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Week 12: Investing in countries that are not free
In this issue: ▸ Facing reality ▸ Financing the democratic retreat ▸ Investing in ‘Not Free’ countries ▸ The sad story of Roman Abramovich ▸ The big disconnect ▸ A secret diary worth reading
As the days go by, with the people in Ukraine getting systematically killed and expelled from their homes, and the Earth poles being 40 degrees warmer than they should be, business as usual continues.
In the face of terrible urgency, and in the name of all you love, how far are you willing to go? Think about it for a while.
What is the term psychologists use to describe systematic avoidance of facing reality? I don’t know if they have terminology for the state we are in right now to be honest.
What does it mean to face reality? Facing reality, according to what has been written, means taking action even when, or especially when, finding the way is difficult. Avoiding the difficult conversations doesn’t eliminate the need to have the conversation. It means that you prolong the pain and likely destroy trust in the process.
The Ukrainian president is doing a 24/7 plea to world, and his message is rather clear. Stop importing Russian oil and gas, stop helping the regime finance its aggression, help Ukraine defend itself.
Yes, we listen and parliament members in nations around the world stand up and clap their hands – and then the lights go out, the video stream is over, and we’re back to business as usual.
We still import oil and gas from Russia, and we will continue to do for some time. Russia has even managed to make the payments on its sovereign debt bond recently and has not yet defaulted as it did 1917. Yes, we send weapons to Ukraine, but not really the real stuff. It’s complicated. Sure it is.
Financing the democratic retreat
The democratic retreat affects countries in all continents: Turkey, Poland, Hungary, Russia, Nicaragua, Venezuela, Bolivia, Niger, the Philippines and India, among many others. Even in countries such as Brazil, Italy and the US, the standards of liberal democracy have been eroded.
Yet, while it is not easy to measure democratic standards, it is not impossible.
The Economist Intelligence Unit has produced a Democracy Index since 2006. Its 2019 edition reported its worst score to date.
Freedom House has produced an annual Freedom in the World report since 1973, which now covers 195 countries and 14 territories. Its index incorporates factors such as the electoral process, political pluralism and participation, the functioning of government, freedom of expression and of belief, rights of association and organisation, the rule of law and personal autonomy and individual rights. It groups countries as Free, Partly Free and Not Free.
The 2019 report states that “freedom in the World has recorded global declines in political rights and civil liberties for an alarming 13 consecutive years, from 2005 to 2018. The global average score has declined each year, and countries with net score declines have consistently outnumbered those with net improvements.”
Meanwhile, the amount of finance available to such governments has been on the rise.
We are not in the age of Anthropocene as much as we are in the age of Capitalocene.
Investing in ‘Not Free’ countries
According to the Bank for International Settlements, as of mid-2019 there were $2.7tn of outstanding international debt securities issued by developing countries, of which $1.2tn were sovereign bonds. Of these, about one-third were issued by countries described by Freedom House as Free, one-third by countries described as Partly Free and one-third by Not Free countries.
Some of the biggest issuers are countries whose democratic credentials have deteriorated fast in recent years, such as China, Russia, Turkey and Poland. The flows of funding are impressive. In January this year alone, EM sovereigns issued $33.1bn and EM corporates $77.5bn, the second-highest monthly issuance on record. While democracy is in retreat in many emerging markets, more global funds are being allocated to support their governments.
Are there any portfolio allocation limits for countries where standards of democracy have deteriorated by more than a certain margin in the previous year or whose democracy index is below a certain threshold? What percentage of their portfolios is allocated to countries that are Partially Free and Not Free? Is your portfolio allocation increasing for countries whose democracy score has fallen significantly in the previous year? I have tried to find this information but this is not easy and to be honest not really available. Democracy is not for free, right?
Autocratic regimes, democracy, human rights, these topics are nowhere today in ESG analyses. What do ESG managers do on human rights? They usually try to avoid political statements...
Fund managers touting ESG standards held at least $8.3 billion in Russian assets right before President Vladimir Putin launched a war on Ukraine. That figure is based on an analysis by Bloomberg of roughly 4,800 ESG funds representing more than $2.3 trillion in total assets. Of those, about 300 were directly exposed to Russia, though the figure may be higher.
