Tag: News

 The Continuing March Upwards of Private Credit

Private credit can trace its roots back to the 1980’s where companies with strong credit/borrowing records were being loaned funds directly from insurance companies. However, post the 2007 – 2009 Global Financial Crisis, private credit really came into its own as an alternative to bank lending, especially as financial regulators were cracking down on those deposit taking institutions who were involved in risky lending. In today’s market, private credit has become a major contender in the loans market, and a serious rival to banks and similar lending institutions.

As of June 2023, data released shows that global closed-end private debt funds* have assets under management of circa USD1.7 Trillion, whereas as of close of business December 2015 global assets under management were circa USD500 Billion. Indeed, expert money managers suggest that by 2028, due to possible massive shifts in the financial markets, borrowers would flock to the front door of private credit funds, boosting the value of the global private debt market to USD3.5 Trillion. 

Closed-End Fund – This fund is a type of mutual fund, and in order to raise capital or investment, the fund issues a fixed number of shares through a one-time initial public offering (IPO). The shares can be bought and sold on a stock exchange if the fund is quoted, but no new money can be received into the fund once the IPO closes. Access to closed-end funds is only available during a New Fund Offer (NFO).

Open-End Fund – As opposed to a closed-end fund, the open-end fund such as mutual funds and exchange-traded funds (ETF’s) accept new capital on a constant basis and also issue new shares. 

Mutual Fund – This is an investment opportunity where monies/investments are received from a wide range of individuals and pooled together in order to purchase a wide range of stocks, bonds and other securities. Funds are managed by professional money managers and are structured to match the prospectus where the investment objectives are stated.

Private credit is responsible for providing a vast amount of financial resources into a number of differing investment strategies, some of which are outlined below.

1.     Mezzanine Finance – Mezzanine loans or capital can be structured either as subordinated debt or as equity which is usually in the form of preferred stock. Mezzanine financing is recognised as a capital resource which can often be seen as subordinated debt and sits between higher risk equity and less risky senior debt. To facilitate the explanation of mezzanine debt, below are the definitions of senior debt and subordinated debt.

·      Senior Debt – often issued in the form of senior notes and also known as a senior loan, is a debt that will be paid first by the borrowing company. In other words, it takes priority over other unsecured debt and in the event the borrowing company goes into liquidation, owners of senior debt will be the first to be repaid.

·      Subordinated Debt – or as the name implies junior debt, is usually the last type of debt to be repaid. It has a lower status to senior debt and hence the name subordinated debt. Typically, subordinated debt or loans will carry a lower credit rating and will therefore offer a higher return than senior debt.

2.     Venture Debt – Venture debt, sometimes referred to as venture lending, is a certain type of debt lending to venture-backed companies. A venture-backed company that receives venture debt is defined as companies who are at the start-up stage of their existence and rely on venture capital to expand their business. Typically the company has yet to make a profit, and loan size is usually based on the company’s recurring revenue

3.     Distressed Debt – Private credit funds are known a). for buying up corporate debt that is currently trading well under its original value and b). where companies are in difficulties to provide new financing, with a view to make a profit when the company either liquidates or restructures. 

4.     Direct Lending – This type of lending by private credit funds, (aka unitranche loans), are typically a senior term loan (first lien and the least) but can also involve credit lines and second lien loans which are subordinated to the first lien. 

5.     Special Situations –  As the subject suggests, loans in this case are applicable when a special situation or event occurs, and the company’s profitability or growth (a company’s metrics) are not taken into account when lending decisions are made.

A number of experts have asked the question: will private credit stand a sustained protracted recession? Private credit fund managers have answered that in many cases their loans are safer as they are locked in for longer than your standard lending institutions. However, the uncertainty that surrounds the terms in the private credit market means that in a recession no one really knows how far valuations would fall, and as a result would investors in funds that are struggling be able to sell out their positions. 

Regulators in the United States, the United Kingdom and the European Union are looking at expanding regulation in the private credit market. Indeed, regulators in the EU are putting strictures in place which ensure that private credit funds will diversify risk, and will cap leverage, whereby funds use borrowed funds to enhance profits. However, it appears that regulation will remain somewhat opaque as there seems to be a lack of appetite to bring regulation in line with banks and other lending institutions. This of course may reflect the attitudes of many governments, who seem happy to encourage private credit investment that they deem too risky for banks.

Interest Rate Overview: Eurozone, United States, United Kingdom February 2024

As predicted by many commentators, the governing council of the ECB (European Central Bank), the Federal Open Market Committee (FOMC) of the United States Federal Reserve and the Monetary Policy Committee (MPC) of the Bank of England, all kept interest rates on hold. All three central banks cited the continuing fight against inflation as the reason for keeping interest rates on hold, but as many experts are predicting, interest rates will fall in 2024 in all three jurisdictions.

The Eurozone

On Thursday 25th January the Governing Council of the ECB announced for the third time in a row that interest rates were being held at a record high of 4%, reaffirming their fight against inflation. Many traders and analysts in the financial markets are betting on a rate reduction at the next Governing Council meeting on April 11th, 2024. 

However, Governor Christine Lagarde announced it was “premature to discuss rates”, though some unnamed members of the council have added that if upcoming data shows that inflation is beaten, then the April meeting could be dovish for a fall in interest rates at the June meeting. Despite these utterances, many in the financial markets believe the ECB have got it wrong and will be forced to cut interest rates in April.

