Can immigration fix Canada’s economy?

This article is about the economic effects of immigration, so as a Canadian citizen, let me begin with the customary acknowledgement that I am totally pro-immigrant! Yes I was born in Canada, but my parents were immigrants. My wife is an immigrant. Even one of my daughters was born outside the country and technically immigrated. And immigration is a difficult subject anywhere because politicians often deflect problems by blaming them on migrants.

Anyway, now that is out of the way, and purely from the point of economics – why is Canada trying to ramp up its population growth through immigration? In 2023 the rate was 3.2 percent, which was the highest in the OECD.

The usual argument put forward by economists in favour of boosting immigration is that we need young workers to support all the Boomers who are collectively easing into what looks like being a very expensive retirement. There is huge demand for workers in sectors such as agriculture, construction, healthcare, and so on – jobs which are often eschewed by locals because the pay is low.

However, the availability of cheap immigrant labour means that firms have less incentive to invest in productivity-enhancing machinery – which helps explain why Canadian productivity has slid in recent decades to about 72 percent of that of the US.

And of course immigrants age and retire and bring in older family relatives themselves, so immigration might give a temporary boost to the work force but is not a viable long-term solution. Finally, immigration may be contributing to the problem it is supposed to solve.

According to Statistics Canada, 32 percent of Canadians in their 20s “did not believe they could afford to have a child in the next three years” due to lack of “suitable housing.” This might explain why Canada’s birth rate has plummeted to 1.33 births per woman, which is nowhere near the replacement number of 2.1. But excessive levels of immigration boost inflation and competition for scarce housing, which will make finding rooms for babies even less affordable.

Another reason put forward for the low birth rate is anxiety about things like climate change. Some young couples are reluctant to bring children into a world they see as being on the edge of environmental catastrophe. Since Canada is one of the highest per capita greenhouse gas emitters on the planet, growing its size also directly damages the environment. So what is going on?

Buy my house
There is also another economic reason why some governments want to maximise immigration, which is that in theory it supports house prices. After all, as they say, immigrants don’t carry houses on their backs when they come in. And house prices are very important to debt-addled Canadians (ratio of household debt to GDP highest among the G7 countries).

As Finance Minister Chrystia Freeland previously explained, “The core problem with housing in Canada is we just don’t have enough housing. It is just a mathematical thing – Canada has the fastest-growing population in the G7.”

To homeowners, that decodes to: house prices will go up! Our investments (and retirements) are safe! This is especially useful given that much of Canada’s economy is based on real estate – from realtor fees to financing to insurance to construction.

But (speaking as a quantum economist) Freeland was using the wrong kind of math. The housing boom which underpinned the economy over the last few decades had less to do with population growth than with declining interest rates; and just as immigrants don’t come in bearing houses, most of them don’t also come in bearing massive downpayments. So the fact that we have a housing shortage doesn’t necessarily translate to higher prices – it might just mean that people have to pack themselves into smaller spaces (ask an international student in one of our overcrowded university towns).

From a purely economic standpoint, immigration does boost the total size of the economy – if you double the population then the economy is twice as large – but what is the point? A better measure is quality of life, which is a separate thing – and according to metrics such as per capita GDP is in decline. The whole approach seems outdated in a world where what matters (or should matter) from an economic perspective isn’t headcount or house prices but things like technology, innovation, resources, and environmental protection.
These problems are of course not limited to Canada, which is why housing, immigration and climate change are huge political issues in countries such as the UK, Australia, New Zealand, France, and so on. And why economics Nobel winner Angus Deaton wrote in March 2024 that he no longer subscribes to what he calls the “near consensus among economists that immigration to the US was a good thing.”

The reality is that immigration is great in moderation, and enriches us in many ways (not just economic), but it is not an all-or-nothing binary choice.
If a country like Canada wants a better economy in the future, as opposed to just a larger one, then maybe it is time to focus a little more on growing its own.

Unprecedented rain in Dubai raises questions

On April 16, Dubai experienced its heaviest rainfall in 75 years, disrupting lives across the city. While the city is typically associated with a dry climate and scorching heat, residents found themselves unexpectedly rushing for umbrellas to protect themselves against heavy rainfall. It hardly rains in Dubai, which is why the drainage system was not included in city planning. As a result, a significant portion of the water remained stagnant due to urbanisation and inadequate drainage infrastructure, exacerbating flooding in many areas. Blocked roads made it difficult for people to resume their daily activities, with grocery stores unable to restock and several employees having trouble reaching their workplaces.

The storm in Dubai not only caused inconvenience for its residents but has also jolted investors and businesses across the UAE. Dubai is heavily dependent on its tourism industry and all businesses flourish under this industry. Being UAE’s financial hub, Dubai has the busiest airports in the world. Due to the heavy storm, approximately 1,000 flights were cancelled, leading to days of subsequent delays. Motorways remained submerged until the rain stopped. Around 21 people sadly died across the UAE and Oman.

These circumstances do not present a favourable picture to the investors. They had not predicted that natural disasters such as rain would have such an impact and must now be factoring it into their future investment decisions. At present, their main concern will be whether it is a one-time thing or something set to continue.

Meanwhile, scientists and researchers are divided about this sudden rainfall. Some are blaming seeding, whereas many think it is due to global warming. According to Richard Washington, a professor at Oxford University, it is technically quite difficult to blame seeding alone for this storm. As per World Weather Attribution, “heavy precipitation hitting vulnerable communities in the UAE” is set to become “an increasing threat as the climate warms.” If this sort of event is now the norm, it will raise concern for Dubai’s investors. Additionally, it will pose challenges for Western investors, for whom one of the key attractions of residing and investing in Dubai is its weather.

Government response amid crisis
A positive sign for the investors is that the Government of Dubai has assured its residents that it will provide damages for the loss suffered and the UAE has allocated $544m for repairs caused by the storm. The UAE Central Bank, on the other hand, has confirmed that insurance claims will be provided for damaged homes and vehicles if the party holds a comprehensive insurance policy against loss and damage.

The bank has instructed all financial institutions to offer a six-month repayment deferment to customers with personal and car loans affected by flooding. It has assured that customers will not be bound to pay any additional amount, interest, or profit charges. Moreover, the principal amount of the loan will also not be increased.

Insurance companies in the UAE were not prepared to manage such claims, and have taken time to settle them, with claims made by customers against loss and damages backed by UAE Central Bank, which is a sigh of relief for many investors. However, it will be quite challenging for consumers to file a claim, especially regarding negligence, even if they have comprehensive coverage. For instance, if you have knowingly parked a car or a vehicle in a flooded area or if you were driving in a rain-affected area. Rejection of these kinds of claims could put a dent in investor confidence.

Dubai knows that it cannot afford to lose its reputation as both an attractive travel destination and ‘safe haven’ for investors to mere rain. Therefore, it has deployed thousands of workers to bring back normalcy. Other than banks and financial institutions, many developers in Dubai are also facilitating the repair of residential property damage. As per Khaleej Times, the CEO of Damac Properties, which is the largest property developer in Dubai, has also come forward to provide assurance to its residents that they will repair all their property damages at no cost. But the real question for investors is perhaps not about repairs, but about an upgrade to the city’s drainage system.

Dubai’s investors will certainly have this playing on their minds while looking for business opportunities. Investors will be looking to see how the Dubai government intends to support them in the case of flooding or other extreme weather events. They will carefully assess and scrutinise how insurance companies will facilitate them, what is covered and what is not. Considering current predictions, the likelihood of more severe rainfall events in the future remains high. Therefore, the government of Dubai must prioritise providing assurance to its potential investors by taking proactive measures to address the city’s inadequate drainage infrastructure and improving insurance policies. By tackling these challenges, Dubai can mitigate these risks and maintain its attractiveness as a destination for investors and residents alike.

The next phase of digital banking

The proliferation of smartphones and the increasing reliance on mobile technology have created a fertile environment for digital wallets and real-time payments, which are undergoing rapid evolution. This is progressively transforming the banking industry worldwide, especially in the UK, the US and European countries, driven by rising consumer demand and regulatory changes.

E-wallets, which allow consumers to store, manage and transfer their financial assets, offer alternatives for those without access to traditional banking services. Consumers are now accustomed to managing their finances online, whether that is checking balances, transferring funds, or applying for loans. This reflects a fundamental shift in consumer behaviour, where convenience and accessibility dominate. Further, the enhanced security features they offer, such as tokenisation – allowing the digital banking system to identify and process the transaction without exposing the user data – and biometric authentication – the use of unique physiological or behavioural characteristics of individuals for authentication and security purposes – have helped relieve concerns about fraud and identity theft, leading to further adoption of the tech.

A notable trend of younger generations moving towards digital wallets for everyday use has emerged, particularly in the UK and the US. According to the 2024 digital banking statistics in the UK, the number of digital-only bank account holders is higher among younger generations. More than half of Generation Z (55 percent) – the age group between 18 and 26 years old – and half of millennials (50 percent) hold at least one digital-only bank account in 2024. Meanwhile, just one in five members of the silent generation and baby boomers hold a digital-only bank account (21 percent each) and a third of Generation X (34 percent).

Just under one in five millennials and Generation Zers (18 percent) who do not currently have a digital bank account intend to open one at some point in the future, as well as 15 percent of those in Generation X.

Digital overtakes traditional
According to a Forbes Advisor survey on digital wallets which was revealed in 2023, around 53 percent of US consumers used digital wallets more often than traditional payment methods. Members of Generation Z were the most likely to adopt digital wallets as their primary payment method for shopping (91 percent) and travelling (86 percent).

The UK has seen significant strides in digital wallet adoption

In the US, technology giants like Apple, Google, and PayPal have set the stage with digital wallets that leverage the cloud to offer seamless, real-time transaction capabilities. These firms, with extensive user bases and access to the latest technological solutions, have made platforms such as Apple Pay, Google Pay, and PayPal household names, offering consumers secure and efficient payment solutions both online and in-store.

Similarly, the UK has seen significant strides in digital wallet adoption, buoyed by a flourishing fintech ecosystem and a friendly regulatory environment. Companies like Revolut, Monzo, and Wise have revolutionised the market with features such as instant notifications, budgeting tools, and competitive rates for international transfers. This recent spate of innovation can in part be attributed to the UK’s Open Banking initiative which fosters innovation and competition.
Overall, while there are similarities in the evolution of digital wallets and payments between the US and the UK, there are also differences shaped by factors such as regulation, consumer behaviour, and market dynamics.

Indeed, regulatory-wise, the UK has always been a more conducive environment for the growth of digital payments as the Financial Conduct Authority (FCA) has played a significant role in promoting competition and innovation in the financial services sector. In contrast, the regulatory landscape in the US has been more fragmented, with multiple regulatory bodies overseeing different aspects of the financial industry, which has sometimes hindered innovation.

Accelerated innovation
While the UK is not obligated to follow Europe’s banking regulations like Single Euro Payments Area (SEPA), Payment Services Directive 2 (PSD2) and Payment Services Directive 3 (PSD3), these mandates have still accelerated innovation and adoption of digital banking in the UK.

The US has not experienced the same rate of adoption of new financial capabilities as the UK, in many ways because European banking and payment regulations have not been as influential overseas. US consumers are increasingly flocking to digital banking and payments and with country-wide regulations expected this will likely accelerate in the coming years.

In this regard, global financial technology company Sopra Banking Software CEO Eric Bierry said that especially in the US, there is a large market demand for instant payments, with key players in this space including Zelle, The Clearing House’s RTP network, Visa Direct, Mastercard Send, Venmo, Paypal and Square processing more than $900bn in annual real-time transaction volume. On the other hand, in the UK, while the Faster Payments Service has been driving quick payments across many UK banks for more than 15 years, recent proposals seek to make instant payments even more secure for consumers as fraud and scams increase.

Alex Reddish, managing director of the UK fintech business Tribe Payments, highlighted that while the UK and Europe may be nearing saturation with digital banking, the evolution of the sector is far from over. “Continued innovation, regulatory developments, and shifting consumer preferences will shape the future of banking in Europe and the UK, ensuring that the industry remains dynamic and responsive to future demands,” he claimed. Reddish pointed out that on the other hand in the US, the largest financial services market in the world, some progress is likely to be much slower, although the market has always shown its ability to adapt quickly and leapfrog phases like contactless payments which the UK and Europe pioneered.

Partnerships between technology companies, financial institutions and merchants have also played a crucial role in promoting the adoption of digital wallets. “These collaborations have expanded acceptance networks, raised awareness about the benefits of mobile payments, and incentivised consumers with rewards and discounts,” Reddish added.

Security remains a top concern
Looking ahead, both the US and the UK are likely to see further innovation and growth in the digital payments space. Nevertheless, despite these advancements, challenges remain, particularly in the realms of cybersecurity and regulatory space. According to a data breach report released by IBM in 2023, cyber attacks disproportionately impact the financial services industry, which is second only to the healthcare industry in terms of cost per breach.

The regulatory landscape in the US has been more fragmented

Chris McGee, managing director of the financial services practice at global management and technology consulting firm AArete, stressed that security remains a top concern in both regions, and the need for cybersecurity remains a major trend in digital banking. “Banks are using AI to evolve digital banking in several areas, including security detection. AI can detect fraud and other potential risks faster than ever before while helping banks comply with a growing number of regulations. AI will increasingly play a key role in protecting customers’ assets and personal data and, crucially, in earning customers’ trust, especially as customers continue to explore the use of digital wallets to pay for goods and services.”

Likewise, Bierry revealed that one of the biggest challenges that both US and UK banks will face will be around generative AI. “Banks see clear business value with AI, but they nonetheless worry about how generative AI tools will affect areas like security and the banking workforce overall. Banks will need to devote time to not only onboarding AI tools themselves, but also educating teams and consumers about their impact. While banks will certainly face challenges integrating GenAI into their businesses, it also offers them an incredible opportunity,” he said.

“Regulations will pose another challenge to US and UK banks. As requirements continue to evolve and new policies come into play, banks must stay up-to-date to ensure compliance. After the failure of a series of banks last year, regulators are set to introduce several new policies this year that aim to prevent something like this from ever happening again,” Bierry added.

According to Bierry, regulators are likely to focus on policies protecting consumers and their financial data this year, especially as innovative financial products and services emerge in the era of open banking and AI.