The Bloomberg analysis also found that at least 13 of the ESG funds holding Russian assets were classified as so-called Article 9, which is a category within Europe’s Sustainable Finance Disclosure Regulation that denotes the very highest level of sustainability. A further 137 funds were labelled Article 8, which indicates to investors that they “promote” ESG characteristics.
With sustainable investing now a $40 trillion industry that’s been embraced by the world’s biggest financial firms, it’s being applied to virtually all markets and investment products. Banks deal in ESG derivatives, while asset managers track a vast array of indexes from providers like MSCI that offer varying degrees of ESG alignment.
Many of the ESG funds that say they’re now trapped in Putin’s Russia tracked such indexes, in large part because the supply of genuinely green or social assets hasn’t been able to keep up with the breathless surge in investment demand.
The sad story of Roman Abramovich
Yes, the financial industry is deeply entwined in Putin’s Russia, in many ways.
Here’s one example: For two decades, the Russian oligarch Roman Abramovich has relied on a circuitous investment strategy, deploying a string of shell companies, routing money through a small Austrian bank and tapping the connections of leading Wall Street firms, to quietly place billions of dollars with prominent U.S. hedge funds and private equity firms, according to people with knowledge of the transactions.
Using a network of banks, law firms and advisers in multiple countries, Roman Abramovich invested billions in American hedge funds. Wealthy foreign investors like Mr. Abramovich have long been able to move money into American funds using such secretive, roundabout setups, taking advantage of a lightly regulated investment industry and Wall Street’s willingness to ask few questions about the origins of the money.
You can read more on this rather sad story here.
The big disconnect
Now on to the financial reality of climate change, and even this reality is not what we are told it is. It is a pledged reality.
A comprehensive assessment of the world’s 30 largest listed financial institutions shows a clear disconnect between the concrete short-term targets and actions needed to address the climate emergency and the limited, long-term targets currently being set by the financial sector.
The research finds that despite an increase in long-term climate targets and voluntary climate-related reporting by these groups, financial institutions continue to show a significant lack of meaningful short-term action in the face of the climate crisis.
Despite 29 of the 30 assessed financial groups having set 2050 climate goals in line with the Glasgow Financial Alliance for Net Zero (GFANZ) initiative, all 30 FIs remain members of financial industry associations which are opposing emerging sustainable finance policy, including finance sector disclosure requirements in the EU and requirements to consider ESG as part of investment duties in the US.
Furthermore, 15 of the 30 are members of real-economy industry associations which have lobbied directly in line with fossil fuel interests, including the US Chamber of Commerce and the American Gas Association. A small number of financial institutions, most notably BNP Paribas, AXA and Allianz, are bucking industry trends and engaging on sustainable finance policy with mostly ambitious positions.
The 30 assessed financial institutions cumulatively enabled at least $740 billion in primary financing to the fossil fuel production value chain in 2020 and 2021, equivalent to 7% of their total primary financing in this period.
This financing stands in direct contrast to science-based guidelines from the Intergovernmental Panel on Climate Change (IPCC) and the International Energy Agency (IEA), making clear the need for the rapid scale-down of coal, oil and gas exploration and production and halve global emissions by 2030.
The largest enabler of fossil fuel financing was J.P. Morgan with $81 billion in 2020-2021.
It is unclear whether or how the institutions plan to address these disconnects, with only 11 financial institutions having set targets across multiple sectors and climate-related reporting by financial institutions containing significant gaps across the board. Only 7 of the 30 FIs have set thermal coal exit plans in line with IPCC 1.5° C guidelines, while only Barclays, BNP Paribas, ING and Societe Generale have committed to reducing oil and gas exposure by 2025.
It remains likely that the financial sector will continue to enable real-economy activities misaligned with 1.5 °C climate scenarios as long as they remain legally and economically viable in the short term.
It is also likely that finance as a whole will continue to lag on concrete climate action while the necessary binding climate policy and regulations remain absent. This is further exacerbated by finance’s indirect opposition to climate finance regulations through its industry associations. The GFANZ initiatives’ statements reflect this, noting policy advocacy as a priority.
A secret diary worth reading
Before closing this mirage session called reality, just one more thing: Tariq Fancy, ex-CIO at BlackRock, recently published an essay entitled The Secret Diary of a ‘Sustainable Investor’. You can read it here.
It’s truly insightful read and I recommend a bottle of something strong to accompany you on the journey through this piece. Coffee or tea just won’t cut it.