The United States

On Wednesday January 31st, 2024, the Federal Reserve kept policy rates at a 22 year high of 5.25% – 5.50%, where the Chairman of the Federal Reserve Jerome Powell gave a massive endorsement on the economy’s strengths. He further advised that with the on-going expectation of falling inflation, coupled with economic growth, that rates had now peaked and would fall in the coming months. However, despite this pledge, Chairman Powell went on to say that he did not expect a rate cut at their next policy meeting in March, as they wish to see on-going positive data on the reduction of inflation to their figure of 2%. 

Interestingly, the Federal Reserve is hoping to accomplish beating inflation through tighter credit without putting the economy into recession, which historians suggest they only accomplished once in the last 100 years. But with inflation falling more quickly than expected, (2.6% as at close of business 2023), the Chairman is coming under political pressure to reduce rates in March. 

A massively divided country is going to the polls in November to elect a new president, and Chairman Powel received written requests to reduce interest rates from Senator Elizabeth Warren (Dem, former presidential candidate), and Senate Banking Committee Chair Sherrod Brown (Dem). Some market experts are suggesting that there is a circa 63% chance that the Federal reserve will cut interest rates in March, but with seven weeks of economic data to come the markets will have much to mull over.

United Kingdom

On February 1st, 2024, the Bank of England’s MPC announced that it was holding interest rates steady at 5.25%, admitting that a rate cut had been part of their discussions. In the end there was a split decision in the MPC with six members in favour of holding, two members voting to increase rates and one member voting for a drop in interest rates. Interestingly, this is the first time since the Covid-19 pandemic that a rate-setter has voted for a cut in interest rates, and the first time since the global financial crisis of 2008, that there has been a three-way split in the MPC.

Following the announcement, The governor of the Bank of England Andrew Bailey announced that “the level of bank rate remains appropriate, and we are not yet at a point where we can lower rates”. He also pointed out that there is an upside risk to inflation due to continuing trade disruptions, and ambiguously advised how long policy remains restrictive depends on incoming data. However, experts suggest that the Bank of England is now warming to rate cuts in 2024, with officials believing that consumer price inflation will be at 2% in the second quarter, mainly due to falling energy prices., a year earlier than forecasted last November.

Market analysts mainly agree that whatever the statement that comes out of the above central banks, interest rates are set to fall in 2024. It would appear that the Bank of England is set to lag behind the ECB and the Federal Reserve when it comes to cutting interest rates. However, better than expected January US employment figures may delay a US interest rate cut beyond March, and as to whether or not they all fall at the same time, only time will tell.

The Growth of the Private Credit Market and the Potential Pitfalls

What is private credit and why has the  growth of this particular market been so spectacular? Looking back at the lending market as a whole, first there were the banks, then debt specialists and private equity entered the lending market, quickly followed by hedge funds and wealth managers. The private credit market really began to make its mark after the 2007 – 2009 Global Financial Crisis, when banks tightened their belts and pulled back from lending. Today, not only on Wall Street in the United States, but in all major financial centres, the buzz word on everyone’s lips from venture capitalists to sovereign wealth funds is private credit.

An explanation as to what private credit represents is where SMEs (small and medium-sized enterprises) who are non-investment grade and typically represent the recipients of loans from non-bank lenders. This market can serve as a diversifier as debt is less correlated to equity markets, and due to periodic income from repayments the J-curve is smaller*.

*J-curve – is a trendline that shows an initial loss followed by a dramatic gain, hence the j-curve.

In a nutshell private credit targets non-investment grade SMEs, and unlike private equity there is no direct management involvement. Any added value will come mostly from restructuring. The type of investments are usually direct loans which relate to senior instruments in the capital structure, often accompanied with bespoke terms and floating-rate coupons**.However, it must be pointed out that as the market has expanded so have the catchment levels, with the market catering to a more diverse base. 

**Floating-Rate Coupons – A floating rate note, commonly referred to as a FRN, is a debt instrument with a variable interest rate or coupon which is tied to a benchmark rate such as Libor (London Interbank Offered Rate) which of course has now been replaced in the US Dollar market by SOFR, (The Secured Overnight Financing Rate) and in the GBP market by Sonia, (Sterling Overnight Index Average). Many FRN’s have coupons that pay quarterly, and investors can benefit from increasing interest rates as the note adjusts periodically to current market rates.

The private credit boom has recently been driven by central banks monetary tightening policies which began in 2022 with unprecedented rate hikes over the next year to late 2023. The Federal Reserve raised interest rates ten times over in this period from a low of 0.25% to a high of 5.25%. Similarly in the United Kingdom, the Bank of England increased its key benchmark rate eleven times from a low of 0.25% to a high of 5.25%, and in Europe the ECB (European Central Bank) raised its rates seven times from a low of 0% to a high of 3.75%.

This has inevitably forced borrowers to look elsewhere to look for alternative lending sources, and the private credit market has benefited considerabley. Indeed, earlier this year in the United States, a number of mid-cap banks ran into liquidity problems, and this together with higher interest rates prompted some the more traditional lenders to exit certain business lines or unload assets. Hence, the retreat of bank lending, higher interest rates and bigger fees have brought a large number of new players to the private credit market, which has turned from what was essentially a niche market to a must-have market. 