Attractive targets
Likewise, Maureen Doyle-Spare, head of asset and wealth management and insurance at UST, a US digital transformation solutions company, highlighted that security is paramount because digital wallets contain so much sensitive financial data, which makes them very attractive targets for cyber attacks.

“Robust encryption, multi-factor authentication, and vigilant monitoring are essential for safeguarding user information. Additionally, interoperability also poses challenges, as seamless compatibility among various digital wallet platforms is crucial for enhancing the user experience. Furthermore, scalability is a pressing concern, as advanced infrastructure is needed to handle increasing transaction volumes without compromising speed or reliability,” she said.

Modernising existing and outdated banking infrastructure poses a significant hurdle for banks and fintech companies across the globe. Both markets in the US and the UK are likely to face similar challenges to reach their full digital banking potential. Aside from market differentiation difficulties due to the commoditised nature of digital banking services, neobanks will have to navigate regulatory frameworks primarily designed for traditional banks, which can be resource intensive and slow down innovation.

High customer acquisition costs and low per-customer revenue also present profitability challenges.

Africa’s currency crisis

In September 2023, Nigeria was upbeat after Emirates Airlines agreed to resume direct flights to the country. This came after an 11-month hiatus, the root cause of which was an inability to repatriate $85m in revenues trapped in the country due to a grievous currency crisis. Emirates was not alone in suspending operations. Etihad Airlines had done the same. Cumulatively, global carriers had a staggering $812m stuck in Nigeria when Emirates was suspending operations in November 2022, according to the International Air Transport Association.

The airlines’ fiasco is one case that was overly amplified. The reality is that Africa is a hotspot of suffering for multinationals. One major contributing factor is the currency crisis. Essentially, weak domestic currencies have made it difficult for foreign companies to repatriate revenues and profits. Worse still, they have battering effects on asset valuations of local subsidiaries. Instead of making a ruckus like Emirates, a majority of multinationals have opted to exit the continent silently. Many more are scaling down operations to minimise the losses.

“The high cost of doing business, red tape and a looming risk of devaluations reaching a critical mass is rendering operations in Africa unprofitable,” says Irmgard Erasmus, a senior financial economist at Oxford Economics.

Across Africa, the currency crisis is becoming endemic. The problem is profound in countries like South Africa, Nigeria, Egypt, Kenya, Ghana, Zambia, Ethiopia and Zimbabwe. In Egypt, for instance, the local pound has lost more than two-thirds of its value against the dollar since early 2022. Last year, Nigeria’s Naira was ranked among the worst-performing currencies in the world after depreciating by 49.4 percent.

In Zimbabwe, the local dollar has become a basket case. It has lost over 70 percent of its value on the official market since January this year. With businesses and traders shunning it in favour of US dollars, the Reserve Bank of Zimbabwe has reacted by launching a new currency called ZiG. It will be anchored on gold reserves and a basket of foreign currencies.

Out of Africa
The currency crisis has ignited widespread suffering and caused policymakers sleepless nights. For foreign companies, the impacts have been devastating. Many are finding it hard to bear the pain. When it exited Africa in 2021, UK’s financial conglomerate Atlas Mara cited currency volatility as a big factor in its decision. At the time, currency depreciations had caused a staggering $145m decline in the dollar value of its assets.

It has not been easy for most African countries to weather the storm of the global recession

Barclays Bank, Procter & Gamble, Glaxo-SmithKline, Cadbury, Eveready, Bayer, Nestle, Unilever have all also exited or significantly scaled down operations. Though other factors have been at play, weak currencies have been a common denominator.

It is not just multinationals that are feeling the pain. Institutional and individual investors in Africa’s capital markets, private equity firms and venture capitalists are also taking a beating. A case in point is South Africa. Johannesburg Stock Exchange data show that foreign investments outflows have amounted to $53bn over the past eight years. Last year, equities worth $8.3bn were dumped. In the Kenyan bourse, the exodus has been acute in recent times. The trend continued in the first quarter of this year with foreign investors selling $17m worth of stocks.

Repatriation of earnings is just one side of the problem for investors. Another that is more severe is substantial losses when weak domestic currencies are converted to hard currencies like dollars and pounds. “The exits and outflows showcase how powerfully foreign investors can react when their confidence is dented by a cratering currency,” states Jonathan Munemo, Economics professor at Salisbury University’s Perdue School of Business.

A combination of factors has conspired to inflame the currency crisis. The basics are an idiosyncratic component related to structural imbalances and external pressure in the form of tight global funding conditions and geopolitical risks. On the global stage, the aggressive rate hiking by the US Fed since March 2022 aimed at tackling stubbornly high inflation stands out. Its effect has been the value of the dollar rising substantially and exerting pressure on Africa’s currencies.

Turning up the heat
Surging global food and energy prices triggered by the war in Ukraine have amplified inflation pressures. Countries with high debt loads are also being forced to spend squeezed revenues on repaying expensive loans, heaping more pressure on currencies already weakened by depleted foreign exchange reserves. Currently, about 40 percent of public debt in the continent is external with over 60 percent of it being in US dollars.

Cases of countries with worsening debt burdens enduring intense exchange rate depreciations are ripe. Kenya offers a perfect example. With a public debt standing at $82bn, persistent fiscal deficits and dwindling reserves, the shilling reflected market concerns of a potential sovereign debt default on a $2bn Eurobond that matures in June 2024. Over the period between March 2022 and December 2023, the shilling weakened by 22 percent to the dollar. The freefall was more elevated at the beginning of this year. It was only arrested after the Kenyan government concluded a buyback operation of the maturing Eurobond.

“It has not been easy for most African countries to weather the storm of the global recession, monetary tightening and disruptions to global markets,” observes Christopher Adam, Professor of Development Economics at Oxford University.

While depreciations have battered the operations of foreign companies and investors, hysterical efforts by governments to stabilise domestic currencies have not made the situation any more bearable. Repatriation risks are most acute in countries relying on rigid forex regimes with currency convertibility issues also persisting in countries with flexible regimes. “Persistently high external financing needs tend to stand at the root of repatriation challenges,” explains Erasmus.

Across the continent, it has been a playbook of desperate measures to arrest the currency crisis. In Nigeria, the reform-minded administration of President Bola Ahmed Tinubu is implementing policies like unifying the multiple exchange rates and enabling market forces to set the exchange rate. The administration also intends to raise $10bn to boost forex liquidity.

Crippled by a prolonged economic crisis, Egypt is finally acknowledging that the path to economic transformation requires painful adjustments. The country has agreed to adopt a flexible exchange rate regime in line with International Monetary Fund demands in order to access an $8bn bailout. Beside the bailout, the country has also since secured an investment deal worth $35bn from the United Arab Emirates and mobilised $7bn and $6bn from the European Union and the World Bank respectively. Apart from helping stem a suffocating forex shortage, the war chest has enabled the country to float its currency, easing pressure on the pound.

The effects of policy interventions to tackle structural imbalances cutting across liquidity constraints, market distortions and lack of transparency in the forex market are somewhat yielding fruits. The Naira, for instance, has since taken a drastic turn in fortunes. In April, it was the world’s best-performing currency after gaining 12 percent against the dollar, building on a 14 percent surge in March, according to Goldman Sachs.

“Currency reforms will be welcomed by foreign investors and could spur capital inflows if they are successful in stabilising the exchange rate,” reckons Munemo.

A hard road ahead
A growing number of African countries are showing willingness to accommodate unpopular policies for long-term domestic currency stability. A few, like Ethiopia, are still clinging to a rigid forex regime. The net effect is subdued foreign interest in the government’s ambitious privatisation and sectoral liberalisation agenda. Despite its rigidity, the country is, however, dangling the carrot to ensure foreign direct investments keep flowing in. In September 2023 the National Bank of Ethiopia approved offshore accounts for strategic investors. Apart from making it easy for investors to manage their financial obligations, the directive also guarantees foreign currency convertibility for dividend repatriation and loan repayments.

Currency reforms will be welcomed by foreign investors and could spur capital inflows

“When restrictions are imposed in order to stabilise the exchange rates, private companies and individuals have the incentive to bypass official channels. This forms the basis of parallel or black markets in foreign exchange,” states Adam.

The parallel or black market continues to thrive in Africa. In some countries, it serves as the lifeline owing to the fact that it typically offers higher rates than the official exchange rate. Granted, the black market is a crucial component of the economy. Primarily, it offers a channel for individuals and businesses to access forex that may be scarce or overregulated in the official market. However, it also has damaging effects. For foreign investors who want to operate in stable, predictable and transparent environments, it can be a huge deterrent.

That deep entanglement with the dollar, and other hard currencies, has caused immense suffering for African countries, is indisputable. This explains why leaders in the continent led by Kenya’s William Ruto have been clamouring for de-dollarisation and development of homegrown local currency debt markets. The anti-dollar revolt is fuelled by popular consensus that advanced countries are often insensitive to how policies designed to provide stability in their own economies end up exporting currency instability to Africa. Additionally, if African countries borrowed more in their own currencies, they would escape the pains of exchange rate fluctuations spurred by rising global interest rates. The continent, however, understands that this is easier said than done.

The race is on in the electric vehicle revolution

Words like ESG, circular economy, sustainability, global warming, carbon footprint, carbon offset, and net zero have become entrenched in everyday language, and, like it or not, when it comes to transportation, the electric vehicle (EV) revolution is in full swing. We are being encouraged to ditch our combustion engines in favour of cleaner energy, and with good reason: not only is electric kinder to the planet, but oil is a limited commodity and won’t last forever.

However, despite media reporting of a slowdown in sales, EV Volumes’ recent report showed that sales of electric vehicles, both battery electric vehicles (BEV) and plug-in hybrids (PHEV), increased by 35 percent in 2023. Additionally, Statista reports that in 2024, the global revenue in the electric vehicles market is projected to reach $623.3bn.

All of which is good news for investors looking to capitalise on this emerging trend. By looking further down the supply chain beyond car manufacturers, there are many areas in the sector that present attractive investment opportunities, such as battery and other technologies, supporting services and infrastructure, and with enough research investors can position themselves to reap the benefits.

The case for EVs
Excluding water vapour, which varies between 0–4 percent, Earth’s atmosphere comprises approximately 78 percent nitrogen, 21 percent oxygen and 0.93 percent argon, with the remainder made up of trace gases, including the so-called greenhouse gases; carbon dioxide, methane, nitrous oxide, and ozone. While greenhouse gases account for only 0.04 percent, or 400 parts per millions (ppm), of gases in the atmosphere, they, along with water vapour, absorb the heat energy that the Earth gives off, trapping some of it in the atmosphere and emitting the rest back to Earth and space. And this causes a vicious cycle. As the heat energy in Earth’s atmosphere increases, humidity increases, which heats Earth further.

Transportation accounts for approximately 15 percent of all global energy-related energy emissions, and EVs have emerged as one solution to help mitigate the impact of combustion engine emissions and reduce the effects of climate change.

Growth drivers of the EV market
20 years ago, car buyers were encouraged to buy diesel vehicles as they were better for the planet. Obviously we know now that wasn’t the case and with more information at our fingertips, car buyers are more aware of the environmental benefits of EVs, but market growth is determined by several factors that affect EV adoption.

EV manufacturers promise both risk and reward in equal measure

Buying or leasing a car is a huge investment, so price remains a major driver of the market. And while prices are slowly coming down, the cost of an EV is still higher than that of a petrol equivalent. Thankfully though, with more manufacturers hopping on the proverbial electric bandwagon, there is now considerably more choice for consumers.

The next growth driver is battery life and range, and though it’s fair to say that while both battery life and range have significantly improved over the last few years, there is still a way to go before consumers feel confident about their EV comfortably covering a long drive without the need to stop and charge several times. A continuously expanding charging infrastructure along with the potential improvements to use faster, universal charging points will help drive market growth and assuage concerns when it comes to range and journey time.

The final growth driver is the availability of government incentives and subsidies that help consumers reduce the cost of swapping from petrol to electric. Alongside policies that improve and expand the charging infrastructure, this will help to make EVs a more attractive option for consumers.

Investment opportunities
If you are an investor looking to diversify your portfolio and take advantage of the headway being made in the EV market, where should you look? Starting at the top of the supply chain, EV manufacturers are the obvious place for a potential investor to begin sizing up the shape of the market and analysing the relevant data.

Many of the ‘old guard’ car manufacturers such as Ford, Volkswagen and General Motors have added plug-in hybrids to existing car marques while some have even designed futuristic-looking pure electric ranges. Then, of course, there are the new kids on the block such as Tesla and Rivian, to name two, that would require much deeper analysis as they sit firmly on the riskier side of a balanced portfolio. So, whether you are after the stability of the tried and tested or a bit more risk with exciting innovation, EV manufacturers promise both risk and reward in equal measure.

With recent advancements in lithium-ion chemistry, energy density, battery life and safety, and the development of solid-state batteries, and more, these links in the supply chain, which includes leading manufacturers, materials suppliers and R&D firms, plays a vital role in shaping the future of EVs. The companies leading these technological innovations are the ones potential investors should analyse because as they position themselves as leaders in the race to power the future, they could yield significant returns.

Leading battery manufacturers include Panasonic, Samsung, LG Energy Solutions, and Tesla, and with the demand for EVs set to increase, it stands to reason that they should grow alongside the industry. Battery manufacturers provide investors with the opportunity to add to their ESG portfolio and potentially capitalise on the battery market. But what about the raw materials needed for the batteries? For an average EV lithium-ion battery, 60–75 percent of the weight comes from the energy cells, which is roughly 8kg lithium, 35kg nickel, 14kg cobalt and 20kg manganese, with the remaining 25–40 percent taken up by the battery’s metal casing and cables, along with the thermal and battery management systems.

As the demand for batteries increases so does the demand for the raw materials, and while it’s a very risky part of the market, a canny investor might want to take a look at the leading miners of these minerals.

As technology becomes ever more sophisticated, the EV battery of tomorrow will be completely different to that of today, thanks to the efforts of research and development, meaning that R&D firms should definitely make the cut when it comes to looking at potential investments, especially as many governments are providing incentives to support the development of EV technology. For example, the UK government recently announced a £71.5m combined government and industry investment for automotive R&D projects.

