"At the current fiscal stance, the region’s financial wealth could be depleted by 2034. Fiscal sustainability will require significant consolidation in the coming years." This is the stark warning for the Gulf Cooperation Council (GCC) countries in an IMF policy paperpublished yesterday (6 February). The time frame could be shorter with greater improvements in energy efficiency or faster introduction of carbon taxes globally.
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The IMF Board yesterday approved a new US$5bn 18-month Standby Arrangement (SBA) for Ukraine, as expected (see IMF statement here). The approval provided an initial disbursement of US$2.1bn (a bit more than we had anticipated) with the remainder phased over four reviews.
There were few surprises in the IMF statement itself, as much of the policy discussion has been well flagged, although it did describe programme risks as "very large", which is quite an admission (for our preview, see here). We await publication of the full board paper for more details.
However, our key takeaway at this stage is the IMF's more cautious growth outlook. The IMF projects real GDP growth at just 1.1% in 2021, and 3.0% in 2022, which is much softer than the V-shaped recovery that investors might have been expecting. This follows -8.2% this year. The National Bank of Ukraine (NBU) expects -5.0% this year, and a fast V-shaped rebound in H2 20, with growth recovering to 4.3% in 2021 and 4.0% in 2022. Absent the board paper, it is not clear why the IMF is now more cautious on Ukraine's growth outlook, especially when it is expecting a stronger V-shaped recovery elsewhere (it is also more cautious than it was in the WEO in April, but that is understandable given the passage of time and as the full effects of Covid-19 become clearer). Its caution might be because of the pausing in Ukraine's structural reform agenda, caused by Covid-19, a resulting weaker contribution from land reform, and overhang from large financing needs.
The IMF's more cautious growth outlook could dent the outlook for the GDP warrants, which have been on a tear during this market rally. The warrants were indicated at 93.2 mid as of cob 9 June on Bloomberg, up from their post-Covid-19 crisis low of 51.8 (although below their pre-Covid-19 high of 110 in February). While this year, and prospects for a payment in 2022, was always going to be a write-off post-Covid-19, warrant holders were looking through this to 2021, when the country's growth outlook seemed more promising. But according to the IMF projections, with growth expected to be below the 3% payment trigger this year and next, there is no prospect of another payment on the warrants before 2023, based on the two year payment lag (a very small payment should be due next year based on 2019 growth), and maybe not before 2024 given growth of 3%-flat in 2022. This contrasts with the NBU's forecasts of 4% growth in 2021 and 2022, within which payments would accelerate under the payment formula, producing more significant payments in 2023 and 2024, respectively. The NBU's upbeat growth forecasts may have been one of the catalysts for the warrants' rally (together with the global EM rally and the IMF money being on its way).
The IMF statement confirmed what we already knew about programme motivations. The humanitarian and economic crisis stemming from the Covid-19 pandemic had created large balance of payments and fiscal financing needs, caused by a sharp decline in revenues and large emergency spending needs, and re-focused policy priorities away from deep structural reforms, where reform implementation had been called uneven in the IMF's parallel Ex-Post assessment. The new IMF programme provides balance of payments and budget support, while safeguarding achievements to date and advancing a small set of key structural reforms. The programme should catalyse additional financial support from the World Bank and EU.
The programme has four priorities: (i) mitigating the economic impact of the crisis, including by supporting households and businesses; (ii) ensuring continued central bank independence and a flexible exchange rate; (iii) safeguarding financial stability while recovering the costs from bank resolutions; and (iv) moving forward with key governance and anti-corruption measures to preserve and deepen recent gains.
But risks to the programme are described as "very large" and the IMF warn that government financing needs are large, too. We recognised this in our previous research, where we calculated a public sector ﬁnancing requirement of over US$20bn this year. We expect most of this will be filled by domestic rollover, IMF and other IFI financing, and international bond issuance, but that still leaves a reasonable unidentified financing gap in our view. We await publication of the IMF's board paper to see details on the IMF's arithmetic and assessment of Ukraine's financing needs.
Continued reliance of financial markets on LIBOR poses clear risks to global financial stability.
Transition away from LIBOR by end-2021 requires significant commitment and sustained effort from both financial and non-financial institutions.
Report includes three sets of recommendations to support LIBOR transition.
The Financial Stability Board (FSB) and Basel Committee on Banking Supervision (BCBS) today published a report on Supervisory issues associated with benchmark transition. Continued reliance of financial markets on LIBOR poses clear risks to global financial stability. Transition away from LIBOR by end-2021 requires significant commitment and sustained effort from both financial and non-financial institutions across many jurisdictions. The report includes insights on remaining challenges to transition based on surveys undertaken by the FSB, the BCBS and the International Association of Insurance Supervisors (IAIS). It sets out recommendations for authorities to support financial institutions' and their clients' progress in transitioning away from LIBOR.
Most FSB jurisdictions have a strategy in place to address LIBOR transition, as opposed to only half of the surveyed non-FSB jurisdictions. Authorities in LIBOR jurisdictions are relatively more advanced in taking initiatives to facilitate and monitor benchmark transition. Financial institutions in these jurisdictions have shown better progress, although significant challenges remain. In light of the expected cessation of LIBOR after end-2021, authorities should strengthen their efforts in facilitating financial and non-financial institutions to transition away from LIBOR.
The report includes three sets of recommendations to support LIBOR transition that should generally be applicable to all jurisdictions with LIBOR exposures.
Identification of transition risks and challenges - authorities and standard-setting bodies to issue public statements to promote awareness and engage with trade associations, and authorities to undertake regular surveys of LIBOR exposure and to request updates from financial institutions.