Today the private credit market has expanded its philosophy to what has been described as a catch-all concept. Indeed, the market now incorporates traditional direct lending to the SMEs to finance buyouts, real estate and infrastructure debt. Experts advise that this will help fund managers to profit from strategies which can shield them from the volatility of mark-to market* losses in public markets. The expansion can be seen by the number of new players entering the market, such as large asset managers who are bolting on private market funds to their existing businesses or in the private equity world  increasingly using private market companies for their acquisitions. Indeed, the risk strategies employed by the new entrant private credit funds differ massively from one company to another. For example, some companies are offering high-risk mezzanine finance* to companies that are struggling, whilst mid-sized companies with fairly small or low leverage are being offered senior secured debt and private equity are being provided with funding for buy-out transactions. 

*Mark-to-Market – is an accounting practice whereby the value of an asset is adjusted to reflect its true value in changing market conditions. Furthermore, it is also where assets and liabilities are recorded at their current market value, and if a company had to pay off all their debts and liquidate their assets, mark-to-market accounting would provide an accurate value of what the company is worth at that time. 

**Mezzanine Finance – Mezzanine loans or capital can be structured either as subordinated debt or as equity, which is usually in the form of preferred stock. Mezzanine financing is recognised as a capital resource which can often be seen as subordinated debt and sits between higher risk equity and less risky senior debt. To facilitate the explanation of mezzanine debt, below are the definitions of senior debt and subordinated debt:

·      Senior Debt – often issued in the form of senior notes and also known as a senior loan, is a debt that will be paid first by the borrowing company. In other words, it takes priority over other unsecured debt and in the event the borrowing company goes into liquidation, owners of senior debt will be the first to be repaid.

·      Subordinated Debt – or as the name implies junior debt, is usually the last type of debt to be repaid. It has a lower status to senior debt and hence the name subordinated debt. Typically, subordinated debt or loans will carry a lower credit rating and will therefore offer a higher return than senior debt.

Mezzanine financing is a type of junior debt or capital and is viewed as the last stop on the debt borrowing chain or capital structure, before equity is sold in order to raise capital. Mezzanine financing allows companies to access capital beyond that of what can be accessed through senior debt. It is typically longer-term debt (7 – 8) years, and is interest only during the loan period, with amortisation at maturity. Many borrowers view mezzanine finance as “solution based” capital as opposed to permanent capital, serving a specific purpose(s), which can be replaced with lower interest-bearing capital such as senior debt at a later date.

The private credit market has increased by circa 300% in size over the last nine years, with experts valuing the market in the region of USD1.5 Trillion. Indeed, one of the largest alternative credit managers has advised that the industry could grow to the stage where it has replaced USD 40 Trillion of the debt markets. The private credit market began its life by catering to the private equity companies, and like the private equity companies they raise funds from investors. This however is where the similarity ends, as private credit lends debt to their clients whereas private equity as the name suggest invests equity in their clients.

Experts within the private credit market are referring to this boom as “debanking”, which according to one senior player is still in its infancy, while others refer to the current state of the private credit market as “The Golden Moment”. Both analysts and experts suggest that new banking regulations in the United States under proposed Federal Reserve rules will act as a catalyst for the private credit market, as the capital required to support the US wholesale banking industry could increase by as much as 35%. 

However, there are some dissenters from the regulatory arena in the United States who say that the private credit market could prove a risk to the US banking system as, unlike the banking industry, it is subject to indirect and somewhat minimal oversight. Indeed, the Federal Reserve has been requested by lawmakers as to what they, the FDIC (Federal Deposit Insurance Corp), and the Office of Comptroller of Currency were doing to address this issue. However, in a counter statement the American Investment Council trade group advised that private credit services were noy systemically risky and were quoted as saying, “ In this economy, private credit is helping small businesses to get capital to grow and succeed”.

Naysayers and detractors who say the market has grown to a point where there will be failures should not be ignored. Whatever the market, history has shown that there is always a crisis waiting around the corner. The Global Financial Crisis stands out as a case in point as does the mid-cap banking wobble in the United States earlier this year which spread to Europe and led to the downfall of the eminent Swiss bank, Credit Suisse AG. 

New entrants to the market are committing funds in the region of USD500 Million to USD1.5 Billion, despite the fact that some analysts are predicting that the market itself is coming under strain from rate hikes inflicted on economies through central bank quantitative tightening policies. Experts advise that most of the private credit investments that are outstanding as of today would have been contractually agreed eighteen months ago and would have been made against a completely different economic backdrop. 

Most private credit loans are arranged (as stated previously) on a floating rate basis, and the interest hikes over the last year could potentially have a significant effect on the performance of those companies and the funds invested therein. One expert suggests or rather confirms that the whole structure is now coming under strain. Many balance sheets of debtor companies have five to seven turns of leverage and if they had to be refinanced today then every dollar earned would go on interest payments. 

Many players in the private credit market have only experienced bullish tendencies; they have never experienced a bear market or a downturn. Recently released data shows that to date in 2023 the volume of defaults in the direct-lending market in the United States alone reached circa USD1.7 Billion. Indeed, some of the savvier participants are already hiring those with expertise in workout and restructuring including expertise in managing investments in a downturn. Market sentiment and data suggest interest rates are set to fall in 2024 – they can’t come soon enough for many in the private credit market.