For investment purposes, it is also worth considering what happens to a battery once it has come to the end of its life. In the more sustainable conscious world we live in these days, batteries are recycled to help create a circular energy economy. And with about four times lower emissions than virgin materials, recycled battery materials help reduce the carbon footprint further.

When it comes to battery recycling, there are already some big hitters in the sector, such as Ecobat and Li-Cycle Holdings, which is projected to grow from $9bn in 2023 to $56.3bn by 2031. According to McKinsey, driven by several factors including technological progress, supply-chain stability consideration, decarbonisation and ethical supply-chain targets, as well as regulatory incentives and pressure, the battery recycling space is set for significant growth.

Currently, most EVs are charged at home or work, but for higher EV adoption there needs to be a better network of faster chargers to provide the same level of accessibility and convenience that refuelling petrol-powered cars has. In 2022, there were over 450,000 public EV chargers in Europe. This number is set to grow to 1.3 million by 2025 and 2.9 million by 2030. Thankfully there are already some global superstars in this sector including Blink Charging, EVgo and ChargePoint.

Risks and challenges
Investing in the EV market can look attractive, but like any investment, it comes with its fair share of risks and challenges, with the biggest risk being market volatility. As it’s a new(ish) market, stock prices can fluctuate wildly, making it difficult to accurately predict future trends to help make informed decisions. Additionally, not all companies may survive, especially as research and development of all this new technology requires a significant investment which can affect a company’s overall financial health.

Car buyers are more aware of the environmental benefits of EVs

Additionally, government policies and regulations play a vital role in the shaping and growth of the EV market, and any change to regulations or the availability of incentives and grants can impact a company’s potential profitability.

Even if you are a confirmed petrolhead who loves the sound of a V8 engine, there is no denying that, from an investment standpoint, the outlook for growth in the EV market appears promising as governments across the world implement policies to incentivise EV adoption, and advancements in battery technology and charging infrastructure make EVs more accessible and convenient.

However, despite plenty of investment opportunities, market volatility means the EV sector can be a riskier avenue than most, requiring thorough research and analysis to manage the associated risks.

Making IP rights more accessible

IP protection often feels unaffordable for start-ups. With limited resources, demanding investors, and less experience with the necessary systems, many SMEs are reluctant to devote funds towards uncertain patent applications and legal proceedings. For those attempting to compete on the international market, these issues – and costs – are compounded tenfold, and founders and CEOs are quick to push it down the priority list.

Yet IP protection is an essential investment in the long-term future of businesses, and all innovators deserve the ability to defend their intellectual property. As part of continuous efforts to shape a fairer, more equitable patent system, the European Patent Office (EPO) has introduced a vital change to the systems for ‘micro-entities’. With this new fee structure, which joins pre-existing measures aimed at small businesses, traditional financial barriers are no longer debilitating, bringing new hope for the Davids in a world of Goliaths.

Building on solid foundations
With innovation central to economic growth, the EPO has already implemented a series of measures to ensure all businesses can compete on a global scale, regardless of their size. Already existing is the ‘small entities’ categorisation, applicable to natural persons; non-profit organisations, universities and public research organisations; microenterprises; and small and medium-sized enterprises (SMEs).

IP protection is an essential investment in the long-term future of businesses

Those under this umbrella can utilise the language-related fee reductions which aim to ensure organisations can protect intellectual property within a global marketplace. This assistance can be vital for smaller, often cash-strapped businesses, for whom translating patent applications (sometimes with limited time) is financially unfeasible. Under this scheme, those who file their European patent application in an official state language that is not English, French, or German, are entitled to a 30 percent reduction in filing and/or examination fees.

A new EPOch
A vital new scheme joined these measures from April 1, 2024: a new fee reduction scheme for ‘micro-entities’, heralding significant opportunities for small-scale innovators. Alongside the original 30 percent reduction in fees that ‘small entities’ are entitled to, crucially, ‘micro-entity’ organisations are able to apply this reduction to all major payable fees across patent prosecution, including filing, examination, search, designation, grant, and renewal fees.

The new status encompasses the same organisation types as ‘small entities’ excepting SMEs. However, crucially, the ‘micro-entity’ status is now no longer respective of an organisation’s nationality or domicile. Increasing the usability of the status comes at a highly welcome time considering the global economic climate and the EPO’s yearly fee increase that otherwise occurs on April 1.

Checking the terms and conditions
Like claiming ‘small entity’ status, to reap the benefits of being a ‘micro entity’, applicants are required to declare their status in front of the EPO. Reductions can then be applied to any relevant fee payments made alongside, or after, this declaration is filed (from April 1 onwards). If there are multiple applicants for a given application, each individual applicant must qualify. It is also the status of the new applicant which determines whether an application qualifies as a ‘micro-entity’ if any European patent application is transferred. Furthermore, these reductions are only applicable if the applicant has filed fewer than five applications in the past five years.

In order to maintain these benefits, it’s important to know that the EPO will be holding random checks on applicants’ status and so must be informed when there are any relevant changes. If any declarations are found to be false or incorrect, the reduced fee will be categorised as ‘not validly paid.’ The application can then be cast as withdrawn, and while organisations may be able to ‘revive’ it, this process can be even more financially significant. Compared to the USPTO’s 80 percent reduction in fees for ‘micro-entities,’ the EPO’s reform doesn’t appear quite as favourable.

Yet the progress still holds great potential for affected businesses, especially with the change to location determiners, and indicates that the EPO is increasingly aware of the value of smaller persons and organisations.

The future of digital corporate banking

The digitalisation wave has set in motion a fundamental and inevitable change throughout the globe, triggering disruptive growth throughout all aspects of business in the corporate world as it accelerates. Corporate banking and finance services have significantly benefited from this trend alongside the growth in the global demand for innovative solutions that more effectively address the evolving needs of businesses and corporations.

Digital corporate banking is revolutionising the way businesses manage their finances. Thanks to these brilliant digital solutions, businesses can benefit from a variety of tailored banking services and financial tools via innovative, centralised, and secure digital platforms that are easily accessible around the clock and from any place with internet access.

Such banking solutions pave the way for banking providers to build dynamic and highly customisable financing products that best fit different market sectors. ICSFS has been serving the financial and banking industry for many decades, observing and supporting its customers’ transformation journey.

From the early adoption of online and mobile banking to the modernisation of core banking systems, ICSFS has been at the forefront, enabling clients to evolve into true global digital banks through its innovative solutions such as ICS BANKS Global Transaction Banking (GTB). This is our powerful online service which allows corporate banking customers to access their accounts, initiate payment instructions and use other vital banking activities in a secure and agile way, anytime, anywhere.

This next-gen finance management platform is designed on a digital 360° architecture infrastructure to work harmoniously within the modern payments landscape. It also comes packed with intelligent features that encompass transaction capabilities that are not normally found in standard online banking systems.

These clever features cover the entirety of corporate finance tools like cash management, remittances and transactions, standing orders, time deposits, trade finance, reports and analytics, liquidity management, merchant management, corporate setup, and liquidity management services to streamline working capital and maximise ROI.

The appeal of digital corporate banking
The corporate world is no stranger to the monumental benefits of digital transformation. Companies and businesses from across the globe have always been at the forefront of the digitalisation movement. So it is only natural for new banking technologies that are capable of addressing the specific requirements of corporate financing and finance management to garner a great deal of interest from a wide range of corporate customers regardless of their type, size or sector. Large and multinational corporations can benefit greatly from the automated and streamlined processes, detailed reporting and financial planning tools that are offered by these platforms.

With digital banking, businesses have 24/7 access to their accounts and financial services

On the other hand, start-ups and SMEs benefit from digital corporate banking too. These smaller businesses stand to gain value from unrestricted access to the advanced tools and different facilities offered by corporate cash management platforms, including enhanced account management, credit facilities, payments and more.

In addition, tech-savvy managers, financiers and CFOs are especially drawn to the sophisticated capabilities of digital corporate banking, making this an attractive solution for any business looking to improve financial management and operational efficiency through digital means.

What are the advantages of digital corporate banking?
There are countless ways digital corporate banking can transform how businesses manage their finances. Companies that switch to digital corporate banking platforms like ICS BANKS Global Transaction Banking will experience a significant boost in operational efficiency.

With these technologies, routine tasks like payment processing, payroll, account reconciliation and cash management are automated, freeing up valuable time which can be better utilised for strategic growth and innovation. Additionally, with advanced analytics and reporting tools, companies gain real-time insights into their financial health, helping them make smarter, data-driven decisions.

Enhanced customer experience is another significant advantage. With digital banking, businesses have 24/7 access to their accounts and financial services, making it easier to manage finances on their own schedules. This is particularly beneficial for global operations that need to navigate different time zones.

ICS BANKS GTB also offers a high degree of flexibility and parametrisation, enabling businesses to tailor services to meet their unique needs. Features like personalised dashboards, customisable alerts, and integrated financial tools enhance user satisfaction and engagement, whilst opening up new opportunities and revenue streams for the banking provider.

What are the drawbacks of digital corporate banking and how is this being addressed?
Despite the many benefits of digital corporate banking, there are still certain challenges that may arise. Perhaps the biggest drawback is the security risks. For example, if the user neglects to follow cybersecurity protocols and recommended practices, it may expose the company to serious damage including financial loss, cyber-attacks, identity theft, data breaches, and fraud.

AI and ML can enhance various aspects of corporate banking, such as fraud detection, risk management, and customer service

Addressing this issue correctly requires a collective effort by everyone involved to mitigate possible risks. ICSFS places great importance on security: all ICS BANKS systems, modules, and components go through rigorous and thorough scrutiny regularly, with ongoing releases of security updates and patches, and scheduled security audits with all of our clients.

Technical issues and system downtimes are also drawbacks that come with any digital solution, as technology is inherently not immune to outages, glitches, and maintenance periods. Such unavoidable disruptions can come at a time of inconvenience to the user. To mitigate this, ICSFS works on implementing emergency plans and using different system deployment methods to minimise these disruptions and ensure high availability and uninterrupted access, on top of continuously refining ICS BANKS solutions and improving their resilience and reliability.

Is digital corporate banking safer?
Modern technology is certainly capable of offering enhanced security measures that far exceed traditional paper-based methods in any process – and even more so in banking technology in light of continually emerging technologies such as blockchain, RPA’s, Big Data, and AI.

However, technology being inherently more secure doesn’t necessarily mean it is always ‘safer.’ Several key factors must be considered before deeming a system to be safe. These include encryption and authentication procedures, fraud detection and prevention measures, compliance with data privacy regulations such as GDPR and CCPA, cybersecurity and attack prevention, and last but not least, human error.

The takeaway here is that while digital banking technologies do offer a much higher level of security, it is ultimately up to the users to follow best practices and remain vigilant to ensure the safety of their transactions and financial activities. As a global banking technology provider, ICSFS allocates a substantial portion of its resources and manpower to the continuous fortification of its security infrastructure and procedures.

The latest of these endeavours is the acquisition of the Information Security Management System (ISMS) ISO/IEC 27001 Certification for the Data Centre, IT Department, and ICS BANKS Banking & Digital Software Solution Services. Furthermore, ICSFS conducts regular and rigorous security audits of all its systems, as well as closely monitoring all client systems and performing regular updates to their different security and data protection protocols.

What is the future of digital corporate banking?
The future of digital corporate banking is set to be shaped by rapid technological advancements and evolving business needs. One significant trend is the increasing integration of Robotics, artificial intelligence (AI), and machine learning (ML) into banking platforms.

AI and ML can enhance various aspects of corporate banking, such as fraud detection, risk management, and customer service. For instance, predictive analytics powered by AI can help businesses forecast cash flows and manage liquidity more effectively. Chatbots and virtual assistants, driven by AI, will offer more personalised and efficient customer interactions, addressing queries and providing support in real time.

Blockchain technology is also poised to play a transformative role in digital corporate banking. By providing a secure, transparent, and immutable ledger, blockchain can streamline processes such as cross-border payments, trade finance and compliance.

Smart contracts, which execute automatically when predefined conditions are met, can reduce the need for intermediaries and enhance the efficiency of complex transactions. As more banks adopt blockchain, the industry can expect faster, more secure, and cost-effective services, benefiting businesses globally.

ICSFS had the foresight to adopt blockchain technology a few years ago, setting a regional precedent on the commercial use of blockchain technology and demonstrating its benefits in cross-border transfers. The rise of open banking is another crucial development. Open banking allows third-party developers to build applications and services around the financial institution, using APIs to access banking data.

Blockchain can streamline processes such as cross-border payments, trade finance and compliance

This fosters greater innovation and competition, leading to a wider range of financial products and services tailored to specific business needs. Companies can benefit from improved financial management tools, better lending options, and enhanced integration with other business applications.

One of the brightest features of ICS BANKS Banking Solution is that it is built entirely on an open banking backend, offering a rich and diversified catalogue of APIs which allows ICS BANKS solution to communicate clearly and easily with virtually any system. As regulations around open banking continue to evolve, ICS BANKS is fully capable of adapting to any changes quickly and seamlessly, driving further advancements in the sector.

Overall, the future of digital corporate banking will be characterised by greater automation, enhanced security, and increased collaboration. These advancements will not only improve operational efficiency and customer experience but also create new opportunities for businesses to optimise their financial strategies and drive growth.

Maritime trade is sailing to a tipping point

They are known as ‘choke points,’ the canals and rivers through which the world’s trade is transported by ships of all kinds and sizes. And suddenly they are under threat. In fact, two kinds of threat. Missiles fired from Yemen have dramatically cut traffic in and out of the Suez Canal via the narrow Strait of Bab-el-Mandeb in the Red Sea, a historic choke point between the Indian Ocean and the Mediterranean Sea. It may be years before maritime companies feel safe sending their ships through this route.

Simultaneously, long-running tensions between Iran and neighbouring states continue to jeopardise passage through the Strait of Hormuz, the only sea passage from the Persian Gulf to the open ocean. The importance of these straits can be gauged by the fact that more than half of the world’s total shipped crude production passes through Hormuz, Bab-el-Mandeb and the Suez Canal. That’s quite apart from a huge variety of other cargos. While relief to these sea passages can only come through peace, the Panama Canal and other great waterways face a threat that cannot come through politics.

