Tuesday, November 18, 2014

Is South Africa a junk bond nation?

Examining the power of Credit Rating Agencies and South Africa’s latest grading.

It certainly has been a week of gloom. But even for my pessimistic bent, the hysteria all seems to have been a bit over the top with a touch of professional expediency and media sensationalism, in turn unleashing the clichéd yapping of political fox terriers.

The spook of “fiscal cliff” is just one example. Most countries, including many of blue chip ratings, have plunged over that cliff some time ago. Their government debt to GDP ratios far exceed ours at less than half of GDP and the world average at above 100%. Apart from the Sudoku nature of these metrics, these countries have simply learned how to abseil down that cliff despite not knowing how much rope is left. That rope is the ability to pay with the assumption that the bigger and more powerful you are the longer the rope you have. There’s something quite immoral in that concept – one that applies equally to individuals in withholding credit from the needy, but supporting reckless ostentation of a few.

Adding to the dimming of the lights was Moody’s downgrading of South Africa’s credit rating triggering an unsanctionable hysteria of imminent junk-bond status. Not likely, according to this recent well considered argument with some highly informative charts by David Knee, Head of Fixed Income at Prudential. To this I would add a few perhaps more subjective and speculative considerations.

· Credit ratings are by their very nature comparative and with bourgeoning debt and continued lower economic growth in many countries there should be a logical resistance to downgrades in isolation of the overall global environment.

· As a country sovereign debt nears speculative or non-investment grading the implications of a downgrade become severe, arguably requiring a major economic shock or change in circumstances to warrant a plunge to junk bond status.

· Could this, one wonders, open such an agency to a liable suit, as we have already seen in the $5bn claim against Standard and Poor’s?

The rating agencies themselves have come under severe scrutiny since the collapse of 2008, shouldering much of the blame for those events and posing the question of who rates the raters and indeed even whether they have a right to exist. This is not a new debate and in defence the agencies can employ disclaimers, while their supporters argue that they are merely expressing an opinion under freedom of speech.

This is disingenuous. They are not merely a messenger. While it is true that their pronouncements are based on mostly known factors arguably not always fully and independently researched, they can and do have a severe impact on the lives of millions. In some cases they have regulatory weight behind them with statutory rating requirements for institutional investors such a pension funds. In America, regulations still make it virtually impossible to sell unrated bonds.

It is a moot point whether these agencies are comfortable with this power. But they have it. Whether they deserve it or should have it has become academic but under such circumstances they can expect their credibility to be constantly challenged, sometimes unfairly, but also with some justification.

For one thing they are puppet masters in the murky world of financial services and frenzied speculation that present an enormous cloud over the real global economy. As such there is a high inherent danger of them being incubators of insider trading that could make the Libor scandal look like shoplifting a Crunchie from Checkers. In fairness again, so far there has not been a hint of that.

Perversely, scrutiny and potential lawsuits could affect their judgement especially when it comes to sovereign risk ratings. It is far safer to be pessimistic than optimistic. Being in a speculative environment, this could have a subconscious negative effect on the ratings of less popular and riskier instruments, especially adjustments in response to changing conditions. This may be understating their objectivity, but that is simply the subjective nature of the beast.

Then there’s the tricky intermediary role between issuers and investors. CRA income is sourced mainly from issuers. Entities that issue investment instruments hire ratings agencies and can fire them if they do not like the ratings, presenting an inherent conflict of interest between the transacting parties.

At the very least it is an industry still very much in a state of change and constant reform. There have been ground breaking amendments to America’s Dodd-Frank Act enhancing SEC controls over agencies while most countries including Europe have been revamping domestic legislation covering the industry. The point is whether one can expect such legislation to eventually guarantee the same impartiality, accountability and liability applicable to independent auditing firms.

The greatest indictment of the industry is its restricted nature. There are really only three global players all with a mostly Western Anglo Saxon perspective. They control 95% of the global market, with Fitch having 15%, Moody’s 40% and S&P 40%. It is a very profitable business, and despite the serious knock to their reputation in 2008, the three agencies are thriving with the explosion of paper in the bond and securities markets.

As far as South Africa is concerned, unless there is a new unforeseen and major shock (of which hopefully the latest organised labour turmoil will not be one) we do not deserve and are not near junk bond status. We may even be able to tap alternative funding such as from the BRICS development bank. Of course, as we have seen with Eskom, ratings for other South African borrowers are a different matter. They will not only have to deal with additional pressure from a lower sovereign debt rating but face closer scrutiny of their individual prospects and management – perhaps not such a bad thing given the appalling state of many of our state owned enterprises.

