God’s Work?

A little misunderstanding

One of the more interesting events of the past week was the sacking of Cardinal Giovanni Becciu, who amongst other duties was responsible for the Vatican’s ‘sainthoods and beatification department’. He was, as a circuit court judge might put it ‘no saint himself’, and despite his pleadings of innocence that it was all ‘a misunderstanding’, his involvement in a number of dubious property transactions was enough to end his career.

This is not the first financial scandal in the Vatican to put it mildly, and in general the relationship between finance and religion is usually not a close one (relatedly German academics have found an inverse relationship between trustworthiness and willingness to work in the financial services industry).

Apart from the pronouncement by the former chief executive of Goldman Sachs that the bank was doing ‘God’s work’ there are few people who think religion and finance go hand in hand. One exception was Sir John Templeton, whom I had the honour to meet a number of times.

However, the idea that finance can do good, and shape the world in a progressive way has gained some credence with the rise of ESG (Environmental, Social and Governance) investing. Together with the fast growing ETF (Exchange Traded Fund) industry, ESG is now one of the hottest areas in investment management (ESG ETF’s are therefore very hot).

The premise of ESG investing is to better direct capital away from ‘sinning’ companies (e.g. tobacco companies, miners, weapons manufacturers) and towards those who behave in a socially responsible way. In practice, investors use ESG ratings to score companies according to their ESG contribution, and in most cases avoid companies with poor ratings. In reality however, this does not work that well.

First, ‘sin’ companies tend to have a very good performance track record. The work of academics Elroy Dimson, Paul Marsh and Mike Staunton shows that the tobacco and alcohol stocks are amongst the very best performers over the past one hundred years. Secondly, many companies are adapting to ESG ratings and in some cases, can appear superficially ‘ESG’ friendly whilst their underlying instincts do not change much.

Thirdly, the age of QE (quantitative easing) has lowered the cost of capital for companies, so that in a market climate of plentiful liquidity, there is arguably less of a penalizing effect from ESG active investors. Facebook for example, does not have a good ESG rating, but as a mega sized social media company with high expected earnings growth, it is in the ‘fashionable’ part of the stock market.

So, if finance is to steer capital in the right or ‘good’ direction, ESG as an investment style needs to acquire ‘teeth’ or real impact. There are several emerging avenues here.

One relatively strict approach is to forgo the prospect of decent returns on ‘sin’ stocks and restrict the universe of stocks in a portfolio according to certain criteria. Islamic Sharia based portfolios do this, as do portfolios owned by various branches (i.e. Germany) of the Catholic Church. Practically these portfolios would exclude stocks in sectors like weapons, mining, alcohol etc.

Another approach that is slowly on the rise is ESG activism, where an activist fund will take a position in the security of a company with the aim of campaigning to make its business better in terms of governance, less environmentally unfriendly and more socially responsible. If and where these activists are sincere about improving corporate behaviour, there is scope to find mechanisms where passive investors can pledge the voting rights of shares they hold to be voted in an ‘ESG friendly manner’, especially in areas like executive compensation.  

A third more telling reform, would be for central banks to adopt a very strict ESG approach to their asset purchases, in the manner of the ‘Quid Pro Quo’ this note had discussed in March (https://thelevelling.blog/2020/03/22/quid-pro-quo/).

In the light of the finding by the US Select Subcommittee on the Coronavirus Crisis found that that ‘383 companies whose bonds were bought by the Fed paid dividends to their shareholders, including 95 that also conducted layoffs, and 227 companies had been accused of illegal conduct sometime in the past three years’, central banks in general and the Fed in particular have room to make a significant impact on corporate social responsibility by only buying assets of firms who have credible ESG credentials.

If they were to do so, and technically there is no reason why not if they follow clear data based ESG frameworks, it would be a corporate game changer. In reality many regulators are well behind the curve here, if the behavior of BaFin (German financial regulator) in the face of egregious corporate governance breaches at Wirecard is anything to go by.