Facilitation of LIBOR transition - authorities to establish a formal transition strategy supported by adequate resources and industry dialogue. Supervisory authorities should consider increasing the intensity of supervisory actions when the preparatory work of individual banks is unsatisfactory.
Coordination - authorities to promote industry-wide coordination, maintain dialogue on the adoption of fallback language, consider identifying legislative solutions, where necessary, and exchange information on best practices and challenges. The FSB and the standard-setting bodies will coordinate at the international level to identify key common metrics for monitoring transition progress.
LIBOR transition is a G20 priority and the report responds to the G20 request to identify remaining challenges to benchmark transition and to explore ways to address them. The report will be delivered to G20 Finance Ministers and Central Bank Governors ahead of their virtual meeting on 18 July.
Notes to editors
The FSB set out in 2014 a series of recommendations for strengthening key interbank offered rates (IBORs) in the unsecured lending markets, and for promoting the development and adoption of alternative nearly risk-free reference rates, where appropriate. The FSB published its most recent annual progress report in December 2019 on implementation of the recommendations.
The BCBS published a newsletter in February 2020 outlining regulatory and supervisory implications related to benchmark rate reforms.
In the first quarter of 2020, many markets felt the first shocks of the COVID-19 pandemic on the global economy. However, inflows into Environmental, Social, and Governance (ESG) funds were resistant to the prevailing trend, and the sector saw robust levels of investment. How has ESG managed to outperform other sectors of the market?
In the first quarter of 2020, ESG funds saw inflows of US$36bn, showing resilience in the face of widespread market volatility caused by COVID-19.
The region that recorded the largest inflows was Europe excl. UK, with US$17bn. However, inflows into the U.S. and the UK tailed off somewhat on a quarter-on-quarter basis.
During the period, the majority of ESG funds have outperformed their technical indicators.
While the global economy has been struggling after the severe shock caused by the COVID-19 pandemic, there have been record ESG inflows. How has this sector weathered the storm more resiliently than others?
We should first look at how ESG flows in Q1 showed equal parts divergence and alignment with broader fund market flows. These flows most likely represent both the nascent nature of the ESG product space and the orientation of investors allocating into these funds.
Globally, total ESG flows registered around US$36bn, which was the lowest quarterly flow amount for over a year. All things considered, that isn’t too bad when you look at the events that took place in the markets in the first quarter.
The big winner forglobal ESG flowswas equity products. They checked-in at just shy of US$20bn in new money.
This was about two-thirds of the approximately US$30bn flows into equity funds in the record-breaking prior quarter, and the second-highest quarterly equity flow number in the past decade.
Similar to the broader funds market, flows into equity funds continued on a fairly steady trend from prior quarters, registering quarterly flows that were close to record highs.
Investors in ESG funds tend to focus more on values than valuations, and they are accordingly less likely to be found pursuing market timing agendas and trading across asset classes.
Similar again to the broader fund space, ESG funds saw flows into money market products in Q1. However, this was off the back of Q4 2019, which saw very small outflows from these investor safety nets.
The behavior of ESG money market funds is somewhat erratic because they actually saw small outflows during the last market downdraft in Q4 2018, when one would expect money to pile in. They seem to be used more tactically for trading or parking, as opposed to strategically for asset allocation purposes.
Activity in bond funds, however, showed a divergence from prior trends and the broader markets as a whole.
Non-ESG products saw an exodus out of bond funds in Q1, particularly in the U.S., while ESG bond funds went from a fairly steady and robust trend of quarter-on-quarter inflows to near zero flows activity in Q1 this year. Nothing came in and, importantly, very little went out.
Regional ESG activity
From a regional perspective, inflows into ESG funds over the last 10 years have been dominated by certain regions.
In particular, investors have been solidly investing into EMEA excl. UK funds, followed by offshore funds (as defined by Lipper Methodology). UK and U.S. funds, which saw some of the largest interest from investors in 2019, has tailed off in 2020: UK 4Q19 $4.3bn vs 1Q20 $2.3bn; and U.S. 4Q20 $6.7bn vs $2.4bn
Global estimated fund flows chart (interactive) – below graph is a placeholder
Investors’ appetite for risk
Collectively, ESG investors showed a little more appetite for risk, and stuck to their long-term allocation strategies.
In the broader funds market, investors sold out of fixed income, held back on equities, and piled into money markets. ESG displayed a muted version of these three trends by going flat in fixed income, tempering inflows into equities, and revisiting money markets after a quarter of negligible flows.
When analyzing if ESG funds outperformed in the first quarter of 2020, it needs to be considered how difficult it is comparing such a small universe of funds with the broader funds markets.
Watch: Refinitiv Perspectives LIVE — ESG Investment, a cure all for asset management?
How did the oil market affect ESG investing?
A further consideration is the coinciding disruption in the oil market, which impacted all manner of carbon-intensive industries that many ESG funds tend to allocate away from.
In fact, the first part of the market sell-off in carbon-intensive industries was likely more tied to the oil market gyrations and less about COVID-19. However, the global pandemic impacts were felt more in the latter half of March and sealed the performance fate of these stocks.
In spite of that, the outperformance of global ESG funds versus the broader market was a little more than 1 percent on a net basis, with about 54 percent of ESG funds outpacing their conventional funds peers.
Chart: percentage of equity funds over-performing or underperforming (chart needs correct casing)
Considering the massive differences in the number of non-ESG funds and the breadth of product types, this is like comparing apples with oranges, but worth keeping an eye on.
A similar analysis of U.S. ESG funds showed even less significant results. Conventional funds had a much wider spread of returns and only trailed ESG themed funds by 10 basis points on a net performance basis.
We’ll revisit this comparison after another quarter or two to get a better picture and assess if there is a relationship worthy of note there.