The carbon footprint fine print

Freddie Woolfe, Analyst, Global Sustainable Equities, discusses the merits of adding carbon emission data to consumer product labels, and the UK financial regulator’s closer look at ESG investment funds.

 

One of the world’s largest consumer products company recently announced plans to add carbon footprint data on product labels in North America and Europe this year, and on all its products over the next five years.

 

What’s interesting about this is that the company recognizes that the data is unlikely to be 100% accurate in the near term, and they are going ahead anyway, realising that there isn’t time to wait for complete accuracy to get the consumer engagement and behaviour change that is required if we are to hit global climate targets.

 

Separately but equally interesting, the UK Financial Conduct Authority recently issued some guidance in a letter to fund managers on the topic of sustainable and ESG (environmental, social and governance) investment funds that indicates an enhanced approach by the regulator towards sustainable investment.

 

It follows a significant increase in applications for new sustainable-labelled funds (as well as the renaming of funds) that the FCA has seen recently, and the regulator’s perception that many of these applications have been of poor quality.

 

The FCA letter sets out a range of guiding principles for the design, delivery, and disclosure of sustainable funds, which we certainly see as very positive. It highlights the issue of ‘greenwashing’, or making misleading claims about how environmentally sound a fund may be, that we worry goes on in this segment of the market.

 

The letter underscores the regulator’s increasing focus on ensuring that claims to be ESG are reflected both in the investment process and properly justified in evidence. I suspect the letter is an indication of wider future action by the regulator.

 

Banking sector in good health, but where’s the loan growth?

Paul Pulickal, Credit Analyst, Fixed Income, discusses the latest figures from US banks, which shows the sector continues to struggle for loan growth, and an encouraging result for UK banks from the latest balance sheet stress test.

 

There were a few key factors that investors had their eyes on regarding US banks coming into Q2. Firstly, what the scope was for further reserve releases where expectations were for a continuation of what we saw in Q1, when large bank released over $8bn driven by low levels of delinquencies supported by the government’s fiscal measures. Secondly, last year we saw trading revenues (especially in fixed income, currencies and commodities) at extremely elevated levels and the expectation was that this would normalise, with some pick-up in underwriting and advisory as M&A, IPO and debt issuance see increased activity compared to this time last year.

 

In the event, there weren’t many surprises, with large banks releasing approximately $6.8bn of reserves in Q2. Trading revenues were indeed weaker compared to last year, partially offset by higher underwriting and advisory income. Asset quality continued to be strong, with retail delinquencies around multi-decade lows, and an improving economic outlook and ample access to capital market liquidity supporting corporate and commercial borrowers.

 

The final question that investors had was on underlying loan demand, which so far has been very weak, leaving banks flush with liquidity. In Q2 deposits continued to outpace loan growth, as QE and the drawdown of the Treasury General Account flooded the banking system with reserves that banks cannot find a home for. This builds pressure from a regulatory capital viewpoint, as seen in demand for the Fed’s Overnight Reverse Repo facility which peaked at just under $1 trillion last month.

 

Going forward, the expiry of eviction moratoriums, student loan forbearance and mortgage relief programmes may potentially be source of stress to the consumer. On one hand, delinquencies could rise from their current low levels, however this may also prove the catalyst for some degree of consumer re-leveraging/balance sheet growth.

 

In the UK, the FPC published its latest Financial Stability Review earlier this month, which included the 2021 interim stress test looking at how the balance sheets from the eight participating banks performed against a severely negative path for economy from 2021-2025 (far worse than the central expectation of the Bank of England’s Monetary Policy Committee).

 

The banks came into the stress test with aggregate CET1 ratios 3x higher than before the Global Financial Crisis. Results were strong with the trough in capital above that experienced in previous tests despite significant credit impairments. This outcome was a key contributing factor in the decision to lift restrictions on distributions, signalling the regulators comfort with bank capital levels. The Bank of England concluded that as fiscal support measures in the UK gradually phase out, the banking system is in a position to support both consumers and businesses.

 

Has investing in China grown riskier?

Jason Pidcock, Head of Strategy, Asian Income, explains why he’s cautious about investing in China, though more positively, he believes the backdrop for Asia as a whole is looking much brighter.

 

Regulatory risks for several sectors in China have picked up, causing selloffs in Chinese equities. Last weekend, the government unveiled a sweeping overhaul of its education technology sector, banning companies that teach the school curriculum from making profits, raising capital, or going public. These companies can no longer accept overseas investment, which could include capital from offshore-registered Chinese entities. All vacation and weekend tutoring related to the school syllabus is now off-limits; unsurprisingly, restrictions have decimated the valuations of several education tech companies. Concerns have also spread to other companies in the tech sector that either have stakes in education or that are involved in areas like food delivery, where regulatory risk is picking up, too.

 

The Chinese government is able to move goalposts very rapidly – until last week, the private education sector was thriving, with plenty of overseas investment and a lot of companies listed in the US. The government has cited concerns about a level playing field: it doesn’t want China to be so elitist and it doesn’t want the sector to be beholden to foreign capital. But to me, this is just a continuation of the crackdown on several companies that we’ve seen over a number of months. There’s been a clear impact on valuations for companies across a range of sectors recently. I don’t think this is just down to regulatory risk, but I believe President Xi is becoming a riskier head of government for several reasons.

 

For example, President Xi recently made his first official trip to Tibet’s Himalayan border region, pledging to bolster construction as tensions simmer along the country’s contested border with India, suggesting that he places the border struggle with India close to the top of China’s national agenda. Elsewhere, the US, the UK and NATO allies have formally attributed the Microsoft Exchange hack earlier this year to actors affiliated with the Chinese government, which is the first condemnation by NATO of China’s cyber activities. The group accused the Chinese government of being behind a series of malicious ransomware, data theft and cyber-espionage attacks against public and private entities. Furthermore, in the West, there are typically term limit customs or laws preventing, or discouraging, heads of government from presiding in power for more than 8 to 10 years, with the view being it’s healthy for a handover after such a long period of time. In autocracies, however, leaders can attempt to stay on indefinitely.

 

The combination of these factors, along with ongoing environmental concerns in China, lead me to believe that the risk for capital deployed there has risen markedly. As such, I continue to avoid exposure to China, apart from consumer staples stocks which I believe should be less impacted by regulatory crackdowns.

 

Beyond China, in my view the backdrop in Asia is looking pretty strong. Covid-19 cases are falling again in many countries, including India. Company profit announcements have generally been very good too, particularly in countries like Taiwan and Australia. So, overall, I remain constructive about the Asia Pacific region, despite my concerns about investing in China.

The value of active minds: independent thinking

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