China Snowball Derivatives and their Potential Losses

USD13 Billion worth of China Snowball Derivatives are approaching loss levels as the ongoing route of China’s stock market is pressurising these structured products, threatening to raise market volatility. Indeed, over the years snowballs have attracted China’s wealthy and institutional investors, but a rapid decline in the Chinese stock market is now exposing risks to these derivatives hitting loss-triggering levels. But what exactly are “Snowball” derivatives?

A Snowball product is a structured hybrid derivative which pays a bond-like coupon and consists of additional options on basic financial assets, which include underlying assets such as stocks or stock indexes. The word snowball derives from the fact that coupons can be rolled over and coupon pay-outs rely on the underlying asset trading within a certain range. 

Currently, experts are advising that circa USD4.2 Billion (Yuan30 Billion) of snowballs that are tied to the CSI 1000 Index* are approaching levels that trigger losses at maturity, whilst another circa USD8.4 Billion (Yuan 60 Billion) are between 5 and 10% away from their knock-in** thresholds. This week on Wednesday 15th January, the CSI 1000 index closed at its lowest level since April 2022. 

*The CSI 1000 Stock Index – This index is composed of 1,000 small and liquid stocks of all A-shares, excluding the CSI 800 constituents (follows the 800 largest stocks by free-float market cap and represents large and mid-cap A-share stocks). It reflects the stock price performance of a group of small-cap companies in the Chinese A-share market. 

**Knock Ins – There are two types of knock-in options: down-and-in and up-and-in. The former (currently China’s problem) is triggered if the underlying asset price falls below a certain level and the latter is triggered if the underlying asset price rises to a certain level. 

During the Covid-19 Pandemic, snowballs gained in popularity among the wealthy Chinese and asset managers, with brokers typically offering such grand returns or coupon rates of between 12 and 20%. 

Between February and April 2023, many of the outstanding snowball derivatives were issued, and since then the CSI 1000 has fallen by circa 22%, and for those who bought a one year contract with an 80% knock in last February, if there is no rebound in the market, next month they may be holding some serious losses. 

Despite government efforts to kick-start the stock markets by halving stamp duty on stock trades (August 2023), or their own exchanges launching new blue chip benchmarks where sectors such as chip manufacturing or renewables are granted greater weightings, sadly for snowball holders such small measures have failed to work with many investors now looking elsewhere. Unless the government engages in the type of quantitative easing as seen in the past in Europe, the United Kingdom and the United States, there is little else the government can do to stop the pessimism that is sweeping through the stock markets, signalling losses for many snowball holders.

What is the forecast for China in 2024?

China, the world’s second largest economy, kicks off 2024 with a much weaker economy, raising doubts about the underlying foundations on which its decades of amazing growth is built. Once China’s draconian Covid-19 pandemic laws were revoked, their leaders expected it would be business as usual for their economy. However, instead of consumers returning to malls, increases in land auctions and home sales, and factories tooling up for increases in demand, foreign firms have pulled money out, factories are facing waning demand, consumers are saving not spending, two of the largest properties companies along others have defaulted on their loans and local government finances are in a complete mess.

Reforms have always been particularly difficult in China, but the leaders are now presented with some tough choices if things are to improve in 2024. However, it has been an inauspicious start as Hong Kong’s flagship, the Hang Seng Index, started 1.5% down on 2nd January 2024. Mainland China’s CSI 300, which measures the top 300 stocks listed in Shenzhen and Shanghai, also dropped 1.3% and in excess of 43% since its peak in 2021. Both indexes were two of the worst performers in 2023 with a slowdown in production activity, lukewarm consumption, a prolonged property slump and concerns over Beijing’s crackdown on the tech sector.

However it is not all doom and gloom for the Chinese stock markets. Experts say that the trends in the Hang Seng Index are closely related to the number of IPO’s (Initial Public Offerings), and the same experts are predicting that HK$100 Billion (Circa £10 Billion and $7.8 Billion) will be raised in Hong Kong in 2024, just over double of that raised in 2023. A number of analysts have gone on to say that today the risk premium of Chinese stocks has reached a level that, in the past, has led to returns nothing short of spectacular. Indeed, the yield gap between stocks and bonds has now reached circa 5.5% and has rarely been this big, in fact the dividend yield of the stock benchmark has risen above the dividend yield of the long term bond benchmark for the first time since 2005. Adding to this optimism for Chinese stocks in 2024, a well-known emerging markets equity fund in the United States boosted its equity holdings of China and Hong Kong stocks in one of their funds to 33% of its portfolio. This confirmed that, in their view, the relentless selling is just about over and 2024 will be a good year. 

On economic growth, top Chinese officials have pledged to put this at the forefront of their economic plans. However, the hole in this plan is the lack of measures to boost consumer spending, which may end up making it hard to deliver on this statement. The tone for economic development for the following year is usually set at the CEWC (Central Economic Work Conference) which finished on the 9th of December 2023. This closely watched conference announced that policy would focus on “the central task of economic development and the primary task of high quality development”. Analysts have suggested that this conference was more pro-growth than in previous conferences, however they went on to say that potential growth levels of circa 5% would be hard to achieve without stimulus measures directly targeting consumer spending. Indeed, there was a complete silence on increasing household income and consumption support policies, and many analysts agree that weak consumption is a major drag on the economy.

