on presidency, Xi is set to become modern China’s longest-serving leader – and the nation’s most powerful ruler of the post-Mao age.
While Xi has tightened his grip on power, he now faces myriad challenges as he moves into his second decade in charge. After years of almost unfathomable economic growth, China is showing signs of a slowdown. The pandemic has left deep scars on the world’s second-largest economy. Strict ‘zero-Covid’ lockdowns have wreaked havoc on every aspect of business in China over the past three years, and in 2022, the Chinese economy grew at the slowest rate in three decades, falling behind the rest of Asia for the first time since the early 1990s. Despite rallying somewhat following the abrupt end to ‘zero-Covid,’ the nation’s nascent economic recovery remains uneven and uncertain.
Elsewhere, geopolitical tensions with the West, skyrocketing youth unemployment and an ongoing housing market slump all pose a problem for China in the near term. But the nation also faces significant long-term threats to its economic health. Its population is ageing rapidly, with 400 million people expected to be aged over 60 by 2035. What’s more, China is thought to be one of the countries most exposed to climate change, with rising sea levels, extreme flooding and food insecurity among the challenges caused by a warming climate. And, all the while, an increasingly insular political regime threatens to derail the country’s global economic ambitions.
The days of double-digit growth may well be over. It’s clear that the Chinese economy stands at something of a crossroads, with a host of challenges looming large on the horizon. Will Xi’s China be able to adapt and overcome – or is this 21st-century success story now one for the history books?
The great slowdown
Since coming to power in 2013, President Xi has overseen immense economic growth. Average income has doubled since 2012, and GDP has grown by over 100 percent in the same timeframe. For many, living standards have significantly improved, with the President declaring “complete victory” in eradicating absolute poverty among his 1.4 billion Chinese citizens.
Semiconductor prohibitions suggest a significant escalation in the Sino-US tech arms race
Impressive results, certainly. But now China finds itself butting up against that age-old developmental issue – how to sustain growth in the long term. Double-digit growth can’t be maintained forever, and China’s rapid rise is now steadily slowing. Since the turn of the century, the nation’s growth rate has been roughly halving every decade, falling to just three percent in 2022 as ‘zero-Covid’ took its toll on the economy. While by no means catastrophic, this represented the Chinese economy’s weakest performance since 1976 – the last year of President Mao Zedong’s rule.
However, despite some gloomy economic forecasts, the nation managed to defy expectations and show some early signs of recovery in the first quarter of this year. According to China’s National Bureau of Statistics, the economy grew by 4.5 percent in the first three months of 2023, boosted largely by an unexpected rise in retail sales. If it can maintain this momentum, the country may well be on track to exceed its own modest growth target of five percent for 2023. But a rapid recovery is by no means guaranteed. As countries around the globe grapple with their own economic woes, the demand for exports remains subdued – which is bad news for the ‘world’s factory,’ as China is commonly dubbed (see Fig 1).
Output from the nation’s factories continues to miss forecasts, and other Asian nations including Vietnam, Malaysia and Bangladesh are beginning to snap at China’s heels in the manufacturing and export markets.
Elsewhere, the ongoing property market crisis continues to weigh down the Chinese economy. Commentators have called it a ‘slow-motion financial crisis,’ with economists drawing gloomy comparisons with the Lehman Brothers scandal. The once-booming property sector has been hit by a liquidity crisis. An ever-growing number of real estate companies are beginning to struggle with their enormous debt piles and are defaulting on repayments, with property firms putting the brakes on their construction plans as they look to manage their troubled finances. As apartments in China are typically sold ‘off-plan,’ or before completion, property developers are failing to build homes that have already been purchased.
Across China, thousands of unfinished homes sit vacant and unoccupied, while disgruntled homebuyers refuse to pay their mortgages on apartments that were never completed. Despite recent attempts by Beijing to prop up the ailing sector, the housing market remains a weak spot in the Chinese economy, with house prices and sales stuck in a prolonged slump. This is a far-reaching crisis with no quick fix, and without government intervention, threatens to drag the economy down at a time when it needs to be firing up.
Youth discontent
There is little doubt that the impact of China’s ‘zero-Covid’ lockdowns has been disproportionately felt by the nation’s youth. Layoffs, hiring freezes and a widespread jobs drought have combined to create a jobs crisis for young people, with one in five Chinese youths now classed as unemployed.
China has become increasingly isolated on the international stage
While the pandemic has pushed youth unemployment to near record highs, it is certainly not the cause of China’s graduate woes. Before the arrival of Covid-19, joblessness among young Chinese people hovered around 13 percent in urban areas – already high when compared with other international cities. Despite recent shifts towards establishing a consumption and service-driven economy, manufacturing remains essential to Chinese growth. Indeed, the manufacturing sector has the highest shortage of workers of all industries in China – and yet these physically demanding manual jobs are unlikely to appeal to the 10.76 million university graduates that finished their studies last year.
To make matters worse, the job opportunities that Chinese graduates have begun to depend on – in the thriving and well-established tech sector, for example – have been badly hit by a new wave of government scrutiny. In late 2020, the Chinese government launched a regulatory crackdown on big tech, wiping off more than $1trn in value from some of the country’s biggest companies. Concerned that some of the nation’s businesses were simply becoming too powerful, the government looked to rein in private enterprise through a series of stringent regulations – taking aim at the tech giants first and foremost.
Under this enhanced government scrutiny, many of China’s best-known tech companies have undergone a radical restructuring and downsizing since 2020, making mass layoffs along the way. Online retailer Alibaba, social media site Weibo and entertainment giant Tencent were among the tech firms making job cuts in 2022, contributing to a large-scale jobs crisis in one of China’s most promising sectors.
Corporate crackdown
Tech isn’t the only sector haemorrhaging jobs, however. The government’s clampdown on big business has targeted a range of powerful industries, from real estate to the $150bn private tutoring industry. In the summer of 2021, China’s State Council officially banned all for-profit tutoring companies from teaching core curriculum subjects, including Maths, English and Chinese. It also banned all private firms from offering after-school studies, as well as weekend and holiday classes, and demanded that all existing tutoring companies register as non-profits. This sudden, severe curtailing of the private tutoring sector was intended to reduce the financial burden on parents and academic pressures on children – many of whom have been attending additional classes since preschool age.
Whether the measures will succeed in reshaping China’s famously competitive education system remains to be seen – but the impact on jobs is undeniable. Tutoring opportunities began to dry up dramatically in the wake of the crackdown, with education industry job postings dropping 49 percent in Beijing in the month following the move. Up to three million tutoring positions may be affected by the new policy, aggravating the race for jobs among young, educated university leavers.