It is the existential risk of record-breaking droughts that affect the Rhine, Mississippi, Mekong and other waterborne trade routes. The prevailing situation proves the vulnerability to terrorism and climate of the supply chains that have evolved over many years, in some cases over centuries.

A thousand ships
To take the Panama Canal first. In more normal times about 1,000 ships go through its locks each month, carrying some 40 million tonnes of goods. As the International Monetary Fund explains; “The Panama Canal can reduce the sailing distance from the Atlantic to Pacific and vice versa by a vast 8,000 nautical miles. Its efficiency and time-saving nature make it a crucial resource for the shipping industry, with an estimated six percent of global trade passing through it.”

Climate change is now threatening the shipping lanes that underpin global commerce

But when slots are in short supply, ships that cannot book one (or cannot afford to do so) must find a different route. In times of peace this would be the Suez Canal, which typically transits 12 percent of global trade, worth around $1trn a year. But with no other option available the shipping giants have been sending their vessels around Africa’s Cape of Good Hope, which extends the voyage by up to two, often extremely rough, weeks of sailing. This raises fuel and operating costs, causes delays and increases the price of the landed goods. According to consultant LSEG Shipping Research, the transit times from diverting a tanker from Asia to northwest Europe via the Cape of Good Hope have doubled to 32 days and added nearly $1m for each voyage. The extra costs for a container ship are less but still significant.

Happily, there has been some relief in the Panama Canal. The restrictions on passage have been progressively eased – but not lifted – as the El Nino-triggered drought throughout Central America goes on its way. In mid-April the hard-pressed Panama Canal Authority approved the passage of up to 32 ships a day including those with deeper draughts of nearly 14 metres. At the height of the drought in early 2024, approvals had been roughly halved. Some vessels could scarcely clear the bottom of the canal. The resulting disruption to supply chains was profound.

Due to restrictions, tonnage passing through collapsed by a third, according to maritime consultancy Clarksons Research. And although the drought is lifting, if the rainy season is late then restrictions could return.

Golden waterway
In the meantime, major natural waterways are at risk and the economic implications are profound. Dubbed China’s ‘golden waterway,’ Asia’s longest river, the Yangtze, which ferries some three billion tonnes of a hugely diverse range of products in a good year to about 100 countries, suffered a nearly cataclysmic drought in late 2022 that made the shipping world wonder about the river’s future navigability. And it still does.

Water levels at one of the giant ports on the 3,915-mile-long river fell to the lowest level since records began in 1865 as simultaneously depths at the river’s many tributaries followed suit. Although officials preferred not to tell the worst, the truth is that the Yangtze was reduced to half its normal width. If another drought hits the region, nobody knows how low the Yangtze could go.

Other logistically important and historic waterways like the Rhine, Mississippi and Mekong are also under threat. The Mississippi, which also experienced drought-induced bottlenecks in 2022, ranks second globally in inland waterways in terms of freight carried, with 600 million tonnes a year, while third-ranked Rhine carries 300 million tonnes.

The Mekong, the longest river in Southeast Asia along which some 60 million people live and work, has suffered increasingly severe droughts for two decades. Although it is floods that make the headlines as houses, cars, cattle and people are swept along a muddy torrent, it is droughts that create the most damage. “Unlike flood, drought only brings socio-economic hardship to riparian countries, especially riverine communities,” notes the multinational Mekong River Committee, pointing to ruined crops, fresh water shortages and disappearing fish.

Considerable uncertainty also hangs over the war-torn straits. If peace is restored, which looked unlikely in mid-April, their militarily strategic position in an increasingly volatile region makes the case for alternative supply chains even more urgent. Supply chains have many elements and, as Oxford-based PortWatch explains, delays in these choke points lead to further disruption all along the route, including ports that depend on the smooth functioning of the canal. Most of the research points in one direction. In early 2024, a report by the Atlantic Council, a respected US think tank, feared that “climate change is now threatening the shipping lanes that underpin global commerce.”

Citing a massive imbalance in the way that weather works, the report said; “The disruption to the way water moves between the Earth and the atmosphere – the patterns of rain, evaporation, condensation, and runoff that affect how much water flows through the world’s waterways – appears to be here to stay. Global supply chains depend on these waterways. With climate change expected to make extreme weather more frequent, a big rethink of how goods move around the globe is necessary.”

Beached business
Others express similar concerns about future disruption to the world’s complex highways to the sea. “Pressure on global shipping routes is creating stress in global supply chains again, soon after the acute disruption experienced in the pandemic,” insurer Swiss Re noted in a much-quoted February 2024 report. Entitled Navigating shipping disruptions: signs of rougher seas ahead, the author more or less echoed the Atlantic Council: “More frequent droughts are likely to jeopardise transit volumes in the Panama Canal, and climate change is already affecting river shipping, as seen in the Rhine and Mississippi. We view these as headwinds to the long-term resilience of global shipping trade.”

A big rethink of how goods move around the globe is necessary

But what can be done? Some have suggested shallower-bottomed vessels, others deep dredging. While the first is practicable but would send half the world’s river-going fleet to the scrap yard, the second is routine on most of the great waterways but on nothing like the required scale. Then there are ‘road bridges,’ basically overland transport by trucks and trains that would supplement or even replace waterways when they become impassable.

The boldest alternative by far would be another canal connecting the Pacific and Atlantic Oceans through Nicaragua. A Chinese company established by a certain Wang Jing, supposedly having ties to the Beijing government, has claimed a 100-year concession and a 173-mile route has been drawn up for a waterway that would take far bigger vessels than the Panama Canal, in fact ships like giant bulk carriers with depths of 26 metres. But the project would cost $40bn and would pass through pristine Lake Nicaragua, rainforest and wetlands, not to mention a geophysically unstable region.

As the Smithsonian magazine reported in 2014 when digging was supposed to begin, “the canal route lies in the middle of a hurricane belt.” Other more definite initiatives should help plug emerging gaps in the global supply chain. Abu Dhabi has signed a preliminary deal with Iraq to jointly develop a strategically located new port on the northern tip of the Persian Gulf near Basra. Named Al-Faw Grand Port, it is expected to open by the end of 2025 and link ‘east and west,’ according to its supporters. It will be big enough to take containers, dry bulk and tankers.

As war disrupts sea routes in the region, new supply chains are emerging. In early 2024 Turkey and Iraq unveiled a 1,200-km, $17bn road and rail link project – a land bridge, in short – that will connect Iraq’s main port to the Turkish border and then into Europe.
Ominously for Egypt, it will avoid the Suez Canal entirely.

The global race for AI regulation

EU negotiations are known for dragging on too long, with deals often struck after midnight, products of exhaustion and relentless horse-trading. The one the European Council and the EU Parliament struck the night between December 8 and 9, 2023, was no different. Its final product, the EU AI Act, is the first major piece of legislation governing artificial intelligence (AI), including ‘generative AI’ chatbots that have become the Internet’s new sensation since the launch of ChatGPT in late 2022.

Just two days later, Mistral AI, a French start-up, released Mixtral 8x7B, a new large language model (LLM), as the computational models behind generative AI are known. Although smaller than proprietary equivalents, it is in many ways superior due to its idiosyncratic setup that combines eight expert models. More ominously, its open source code is exempt from the Act’s stricter rules, posing new problems to regulators.

Mixtral’s disruptive potential is emblematic of the difficulties facing regulators who are trying to put the AI genie back in the bottle of the law. For its part, the tech industry thinks it knows the answer: self-regulation. Former Google CEO Eric Schmidt has argued that governments should leave AI regulation to tech firms, given their tendency to prematurely impose restrictive rules. For most policymakers, however, the question remains: how do you regulate something that changes so fast?

Laying down the EU law
Coming into force in May 2025, the AI Act represents the first attempt to answer that question. By covering nearly all AI applications, it aims to establish a European, and possibly global, regulatory framework, given the bloc’s reputation as a regulatory superpower. “Large, multi-jurisdictional businesses may find it more efficient to comply with EU standards across their global operations on the assumption that they will probably substantially meet other countries’ standards as well,” said Helen Armstrong, a partner at the law firm RPC. It is also the first stab at dealing with foundation models, or General Purpose AI models (GPAI), the software programmes that power AI systems. The act imposes horizontal obligations on all models, notably that AI-generated content should be detectable as such, with potential penalties up to seven percent of the miscreant’s global turnover.

How do you regulate something that changes so fast?

The Act follows a tiered approach that assigns varying levels of risk and corresponding obligations to different activities and AI models. GPAIs are classified into two categories, those with and without systemic risk, with the latter facing stricter rules such as being subject to mandatory evaluations, incident reporting and advanced cybersecurity measures including ‘red teaming,’ a simulated hacking attack. What constitutes ‘systemic risk’ is defined according to multiple criteria, two of which are the most crucial: whether the amount of computing used for model training is greater than 10^25 ‘floating point operations,’ an industry metric, and whether the model has over 10,000 EU-based business users. So far, only ChatGPT-4 and possibly Google’s Gemini meet these criteria.

Not everyone finds these criteria effective. “There could be high-capacity models that are relatively benign, and conversely, lower-capacity models that are used in high-risk contexts,” said Nigel Cannings, founder of the Gen AI transcription firm Intelligent Voice, adding that the computing criterion might encourage developers to find workarounds that technically comply with the threshold without reducing risks. Current AI research focuses on doing more with less by reducing the amount of data required to produce acceptable results. “These efforts are likely to break the compute barrier in the medium-term, thus making this regulation void,” said Patrick Bangert, a data and AI expert at Searce, a technology consulting firm, adding: “Classifying models by the amount of compute they require is only a short-term solution.”

The Act’s final draft is the product of fierce negotiations. France, Germany and Italy initially opposed any binding legislation for foundation models, worrying that restrictions would hamper their start-ups. As a counterproposal, the Commission suggested horizontal rules for all models and codes of practices for the most powerful ones; the selected criteria were a middle-of-the-road compromise. “There was a feeling that a lower threshold could hinder foundation model development by European companies, which were training smaller models at that moment,” said Philipp Hacker, an expert on AI regulation teaching at the European New School of Digital Studies, adding: “This is entirely wrong, as the rules only codify a bare minimum of industry practices – even falling short of them by some measures. But there was a huge amount of lobbying behind the choice of the threshold and hence we have an imperfect result.”

Others find the Act’s purview too sweeping. “It’s far more effective to regulate use cases instead of the general technologies that underpin them,” said Kjell Carlsson, an AI expert at Domino Data Lab, an AI-powered data science platform. Many European start-ups and SMEs have said that restrictions could put them at a disadvantage compared to their competitors. Compliance is easier for foundation model providers that invest vast sums in training data, amounting to just one percent of their development costs according to a study by the Future Society, a think tank studying AI governance.

For sceptics, the solution chosen is another brick in the EU’s regulatory wall, stifling innovation in an area where Europe badly needs success stories. The bloc has produced few AI unicorns compared to the US and China, while lagging behind in research. Nicolai Tangen, head of Norway’s $1.6trn sovereign wealth fund, which uses AI in its investment decision-making processes, has publicly expressed his frustration with the EU’s approach: “I am not saying it is good, but in America you have a lot of AI and no regulation, in Europe you have no AI and a lot of regulation.” Hurdles European firms face include a fragmented market, stricter data protection regulations, and challenges in retaining talent, as AI professionals are drawn to higher salaries and funding opportunities elsewhere.

The Act may make things worse according to Hacker, because of its undeserved “bad reputation”: “It is not particularly stringent, but there has been a lot of negative coverage and many investors, particularly from the international venture capital (VC) scene, treat the Act as an additional risk. This will make it harder for European unicorns to attract capital,” he said. Not everyone agrees with this assessment. “For VCs, it is only a new criteria to add to their assessment scorecard: is the company developing a model or product that is and will remain EU compliant, given the Act’s guidelines?” said Dan Shellard, Partner at Breega, a Paris-based venture capital firm, adding that regulation could create opportunities in the regtech space. Some even think it will foster innovation. “Forcing companies to work on problems where they have to be more transparent and responsible will likely unleash a different wave of innovation in the field,” said Chris Pedder, Chief Data Scientist at AI-powered edtech firm Obrizum.

Julian van Dieken’s work made using artificial intelligence is part of the special installation of fans’ recreations of Johannes Vermeer’s painting Girl with a Pearl Earring

Another problem is that technology is evolving faster than regulation. The release of open-source models like Mixtral 8x7B is expected to enhance transparency and accessibility, but also comes along with significant safety risks, given that the Act largely exempts them from regulation unless they constitute systemic risk. “There is a wider range of compute capabilities available to the open source models – a big chunk of users will be playing with local compute capability rather than expensive cloud-based compute resources,” said Iain Swaine from BioCatch, a digital fraud detection company. “Malware, phishing sites or even deepfakes can be more easily created in an environment that is no longer centrally controlled.”

Divided America
On the other side of the Atlantic, the US remains a laggard in regulation despite its dominance in commercial AI. Its regulatory landscape remains fragmented, with multiple federal agencies overseeing various aspects of AI. An executive order has tasked government agencies to evaluate AI uses and forces developers of AI systems to ensure that these are ‘safe, secure and trustworthy’ and share details about safety tests with the US government. Without the backing of the Republican-controlled Congress, however, it may be doomed to remain toothless, while Donald Trump has vowed to overturn it. Congress has launched its own bipartisan task force on AI, but this has produced little so far. Partisan splits make any agreement before elections in November unlikely. US regulation is expected to be less strict than its European counterpart, given that US governments traditionally prioritise innovation and economic growth.

In America you have a lot of AI and no regulation, in Europe you have no AI and a lot of regulation

“AI will be an area in which both Congress and the executive branch take a very incremental approach to regulating AI – including by first applying existing regulatory frameworks to AI rather than developing entirely new frameworks,” said David Plotinsky, partner at the law firm Morgan, Lewis & Bockius, adding that states may fill the vacuum. The risk, he added, is a “patchwork of regulations that may overlap in some areas and also conflict in others.”

The debate is informed by apocalyptic forecasts that the advent of an omnipotent form of AI may pose an existential threat to humanity. Some, including Elon Musk, have even called for a halt on AI development. However, more prosaic issues seem more urgent. A major concern is the rise of monopolies, particularly in generative AI, although the emergence of several competitors to ChatGPT has allayed concerns that a monopoly of OpenAI, the company behind ChatGPT, is inevitable. “Given the industry’s high barriers to entry, such as the need for substantial data and computational power, there is a real risk that only a few large incumbents, such as top big tech, could dominate,” said Mark Minevich, author of Our Planet Powered By AI.