On the deflation front, China has been fighting this for most of 2023 due to weak spending and the property slump, and finally policymakers have indicated that they will address this problem, which up to now, has been studiously ignored. Deflation is not good for the economy as falling prices are a major concern, and companies and consumers may put off investments and purchases anticipating a further fall in prices, which in turn can further slow the economy. Acknowledging this problem a quote from the 2023 CEWC said “Total social financing and money supply should be in line with economic growth and the price target”, which basically refers to the amount of financing needed for the real economy. Analysts noted that this was the first time the Price Target had been alluded to, indicating a more accommodating monetary policy. This suggests there will be interest rate cuts in 2024 acting as a stimulus to the economy. It should be noted that the CPI (Consumer Price Index) fell 0.5% in November 2023, the biggest since the Covid-19 Pandemic, marking an acceleration in the rate of deflation. 

The property market has been a major headache for Chinese policy makers and the economy, with experts advising that property market stabilisation should be very near the top of economic priorities. This is because there are signs that the crisis within the property market is spilling over into the broader economy, including consumer confidence and financial markets. The CEWC confirmed that Chinese policymakers will meet this problem head-on by announcing the importance of resolving risks in “real estate, local government debt, and small and medium sized financial institutions”. They went on to say that the government, with regard to three major areas, will accelerate construction in public infrastructure facilities, affordable housing and urban village redevelopment. The property industry accounts for circa 30% of Chinese Gross Domestic Product (GDP), and the real estate slump has accounted for many of China’s current economic problems. House sales have gone south dramatically with developers’ debt problems spilling over into the shadow banking system*.

*China’s Shadow Banking System – This refers to financing outside of the formal Chinese Banking System and is conservatively estimated by experts to be in the region of USD3 Trillion. Such financing is made by banks through off-balance sheet activities or by non-bank financial institutions such as Chinese Trust firms. These trust companies sell investment products to qualified investors and the funds are used to invest in a wide range of financial assets, plus they are used to lend to property developers and their project companies and to local government financing vehicles who in turn lend to property companies. 

Politically, experts suggest that China’s leaders will look to thaw relations with the United States and Europe, if only for economic purposes. Indeed, President Xi Jinping met with President Joe Biden in San Francisco back in November 2023 and recently met with EU Commission officials in Beijing in an effort to keep the European Union close for trade purposes and to get access to technology. However, any perceived thaw will be down to economic expediency and nothing more. In fact, for the first time President Xi Jinping announced in his New Year speech that the economy is facing troubles in such areas as employment, with many finding it difficult to fund basic needs and enterprises having a tough time. He went on to say that we will consolidate and strengthen the momentum of economic recovery. 

Outside influences may have a direct impact on the Chinese economy in 2024. President Xi’s desire to control or unify Taiwan could put China in direct conflict with the United States. The looming presidential election in Taiwan has three candidates, the Beijing sceptic William Lei (Democratic Progressive Party), the Beijing friendly Hou You-Yi (Kuomintang)  and the third candidate Ko Wen-je who will follow the outgoing president’s approach. Beijing will look at this election as a litmus test for a non-violent unification. The possibility of a second Donald Trump term could end up being a real wild card for China/ United States relations, and could well impact some of China’s geopolitical goals. The preferred candidate for China, according to experts, would be anyone showing weakness towards NATO, Ukraine and Taiwan.

The rhetoric coming out of Beijing is setting the tone for 2024 with their ambition for progress, development and global cooperation (with the United States? We will have to wait and see) focusing on growth, sustainability and innovation, paying particular attention to the property sector. The policymakers are looking to promote long-term prosperity and stability in Hong Kong as a vibrant financial sector, as this is also essential in the rehabilitation of China’s economy. However, the property sector could really make or break China’s economy in 2024. There are many failed real estate projects in China and the crisis has also enveloped the once untouchable real estate developer Country Garden, considered by many to be a safe investment. The real worry for Beijing is a dip in housing prices, as roughly 70% of all Chinese household assets are invested in property. The government has continually fiddled with economic data, which they will have to stop in order to get more outside investment, but whilst official figures show housing prices remaining static, it is estimated that house prices have fallen by 15% in many cities and by circa 30% in Beijing.

If indeed the authorities start releasing proper economic data, and can show a credible effort at solving the property sector crisis, then according to many experts FDI (Foreign Direct Investment) will pick up as will the economy. There are many doom mongers who are saying it will be the same old China, all talk and dodgy economic data, but if those who predict a rise in the stock markets are to be believed, in 2024 China will not only talk the talk but walk the walk as well. 

 2023 Closes with Global Equities Charting Big Gains

As the financial curtain came down, marking the end of 2023, a heart-stopping rally in the last two months of the year showed global stock markets with strong annual gains due to investors betting on the fact that major central banks have finally stopped their monetary tightening policies and will indeed cut interest rates 2024. The MSCI World Index* has, since late October 2023, surged by 16%, and, with a flurry of late trading on the 29th of December, showed an annual gain of 22% . This was reflected in recent data showing that in western economies inflation is falling faster than expected, which, as mentioned above, dramatically changed the perception of interest rate changes. Indeed, Jerome Powell, Chairman of the Federal Reserve, fanned the flames of an equity rally in December by announcing that borrowing cost may have peaked.