And it’s a similar story in the beleaguered real estate industry. In an attempt to curb excessive borrowing by property developers, the government has piled on regulatory pressure. New restrictions on debt growth and borrowing have sought to bring the troubled industry back under control – and have toppled a number of struggling property firms along the way.
Evergrande Group, China’s second largest property developer, only narrowly avoided collapse after the government stepped in to help restructure its colossal $300bn debt pile. But others haven’t been quite so lucky. Losses and layoffs have been inevitable as firms grapple with their dire finances. One company, based in the south-western city of Chengdu, was reportedly forced to lay off 90 percent of its workforce in 2021, while the largest property developer in Henan province has also cut 7,000 of its staff. Despite Beijing’s recent efforts to ease the liquidity crisis, these interventions won’t be enough to save every firm from going under. And fewer firms mean fewer opportunities for graduates entering the jobs market – and certainly won’t help to bring down China’s stubborn youth unemployment rate.
Frosty relations
Domestic issues aren’t the only thing holding back China’s economy. Beijing’s relationship with the West has soured in recent years, with human rights concerns, differing approaches to Covid-19 and a growing Sino-Russian alliance all contributing to a widening ideological gap between China and the rest of the world.
Indeed, aside from its partnership with Russia, China has become increasingly isolated on the international stage. Upon his reappointment as head of the Chinese Communist Party, President Xi Jinping took an unambiguous swipe at the West in a speech made to delegates at the ruling party’s annual congress.
“Western countries led by the United States have implemented all-round containment, encirclement and suppression of China, which has brought unprecedented severe challenges to our country’s development,” the Chinese leader is reported to have said. The comments have done little to ease the tensions between Beijing and Washington, which have been steadily worsening since the Trump-era trade war that was launched in 2018.
While President Joe Biden has taken a somewhat softer stance on China than his predecessor, tensions between the two nations remain fraught. Now in its fifth year, the trade war between the US and China shows little sign of abating, with President Biden imposing fresh restrictions on US exports to China – specifically on the sale of US-made semiconductors. Given China’s dependency on foreign microchips – spending more on semiconductor imports each year than it does on oil – the stringent restrictions threaten to throttle China’s thriving microchip sector. Although President Biden has stressed that he seeks “competition, not conflict” with China, the sweeping semiconductor prohibitions suggest a significant escalation in the Sino-US tech arms race.
In Europe, meanwhile, relations remain equally strained. China’s continued support for Russia throughout the ongoing war in Ukraine has undoubtedly damaged its diplomatic ties with the EU. At a recent speech in Brussels, the president of the European Commission, Ursula von der Leyen, stressed that Europe needed to urgently reassess its relations with China, in light of the nation’s “policies of disinformation and economic and trade coercion.”
Despite the decidedly frosty atmosphere between the two sides, however, neither can risk any damage to their trade relationship. Trade between China and the EU is worth an extraordinary $1.9bn per day, with the continent increasingly reliant on China for the critical raw materials it requires for its green transition. As Von der Leyen noted in her speech at Brussels, it is simply not in Europe’s economic interest to “decouple” from China, but it may need to “de-risk” its trade with the superpower in future.
“Our relationship is unbalanced and increasingly affected by distortions created by China’s state capitalist system,” the EU chief said. “We need to rebalance this relationship on the basis of transparency, predictability and reciprocity.”
Diplomatic ties between the two sides are most certainly frayed, with little indication of a rapprochement. Unless it can urgently repair its relations with the EU, Beijing may find itself distinctly isolated on the world stage.
The grey wave
From strained international relations to a looming youth unemployment crisis, China is grappling with a number of threats to its economic health in the near term. But look to the long term, however, and it is clear that the nation faces far greater challenges in the decades to come.
Last year, China’s population fell for the first time since 1961 (see Fig 2). Following many years of slowing birth rates, the historic drop means that China’s population is now in decline – with experts predicting that the trend will continue for many more decades to come. The United Nations anticipates that the nation’s population could reduce by 109 million by 2050, with India recently knocking China off the top spot as the world’s most populous country. While China’s demographic challenges are certainly well-documented, the speed at which the population has seemingly peaked has come as something of a surprise. Despite recent government efforts to increase the birth rate – including introducing a three-child policy in 2021 – the new family planning initiatives have failed to reverse the country’s rapid demographic decline.
Economically speaking, this all spells trouble. An ageing population means that China’s workforce is steadily shrinking, while the growing cohort of retirees is beginning to put increasing pressure on the state. According to official estimates, the working age population is expected to fall by 35 million over the next five years, prompting fears that the labour force will soon be unable to support the needs of the elderly population. The retirement age, meanwhile, remains one of the lowest in the world, at 60 years for men and 55 for women. This places significant strain on China’s pensions system, with the Chinese Academy of Social Sciences predicting that, without significant changes to retirement policy, the country’s main pension fund will be depleted by 2035. However, strong resistance to raising the retirement age – particularly among the young – makes it a hard sell.
As countries around the globe grapple with their own economic woes, the demand for exports remains subdued
Indeed, many young Chinese born during the ‘one-child’ era are already trapped in what is known as the ‘4-2-1’ phenomenon. China’s underdeveloped private pensions industry means that families are often forced to cover the cost of care for their elderly relatives. Only children therefore face the prospect of supporting four grandparents, in addition to their two parents, without the assistance of siblings to help shoulder the costs. Already burdened with multiple caring responsibilities, many young Chinese citizens are already feeling too financially stretched to consider adding children into the mix.
What’s more, the high cost of living in China, rising childcare costs and the growing youth jobs crisis are all contributing to a general reluctance to start a family. The nation’s ‘one-child’ policy continues to cast a long shadow, making small family units the social norm. Despite President Xi’s best efforts to boost the birth rate, these deep-rooted mores will be hard to reverse, and the rapidly-approaching ‘grey wave’ is likely to be China’s defining challenge for the next half century.
A warming world
Just as China’s population is dramatically shifting, so too is its climate. For decades, fossil fuels have powered China’s remarkable economic growth, leaving it in the unenviable position of being the world’s biggest carbon emitter. Despite pledges to peak and subsequently phase out its fossil fuel usage, China continues to consume vast amounts of ‘brown energy,’ with the nation’s coal and gas production both hitting record highs in 2022.