Policymakers are also mindful of the impact of legislation on US competitiveness, as AI is increasingly seen as an area of confrontation in the troubled relationship with China. US President Joe Biden has directed government agencies to scrutinise AI products for security risks, while another executive order directed the Treasury to restrict outbound AI investment in countries of concern. “The US will wind up needing to adopt some sort of risk-based approach to foundation models,” estimated Plotinsky, who has served as acting chief of the US Department of Justice’s Foreign Investment Review Section, adding: “Any risk-based approach would also need to take into consideration whether the foundation model was being developed in the US or another trusted nation, as well as what controls and other safeguards might be necessary to prevent potentially powerful technology from being transferred to countries of concern.”

The Chinese puzzle
China’s ambitions justify such concerns. Its government aims to make the country an AI leader by 2030 through massive government funding. China is already the largest producer of AI research. Its Global AI Governance Initiative, a set of generic proposals for AI rules beyond China’s borders that include the establishment of a new international organisation overseeing AI governance, is indicative of its aim to influence global regulation. The initiative also includes a call to “oppose drawing ideological lines or forming exclusive groups to obstruct other countries from developing AI,” perceived as a reference to US legislation aimed at curbing US investment in China’s AI industry. “In international forums, China wants a seat at the table and to have a say in shaping global development of AI regulation,” says Wendy Chang, an expert on Chinese technology from the think tank Mercator Institute for China Studies. “But domestically, there is the additional task of maintaining Beijing’s tightly run censorship regime, which comes through sometimes quite explicitly such as requiring generative text content to ‘reflect socialist core values’.”

The EU has fired the first shot in the race for global AI standards

These values may hamstring China’s bid to become a global leader in AI, although the government wants Chinese firms to develop Gen AI tools to compete internationally; both Chinese tech giants Baidu and Alibaba launched their AI-powered chatbots last year. The initial draft of the country’s rules for generative AI required developers to ensure the ‘truth, accuracy, objectivity, and diversity’ of training data, a high threshold for models trained on content gathered online. Although recent updates of the regulation are less strict, meaning that Chinese firms are no longer forced to ensure the truthfulness of training data but to ‘elevate the quality’ and ‘strengthen truthfulness,’ barriers remain substantial. One working group has even proposed a percentage of answers that models could reject.

Given the tendency of chatbots to come up with disinformation, such rules may force Chinese firms to use limited firewalled data to train their models. Currently, Chinese firms and citizens are not permitted to access ChatGPT. In one case, the founder of the AI company iFlytek had to issue a public apology when one of the firm’s AI tools produced text criticising Mao Zedong. “Beijing’s need to enforce information control domestically is a big Achilles heel for its AI development community,” said Chang. “Compliance would pose large hurdles for tech companies, especially smaller ones, and may discourage many from entering the field altogether. We already see tech companies veer towards more business-oriented solutions rather than working on public-facing products, and that is what the government wants.”

The Chinese government has rolled out detailed AI regulations, with a comprehensive national law expected to be issued later this year. Its regulatory approach focuses on algorithms, as shown by its 2021 regulation on recommendation algorithms, driven by concerns over their role in disseminating information, a perceived threat to political stability and China’s concept of ‘cyber sovereignty.’ Crucially, the regulation created a registry of algorithms that have ‘public opinion properties,’ forcing developers to report how algorithms are trained and used. Its remit has recently expanded to cover AI models and their training data, with the first LLMs that passed these reviews released last August. China’s deep synthesis regulation, finalised just five days before the release of ChatGPT, requires that synthetically generated content is labelled as such, while its cyberspace regulator recently announced similar rules for AI-generated deepfakes.

Who owns this picture?
Another emerging battlefield is the ownership of the intellectual property for the data that power foundation models. The advent of generative AI has shocked creative professionals, leading to legal action and even strikes against its use in industries hitherto immune to technological disruption, like Hollywood. Many artists have sued generative AI platforms on the grounds that their work is used to generate unlicensed derivative works. Getty Images, a stock image supplier, has sued the creators of Stable Diffusion, an image generation platform, for violating its copyright and trademark rights.

 

AI poses new challenges for financial regulators

Finance is one of the sectors where the use of AI poses grave risks, with areas like risk modelling, claims management, anti-money laundering and fraud detection increasingly relying on AI systems. A 2022 Bank of England and FCA survey found that 79 percent of UK financial services firms were using machine learning applications, with 14 percent of those being critical to their business. A primary concern is the ‘black-box’ problem, namely the lack of transparency and accountability in how algorithms make decisions. Regulators have noted that AI may amplify systemic risks such as flash crashes, market manipulation through AI-generated deepfakes, and convergent models leading to digital collusion. The industry has pledged to aim for more ‘explainability’ in how AI is being used for decision-making, but this remains elusive, while regulators themselves may fall victim to automation bias when relying excessively on AI systems. “Transparency sounds good on paper, but there are often good reasons that certain parts of certain processes are kept close to a financial institution’s chest,” said Scott Dawson from the payments solutions provider DECTA, citing fraud prevention as an example where more transparency about how AI systems are used by financial services firms could be counterproductive: “Telling the world what they are looking for would only make them less effective, leading to fraudsters changing their tactics.”

Another concern is algorithmic bias. The use of AI in credit risk management can make it more difficult for people from marginalised communities to secure a loan or negatively affect its size and conditions. In the EU, the proposed Financial Data Access regulation, which will allow financial institutions to share customer data with third parties, may exacerbate the challenges facing vulnerable borrowers. The EU AI Act tackles the problem by classifying banks’ AI-based creditworthiness operations and pricing and risk assessments in life and health insurance as high-risk activities, meaning that banks and insurers will have to comply with heightened requirements. “New ethical challenges are triggering unintended biases, forcing the industry to reflect on the ethics of new models and think about evolving towards a new, common code of conduct for all financial institutions,” said Sara de la Torre, head of banking and financial services at Dun & Bradstreet, a US data analytics firm.

 

In response, the platform’s owners announced that artists could opt out of the programme, tasking them with the protection of their intellectual property. Such legal action has sparked a debate on whether AI-generated content belongs to AI platforms, downstream providers, content creators or individual users. Suggested solutions include compensating content creators, establishing shared revenue schemes or using open-source data. “In the short term, I expect organisations placing greater reliance on contractual provisions, such as a broad intellectual property indemnity against any third party claims for infringement,” said Ellen Keenan-O’Malley, a solicitor at the law firm EIP. So far only the EU has taken a clear position; the AI Act requires all model providers to put ‘adequate measures’ in place to protect copyright, including publishing detailed summaries of training data and copyright policies. “An outright ban on using copyrighted images for AI training would ban AIs that mass-produce custom art,” said Curtis Wilson, a data expert at the tech firm Synopsys. “But it would also ban image classification AI that is used to detect cancerous tumours.”

A shattered world
As the next frontier in the race for tech supremacy, the deployment of AI has geopolitical repercussions, with Europe and China vying for a chunk of America’s success in the field. Hopes for a global regulatory framework are perceived as overly optimistic across the tech industry, given the rapid development of AI models and the different approaches across major economies, meaning that only bilateral agreements are feasible. A recent Biden-Xi summit produced an agreement to start discussions, without any details about specific actions. The EU and the US have agreed to increase co-operation in developing AI-based technology, with an emphasis on safety and governance, following a similar pact between the US and UK to minimise divergence in regulation. The first global summit on artificial intelligence, held in the UK’s Bletchley Park last November, issued the Bletchley Declaration, a call for international co-operation to deal with the risks of deploying AI. So far, this has not translated into action.

For the time being, the prospect of common regulation for AI seems to be distant, as policymakers and tech firms face the same headwinds that are leading the global economy to fragmentation in an era of rapid deglobalisation. The EU has fired the first shot in the race for global AI standards, opting for horizontal, and for some overly strict, rules for AI systems; the US, hampered by pre-election polarisation and the success of its AI firms, has adopted a ‘wait-and-see’ approach that practically gives the tech industry a free hand; China, true to form, sticks to censorship domestically while trying to influence the emerging global regulatory framework. “The challenge going forward is not allowing China to dictate what standards are or promote policies regulating AI that favours them over everyone else,” said Morgan Wright, Chief Security Advisor at SentinelOne, an AI-powered cybersecurity platform.

A bigger challenge, however, remains catching up with the technology itself. If the advent of loquacious chatbots in 2022 caught the world by surprise, the next waves of AI-powered innovation have left even experts speechless with their disruptive potential. “The field is moving so fast, I am not sure that even venture capital firms not deeply immersed in the field for the last decade fully understand AI and its implications,” said Alexandre Lazarow, founder of the venture capital firm Fluent Ventures.

For regulators, things may be even worse, according to Plotinsky from Morgan, Lewis & Bockius: “The technology has evolved too rapidly for lawmakers and their staffs to fully understand both the underlying technology and the policy issues.”

The private equity storm

On April 22, Nathanaël Benjamin was in an ominous mood regarding the state of the private equity (PE) market. In a speech delivered at a Bloomberg event, the Bank of England (BoE) Executive Director for Financial Stability Strategy and Risk was blunt when bringing attention to the industry that has grown in size, complexity and interconnectedness. From the speech titled ‘Not-so-private questions,’ it was crystal clear that regulators are reaching convergence: the PE industry has ballooned to levels that could pose threats to the global financial systems, yet it continues to operate in opacity.

“Shining a light on the current dynamics in the private equity market is crucial at this juncture, given the important role the sector plays for the real economy,” said Benjamin. He added that making sure the financial system evolves in a way that is conducive to safe and sustainable financing practices is essential for durable economic stability.

For Benjamin, a member of BoE Financial Policy Committee, current realities facing the PE market have converged to present the ideal moment to focus the spotlight on the industry. Notably, recent developments have the potential to disrupt the supply of funding to real economy companies. Besides, they have the potential to cause systemic institutions, including banks, to experience significant and correlated losses due to exposures linked to private equity.

“These dynamics, as well as exogenous shocks, could all be amplified by vulnerabilities in this sector, such as opacity and interconnectedness across institutions and markets. So this is typical financial stability ground. That’s why we care,” he stated.

Clearly, these are not the days when regulators turn a blind eye on the PE market. Having achieved exponential growth over the past two decades, the industry is floundering. Up until two years ago, the PE market had managed to thrive riding on a model built on cheap financing and leverage. However, the confluence of higher borrowing costs, market volatility and economic uncertainty has brought about considerable challenges for the PE ecosystem. These challenges have regulators ringing alarm bells.

“Clearly debt markets have impacted returns,” says Mike Donaldson, CEO at South Africa-based RMB Corvest, a pioneer in private equity that is 100 percent focused on equity investing, with PE being its primary asset class. He adds that while PE has encountered headwinds in recent times, what is indisputable is that PE has matured into a multi-trillion-dollar industry that is absolutely critical in driving growth of businesses and job creation.

The PE growth trajectory
That PE has achieved phenomenal growth is evident. Data indicates that globally, assets under management in the private equity sector have increased significantly over the past decade from $2trn in 2013 to $8trn in 2023. The industry, however, remains relatively small compared to the public equity market, whose size stands at $100trn and banking sector balance sheets at $98trn.

The vibrancy of capital markets is facing real threats from Private Equity firms

In the US, PE firms generate vast economic output. They create 12 million jobs and contribute 6.5 percent of the gross domestic product, amounting to $1.4trn. In the UK, the sector plays a crucial role in funding businesses, with around $313bn actively invested in companies. British Private Equity and Venture Capital Association data show that last year, UK businesses backed by PE and venture capital (VC) employed 2.2 million workers (1.9 million are PE-backed only), collectively earning $94bn. More notably, suppliers to these businesses employ an additional 1.3 million workers. Overall, this is comparable to the entire education sector’s workforce.

The situation is similar across other regions including Asia-Pacific, Latin America and Africa. In Asia-Pacific, for instance, PE investments have been on a growth trajectory, hitting a five-year high of $244bn in 2021 according to KPMG. In recent months, however, investments have plunged to $84.7bn. In Africa, the PE industry has emerged as a lifeline providing alternative routes to growth for companies that may otherwise have struggled to achieve the requisite scale. PE and VC investments in Africa soared 66 percent in 2022 to $7.7bn according to S&P Global Market Intelligence data, the highest aggregate value for the region.
“The flow of PE investments has been healthy in Africa and continues to facilitate growth for many businesses for which bank credit was not easily accessible,” notes Paras Shah, Managing Partner at Bowmans Kenyan office. He adds that the majority of the deals in the continent are relatively small, ranging between $15m and $25m. This, however, reflects the small nature of the market.

Visibly, PEs have unleashed their pooled financial war chest to snap up valuable companies in pursuit of handsome returns within the shortest period possible. Companies in industries like software, communications, IT and media, semiconductors, health and pharmaceuticals, renewable energy and agriculture have attracted massive investments across the globe. It has been a similar case for sectors like financial services, transport, fast moving consumer goods and tourism and hospitality.

The growth of the PE industry and its expanding tentacles of influence is also bringing about another phenomenon – migration of highly qualified professionals from industries like banks and insurance to PE ventures. Banks, in particular, are feeling the weight of the exodus with erstwhile employees now becoming direct competitors or clients. More alarming, however, is that banks are witnessing an increase in default rates of leveraged loans. Though unclear how deep the malady runs, for banks that are overly exposed the risks have the potential to blink red.

Into the unknown
After years of sustained growth, the PE market has over the past two years been sailing in uncharted waters. The rosy growth that had been witnessed in prior years started to crash in 2022, and continued last year. The root cause of the crumble: the Fed’s rapid increases of interest rates, the sharpest since the 1980s. The Fed’s aggressive approach to arrest stubborn inflationary pressures has had contagion effects, instigating hikes across the globe.

“The strong growth and attractive returns of the private equity asset class over the last 10 years has occurred during a period of low interest rates. However, since the start of 2022 interest rates have increased substantially,” observed Benjamin. He added that markets are not expecting for the foreseeable future a return to the low levels seen in the recent past.