*MSCI World Index – This is a stock index maintained by Morgan Stanley International (MSCI) and is designed to track broad global equity-market performance. This index is composed of stocks belonging to circa 3.000 companies from 23 developed countries and 25 emerging markets. 

The rise in global equities as reflected in the MSCI World Index is the best run on an annual basis since 2019, when a similar run reflected a 25% gain. The S&P 500 finished the year up by circa 24% which was mainly due to a massive rally in megacap tech stocks.  European markets, after a lacklustre 2022, posted positive gains in 2023 with Italy’s FTSE MIB charting gains of circa 30% and Germany’s DAX coming in with an impressive 20% increase. The overall increase for European equities was reflected on the STOXX 600* charting a gain of 12.6%. Elsewhere all three indexes in Japan posted hefty gains in 2023 with the Nikkei Stock average finishing the year up 28%, this being the best rally since 2013 which reflected a rise of 57%. 

*STOXX 600  Index – This index tracks 600 of the largest stock exchange listed companies from 17 countries in Europe. The countries represented are Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, Switzerland and the United Kingdom.

The big omission from the global rally in stock markets is China, where the world’s second largest economy has suffered from problems in their property sector. As a result, the expected recovery has faltered. Indeed, China’s CSI 300, which measures the largest companies listed in Shenzhen and Shanghai, fell by 11.38%. Their flagship financial centre, Hong Kong, has suffered over the years and in 2023 stocks were particularly hard hit, with experts advising the Hang Seng index is the worst performer of 2023. 

Sadly, in the United Kingdom the FTSE lagged behind their counterparts in the United States and Europe by posting a gain of 4% in 2023. Experts suggest that this is down to a stubborn inflation rate, energy companies that are oil-price exposed, and a preponderance of mining companies that are overexposed to and rely on a slowing Chinese economy.

Many expert strategists seem to be sitting on the fence when calling the outlook for 2024. This year will determine the fate of the political leadership for half the global economy, the final battle against inflation and the fate of the current business cycle. The IMF (International Monetary Fund) has issued figures for world growth in 2024 as 2.9% with investors being excited as the IMF issued growth figures for the Asia Pacific region as 4.2%. Specifically in Singapore, Vietnam and Taiwan, analysts suggest these countries could outperform in 2024 due to the potential upswing in global tech, as they have a high concentration of manufacturing and R&D facilities. All in all many experts are suggesting a wait and see policy, as we see how the US/China relationship unfolds, the on-going ramifications of the Russia/Ukraine war, where interest rates stand in June this year, and whether or not the USA economy enjoys a soft landing.

Is it Time for the USD25 Trillion Global Cargo Trade to go Digital?

Paper documents still rule the world in global cargo trade. Indeed within this USD25 Trillion business, there is, at any one time, four billion paper documents in circulation. Importers, exporters, banks, brokers, financiers et al all rely on paper documents, which finance and move global resources around the world. It is a system that has seen little change since the 19th century and yet paper documents are frequently subject to fraud (i.e., fake or altered), get lost, and can with any particular journey add huge amounts of time.

With regards to time, data released by experts within this area suggest that the time to process a single bill of lading (paper document along with others) required for the transportation of goods, from issuance to customs clearance which for example includes preparation, issuance, shipper to bank, shipper bank to buyer bank, buyer bank to buyer, submission for customs clearance is circa 16.4 hours. Digitisation will dramatically reduce the time spent on processing.

Company lawyers are still today flying many miles to get a bill of exchange signed off at the last minute. This happened in Singapore in the late 2000’s where a lawyer flew to Hong Kong from Singapore and back in one day, (circa 5,000 miles) in order to have a bill of lading signed off by a client. Typically, this process does not happen every day but digitisation would reduce this process to minutes.

Below are examples of the main type of paper documents usually required under a documentary letter of credit that underpin global trade.

· Bill of Exchange or Draft

· Airway Bill (if air freight)

· Road Transportation Document (if road freight)

· Bill of lading

· Pro Forma or Commercial Invoice

· Insurance Policy and Certificate

· Certificate of Origin

· Inspection Certificate

· Packing List

· Warehouse Receipt – when kept in safe custody after goods arrive.

Based in Paris the ICC (International Chamber of Commerce) currently estimates that circa 1% of transactions within the global trade financing market are fraudulent equating to roughly USD50 Billion per annum. The principals involved, such as traders, banks, other financiers and parties, have, according to recently released data, lost USD9 Billion in falsified documentation over the last ten years. Experts are saying that sending duplicate documents to banks involved in a transaction or falsifying documents are the easiest types of fraud to commit.

Examples of fraud can be seen in the metals market which, going back in history and up to today, has been beset by fraudulent scandals. Some of the latest incidents have encompassed some of the world’s leading trading companies and houses including warehouses connected to the London Metal Exchange (the world’s benchmark futures market for base metals) which were proven to have shortcomings. In the world of metals, the commodity or collateral is usually underpinned by the likes of shipping documents (e.g., quantity ownership, location of goods and quality) and warehouse receipts. Such documents are open to fraudulent misrepresentation, such as being fake whereby the material maybe fictitious, or a single cargo may be pledged for multiple loans which is referred to as over-pledging.