China remains stubbornly dependent on fossil fuels, but the country’s clean energy transformation can’t come soon enough. The nation is highly vulnerable to climate change, and without significant adaptation, is set to suffer the world’s most severe economic losses as a result of rising sea levels and associated extreme flooding. Already, the nation is beginning to feel the impact of a rapidly changing climate, with extreme weather events becoming alarmingly frequent. In June 2022, southern China was hit by a record-breaking heatwave that lasted over 70 days, triggering a far-reaching drought and sparking a series of forest fires that further damaged crops and threatened the August harvest.
The country’s northern and western states, meanwhile, endured a number of devastating and deadly flash flood disasters in 2022, with thousands forced to leave their homes in a mass-evacuation drive from the worst-affected areas. And experts have warned that the nation will need to prepare for similarly devastating events in 2023 and beyond.
As China braces itself for further floods, droughts and heatwaves this summer, the need to decarbonise the economy has never felt quite so urgent. China is already making significant progress in its green transition – and invests more in clean energy than any other country in the world. It is the world’s largest producer of both solar and wind energy, with 2.7 million people employed in the solar energy sector alone. Over half of the world’s supply of electric vehicles are made in China, and renewable energies already account for over 40 percent of the country’s total electricity generation.
The ongoing property market crisis continues to weigh down the Chinese economy
All positive moves, certainly. But China’s carbon emissions are yet to peak. Around the globe, countries are making significant progress in cutting their carbon levels, with the US – the second worst CO2 emitter – having peaked its carbon emissions in 2007. China, meanwhile, continues to increase its production of fossil fuels alongside its investments in clean energy, suggesting that it is in no immediate rush to transition to green. Despite its measured, phased approach to decarbonisation, Beijing is undoubtedly acutely aware of the immense financial potential of the green energy industry – and that it may well prove to be a vital bright spot in an otherwise ailing economy.
China’s boom era might just be over. Years of double-digit growth are impossible to maintain in the long term. But that doesn’t mean that the nation’s days as an economic heavyweight are over – far from it, in fact. Despite the short- and long-term challenges to its economy, the decades ahead will bring opportunities alongside setbacks. Green energy, AI and even a burgeoning healthy ageing industry all represent high-growth possibilities for the Chinese economy. If Beijing can successfully respond to the challenges ahead, its lower-growth ‘new normal’ may prove to be the key to a more sustainable future.
In November 2022, artificial intelligence company OpenAI released ChatGPT – a language-processing chatbot that can do everything from coding and creating webpages to writing sonnets, raps and dissertations – in eerily human-like words. Less than two months later, Microsoft had announced plans to invest $10bn in the company. The development sent ripples through almost every industry, becoming the fastest-growing consumer app in history; according to estimates by UBS, it had racked up 100 million monthly active users by late January – an achievement that took nine months for TikTok and over four years for Facebook. It’s now widely conceived as one of the most advanced AI developments to date. “ChatGPT is scary good,” Elon Musk tweeted in December. “We are not far from dangerously strong AI.”
Researchers and analysts have since been investigating the potential impact on jobs in everything from computer programming to writing and marketing, while some have speculated it could be the downfall of search engines; Gmail developer Paul Buchheit tweeted in December that “Google may be only a year or two away from total disruption. AI will eliminate the search engine result page, which is where they make most of their money.” In response, Google released AI chatbot rival Bard – one of at least 20 AI-powered products set to be showcased for its search engine this year (among them an image generation tool and an app-developing assistant). Meta meanwhile established a new generative AI team, as Zuckerberg declared that the company’s “single largest investment was in advancing AI and building it into every one of its products.”
Recent advancements
These developments signify a notable step forward in the march of AI, and a clear advancement on the likes of Siri, Alexa and other tools that have already become part of our everyday lives. They aren’t the only recent advancements, of course. In the past few years, we’ve seen rapid progress in AI-powered machines, from robots working on Tesla’s assembly lines to Sophia the humanoid – the realistic bot by Hong Kong company Hanson Robotics that can have conversations, mimic human facial expressions and adapt to new situations using machine learning.
Last year, Google’s DeepMind technology meanwhile managed to predict the structure of nearly every protein known to biology (200 million in total). AI-powered self-driving cars by General Motors’ Cruise firm and Google-owned Waymo have been tested on the roads of San Francisco and other US cities, while developments in deep learning and computer vision are creating ever more human-like capabilities; AI can now recognise objects and people, and some can even recognise emotions or tell if someone is lying.
Revolutionising the workforce
The advantages of these developments are already being seen, of course; in healthcare, AI algorithms can create personalised treatment plans and diagnose diseases, while in agriculture, the technology can help reduce waste and optimise farming practices. It could have other environmental benefits, too; research by the Boston Consulting Group found AI could cut global emissions by up to 10 percent by 2030. In the finance sector, algorithmic trading, automated investing and AI anti-fraud defences are already common practice.
The likes of ChatGPT, Bard and DALL-E, OpenAI’s image generation tool, are now bringing AI to the creative industries, speeding up tasks previously only accomplishable by humans. The obvious perks of this include boosting efficiency, cutting costs for businesses and enhancing the workforce as a whole (see Fig 1).
A study by MIT economists Shakked Noy and Whitney Zhang, Experimental Evidence on the Productivity Effects of Generative Artificial Intelligence, found using ChatGPT reduced the time for writing assignments by almost half.
Another study, The Impact of AI on Developer Productivity: Evidence from GitHub Copilot, looked at the impact of using AI coding assistant Copilot for programme developers, and found it sped up the job by 55.8 percent.
The tech could also help less experienced developers get a foot in the door, according to Sida Peng, co-author of the study and a PhD student in Computer Science at Zhejiang University. “Developers of all levels are experiencing productivity gains,” he says. “But when we looked at percentage increase in productivity, we saw stronger effects with less experienced developers. We see it as lowering barriers and levelling the playing field. This points to a promising future where AI tools help raise the floor on human performance and help more people transition into careers in software development.”
Robot jobs
But while so far these tools are only being used to assist humans – ChatGPT is known to give wrong answers so needs real people to fact-check, while Copilot needs a human developer to work it – some believe AI could soon start to eat into the jobs market. A World Economic Forum report in 2020 already predicted the loss of 85 million human roles to machines by 2025. Recent advancements might just have sped that up.
Pengcheng Shi, Associate Dean in the Department of Computing and Information Sciences at Rochester Institute of Technology, believes we’ll start to see major changes in the coming years. “Just like those revolutionary technologies of the past, AI will make some job functions obsolete,” he told World Finance.
“Computer programming jobs have already been impacted. In many cases, 80 percent of the code has already been written by Copilot or other AI tools,” he says. “If you’re a programmer for Microsoft or Google or Meta, your job skills will need to be far more than coding. For big tech, I’d foresee that ‘basic programmers’ will play diminishing roles over the next five to seven years.”