High borrowing costs have inevitably exposed the PE industry’s soft underbelly. Apart from sapping the confidence of investors, it has brought about excruciating challenges. Evidently, it has been a season of slump across all matrices for PE cutting across fundraising, dealmaking and exits. The ripple effects are being felt across the whole ecosystem. Desperate companies – a majority being small and medium-sized companies (SMEs) – in need of growth capital cannot attract financing.

General partners (GP) who manage funds are feeling the squeeze in terms of management fees and carried interest dry up. Limited partners (LPs), the investors into the private equity funds who include sovereign wealth funds, insurers, pension funds, foundations, and wealthy individuals, among others, are in a state of despair, with funds returning the lowest amount of cash since the financial crisis 15 years ago. The “majority of PE houses have not realised their core investments during these cycles and have chosen to hold for longer,” explains Donaldson.

Global consultancy firm Bain & Company’s 15th Annual Global Private Equity Report clearly captures the reality of the PE industry in recent times. The report contends that echoes of the 2008 global financial crisis have reverberated loudly. However, the industry has never seen anything quite like what has happened over the last 24 months. “The sheer scale and speed of rate rises last year, and the uncertainty around that, was a shock for the industry in 2023,” said Hugh MacArthur, global private equity practice chairman at Bain & Company.

Confidence was the first casualty of the Fed’s jacked rates, something that left the PE industry gasping for air in terms of investments, according to the report. In 2023, buyout investment value dropped to $438bn, a 37 percent nosedive from 2022 and the worst total since 2016. When compared to 2021’s peak, it was 60 percent down. Overall deal count dropped by 20 percent to around 2,500 transactions. Against 2021 highs, deal count was down 35 percent. The malaise infected regions across the world, with North America, Europe and Asia-Pacific experiencing significant declines. While dealmaking was badly off, exit activity fared even worse as rising interest rates and macro uncertainty left buyers and sellers at odds over valuations. In fact, exits have propelled to the pinnacle and have become the PE industry’s most pressing conundrum. Apart from seizing up and stanching return flows of capital to LPs, they have left GPs sitting on an aging $3.2trn of unsold assets. This accounted for a staggering 28,000 companies in which PEs cannot exit.

The sheer scale and speed of rate rises last year, and the uncertainty around that, was a shock for the industry

Notably, the median holding period for a buyout has also increased and now stands at 5.6 years, way above the industry norm of about four years. In 2023, the businesses that held for a lengthy four years or longer comprised 46 percent of the total, the highest since 2012. The plunge in exit activity saw buyout-based exits drop by 44 percent to $345bn by value globally. The number of exit transactions fell by 24 percent to 1,067 during the year. A drop in exits was recorded across all geographies.

“Breaking the logjam will need GPs to take charge of their destiny in terms of how they can manage portfolios in order to generate increased distributions for LPs,” noted Rebecca Burack, head of the global private equity practice at Bain & Company.

This is critical, and somewhat urgent coming on the backdrop of PE funds returning the lowest amount of cash to investors last year. Data by US-based investment bank Raymond James Financial shows that distributions to LPs totaled 11.2 percent of funds’ net asset value. This was the lowest since 2009 and stood well below the 25 percent median figure across the last 25 years.

No way out
Inabilities by PE funds to exit and return capital to LPs had a battering effect on fundraising. The silver lining is that new fundraising contributed an impressive $1.2trn to the stunning $7.2trn in fresh capital the industry has accumulated since 2019. That, however, was the only positive. This is because the amount raised last year was actually the least the industry has pulled in annually since 2018. More tellingly, it was down 20 percent from 2022 totals and almost 30 percent off the all-time high in 2021.

The biggest contributing factor in fundraising plunge is that low returns have prompted LPs to become overly selective on any new redistributions. In essence, LPs are opting to carry out thorough due diligence seeking to zero in on GPs that have over the years demonstrated resilience in returning capital. “Assuming patient capital, the returns should materialise once markets re-rate,” explains Donaldson. Investments, exits and fundraising challenges have put the PE industry at a crossroads. The situation has been exacerbated by a whole basket of dry powder that cannot be deployed due to slowdown in dealmaking. According to S&P, global private equity dry powder soared to an unprecedented high of $2.5trn in 2023 from $2.3trn in 2022, an eight percent increase. Notably, 25 PE firms held 21.8 percent of the dry powder, 19 of which were headquartered in the US. Apollo Global Management led all other firms, with $55bn in uncommitted capital available to its private equity strategies. Other firms sitting on record levels of dry powder include Blackstone, KKR, Carlyle Group, CVC Capital, Warburg Pincus, Brookfield, Bain Capital and Advent International, among others.

“The accumulation of dry powder is an indication that firms have been facing challenges in looking for deals. There haven’t been that many targets,” notes Shah. He adds the economic uncertainties have created a scenario in which investors are more restrained and selective. The dynamics have also been complicated by the valuation gap, which has been one of the primary impediments to dealmaking in recent months. Due to high interest rates, vintage PE assets have faced the risk of valuation mismatches at exit. To a large extent, this explains the increase in the median holding period for a buyout.

The valuation quagmire has forced GPs and LPs to seek solace in the secondary market in pursuit of liquidity. Yet even here, increased supply has put downward pressure on the prices and valuations. Research by US-based financial services firm Jefferies shows that secondary volumes stood at $112bn in 2023 compared to $108bn in 2022, representing a four percent increase. Robust buyer demand, significant supply of both LP portfolios and GP-led opportunities and stabilising market conditions drove secondary volume higher. Of importance to note is that although pricing overall had improved due to rising public valuations, only one percent of LP interests were priced above the net asset value (NAV) of the company portfolio.

“Sustained high interest rates in 2023 altered investors’ required return on capital and limited their use of leverage, resulting in a mere one percent of funds pricing above NAV, and many older, tail-end interests trading below 75 percent of NAV,” states a report by Jefferies.

Undoubtedly, it has been a turbulent period for the PE industry on all fronts. This, however, did not stop the execution of some earthshaking deals last year. A majority of the top deals closed were valued at below $1bn. Only about a quarter were valued at more than $1bn, according to Pitchbook.

The $13.5bn acquisition of Japanese conglomerate Toshiba by PE firm Japan Industrial Partners stood out among the topmost deals. The transaction was nothing short of groundbreaking. It marked the end of a 74-year era for Toshiba as a listed company. It also gave the struggling conglomerate a new lease of life. Toshiba was just one of a growing number of take-private deals.

Others included Silver Lake with the participation of CPP Investments paying $12.5bn to acquire Qualtrics, an experience management company, and Stonepeak paying $7.4bn to acquire Textainer, one of the world’s largest lessors of intermodal containers. Other notable deals in 2023 included Roark Capital paying $9.5bn to acquire Subway, one of the world’s largest quick service restaurant brands, and Apollo agreeing to buy out the shareholders of Univar Solutions, a commodity and speciality chemical distributor, at a cost of $8.1bn.

The fact that PE firms are increasingly becoming vultures devouring publicly listed companies is among the reasons why regulators are shining the spotlight on the industry. Globally, the vibrancy of capital markets is facing real threats from PE firms. A survey conducted by US-based multinational law firm Dechert last year paints a clear picture. In the survey of 100 senior PE executives in the US, Europe and Asia, 94 percent said they have plans to pursue take-private deals. In 2022, only 13 percent had take-private ambitions.

The enormity of PE devouring publicly listed companies is unprecedented. Over the past three decades or so, the number of listed companies in the US has plunged by more than half from about 8,000 to less than 4,000 currently. A large number have been taken private by PE firms. In the first quarter of this year alone, there were 21 take-private deals according to audit firm AY. “This underscores the degree to which PE firms continue to perceive opportunities and mispricings despite tremendous recent gains in public equities indices,” stated Pete Witte, EY Global Private Equity Lead Analyst.

The end of the tunnel
Unplugging companies and taking them away from the hawk-eyes of regulators and public scrutiny is fuelling the culture of opacity in the PE industry. The effect is that concerns are now mounting that this has the potential to cause tremors, even quakes, on the global financial systems. PE cross cutting links with the banking sector, insurance, pension, sovereign wealth funds, private credit markets and leveraged lending is adding to these fears. “This intricate web of connections adds to the notable lack of transparency, making it difficult to assess financial stability risks,” noted Benjamin.

Over the past three decades or so, the number of listed companies in the US has plunged by more than half

PE portfolio company bankruptcies is another area of grave concern. The devastation of high interest rates has extended to portfolio companies. In the US, for instance, S&P data show that bankruptcy filings by PE and VC-backed companies surged to 104 last year. This was the highest annual total on record, representing 174 percent growth over the 38 filings in 2022 and accounted for more than 16 percent of all US bankruptcy filings. Bankruptcies in the healthcare sector were among the highest, totalling 17.

That the past two years have been distressing for the PE market is not in dispute. The industry, however, is starting to see some light at the end of the tunnel. Easing borrowing costs and a renewed interest from lenders has resulted in a rebound in activity. The trend is projected to gain pace in the coming months. “With rates set to moderate in coming months there is a greater sense of stability,” noted MacArthur. He added that despite the positive signs, cautious optimism overrides prospects in the immediate and medium term.

The first quarter of 2024 offers a glimpse. S&P data show that PE and VC deal value stood at $130.6bn during the period compared to $124.3bn for the same period in 2023, representing a 5.1 percent increase. With 60 percent of GPs expressing optimism on 2024 prospects compared to 34 percent last year, the industry believes the worst is behind it, and probably over.

It has been a turbulent period for the private equity industry on all fronts

The PE industry is looking into the future with renewed potency. Generative artificial intelligence (GenAI) is already shaping up as one of the game-changing tools that are bound to define how the industry operates. The rate of GenAI adoption is proving to be phenomenal. Some 74 percent of PE-backed firms are currently either using AI solutions in their transaction processes or are piloting potential solutions. These cut across making investment decisions, carrying out due diligence, analysing market trends and patterns, streamlining back-office functions to enhancing privacy and safeguarding against cybersecurity.

For the PE market, adoption of smart technologies is not the only necessity. The lessons of the past two years have shown that discarding the principles of measured risk in pursuit of short-term profits can be counterproductive. This reality, coupled by regulators’ resolute view that the PE market must grow in a safe and sustainable manner, is bound to force the industry to change its modus operandi. What will not change, however, is the foundation under which the industry stands – private.

Building climate-proof portfolios

Whether it is wildfires, rising sea levels or catastrophic storms, climate change is leading us into a new and terrifying territory. People, communities, ecosystems, and economies are already battling with the continuous onslaught of climate change, which is putting immense pressure on all fronts. In response, increasing investments in renewable energy, sustainable infrastructure and climate resilience are looked at in order to limit the damaging effects and defend the future of our planet.

There is now, more than ever, a serious demand for climate resilient investments which have the potential to greatly influence the course of business and industries globally. However, there is still a need for awareness and attention to ensure that these investments are being appropriately prioritised and implemented across all kinds of industries.

In a world where a lot of the time incentives are vital to action, building frameworks that support sustainable practices and investments on a larger scale relies heavily on the engagement of governments and policymakers. Opting for easy investments may supply quick profits in the short term but taking on climate resilience is an investment for the sustainable abundance of our planet and its inhabitants, in terms of environmental health and financial stability. At present, only two percent of private climate finance is going into resilience. Which, ultimately, is not enough to deal with the threats of climate change, where greater resources and attention are needed. To really face the climate crisis, we have got to look at the bigger picture, beyond just acknowledging existing threats like carbon emissions. This involves examining every angle of these risks, while enforcing strategies which will lessen the threats brought about by extreme weather and physical hazards.

The world needs policies that work, and not only work but encourage businesses to invest in ways to withstand climate challenges, which means having a true understanding of what those challenges are.

Neutralising the threat
It is difficult to ignore the massive risk carried by climate change in today’s financial world. It is not just an environmental issue anymore; rather a threat to the stability of our entire financial system. Imagine if something happened to disturb large agricultural regions that cause food shortages and price spikes, and how this would impact a variety of industries affecting supply chains, consumer spending and thus the global economy.

Investing in resilient operations is critical for ensuring assets and investments are fit for purpose

According to the intergovernmental panel on climate change “the magnitude and rate of climate change and associated risks depend strongly on near-term mitigation and adaptation actions, and projected adverse impacts and related losses and damages escalate with every increment of global warming.” Supporting this observation, an alarming report, backed by 243 scientists from over 60 countries, warned that even with substantial reductions in greenhouse gas emissions, we are on course to witness a temporary 1.5°C increase in temperature within the next two decades. It is these figures that make you realise how easy it is for our world to continue on its current course without any adaptation or strong mitigation initiatives and eventually crumble. Climate-smart economies offer us a chance to avoid a bleak future by being prepared for any situation, while knowing how to deal with the consequences.

Reports from the 2023 Edelman Trust Barometer survey confirmed that 93 percent of respondents from 14 countries agree that “climate change poses a serious and imminent threat to the planet.” So, although it is obvious there is an awareness of the need for climate resilience, the current state of climate-resilient investments shows a contrasting picture. While a number of regions have seen considerable progress in renewable energy infrastructure and sustainable agriculture, there are still many challenges remaining for research, development and support. Financial incentives are weak, access to climate data and risk assessment tools is limited, there are uncertainties over regulations, and we lack benchmarks for evaluating and comparing climate resilience across different investment opportunities.

These concerns persist due to a combination of factors. Often, the reason for poor financial incentives is because governments and organisations prioritise other sectors or lack the necessary funding. A lot of the time climate data and risk assessment tools have limited access because of the little investment in research and development of data collection infrastructure. Regulations are unclear as a result of complex policies and the differing agendas of various stakeholders, while the lack of benchmarks is often because frameworks are either not widely acknowledged or there is difficulty in maintaining consistent resilience indicators. Neglected issues like these make it problematic for investors when assessing the potential risks and returns of climate-related projects, making for an even less likely investment.

However, among challenges lies opportunity. According to a report by the Boston Consulting Group (BCG) and Global Resilience Partnership (GRP) it was said that for every dollar a company invests in resilient operations and adaptation it can result in financial benefits ranging from twice to 15 times the initial investment. All things considered, taking climate resilience into account with investment decisions means investors would contribute to the sustainability of our environment where it is highly valued while also having a chance to improve their financial performance in the long run. World Finance spoke with the Chief Investment Officer of the Pollination Group, Diana Callebaut, about the current state of climate resilience and the role of finance in combating these atmospheric threats.