In February of this year a well-known company within the metals industry was left facing a loss of circa USD500,000 as the nickel they had purchased did not contain the nickel as specified in documents. Their modus operandi with nickel was to purchase a cargo of nickel aboard ships then on sell that cargo when the ship reached its destination port. However, on one occasion when investigators in Rotterdam checked the contents of a container containing nickel, they found the contents to be of much lower value materials.

In 2020 a well-known energy group purchased copper from a Turkish supplier, but despite documents confirming the cargo was copper, when the containers were opened, they were full of painted rocks. The list of frauds perpetrated within the metals market is very long indeed, and of course fraud is not just found within metals but anywhere that has paper documentation. It would appear therefore that in order to reduce fraud across the industry, digitisation is the only way forward.

Many advocates of digitisation suggest now is the time to go digital, and make use of blockchain technology. In fact, they go on to say that such technology exists today, resulting in a massive decrease in fraudulent transactions. Furthermore, experts advise that that digitisation will be a boost for the sector, as digitised or electronic bills of lading would increase global trade volume by circa USD40 Billion due to a reduction in trade friction (the reduction in time and paperwork) especially in emerging markets. A very important point as muted by experts suggest from an ecological standpoint that by reducing friction in the container trade (e.g., paper documents), 28,000 tress per year could be saved.

An example of less friction has recently been seen between BHP Group in Australia who shipped nickel in containers to Chinese buyer Jinchuan. The transaction was financed by banks domiciled in each country, and using the ICE Digital Trade Platform the full documentation process amazingly took under 48 hours. Interestingly, 65,000 companies (including leading commodity producers) use the ICE Digital Trade Platform, which provides paperless global management solutions, which include digitisation, automation, and accelerates trade and post-trade operations, finance, logistics, compliance and visibility. Whilst 65,000 companies may sound a lot, remember there are still over four billion bits of paper underpinning global trade in circulation at this very moment.

Detractors say that online hacking is an obstacle to digitisation, but the plain fact is that hacking is a lot more difficult than altering a piece of paper. Indeed, expert opinion advises that that circa USD6 Billion could be saved in direct costs by the major shipping lines if they decided on full adoption of digital bills of lading. Furthermore, it is suggested that financiers such as banks would be more willing to finance those counterparts who are considered to be smaller and riskier if the sector went digital.

Currently, the industry is only transacting 2% of global trade via digitisation. However, change is in the air as ten of the world’s top container shipping lines (nine of which are responsible for in excess of 70% of global container freight), have by 2030, committed to digitalising 100% of their bills of lading, (50% by 2028). Happily, some of the worlds largest and most renowned mining companies have given their vocal support to digitisation, these include Anglo America PLC, Vale SA, Rio Tinto Group and BHP Group Ltd, who are all looking to digitise the bulk shipping industry.

So why is that with all the support for digitisation within the industry, only 2% of global trade has been digitised. The answer is a simple one, as the greatest stumbling block to digitisation is Legal. Whilst shipping companies, insurers, traders, banks and other financiers have all got the wherewithal to go digital, at present the only document recognised by English Law that gives the holder title and ownership to a particular cargo is a paper bill of lading. As a result, any deal or transaction which is not legally secured will not receive funding from a bank or cover from an insurance company, and without either of these two participants there will be no transactions.

As a result of this impasse, on the 20th of July 2023 the Electronic Trade Documents Act 2023, having received royal assent, came into effect on the 30th of September 2023*. This act gives the same legal powers to digital documents as paper ones. This represents a massive step forward, as English Law has legally controlled this industry sector for centuries and underpins circa 90% of global commodities and other trade contracts. France is expected to enact similar legislation towards the end of 2023 whilst Singapore (also a centre for maritime law), passed a similar Act or legal framework in 2021 and in 2022 conducted its first electronic bill of lading transaction.

This act is also based on a Model Law** as adopted by the United Nations, as being a transnational body, it is important that they pass statutes that are acceptable to all countries throughout the world. It has been welcomed by many companies throughout the industry and the Trafigura Group has gone on record by saying “We believe this is one of the solutions which would help in reducing documentary fraud”.

*Electronic Trade Documents Act 2023 – The UK Law Commission published their draft bill in March 2022, which this act is largely based on, and it set out the basis of how, under English law trade, documents can 1. Be dealt with and 2. Exist in electronic form, such that an electronic trade document can have the same effect as a paper trade document. The Act goes on to state that a person may possess, indorse and part with possession of an electronic trade document, and anything done in relation to an electronic trade document has the same effect in relation to the document as it would have in relation to an equivalent paper document. This Act amends the Carriage of Goods by Sea Act 1992 and the Bills of Exchange Act 1882.

**Model Law – UNCITRAL (The United Nations Commission on International Trade law) Model Law on Electronic Transferable Records 2017, aims to enable the legal use of electronic transferable records both domestically and across borders. It applies to electronic transferable records that are functionally equivalent to transferrable documents or instruments. Transferable documents or instruments are paper-based documents or instruments that entitle the holder to claim the performance of the obligation indicated therein and allows the transfer of the claim to that performance by transferring possession of the document or instrument. Transferable documents or instruments typically include bills of lading, promissory notes, warehouse receipts and bills of exchange.