Some have linked the wave of tech redundancies (see Fig 2) to firms wanting to invest more in AI. Google CEO Sundar Pichai said the company’s strategy in making its layoffs was to “direct our talent and capital to our highest priorities,” and has since described AI as “the most profound technology in human history.” Zuckerberg’s announcement for Meta’s plans to invest in AI meanwhile came right in the middle of its own wave of redundancies, the same day OpenAI announced the release of GPT-4.
It’s not only programmers likely to feel the impact, of course. A research paper, How will Language Modellers like ChatGPT Affect Occupations and Industries?, looked at which sectors and roles were most likely to be impacted by the new apps; it found that telemarketers and post-secondary school teachers were among the jobs most exposed, with legal services, securities, commodities and investments among the key industries highlighted. It’s not hard to imagine how the likes of journalism and copywriting could be affected, too, while OpenAI’s DALL-E – able to create images from language descriptions, along with similar tools such as Craiyon and Midjourney – could expose those in the design industries.
A new economic sector
Michael Osborne, Professor of Machine Learning at the University of Oxford, believes roles with “a deep understanding of human beings” won’t be going anywhere just yet, though. “As a broad framework, you can expect tasks that involve routine, repetitive labour and revolve on low-level decision making to be automated very quickly,” he said in a UK government hearing on AI in January.
“For tasks that involve a deep understanding of human beings, such as the ones that are involved in all of your jobs – leadership, mentoring, negotiation or persuasion – AI is unlikely to be a competitor to humans for at least some time to come,” he told the committee. “Timelines are difficult, but I am confident in making that assessment for at least the next five years.”
AI regulation would help curb some of these risks, and governments are starting to take action
And rather than spelling the end for the human workforce, optimists say the AI sector will bring about a whole raft of new jobs. The World Economic Forum report predicted it could create 97 million new roles – outweighing the 85 million lost to machines.
“We’re already seeing new specialties like prompt engineering emerge as companies look for people who can effectively engage with AI models,” says Peng. Google’s much-publicised job advert for a prompt engineer, able to initiate the best responses from chatbots for $250,000–$335,000 a year plus equity (no computer science degree required), might just be a sign of things to come.
“I believe imaginative people who can use AI – and other technologies – to solve societal challenges will be in demand,” says Shi. And he believes businesses getting on board now will likely be the ones to win. “I don’t think that every company needs an AI expert, but I do believe that every reasonably-sized business needs to have people who can bridge AI with their core business,” he says. “The fight for such talent will be fierce, but organisations cannot afford not to act quickly. They will need to rethink the strengths and weaknesses of their business models and talent pool, and hire the right people to adopt the technology to maintain competitive advantages.”
Dangers and deepfakes
Of course, as all of this tech develops, so too do the risks – and the need for regulation. Biases and inaccuracies have already been seen in the likes of ChatGPT, while Bard’s reputation was dented by a factual error in its launch demo (Google parent company Alphabet lost $100bn in market value afterwards). It’s easy to imagine the impact if we start to rely too heavily on the new technology.
“One of the key challenges that’s probably the hurdle for AI’s wide adoption in mission-critical applications such as the medical sector and intelligence, is its trustworthiness,” says Shi. Deepfakes, which use AI to synthetically create or alter an image, video or audio recording of someone (often creating fake speech), are already an area of concern. While there are some genuine use cases, including digital effects in films, there are a slew of dangers, too – not least around political propaganda, fake news, video scams and illegally created pornographic videos and images.
After the Russian invasion of Ukraine last year, a deepfake video of Ukrainian president Volodymyr Zelensky telling people to surrender circulated online. A deepfake video of Elon Musk shilling a cryptocurrency scam meanwhile went viral last year. In 2020, fraudsters in the UAE even cloned the voice of a company director asking a Hong Kong bank to make $35m in transfers.
While not all deepfakes are advanced enough to go undetected, some are already convincing – and it’s not hard to comprehend the ramifications if the tech gets more advanced. “What this technology is going to do is, it’s just going to fill our world with imperceptible falsehoods,” Professor Michael Wooldridge, director of foundational AI research at the Turing Institute, told Business Insider. “That makes it very hard to distinguish truth from fiction.”
An existential threat?
It’s not only around deepfakes that AI poses risks, of course. Right now, we’re still in the era of Artificial Narrow Intelligence, or ‘Weak AI’ – where technologies and bots perform pre-defined functions without thinking capabilities. The likes of ChatGPT feel one step closer to ‘Strong AI’, or AGI (Artificial General Intelligence), where machines would be able to think for themselves and make decisions.
It’s easy to foresee the dangers these further developments could present. “I anticipate that AI systems will improve drastically, very fast,” says Shi. “It’s hard to imagine what may happen if, more likely when, the line between human creativity and machine generation is blurred or even indistinguishable,” he says. “We are in the era of AI working for humans, and probably will reasonably soon enter the next era of AI and humans working together. Hopefully humans will never work for AI.”
It isn’t only Shi expressing caution. Elon Musk has notoriously spoken about the dangers of superhuman AI – intelligence that surpasses that of humans – and has called for regulation. “What happens when something vastly smarter than the smartest person comes along in silicon form?” he said in a recent interview with Fox News. “It’s very difficult to predict what will happen in that circumstance,” he said, citing “civilisational destruction. I think we should be cautious with AI and I think there should be some government oversight because it is a danger to the public,” he said.
Back in 2014, Stephen Hawking took it a step further, telling a BBC interviewer that “I think the development of full artificial intelligence could spell the end of the human race. Once humans develop artificial intelligence, it would take off on its own, and re-design itself at an ever-increasing rate. Humans, who are limited by slow biological evolution, couldn’t compete and would be superseded.”
At the UK government hearing in January, University of Oxford researchers voiced a similar warning. “With superhuman AI, there is a particular risk that is of a different sort of class, which is that it could kill everyone,” Michael Cohen, a doctoral candidate in Engineering Science, told the Science and Technology Committee.
Cohen said he believes the appearance of superhuman AI at some point is inevitable “on our current track. There certainly isn’t any reason to think that AI couldn’t get to our level, and there is also no reason to think that we are the pinnacle of intelligence,” he said.
Professor Michael Osborne, also at the hearing, agrees with the bleak, if dramatic, possibility. “AI is attempting to bottle what makes humans special – what has led to humans completely changing the face of the earth,” he said. “If we are able to capture that in a technology, of course it will pose just as much risk to us as we have posed to other species, such as the dodo.”