Our collective institutions and their leaders representing government, business, and labour need a much louder wake up call. If this has to come from a downgrading of our sovereign debt, then so-be it.

They may even deserve it, but for the most part the real victims, ordinary folks don’t!

Friday, November 14, 2014

Putting business on a guilt trip

Is the commendable label of “Homo empathicus” being abused for self-gain?

Having introduced a recent article with some history of my father, let me start this one with an anecdote about my mother. She was a formidable figure who had many weapons in her vast arsenal of persuasion and manipulation.

These were mostly simply what was conveniently at hand such as a tomato box or the flat end of a bread knife. Later I came to appreciate that what modern sissies would call abuse, was simply tough love and a reflection of both the times, and the maternal frustrations of raising four unruly siblings born soon after each other in very modest circumstances.

By far the most formidable of her WMD’s was nonviolent. It was a nuclear missile called guilt. As a devout Catholic she had a talent of pulling a guilt trip on her offspring simply with a look, raised eyebrow or feigned emotional pain. In this she outdid the prowess of ancient priests who defined the sin, the dire eternal consequences, the punishment, and the price of absolution; that conveniently could be paid to them. Or like modern day cult leaders and rogue charismatic pastors who preach the power of empathy, generosity, and charity -- all from behind the collection box.

"Homo empathicus" has been receiving some attention, including a call by our own Cooperative Governance and Traditional Affairs Minister Pravin Gordhan, supported by Cosatu (see article here) for business leaders to adopt this mantle, specifically against the background of large pay disparities. It has also become a growing feature of socio-economic discourse. Regular readers will know that I have always taken issue with exorbitant executive pay. At the same time, I have argued that apart from those builders and creators of business, who mostly have only a passing interest in wealth and profits as affirmation of their contribution, the market for executive “skills” and “talent” is thoroughly broken and remuneration criteria based on shareholder value is misplaced. Appealing to them for “charity” seems to confirm the validity of their pay, not challenge its flawed make-up.

But here's the rub. To see the term homo-empathicus as "soft" and "fluffy" or leftist and socialist is totally out-of-place. It's the same hypocrisy that I have challenged in capitalism claiming to be "market driven"... It is not... It is profit and self-gain driven which is the opposite of being market driven. An assumption that they are the same, or that the one automatically implies the other, is either disingenuous or simply naïve. Taking those motivators to extremes has been the root cause of our modern economic ills.

Homo empathicus is being expediently used in most cases to champion the plight of vested interests, in this case employees. They are clearly asking employers to adopt empathy for their (the implorer’s) self-gain. It is the ultimate insult to empathy itself -- in the same vein as using scripture to justify crimes, or insisting that someone else must act charitably towards yourself.

Business may soon find itself overwhelmed by this new rhetoric, and no doubt it will be the prelude to a plethora of "empathy" consultants to show them ways of faking it. On the other hand – and here is the real opportunity for business – they can seize the initiative and forge the genuine model which is the very foundation of service, common purpose and common fate. Empathy by its very nature is always externally focussed and in business it means everyone having empathy for the customer and society as a whole. All it requires from business is to do what should come naturally, having an external focus on the needs and wants of others in society and then serve those needs with the best product or service at the best price. Rewards in the form of wages, taxes and profits are there to sustain and grow that activity. They are not the purpose of that activity.

Inner empathy (for each other as partners in wealth creation) simply makes good business sense as long as it sticks to the fundamentals of sensible wealth distribution which means meeting the legitimate expectations of all of the stakeholders and encouraging continued contribution. But inner empathy is a means. External empathy is the purpose. Of course it is highly praiseworthy for business and the wealthy to be philanthropic and charitable to those in need. Many of them already are over and beyond the taxes they pay. It is simply inappropriate, if not obscene for the recipients of “charity” to manipulate, emotionally blackmail, or even extort their benefactors to be charitable.

Empathy is a human instinct and a state. Contribution is a behaviour that naturally follows this state. Contributory behaviour is the fundamental requirement for wealth creation, prosperity, job creation and national competitiveness. It is based on the self-evident axiom that when people by and large are giving more than they are taking, they create surpluses and prosperity. The converse creates deficits and poverty. The survival model of business, including profit and wage maximisation, has distorted this focus and has created many economic imbalances.

You cannot expect empathy from others when you yourself are not empathetic. It is a very moot point whether labour itself has been homo empathicus – especially to those who are the intended beneficiaries of their efforts: customers and society as a whole.

At the same time they have relinquished real power. Power based on threats, extortion and self-gain is seldom sustainable. Power based on empathy and contribution is far more so.