The challenge facing the industry is change. People and companies get stuck in their ways and sometimes it is hard to adopt new processes when the current ones have been in existence for hundreds of years. There are many faults with paper, but it is something that everyone across the ecosystem understands, and whilst there is a global approval of digitisation, few are ready or even keen to be the first to dip their toes in the new waters. Experts have rightly expounded on the fact that if digitisation is to work, then everyone across the supply chain must adopt the same data standards, so that communication can move in the most effective way ensuring verification in a truly interoperable manner.

Southport 1 – 1 Farsley Celtic

For the first time since August of this year Farsley Celtic have gone on a three-match unbeaten run, when at the final whistle on Tuesday evening the spoils were even between themselves and Southport. Sadly, the Celts player/manager Clayton Donaldson was forced off near the end of the game which, together with the earlier injury to Darren Stephenson, meant the Celts were forced to play to the final whistle with only ten men. We wish both players a speedy recovery and hope they will be fit for the visit this Saturday to the Citadel of Radcliffe FC in the second round of the FA Trophy. The run of two wins and a draw now see the Celts mid-table and their current form will surely see them rise even higher.

Is the US Government’s Interest on Debt Spiralling out of Control?

In the United States the annual debt interest they pay on Treasury Bills (US Treasuries) has doubled in the last 9 months, and recent figures released shows that debt interest has passed the USD1 Trillion mark as of the end of October 2023. This figure is representative of 15.9% of the entire United States Federal budget for the 2022 fiscal year, which totalled out as USD6.272 Trillion. 

The heavy borrowing coming from Washington DC has driven up bond yields amid worsening metrics, and such borrowing was responsible for the credit agency Fitch to downgrade government debt back in August of this year. The upward shift in interest rates has put the United States government in a position of having to pay more on interest payments in the coming years than was originally calculated.             

Before the Covid-19 Pandemic no one anticipated that interest rates would go so high, and unless interest rates return to their pre-pandemic levels, interest rate debt will spiral out of control. In fact, experts predict that by 2026 the government’s net interest expense may well be 3.3% of Gross Domestic Product (GDP), which will be a new record being the highest ever recorded. 

As an example of how interest rate debt is spiralling out of control, in October 2023, data released showed that circa USD207 Billion in Treasury notes matured, these notes were issued in 2013, 2016, 2018, 2020, and 2021. Calculations carried out by respected analysts show that the weighted average interest rate* was 1.2%. These notes will be replaced by newly issued debt at an average rate of 5%, and the same will happen every month, (though the amounts will differ) for many months to come. 

*Weighted Average Interest Rate – This represents the aggregate rate of interest paid on all debt in a measurement period. The formula for calculating the weighted average interest rate is,

                         Aggregate Interest Payments ÷ Aggregate Debt Outstanding 

                                              = Weighted Average Interest Rate  

However, things may be looking up for the US government as along with the European Central Bank and the Bank of England, the Federal Reserve announced on 2nd November 2003 that it would keep Overnight Federal Funds steady, which is the second consecutive meeting where rates have remained unchanged. Many operators in the financial markets believe that rates will come down in the new year, which will lighten the load on debt interest payments. However, the Chairman of the Federal Reserve warned that if inflation stops declining he reserves the right to increase rates again, thereby increasing the burden on debt interest repayments.

Eurozone Makes Winter Gas Storage Target 2 1/2 Months ahead of Schedule

According to data released by Gas Infrastructure Europe, the European Union has hit their gas storage target 2 ½ months ahead of schedule by posting a 90.1% capacity as of August 16th, 2023. However, be warned, according to expert’s prices will probably remain volatile over concerns regarding the depth of the winter. 

The EU set the benchmark or threshold for gas storage for November 1st, 2023, as they try to loosen reliance on Russian gas to see them through the coldest parts of the winter. However, this is the first time since records began (2016), that storage targets have attained this level at this time of year.

The European gas benchmark TTF Futures, (Title Transfer Facility) fell by 2.5% on 18th August, but still remains high because as experts advised, full inventories during the summer may not compensate for very cold weather in the winter. 

Sadly, the European Union’s demand for gas cannot be met by storage alone, and in the event of colder temperatures, as well as global supply disruptions, Europe could once again be left looking everywhere for gas as they did in 2022.

Experts suggest that the EU will have to compete for liquefied natural gas (LNG), despite current storage levels. Indeed, since the Russian/Ukraine war, and with Russia cutting supplies, the EU have had to purchase supplies from the market to make up the shortfall and this can make them vulnerable to shocks in the global energy market. 

A recent example is potential strikes at LNG export sites in Australia, which together account for circa 10% of global supplies. The market reacted accordingly with the TTF exploding upwards by 40% in the week ending August 12th, 2023. 

Whilst exports of LNG are basically confined to Asian markets, if there was a decline, Asian buyers would have to search elsewhere to make up the shortfall, pitching them directly into competition with the European Union.

If, as some sources suggest, the winter 2023/2024 will be colder than the previous winter, LNG prices may well increase along with that of demand. As the Russian/Ukraine war shows no sign of abating, we can only hope for a milder winter than that which some forecasters have predicted.