Proceeding with caution
This might sound hyperbolic, but it’s not just a few voicing concerns; in a recent survey by Stanford University’s Institute for Human-Centred AI, more than a third of researchers asked said they believed decisions made by AI could lead to ‘nuclear-level catastrophe.’
For these reasons, many have highlighted the need to implement regulation before the machines get too advanced. “The global community must agree how and when we use AI,” Sulabh Soral, chief AI officer at Deloitte, said in a recent statement. “Should we ban AI research into certain areas or ban AI in certain weapons? The danger is a little research leads to one thing and then another and before we know it, it’s out of our hands, either with a bad actor, or, worse, in its own hands,” he wrote. “With a clear global consensus and rigorous regulations, we can sidestep the worst-case scenario.”
Cohen likewise believes it’s crucial to develop laws that prevent “dangerous AI” and “certain algorithms” from developing, “while leaving open an enormous set of economically valuable forms of AI.” Osborne even believes we need regulations comparable to those on nuclear weapons. “If we are all able to gain an understanding of advanced AI as being of comparable danger to nuclear weapons, perhaps we could arrive at similar frameworks for governing it,” he said at the government hearing, emphasising the importance of avoiding an ‘arms race’ between different countries and tech companies – something already being seen between the US and China.
“There seems to be this willingness to throw safety and caution out the window and just race as fast as possible to the most performant and advanced AI,” he said. “I think we should absolutely rule those dynamics out as soon as possible, in that we really need to adopt the precautionary principle and try to play for as much time as we can.”
But tech firms don’t appear to be doing that. In January, Google stated publicly that it would recalibrate the level of risk it was prepared to take on so as to speed up AI development, according to a presentation reviewed by The Times. Chief Executive Sundar Pichai reportedly said the company had created a ‘Green Lane’ fast-track review process to accelerate development and get review approvals quicker. “What they are saying is that the big tech firms see AI as something that is very, very valuable, and they are willing to throw away some of the safeguards that they have historically assumed and to take a much more ‘move fast and break things’ perspective on AI, which brings with it enormous risks,” said Osborne.
Global regulatory action
AI regulation would help curb some of these risks, and governments are starting to take action. In March, the UK government published an AI regulatory framework targeting language modellers such as ChatGPT and image-generating tools including Midjourney AI. The EU has outlined an AI strategy but hasn’t yet enacted legislation. In the US, regulation is still nascent.
One country setting a precedent is China; last March, the government introduced a regulation governing how tech companies can use recommendation algorithms. Then in January, the country implemented legislation around deep synthesis technologies, with the aim of combating malicious deepfakes; these include banning deep synthesis services from disseminating fake news. In April, the Cyberspace Administration of China (CAC) meanwhile drew up a draft for managing generative artificial intelligence services like ChatGPT.
These types of regulation could set a precedent for other nations to follow – but there’s a thin line to tread between curbing risks and not restricting innovation, according to Professor Robert Seamans, Director of the Centre for the Future of Management at New York University’s Stern School of Business. “Any regulation needs to balance two things: one, safeguarding against potential harms, and two, not overly limiting advancement of technology,” he says. “Too often, the discourse on this topic buckets people into one camp or the other. I’d like to see more engagement and discussion around the pros and cons of different types of regulation of AI.”
Experts point to other challenges in creating universal standards for AI. “Ethical principles can be hard to implement consistently, since context matters and there are countless potential scenarios at play,” Jessica Brandt, policy director for the Artificial Intelligence and Emerging Technology Initiative at the Brookings Institution, told VOA News.
“They can be hard to enforce, too. Who would take on that role? How? And of course, before you can implement or enforce a set of principles, you need broad agreement on what they are.”
Future challenges
Shi believes it’s not only regulation around the technology itself that governments will need to tackle, though. “The disparities in wealth and power generated by an AI-enabled economy would be something we have never seen, or even imagined,” he says. “Alongside the ethical and legal boundaries of AI and what it can and cannot do, we need policy to tackle this, and to address the cultural shock many people may face – what is the worth of our work now much of it can be done by machines?”
What happens when something vastly smarter than the smartest person comes along in silicon form?
He believes if these areas can be addressed, the huge, positive potential of AI can be harnessed. “As a researcher, I am optimistic by nature, and have great hope that AI will overall make our lives better,” he says. “Even though I do not see that AI will become evil on its own as many people have feared, I do see that human flaws in ourselves may lead us down that path – hence the necessity of these three, ideally universally agreed upon, accords.”
It remains to be seen how exactly things will develop, of course. “We are just at the beginning of the age of AI,” says Seamans. “I suspect there will be some incredibly innovative use cases that emerge that change the way our economy and society work, much in the way that steam engines and electricity changed economies and societies. We are yet to see what those use cases are.”
Indeed, if governments and tech firms can strike the right balance between implementing regulation without stalling innovation, the world stands plenty to gain. If they don’t get it right, only time will tell what the ramifications might be – and whether the scientists’ bleak forecasts ring true. Let’s hope we never get to find out.
In a challenging year that included global inflation threatening to run out of control, post-Covid caution by the business community and client concerns about the near future, Jordan Islamic Bank once again managed to post improving results across all its main activities.
In short, the institution kept faith with its long-term goals of prudent expansion in a difficult environment.
The numbers tell a story of steadfast growth through thick and thin. In the 2022 financial year JIB, as the bank is popularly known, achieved net profits after tax of $86.2m, with a growth rate of 3.5 percent compared, with 2021. Joint investment profits amounted to $316.1m, with a growth rate of 4.5 percent.
Total assets including certain investment accounts and wakala (investment) portfolios increased to $8.73bn, up by $335m for a growth rate of about four percent. And in one of the bank’s primary roles of providing credit to clients, funds granted to customers jumped to $7.33bn, up by a hefty $645m for a growth rate of 9.6 percent, an impressive figure in the middle of a largely shrinking global economy that reflects not only the faith that the bank has in its clients but also in the fundamental strength of Islamic banking.
And mirroring JIB’s focus on building a robust foundation for the future, customers showed their faith in the institution – now in its 45th year – by boosting deposits including wakala accounts by $353m, up by an impressive 4.7 percent in otherwise challenging circumstances. The directors felt more than justified in approving cash dividends to shareholders at a rate of 25 for a total amount of $70.5m.
As chief executive Dr. Hussein Said explains: “This confirms the bank’s maintenance of a strong capital base and a solid financial position. The bank also continued to maintain the quality of its credit portfolio, as non-performing finances (NPFs) reached 2.68 percent.” However in another example of JIB’S policy of prudence, the NPFs were fully covered by contingency financing.