“Investing in resilient operations is critical for ensuring assets and investments are fit for purpose for the impact of climate change. There is no drawback for long-term investors and only benefits, ensuring assets are able to continue operations,” Callebaut explains.

In recent years, more corporates, financial institutions, and institutional investors are starting to look more closely at the physical and transitional risks associated with climate change. They are publishing climate transition plans with a goal of reaching net-zero emissions while factoring the transition risks into how they decide where to invest their money.

Callebaut continues; “The prevalence of dedicated climate resilience private funds is relatively limited; however there is a significant amount of investment on an asset look through basis in thematic and/or diversified private market funds. For example, owners of infrastructure assets such as airports and ports are aligned with ensuring the longevity of their assets adapting to the impact of climate change. Nice airport has parallel runways, partially built in the sea, making them vulnerable to rising sea levels and rough seas during storms. The operator proactively completed maintenance capital expenditure on existing embankments and sea dikes to strengthen and protect the airstrips on the maritime side of the airport.”

Suggested by Callebaut, there have been proactive measures taken by asset owners to adapt to the impact of climate change and protect their assets from risks such as rising sea levels and storms. However, even with this progress, there are still issues preventing us from investing more money in transitioning to low-carbon economies effectively. Co-ordinating global carbon pricing remains a challenge, and while initiatives like the Task Force on Climate-related Financial Disclosure (TCFD) is making headway in improving disclosure standards, these hurdles with data gaps, analytical tools and inconsistent metrics still exist.

Going forward, the financial system appears to need a thorough reset in order for it to incorporate climate risks and opportunities into central banking, regulation and market practices. Financial markets have the ability to help fuel the transition to a low-carbon, sustainable future by aligning market practices with climate goals.

Clean energy and climate technology are only receiving a tiny fraction of early-stage investments

In fact, we have already witnessed a number of initiatives which have been effective in incorporating climate risks into their strategy. These include creating green bonds, which finance eco-friendly projects, evaluating the resilience of financial institutions’ portfolios against climate-related risks through stress tests, and considering environmental, social, and governance (ESG) factors when making investment decisions.

A wise investment in resilience now is expected to pay dividends for later years by allowing investors to protect the environment and reap significant financial rewards, especially in light of the growing financial costs associated with climate change and natural disasters.

The climate financial outlook
In the words of the Pollination Group, “Climate investments seek to slow the pace of climate change whereas climate resilient investments focus on adaptation and mitigation of the impact of climate change.” It is for this reason that both are so important to take into account when it comes to protecting our planet and preventing any further irreversible damage.

The Global Landscape of Climate Finance Report from 2023 provided information on how proceeds from green bonds are used in a variety of industries, including waste management, buildings, infrastructure, forestry, and other land use. Following a 28 percent growth, reaching $173bn between 2021 and 2022, the question remains, where do these proceeds really end up? Looking at how funds are used to address severe environmental issues more closely, let’s consider how these resources have been distributed among these sectors and what areas warrant more attention.

Funding disparities in agriculture: Despite their potential to reduce emissions, agriculture still receives disproportionately low funding, comprising less than four percent of total mitigation finance.

Allocation of mitigation finance: In recent years, mitigation finance has made great progress, amounting to a total of $1.15trn between 2021 and 2022. According to the report, transportation projects seem to benefit the most from investments, receiving 29 percent, while energy projects account for 44 percent of the total.

Challenges with adaptation finance: Despite reaching a record high of $63bn, resources for adaptation are still far short of what is expected to be needed. The majority of the funding for adaptation initiatives comes from governmental sources, with minimal contributions from the private commercial sector.
Deficiency of AFOLU sector financing: The AFOLU sector, which is very vulnerable to the effects of climate change and has a desperate need for adaptation measures, has a financing deficit, with an aggregate total of just $7bn.

After examining how these funds are allocated, it becomes clear that there needs to be a more equal distribution of resources and a concerted effort to give priority to sectors with the biggest potential for impact, to appropriately address environmental concerns.

Private and public financing
According to Evergreen Climate Innovations, when it comes to receiving capital from private and public sources, there is a seemingly big gap in how it is distributed. Despite the organisation’s efforts to support impactful technologies and businesses, clean energy and climate technology are only receiving a tiny fraction of early-stage investments, a contrast to the $40bn invested in climate technologies through private funding back in 2021. It is hard to know for sure why this growth hasn’t continued a steady increase, but it might be that investor priorities have shifted, or the returns may not have been consistent enough and the easy option is favoured.

Although the amount of public investment allocated to climate change varies enormously depending on government priorities, policies and budgets respective of their region, many countries have been providing more funding to climate-related matters with some allocating large amounts of their budgets to initiatives such as renewable energy development, climate adaptation projects and research on climate change mitigation strategies. As of right now, the largest channels of international public finance supporting climate resilience and mitigation, particularly in developing countries, include the Green Climate Fund (GCF), the Global Environment Facility (GEF) and the World Bank-administered Clean Technology Fund (CTF).

While public investments for climate change are making a difference, advocates push for greater private investor involvement. Deloitte’s Centre for Financial Services FSI Predictions 2023 Report estimated a $2trn private funding shortfall for next-generation climate technologies to reach the target of capping global temperatures at 1.5°C above pre-industrial levels by 2030 (see Fig 1).

In a conversation with World Finance, Climate Safe Lending Network shared its views on what collaborative efforts are needed to effectively address climate challenges.

“During our Banking on Climate Justice initiative – which helped in part outline the rationale for why integrating a climate justice lens into climate transition planning is a non-negotiable component for any climate action given the systemic nature of the challenge – we noticed that cross-sector partnerships were the most effective mechanisms for addressing climate justice and therefore the climate crisis.

Building relationships between traditional and non-traditional financial institutions, as well as with the public sector, can help create new avenues for financial flows, and enable money to get where it is needed, when it is needed, for the true length of time it is needed – collaborating to overcome barriers such as loan term lengths, investment size, interest rates, etc.”

Climate finance hotspots
Geographically, developed economies continue to account for the majority of climate finance mobilisation, with the US, Canada, Western Europe, East Asia and the Pacific leading the way. China in particular has demonstrated exceptional efforts in mobilising domestic climate funding, outperforming the combined efforts of all other nations.

In terms of government involvement in market sector investment, initiatives are underway to collaborate with industries and communities to broaden viable possibilities. In fiscal year 2022, FEMA in the US pledged around $3bn for 748 resilience projects across states and territories, corresponding with international standards. Similarly, the UK government set aside £5.2bn for flood and coastal projects, as well as £750m for the Nature for Climate Fund, which intends to better resilience to climate change. Meanwhile, in Australia, the federal government is driving investment partnerships with large companies such as IAG and National Australia Bank.

While private finance accounts for nearly half of total climate finance, the volume and speed of private investment falls short of what is required. Developed economies have shown greater success in mobilising private finance compared to emerging markets and developing economies. Essentially, there is a real need to narrow the distance between existing funding and the growing demand for climate finance, particularly in developing and low-income economies, to address the challenges of climate changes successfully.

Climate resilience efforts for disclosure
As investors, stakeholders, businesses, and regulators recognise the financial implications climate change could cause, they are pushing harder for transparency in how institutions handle climate risks. Undoubtedly, climate change threatens to drain billions from global economies in the forthcoming decades, primarily through wreckage inflicted by extreme weather events. With that, it is becoming clear that the economic toll of physical climate risks will far outweigh adaptation risks irrespective of scenario or timeframe.

Together, we must make sure our communities are equipped to handle whatever nature throws our way, pressing us to look beyond the world’s carbon fixation. Despite its importance, focusing solely on carbon reduction may overshadow other aspects, such as investing in strong, safe infrastructures to cope with such extreme weather events.

Just as no two snowflakes are alike, climate change affects different regions and communities in completely different ways, which means there is no one solution.
Solutions need to be developed and customised to the needs of each community to adequately address the challenges they face. Building resilience starts at a local level, which means it requires a collective effort from all areas to develop and invest in robust infrastructures that protect lives and businesses.
“For us, one of the more tangible realities of where we believe greater attention and resources need to be directed are on local climate resilience efforts and the reality of how climate justice needs to be seen as a necessary integration into core strategic designs for societal and financial stability.

Practically, this means investments that support people currently most impacted by climate effects, prevent future societal and environmental damage, and shift towards locally centred, climate resilient economies,” shared the Climate Safe Lending Network, on the need to increase attention and resources for local efforts.

One of the biggest problems standing in the way of action on climate change is that uncertainty surrounds the issue. We are uncertain about data collection, the nature of the Earth’s climate system, predicting scenarios and decision-making when it comes to the socio-economic and political aspects. However, it is not just about the uncertainties themselves, as it is human nature to fight against uncertainty. The real challenge is about communicating these uncertainties and recognising the tools we have at our disposal or tools we may need to produce to limit the effects of climate change.

Proactive policies and incentivising strategies are essential in overcoming these uncertainties by providing us with a clear direction and motivation for collective action towards a more sustainable future. Governments can implement measures that encourage investment in resilient infrastructures and promote sustainable technologies. For instance, offering tax breaks or financial incentives for climate resilient projects can spur private sector involvement. Additionally, public-private partnerships can streamline financing and implementation processes for resilient infrastructure.

According to the Climate Safe Lending Network, policies are necessary because of the current inadequacies in the structures of financial institutions, which fail to incentivise climate-resilient measures. Through their network they have actively collaborated on a range of policy recommendations aimed at expediting climate resilience through initiatives like Banking on Climate Justice and an open letter to the Basel Committee on Banking Supervision. Most of these recommendations revolve around ensuring that policy is used not only to accommodate but also encourage new investments in climate resilience at a local level. The multi-stakeholder organisation emphasised the necessity of ensuring that all existing financial activities and investments do not exacerbate environmental deterioration and climate risk without transparency.

“Despite the reality of the need for policy, it is important to recognise this should never be used as an excuse for inaction within financial institutions, particularly given the undeniable realities of climate risks institutions face to their own financial stability and that of the clients they serve. Furthermore, given the political influence of many financial institutions, they have a responsibility to leverage their influence in supporting, rather than opposing laws and regulations that foster climate resilience,” commented the Climate Safe Lending Network.

The technology outlook and solutions
With technology taking the fast lane, there is a big demand for its role in managing climate change. While some technologies aim to cut emissions and prevent the climate crisis from worsening by using renewable energy sources like solar power, hydropower and wind energy, others are geared towards pre-emptively protecting against potential climate change impacts. These solutions include the development of early warning systems, sea walls and the cultivation of drought-resistant crops.

According to the IPCC’s Climate Change 2022 report, digital technologies hold promise in supporting the fight against climate change and meeting sustainable development goals. With this, the report explains how climate technologies like sensors, robotics and artificial intelligence have the potential to reduce the consequences of climate change by improving energy management, increasing energy efficiency, and promoting the use of clean energy sources, creating more economic opportunities.

When we look at technological developments within fields like water resource management, agriculture, and urban planning it is clear that solutions like rainwater harvesting, green infrastructure, sustainable transportation systems and efficient irrigation systems are instrumental to economic growth, social equity and environmental preservation.

Developed economies have shown greater success in mobilising private finance

There was fear that development for climate technology investments might come to an end when the world hit a storm with Russia’s invasion of Ukraine, the accompanying energy crisis in Europe, global economic turbulence, and market decline. Yet investments in climate technologies were growing in spite of the difficulties. Global investments in clean energy technologies are said to have hit a record level, with a substantial amount of funds going toward energy storage technologies, renewable energy projects, and the construction of sustainable infrastructure.

However, while technology appears to play a vital role in improving the impacts of climate change, that’s not to say it doesn’t bring its own challenges. For instance, the use of digital technologies and devices contributes to more e-waste, which can in turn lead to further environmental hazards; automation of certain tasks by technology causes job losses in traditional sectors, adding fuel to the fire for socioeconomic disparities. Another pressing concern is the widening of the digital divide, further marginalising communities with limited access to technologies. With this in mind, the use of technology to address current climate issues must be properly governed to prevent exacerbating them.

As the climate crisis is a multifaceted challenge, our response must be too when formulating a plan of action. The Paris Agreement, aimed at limiting global warming to well below two degrees, is proof that we are serious about confronting climate change. But now it is time we moved from rhetoric to action, as our actions today will determine the future we leave behind for generations to come.

From disparities in climate finance to the need for progressive technologies and resilient infrastructures, the solution lies solely in the collective efforts of individuals. If governments create policies and incentives for sustainable investments, businesses reduce their carbon footprint and invest in renewable technologies, investors choose green investments and communities engage in climate education and awareness, together these small actions will account for a substantial reward. One is a healthier planet and another, a greater long-term financial stability with less risk of major financial losses. Once financial endeavours are entirely aligned with climate objectives, we will witness a whole new dynamic between our economies and the environment.

Like how dropping a pebble in a pond creates a ripple effect, over the course of life, every variable and action influences the outcome, which makes it all the more important to be mindful of our choices and the impact they have on our planet. The sooner we realise everyone plays an equally important role in mitigating the effects of climate change, the sooner we can combine efforts to write our future as we envision it.

Ticking time bomb of debt

One way of measuring global policy-makers’ concerns about the unprecedented increase in debt around the world is the number of times the subject is raised at high-level conferences. And it comes up practically every week, most recently when Kristalina Georgieva, managing director of the International Monetary Fund, told the Atlantic Council in April about her fears that the current decade could be remembered as “the turbulent 20s.”

While prefacing her remarks with observations about some of the things to be thankful for, notably falling inflation, she got onto the urgencies; “The sobering reality is global economic activity is weak by historical standards. Prospects for growth have been slowing since the global financial crisis. Inflation is not fully defeated. Fiscal buffers have been depleted. And debt is up, posing a major challenge to public finances in many countries.”

Debt, the main subject of this article, is certainly up. The numbers ring alarm bells. In the so-called OECD area covering 38 member nations, gross borrowing jumped by exactly $2trn in 2023, from $12.1–$14.1trn. It will get worse; in 2024 the OECD predicts a further increase of $1.7trn. Although the US was the chief culprit, borrowing nearly two thirds of 2023’s $14.1trn, it clearly puts pressure on the global debt markets, whose capacity to issue debt is not infinite.