So, there is an enormous public policy opportunity, which is to make finance more values based. There are already echoes of this in the debate amongst EU countries to tie aid to member states to their adherence to its values (notably in the case of Hungary and Poland). If such a trend does materialize, then it will be one of the positive changes in the post globalized world order.

Have a great week ahead,

Mike

Fantastic Corruption!

Cameron explains corruption

In May 2016, at a summit on anti-corruption the then British Prime Minister David Cameron said in hushed tones to Queen Elizabeth, ‘We’ve got leaders of some fantastically corrupt countries coming to Britain… Nigeria and Afghanistan, possibly the two most corrupt countries in the world’.

A month later he lost the Brexit referendum and the UK has been in a state of chaos ever since.

Nigeria most likely had little hand in Brexit, but the complacency of Cameron did. So too, according to last week’s Commons Intelligence and Security Committee’s report into Russian influence in British politics, did the openness of the Cameron government (and others) to the generosity of Russian donors (fourteen ministers in the Johnson government, including six cabinet ministers have accepted donations from Russians living in the UK).

Britain, which for so long and in the eyes of so many, is the country that has epitomized the rule of law (for instance see Tom Bingham’s book of this title). Its lackluster response to financial and other incursions by Russia, the politization of policy (Cummings v Whitehall) and the faulty response to the COVID 19 crisis have contributed to the view that the robustness of institutions and the rule of law are in decline in Britain.

It is not alone. Last week in an interview with CNN House Speaker Nancy Pelosi declared that the stock market was ‘rigged’, and that this might not be such a bad thing. For a country whose value set is based on capitalism, this is an astonishing admission, though less surprising in the context of the vandalization of the rule of law and institutions in the USA by the President. Most US Presidents have underlined the importance of the rule of law, from Eisenhower to Kennedy to Reagan, but not Donald Trump.

Like Downing Street, the change in moral tack at the White House points to the testing of core values in the two countries whose empires formed the basis of globalization (Britain in the 19th century and the USA in the 20th century), and in that respect, is yet another crack in globalization.

Policy makers in each country should play attention to the elaboration of the link between the erosion of the rule of law to the end of empire by Edward Gibbon in ‘The Decline and Fall of the Roman Empire’. More recently, there is plenty of evidence to show a link between economic growth, financial stability and the rule of law across countries.

If politicians in say the UK, or any other European country for that matter, are happy to take donations from citizens of Russia and China, it is harder for them to claim the moral high ground over China in foreign policy. It is equally problematic for US Secretary of State Mike Pompeo to travel the world looking to build an alliance of democratic countries against China whilst the rule of law is undercut in the US.

If the idea of the rule of law is going out of fashion in Washington and London, it is gaining some allure in Brussels.

Much has been made of the hard won result of last week’s European leaders’ summit (it was the second longest ever, only 25 minutes behind the Nice summit in 2000) in the sense that it has created fiscal capacity for the EU. While the classic division between fiscally conservative or ‘frugal’ countries and those like France and Italy who are fiscally indulgent was on display, a new fiscal fissure is opening up.

The agreement reached last week introduced some (yet mild) conditionality around the rule of law in terms of how it binds aid to EU members (the likes of Bulgaria, Romania and Poland are on the minds of Brussels). Though no sanction has yet fallen on the Viktor Orbans of the world this move is part of a new trend where European values are going to play a more prominent role in political discourse (seven of the top ten countries in the World Justice Project report on Rule of Law are EU states).

In the future, collaboration will be done less on the basis of geography and more on the basis of shared values – this might mean that bodies like NATO and the EU may lose rather than gain members.

It also means that the nations of the ‘old’ world need to realise that their economic and political advantage comes from the rule of law, and that the current race to the bottom in terms of practice of the rule of law, is self-defeating.

Have a great week ahead,

Mike