JIB does not stand still, literally. The bank opened two banking offices in 2022, moving one branch to a new location already owned by the bank. It also converted five banking offices into mini branches that are purpose-designed to service customers in a more accessible way, deploying the latest technology.
Overall JIB’s expanding network now stands at 111 branches and offices spread out in strategic locations throughout Jordan. It is an axiom of good banking that the institution goes where it is most needed.
The ‘digital corners’
Reflecting the global trend towards the provision of seamless, client-friendly banking, JIB opened its second ‘digital corner,’ this one being centrally located in the Pavilion Mall office of the Capital Governorate. It is a place where clients can access a wide range of self-banking services. In addition to this latest one, the bank now boasts three digital corners in Amman, in its offices located on Wasfi Al-Tal Street, in Pavilion Mall and in Areefa Mall.
These new digital corners further the bank’s ambition of increasing financial inclusion. Nothing if not comprehensive in terms of the services they provide, these facilities allow clients to open accounts, update personal information, obtain ATM cards immediately, request cheque books, enquire about the details of financing and financial transfers, and manage beneficiaries, among other transactions. And meeting the demand for instant, street-side services, JIB has now built up a 318-strong network of ATMs spread all over Jordan, ranking it first of all the country’s banks in terms of street-side accessibility.
Simultaneously, true to its philosophy, JIB continues to grow its range of Islamic digital banking services such as Islami Mobile, Islami Internet, Islami ATM and banking cards of all kinds. The culmination of these developments was JIB’s winning of the highly prestigious award as the best and safest Islamic bank and financial institution in Jordan for 2022.
It is an axiom of good banking that the institution goes where it is most needed
But banking is not just about money, as JIB has always recognised. It not only continued to provide food support throughout the year for the most needy families, especially during Ramadan, but a number of the bank’s employees also volunteered to distribute monthly food parcels arranged by the bank to families benefiting from the programmes run by Tkiyet Um Ali in the capital Amman.
Originally, JIB was established to practise investment banking business in accordance with the provisions and principles of Islamic Sharia, and the first branch opened in late 1979. True to the original principles, the bank’s transactions and contracts continue to be subject to the supervision of a Sharia board composed of specialised scholars. As JIB grew, it aimed to meet the economic and social needs of citizens in the fields of banking, financing and investment in accordance with the provisions and principles of Islamic Sharia while, in a continually evolving banking environment, keeping pace with modern banking technologies, for instance in the form of the ‘digital corners.’
Other digital products deployed in recent years have included 3D Secure for safe online shopping, bill payments, e-wallets and CLiQ for instant transfer services. And recognising clients’ growing requirement for year-round services, banking services are available during official holidays, Saturdays and evenings.
Honouring founding principles
That original commitment to Islamic financing and Sharia services has never wavered, as measured not only by the number of clients, but by recognition from prestigious publications such as The Banker and EMEA Finance, and by the obtaining of credit and Sharia ratings from several international rating agencies including Standard & Poors and Islamic International Rating.
The bank’s current charitable work also reflects an ongoing commitment to the cultural and social life of the kingdom. It is proud that its credit-lending provides the essential growth finance for professionals, craftsmen and small-to-medium enterprises that are the foundation of Jordan’s economy. The list of endeavours supported by the bank is too long to define in full, but JIB has long backed conferences, education, safety and occupational health, sponsorship of matters related to the Holy Quran, arts, literature, heritage, energy, environment and water integrity.
Not even the founders of Jordan Islamic Bank would have thought in the late 1970s that their creation would grow to the extent that it had by the end of 2022. Now with over 2,440 employees, JIB’s paid-up capital stands at $282.1m. Total assets under management are about $8.73bn. Total deposits including restricted investment accounts reached $7.80bn. Total financing and investment is about $7.33bn. And profits after tax hit $86.2m. As the bank has long recognised, prosperity is based on prudence.
Tech is punching down the walls, floor joists and windows of finance all about us. But in the rebuilding how relevant is artificial and business intelligence to Islamic finance in 2023 – and beyond? Can a population of two billion Muslims meaningfully harness this tech for good? How big a deal is it and what are the risks as well as the benefits? The combination of Islamic fintech and data science has made huge strides, attracting millions of new customers.
Whatever their religious background, banking consumers want speed, efficiency and privacy. In other words, a smarter banking experience. The scope of fintech is widening, as is the market for its own services and products. It’s getting competitive, but credible transactions need to be handled with much care.
So how does Shariah compliance work in this space now? Who are the main beneficiaries – and when will they see the benefits for real? World Finance gets startling, innovative responses from company managing director Robert Hazboun in an exclusive interview on the cutting-edge direction and speed of Islamic finance in 2023 and beyond.
Where are the new boundaries as far as digital change goes for Islamic finance in 2023? How hard are they being pushed – and how much progress is being made?
Overall I would say that new frontiers and boundaries for digital change in Islamic finance are being pushed very hard, and the pandemic accelerated this trend. Much progress has been made, from blockchain to AI and digital, or neo banks. All of which are being adapted into Shariah-compliance for digital touch points and to extend financial inclusion in the more devout segments of the market.
If Islamic fintech offers consumers and business more control and choice, its popularity may – reasonably – rise, from touch points to scalability. Where are the ‘sticking points’?
There are complexities with Shariah compliance that may slow the full potential of the Islamic fintech experience, even when it clearly offers value and control to consumers and especially with the more subtle regulatory distinctions for each Islamic ideology. This could delay its inclusion in these technologies. Another point is a lack of awareness of its value among customers, especially in non-Muslim countries. Addressing these challenges needs meaningful collaboration between industry players, regulators, scholars and experts in Islamic finance to create an environment that is conducive to the growth and scalability of Islamic fintech solutions. The will is there.
Where do improvements in artificial intelligence (AI) and business intelligence (BI) lie? Are these opportunities – and risks – better understood by clients (banks)?
AI and BI can help Islamic banks to comply with Shariah law, by analysing data, identifying patterns, and highlighting areas of possible improvements to different channels and touch points.
This can help reduce the risk of non-compliance and improve the quality of Islamic banking services and enhance business operations, decision-making processes, as well as customer experiences. However, risks from depending on AI and machine learning in Islamic finance also loom, namely in financing cases that have no precedents in Shariah law.
This can cause confusion, complexity, and prolonged processes to find and interpret the relevant religious texts with regulatory bodies. So it’s complicated. Clients have to prioritise their own continuous learning, collaboration and foster a more data-driven decision-making culture within their own organisations to gain the understanding of the opportunities and risks presented by AI and BI. We’re here to support this.
Given so much AI and BI change, how much ‘future-proofing’ concern is there? How should this be planned and anticipated?