Overall, the markets are awash with debt. The total borrowings – technically ‘outstanding marketable debt’ – of the 38 governments is expected to hit $56trn in 2024. If that is a thought-provoking figure, consider that it will have increased by $16trn in just the last five years. Needless to say, that will be a record.

Perhaps more disturbing, the average debt-to-GDP ratio is also off the scale. In real pre-inflation terms it is up from a pre-Covid 73 percent to about 83 percent in 2023. And it’s certain to rise higher by the time 2024 is out. In the meantime, the cost of new borrowing is rising, with interest rates approaching three percent of GDP.

More trillions
Emerging markets are taking a beating. In the so-called EMDEs (emerging market and developing economy) nations, in 2023 alone nearly an extra $1trn of sovereign bonds were issued, now up to $3.9trn. Although it can hardly be called an EMDE, China has a voracious and rapidly growing appetite for this kind of debt. In 2021 its share of emerging nations’ bonds was 15 percent; now it is 37 percent. That is a number that is sowing alarm among many issuers inside and out of China.

Unsurprisingly, as EMDEs borrow more against less – because their economies are not growing fast enough – the credit ratings are deteriorating with a commensurate increase in the cost of debt. In the category of low-income and lower-middle-income countries, which counts some 130 nations with average per capita GDP of $12,300, there were no less than 24 downgrades against six upgrades, reports the OECD.

The unhappy result is that outstanding sovereign debt has been pushed to unprecedented levels. Although these ratios look better when inflation and longer repayment times are taken into account, the debt still has to be repaid. For many nations it is a ticking time bomb.

It is not just the volume of debt that matters but also its composition. As the OECD explains in its annual review of global debt, the US, the world’s biggest economy, faces the prospect of renewing no less than a third of government debt during 2024. That is a small matter of $11.3trn. No doubt the US Treasury will handle the task but, as the Peter G. Peterson Foundation, an economic ginger group, points out, that is equivalent to nearly $103,000 for every single American.

America’s debt burden has been growing for years; “a mis-match between spending and revenues,” summarises the foundation, citing the cost of an ageing population, underfunded services and other long-term contributory reasons. At least the US can carry its debt. “In emerging markets decisions on debt composition become even more intricate,” notes the OECD. This is because they have to navigate growing volatility, or what the Paris-based body describes as “exposure to fluctuations in global risk sentiment in an increasingly shock-prone world.”

Another policy-maker to voice her concerns – frequently, in fact – is Indian-American economist Gita Gopinath, the IMF’s deputy managing director. In late 2023 at a conference in Washington entitled ‘Fiscal Policy in an Era of High Debt’, Gopinath cited alarming figures about the long-run – and accelerating – growth in public debt levels. “Since the mid-1970s, global public debt has tripled to reach 92 percent of GDP by the end of 2022. So, debt levels had been rising for some time.”

Albeit in sober economic terms Gopinath painted a bleak picture, especially for economically weaker nations; “Rising deficits and debts in countries such as the US have serious ramifications for emerging and developing economies, who are hit by rising rates and weaker currencies. And many economies, particularly low-income countries, are already in debt distress.”

“The combination of record-high global debt levels, higher for longer interest rates, and weak growth prospects poses a triple challenge for policymakers. In a shock-prone world, very few countries will have the fiscal space to support their economies,” Gopinath continued.

Fracturing fiscal rules
So there is a mounting problem. One of the many complexities of reducing global debt is that the old, more comfortable rules have been broken for several reasons. One is the 2008 global financial crisis (GFC) that overnight brought unprecedented levels of quantitative easing – central banks printing money and lending it at rock-bottom rates to the financial sector to prop them up.

Former FTX chief Sam Bankman-Fried

Another is that while most nations have their own fiscal rules, they find it increasingly hard to stick to them and resort to issuing more debt to keep the economy moving. “Deviations from the rules are frequent,” regrets the OECD. “Few have contained debt since the GFC.”

The OECD’s solution is more discipline buttressed by a kind of fiscal police. “We need rules that respond to shocks but with clear mechanisms to correct for non-compliance and that are anchored on spending targets,” it suggests. “Independent fiscal councils can also enhance checks and balances.”

Meanwhile others see the need for a new kind of economics. “Dependence on credit to boost demand imperils the world economy, so we must correct the underlying imbalances,” warns Atif Mian, professor of economics, public policy and finance at Princeton University. In an article in the prestigious Finance & Development magazine, he goes on to call for a “long-term balance between what people earn and what they spend.” Until then though, we have what he calls “a massive debt supercycle that threatens the global economy. Breaking that cycle is one of the most pressing challenges of the 21st century.”

Before that can happen though, habits have to change. Led by largely thriving economies such as the US, government (or sovereign) borrowing has become almost obligatory. And when governments such as Britain sought to reduce its debt in the wake of the GFC, it was widely lambasted for ‘austerity economics’ by citizens who expected continuing largesse from a nation that could ill afford it. France repeatedly runs into the same problems – in fact riotous protests – when the Macron government attempts to follow other nations and slowly increase the age for pension payments, which are steadily undermining the entire economy.

Debt build-up
Debt sprees have been on the rise for well over half a century, starting around the time that the miseries of the great depression began to fade. For example, in the US total debt stood at about 140 percent of GDP between 1960 and 1980, but has since more than doubled to 300 percent of GDP (see Fig 1). And the world has learned from the American example.

As Professor Mian explains; “Not even the great recession of 2008 [the result of the GFC], which in many ways was a result of the excesses of borrowing, could put a dent in debt’s relentless upward march. It would be a mistake to think that 2008 reflected merely some unfortunate policy misstep. The build-up in debt that led to the 2008 crisis stemmed from deep structural imbalances in the economy. Those imbalances persist, as do the dangers associated with them.”

IMF Managing Director Kristalina Georgieva

But where does all this debt and dangerous imbalance come from? Most researchers agree that, paradoxically, it derives from a glut of savings by rich people and rich countries. There is no doubt that the rich are getting richer, as in fact they generally have in historical terms. The top one percent of individuals have been accumulating more and more wealth for more than 40 years, many of them by capitalising on the digital boom. And so have certain countries got richer, notably China, whose rising prosperity ends up in domestic banks and other savings institutions much more than in wealthy western countries. Between them, they claim a disproportionately greater share of global income, which in turn creates financial surpluses that fuel the ‘global debt supercycle.’

Unfortunately, much of this avalanche of debt is ending up in the wrong place because the financial sector – the man in the middle – has been missing its targets. Professor Mian continues; “A well-functioning financial sector would channel the financial surpluses toward productive investments, such as building and maintaining infrastructure and developing technology. Any debt resulting from such productive lending would naturally be sustainable, because returns from investment would pay it off.”

Mian adds; “Unfortunately, a key feature of the debt supercycle is its failure to finance productive investment. For example, even though total debt as a share of GDP has more than doubled, real investment as a share of GDP has remained stagnant, or even fallen over the past four decades.” The alarming conclusion is that around half of the trillions of new debt issued during the past two years is being wasted. Instead of financing investment, which would help create wealth, it has gone to the debt unproductive consumption by households and governments.

Naturally, collapsing interest rates only feed this cycle. Those with long memories will know that in the early 1980s, the US 10-year real interest rate hovered around seven percent. More recently, it’s plummeted as low as below zero. As these rates flow into consumer finance, it prompts ordinary people to spend rather than save.

Crisis management
Behind the scenes, almost oblivious to the general public, there have been debt-related crises.

As the custodians of financial stability, central banks have had to manage upheavals in the rapidly growing non-bank financial sector that could easily have spread more widely with dire consequences. Only adroit and largely anonymous crisis management avoided the worst.

“These [non-bank] institutions have grown in significance across a range of markets, including those that households, businesses and governments use to borrow, save or access financial services,” explains the Bank of England’s Nick Butt, head of the future balance sheet unit, in a recent speech. Pretty much from a standing start, in 20 years Britain’s non-banks have snapped up roughly half of all UK’s financial assets including corporate lending. Other European countries have seen the same developments in what amounts to yet another threat to financial stability.

Why? Because non-banks in Britain, but also elsewhere, are big holders of gilts (sovereign bonds) and routinely resort to the gilt repo market. Although its workings are little known outside financial circles, this is where the Bank of England buys and sells gilt-edged securities. Established in 1996, it is a huge market where billions are transacted every day for the purposes of keeping the banking system liquid. Echoing what other central banks are saying, Butt notes; “The implications of the rise of the non-banks are far from theoretical and have given rise to new vulnerabilities and sources of liquidity risk that have all too real a potential to cause financial instability and impact the broader economy.”

Some might say more actual than potential. In March 2020 the state of the UK government’s bond markets deteriorated rapidly in a general rush for short-dated, cash-like instruments in the middle of the Covid lockdowns. There was a dash for cash right through the financial sector as banks of all types sought to meet their own liquidity obligations. The big dealer banks pumped in around £50bn through the gilt market to help out the central bank but, in a demonstration of the nervousness lurking beneath a highly indebted market, it was barely enough.

A key feature of the debt supercycle is its failure to finance productive investment

The money markets held their breath but got through it. Another crisis in Britain two years later in the immediate aftermath of short-lived prime minister Liz Truss’ shock ‘go-for-growth’ economic policy hit the long-dated gilt market in particular, once again exposing what Butt called “vulnerabilities in liability-driven investment funds” that posed a threat to the country’s financial stability.

It is all about liquidity, especially when the non-banks get the dreaded margin call as their own creditors hear the alarm bells. Right now, central banks and global regulators are working hard on plugging these holes before they get too big. As recently as 20 years ago, life was easier for the likes of the Bank of England, the US Federal Reserve and other major institutions when they had only to worry about the big retail and investment banks. And when global debt levels were not so high.

Better big banks
On the bright side, most of the world’s big, systemic banks are safer than they were before the GFC. Following the lending excesses exposed by that crisis, they hold more capital – the funds that stand first in line to bear losses – and are in a better position to protect depositors. Most countries have enforced these regulations developed by the Bank for International Settlements, albeit with local variations, and global regulators are breathing much more easily about the giants of the financial sector.

Reforms are continuing, currently through what is known as Basel 3.1. As Bank of England governor Andrew Bailey explains, “the key thing here is that across jurisdictions it is implemented faithfully, neither more nor less.” This doesn’t necessarily mean in a highly illiquid world that the threat of bank failures has been extinguished. In early 2023 alone the US, supposedly the bastion of regulation, saw three failures – Silicon Valley Bank, Signature Bank and First Republic – while Switzerland’s once-mighty Credit Suisse had to be rescued before it collapsed. Following a mire of shoddy regulation and inept management, the Swiss government arranged for rival UBS to buy the failed institution for $3.25bn, a transaction completed in June 2023.

It’s not just the volume of debt that matters but also its composition

There are concerns that social media will contribute to the risk of bank failures through a much-feared run. “The sudden withdrawal of bank deposits – accelerated by digital technology – contributed to the failures of these banks,” notes a thought-provoking study by leading European bankers, citing the speed at which news travels, even if it is wrong. This was not the case even during the disastrous bank runs leading up to the GFC when, the study argues, “social media and mobile banking apps were unheard of or barely existed.”

As they conclude; “As events in 2023 illustrate, the risk of sudden bank runs may generally be affected by advancing digital frontiers in banking.” In short, something else for regulators to worry about.

Crypto craziness
They were certainly worried by the lemming-like race for alternative currencies that was symbolised by the collapse in November 2022 of Sam Bankman-Fried’s cryptocurrency exchange FTX and its affiliated hedge fund, Alameda Research. The exchange folded in days after clients learned that Alameda’s losing bets were being covered by the customers of FTX, unbeknownst to themselves.

In a salutary lesson for proponents of ‘metaverse’ currencies, Bankman-Fried has been sentenced to 25 years in prison and ordered to repay over $11bn. Long before FTX went under, central bankers had been warning against plunging into this wild and unregulated market. However the subsequent flight from crypto currencies does not spell their end. Central bankers see a lot of sense in alternative forms of payment and many are developing them. But they will be run under strict controls and regulations.

So what now?
The tight-rope act requires that global debt be steadily reduced and that it is invested much more wisely – that is, in the corners of the economy that will create the right kind of growth. Most economists continue to favour GDP, albeit a more enlightened and nuanced version that focuses on what is good for people and the planet. Good growth, in short. Some, however, argue that growth – and especially the debt-funded version – has passed its time. The ‘de-growth lobby,’ whose figurehead is Greta Thunberg, argues that modern capitalism has got it wrong by focusing on GDP and that living standards are already good enough.

Few outside academic circles buy that argument because ‘good growth’ improves lives. However, as the IMF’s latest World Happiness Report, the 10th iteration of this enlightening study, shows, economic growth isn’t everything. In fact, some of the poorer nations are the happiest.

“When we juxtapose GDP per capita with happiness scores from the report, it becomes clear that while GDP per capita is a significant predictor of happiness, it is not the only factor. As the report outlines, other variables, such as social support, life expectancy, freedom, generosity, and the absence of corruption, also help explain varying levels of happiness between countries,” said the IMF report.

In short, behaviour as well as GDP. This is why Costa Rica, famous for its economic concept of la pura vida, which seeks to take everybody’s wellbeing into account, ranks a high 6.61 on the Happiness Index with a GDP per capita of just $20,000 while extremely prosperous Singapore ranks just below. Strikingly, poor nations like Kosovo (6.37 at $11,690), Nicaragua (6.26 at $5,842) and Guatemala (6.15 at $8,262) rank just below Singapore. However it is unlikely that lowest-ranked Afghanistan (1.86) and Lebanon (2.39) would line up behind the de-growth champions.

IMF First Deputy Managing Director Gita Gopinath

The IMF’s Gopinath, a strategic thinker, sounds a warning to high-borrowing, spendthrift nations. “In today’s environment – where it is politically difficult to cut spending or raise taxes – debt-financed spending may still seem tempting. But that would be a grave mistake, setting debt on an unsustainable trajectory as borrowing costs rise sharply. Governments need to rethink what they can and cannot do. They cannot be the insurer of first resort for all shocks. Revenues also need to keep up with spending,” Gopinath said.

Overall it appears to come down to living within your means.