Future-proofing concerns for banking systems with the rise of AI and BI are centred around data security, compliance, customer privacy, bias and fairness. Also talent acquisition and change management. It’s a lot. Continuously future-proofing is an ongoing endeavour, not one undertaking. A flexible mindset is needed. So adaptability is a priority for handling and strategising the ever-changing realm of AI and BI, absolutely. We are always exploring possibilities to adapt machine learning and AI to Shariah-compliance.
Many Muslims in the West are young, especially in the under-30 age group. This brings challenges as well as opportunity. How well realised is this by yourself?
It’s absolutely realised. The younger Muslim population, especially in the west, is drawn to banking services offering Islamic financing through digital channels which fits into their tech-savvy, on-the-go lifestyle. They’re dependent on them to help them manage their lives. To support this ICS BANKS Islamic Banking is our own customer-centric platform. It’s built from the ground up with decades of tech evolution poured into it offering digital banking products and services such as mobile banking apps and Islamic digital financing platforms. The latest AI, blockchain and digital wallet tech are fully integrated. This keeps Islamic banks and financial institutions relevant for this vitally important demographic, no question about it.
How do your own technology solutions help customers with data-driven pressures – your own and theirs?
Our banking solutions offer tools for data-driven pressures, ethical considerations and data privacy with its own scalable architecture including several reporting methods such as Omnichannel KYC, spending analysis and regulatory reports. These support banks, financial institutions and customers by analysing massive amounts of financial data, detecting trends and patterns, mitigating risk, such as identifying fraudulent activities. We believe this helps banks and financial institutions learn more about their own risk profile, their own distinct customer base, resulting in more personalised and bespoke products – that’s important. This in turn helps customers make better financial decisions. Our products are totally central to their better decision-making process.
Is more personalisation and bespoke product planning part of the broader Islamic fintech landscape? Or is growth slower because of more manual processes to anticipate and plan for?
While some growth rates for Islamic fintechs may have been slow, digital innovation is making it easier to adapt Shariah-compliant products faster. But as Islamic finance evolves and expands globally, there might be variations in interpretation and implementation of Shariah principles across different jurisdictions. This creates complexities and manual processes in anticipating and planning personalised products that comply with the specific requirements of each market – we’re very well aware of this.
How much demand from Western banking business for an Islamic ‘window’ is there? Is demand up?
It is and there are several reasons why. One reason is the growing Muslim population in Western countries, which has led to more demand for Shariah-compliant products and services. Non-Muslim customers are also showing interest in Islamic banking due to its ethical nature, especially in the aftermath of the global financial crisis, which eroded trust in conventional banking systems. While the demand for Islamic banking windows from Western banking businesses is not yet at the same level as in Muslim-majority countries, it is growing and very likely to continue to do so in future.
Where does ICS Financial Systems sit between cloud-based solutions versus traditional banking and personal interaction? Is this less of a tension than in the past?
We totally recognise the need for balance between cloud-based solutions and personal interaction.
Both approaches offer distinct advantages and both, we say, must be integrated thoughtfully for a seamless experience. The ideal equilibrium? It depends, as we must take into account the specific needs and preferences of our customer base, as well as the strategic objectives and resources available to the bank. It’s always a bespoke approach, fundamentally.
An interconnected Islamic global finance ecosystem is still some way off – what’s the timeline, in your view?
The timeline for such an ecosystem is challenging to predict accurately depending on the pace of tech, the level of regulatory support, and a willingness of financial institutions to collaborate and standardise operations. Nonetheless, more investment in Islamic banking software suites and other tech solutions play an important role in supporting the growth and development of the Islamic finance industry. Watch this space, I say.
Might hybrid-type digital products be worth pursuing longer term, which join the best of both banking ‘worlds’? Is this realistic?
In the long run, it’s well worthwhile to pursue hybrid-type digital products that blend the advantages of traditional banking and digital banking. These aim to provide a comprehensive banking experience by integrating in-person service with digital convenience, harnessing emerging technologies. Although there are obstacles like investing in technology infrastructure and adapting to new processes, numerous financial institutions are actively exploring hybrid models.
Consequently, we feel it is reasonable to anticipate a higher prevalence of these models in the future. We’re very optimistic about achieving the right balance when it comes to this.
Dominican multiple banking has made notable progress in innovation and technology in the last two decades by incorporating digital tools and decentralising its services through alternative channels. Banco Popular Dominicano stays at the vanguard of digital transformation with innovative technologies that make life easier for customers, improve process efficiency and expand the reach of its promise of value to society.
The Multiple Bank Association of the Dominican Republic (ABA, according to its acronym in Spanish) recently detailed that the Dominican banking sector registered a total of 5.1 million Internet banking users in 2022, which means an increase of 3.4 million in absolute terms and 302 percent in relative terms since 2015.
Banco Popular Dominicano, the first private capital bank in the Dominican Republic, has been moving forward on improving the efficiency of its operations and consolidating its leadership at the forefront of the digital and technological transformation of Dominican financial services, accelerating the innovation process to expand its transactional capacity and support the bank’s future growth.
Digital adoption
Banco Popular Dominicano was recognised as the most digital and sustainable bank of 2022, and its mobile application, the ‘Popular App,’ is the best in its segment, according to World Finance. In 2022, the bank started the creation of a modern ecosystem of applications that would allow it to penetrate niches of the market with a high potential for banking, such as remittance recipients, SMEs, and the youth segment, thus fostering its efforts to expand financial inclusion to the population.
There has been an increase in users of mobile applications and online banking
Currently, 59 percent of the bank’s customers use ‘Popular App,’ a channel through which more than 45 million transactions were carried out last year, representing an increase of 33 percent compared to 2021.
Of the transactions carried out via Internet banking and the ‘Popular App’, 71 percent were conducted through the application. Overall, 86.9 percent of all Banco Popular’s transactions are carried out through digital channels. Its network of ATMs, which exceed 70 million transactions per year, is advancing in its modernisation with 70 new units, which allow commercial deposits, accept coins and a larger number of bills, and provide greater convenience and speed, especially for its business clients. For these clients, the bank also began the phased launch of a new ‘Popular Empresas App’, which will have a more up-to-date and intelligent approval and product management flow, more advanced functionality for digital check deposits, and more straightforward and intuitive interaction.
On the other hand, to continue promoting responsible control of their finances by the clients themselves, it launched the ‘+Control’ tool on its Internet banking site, which has been widely accepted. It allows users to set consumption limits on their credit cards by hours and days of use, location, types of commerce, and amounts of consumption, online or in-person transactions, among other benefits. Banco Popular completed a vital initiative to transform the commercial management model in its branches, aiming to optimise service and maximise the customer experience, boosting sales and freeing up the operational load.
Thanks to this project, waiting time in the branches was reduced by more than 50 percent, customer satisfaction increased by 60 points, and the productivity of business officers increased by 33 percent. Banco Popular had, at the end of 2022, more than 1.3 million digital customers.
A new way of banking
According to the Superintendence of Banks of the Dominican Republic, the adoption of new technologies has been reflected in the services offered by Financial Intermediation Entities, allowing access to products and services in a wholly digital way during 2022. This advance in digital services has caused branch use to drop from 41.5 percent in 2021 to 35 percent in 2022 in a variety of transactions in different banks. As for mobile applications, these not only strengthen the ties that banks have with their customers but also aid in selling products and services. With these advances already materialising across the banking sector, there has been an increase in users of mobile applications and online banking. The Financial Intermediation Entities have strengthened the rights of these users since more than 50 percent of those surveyed consider claims easy to file through those channels.
Responsible banking
As part of its sustainable vision, last year, the bank expanded the coverage of energy consumption with renewable energy, contracting clean energy for the Torre Popular complex, in addition to the installed capacity of 22,300 solar panels in our branches across the country.
This covers an average of 80 percent of all the energy consumed in the 56 photovoltaic branches and all the buildings that make up the Torre Popular complex and contributes to reducing the emission of 9,258 tons of CO2 into the atmosphere each year.
As an organisation certified internationally as carbon neutral, in 2022, the National Council for Climate Change and Clean Development Mechanism (CNCCMDL) recognised the bank for maintaining carbon neutrality in its operations. This distinction was granted within the framework of Climate Week for Latin America and the Caribbean, which the Dominican Republic hosted in 2022.
The bank’s set of initiatives in favour of environmental sustainability ‘Hazte Eco’ also received international recognition: in Spain, by the Corresponsables Foundation, and in London, by the International Business Awards (IBA), which awarded it a Silver Stevie in the category of Corporate Social Responsibility Programme of the Year in Mexico, the Caribbean, Central, and South America.
This green finance portfolio was expanded in 2022 with three new products to promote sustainability in Dominican society: the ‘Extrahogar Eco’ and ‘ExtraEco’ revolving loans and the ‘HipotEco’ mortgage loan for the purchase of sustainable homes. In addition, as part of its commitments to environmental sustainability, last year, Banco Popular surpassed the milestone of planting more than one million trees in different areas of the country, thus advancing the realisation of a promise the bank had made for 2030.
Regarding financial education and inclusion, Banco Popular continues to expand the offer of digital and face-to-face courses from the ‘Finances with Purpose Academy,’ which has already trained more than 154,000 people. In addition, the ‘Subagente Popular’ network, the largest in the country, has allowed access for 550,000 users to carry out their financial operations, with more than 4.4 million transactions, in the 2,997 affiliated businesses.
Supporting SMEs
For its SME clients, Banco Popular Dominicano created the SME Service Centre, which provides small business owners with detailed assistance, thus prioritising their financial needs. In the same sense of support for SMEs and entrepreneurship, more than 400 clients enrolled in the ‘Impulsa Popular’ online platform and used the tools provided to expand their business plans. At the same time, entrepreneurs took advantage of the benefits of the ‘Emprende Popular’ platform, with specific products, such as the ‘Emprendedores Naranja’ loan, designed for entrepreneurs in cultural and creative industries, which offers, in addition to financial facilities, entrepreneurship workshops for these types of businesses.
As a mechanism to promote the development of the productive sectors and project the country in international markets, our ‘Impulsa Forum’ and the export platform, ‘ProExporta,’ encouraged small, medium, and large-sized Dominican companies to consider export and enjoy the benefits of entering foreign trade. Its ‘Impulsa Popular’ web portal is a pioneering platform in the country, offering free tools to facilitate business management for entrepreneurs. It has over 3,200 articles and videos on finance, marketing, management, and sustainable leadership.
To elevate its digital leadership, the bank signed a strategic alliance with Microsoft to promote the digital transformation of small and medium-sized companies (SMEs) and young entrepreneurs. Through its SME Business Strengthening programme, 1,400 SME entrepreneurs have participated in training and educational opportunities with its allies: the Association of Industrialists of the Northern Region (AIREN), Barna Management School, and the Loyola Specialised Institute of Higher Studies. Additionally, through the ‘Impulsa Popular Franchise’ programme, 61 SMEs have become franchisees.
Tourism sector
The bank continues to lead in the sector as the ‘Bank of Tourism,’ by strengthening its leadership regarding the total volume of loans granted to its hotel clients and the broad value chain that are part of this crucial activity to the Dominican development model. Banco Popular represents almost half of the tourism financing portfolio of all Dominican banks, exceeding $209m in 2022.
To elevate its digital leadership, the bank signed a strategic alliance with Microsoft
Banco Popular’s financial support for tourism is distributed among nearly 800 clients. In 2022, the bank participated again in the International Tourism Fair (FITUR) in Madrid, Spain, of which the Dominican Republic was a partner country that year. This reiterates the bank’s role in supporting tourism, one of the main driving forces for the country’s recovery after the global pandemic.
The bank continues its commitment to the sustainable development of Dominican tourism and the region. It arranged a strategic financing agreement with Grupo Piñero of up to $200m together with BID Invest for the development and growth of tourism in its hotels in the Dominican Republic and Jamaica. This agreement is set to revitalise tourism activity with a sustainable approach in its three aspects: economic, social and environmental, preserving and generating jobs, betting on local suppliers, and reducing the carbon footprint by 60 percent before 2030.
Together with the Ministry of Tourism, it launched the campaign ‘Tourism in every corner’ to promote integration and mobility within the national geography, to diversify Dominican tourism options and to facilitate the creation of new, sustainable projects that allow the inclusion of communities.
Cybersecurity
Within the framework of Cybersecurity Awareness Month, Banco Popular Dominicano held three virtual seminars aimed at companies, young people, and adults over 55 years of age, respectively, with educational content on cybersecurity, part of its permanent education initiative ‘Pistas de Seguridad’ (Security Tips).
In addition, its employees are certified annually in the best and most up-to-date cybersecurity practices. Similarly, the bank reinforces its clients’ cybersecurity thanks to the advanced Security Operations Centre (SOC), which complies with international best practices, intense monitoring, and investigation to curb threats to technological infrastructure. Furthermore, its Network Operations Centre (NOC) constantly monitors its platforms and channels, ensuring the systems’ stability every day of the year.
