The Capital Note

The Capital Note: SEC, USO, SRI, etc.

The U.S. Securities and Exchange Commission logo adorns an office door at the SEC headquarters in Washington, D.C. (Jonathan Ernst/Reuters)

Welcome to the Capital Note, a newsletter (coming soon) about finance and economics. On the menu today: USO, SRI, and BRT.

SEC, USO, etc.

At the start of the year, a barrel of West Texas Intermediate (WTI) oil sold for $60. By late April — in the aftermath of the COVID-19 outbreak and a price war between the Saudis and Russians — WTI went negative for the first time ever. The pandemic so obliterated demand for oil that storage costs came to exceed its market price, forcing energy traders to pay as much as $40 for the privilege of parting with a barrel of crude. The market tumult hit not only producers and traders, but also scores of retail investors holding exchange-traded funds (ETFs).

Negative prices posed a unique challenge for ETFs. Losses on oil futures can theoretically be infinitely negative, but the market prices of ETFs cannot go below zero. Because oil had never gone negative before April, ETF managers had not grappled with the chasm between potential losses on their investments and the floor on the equity values of their funds. After the meltdown, it was unclear who would be on the hook for losses — whether the funds themselves, their investors, or their brokers.

Meanwhile, ETFs scrambled to shuffle their portfolios so as to avoid losses. The United States Oil Fund (USO), among the largest oil ETFs, is designed to track short-term fluctuations in oil prices. But with the market in “contango” — i.e., with the price of oil for future delivery above that for immediate delivery — USO sold forward-month futures contracts and bought contracts for delivery two and three months into the future.

Smart move, right? Wrong, says the Securities and Exchange Commission.

The manager of the $4bn United States Oil Fund (USO) disclosed on Wednesday that it had received a Wells notice from the US Securities and Exchange Commission related to constraints on its ability to hold certain futures contracts in late April and May. Such notices warn recipients that regulatory staff intend to recommend commissioners authorise a civil action, though charges do not necessarily follow.

The charge seems to be that USO’s decision to shift into long-dated futures was not in keeping with regulatory constraints. For their part, the fund’s managers deny the allegations. In any event, an SEC investigation is no fun, but considering the massive, continuous losses USO has faced since inception, it may be the least of their concerns.

— D.T.


 “Socially responsible” investing is (whatever one thinks of the concept) clearly on the rise, and charitable and university endowments are, for fairly obvious reasons, at the forefront of those either embracing the idea or, under pressure, feigning enthusiasm for it.

They will surely, then, welcome moves by the administration to ensure that Chinese companies listed on U.S. exchanges meet domestic auditing standards. Those that do not will, assuming the rulemaking process (which could well stretch past the election) goes through, be delisted.

A report from Reuters last week gave details of the timetable:

Mnuchin and other officials recommended the move to the U.S. Securities and Exchange Commission last week to ensure that Chinese firms are held to the same standards as U.S. companies, prompting China to call for frank dialogue.

Mnuchin told a White House briefing the SEC was expected to adopt the recommendations. “As of the end of next year … they all have to comply with the same exact accounting, or they will be delisted on the exchanges,” he said.

Note that this does not apply only to Chinese companies, although there can be no doubt that they are the principal target of this change.

And, even setting aside the strategic rationale for such a move, there are good prudential reasons for it too.

An earlier report from Bloomberg provided some background:

The President’s Working Group on Financial Markets said… that in order to trade on a U.S. exchange, companies must grant American regulators access to their audit work papers. The group hasn’t determined how to enforce the guidelines, said a senior Treasury Department official who briefed reporters on the condition of anonymity…

The recommendations target a problem that has vexed U.S. regulators for more than a decade: China’s refusal to allow inspectors from the Public Company Accounting Oversight Board to review audits of Alibaba Group Holding Ltd.Baidu Inc. and other firms that trade on American markets. The issue has gained added urgency due to rising tensions between Washington and Beijing and following this year’s high-profile accounting scandal at Luckin Coffee Inc...

China’s accounting firms, including affiliates of giants like Deloitte, Ernst & Young, PwC and KPMG, have long argued that Chinese law bars them from sharing audit work papers with the PCAOB on the grounds that the documents may contain state secrets.

The President’s Working Group addresses that concern by advising a co-audit for companies that are unable to comply with U.S. rules. The co-audit would be performed by an accounting firm that the PCAOB determines has sufficient access to the audit work papers.

“State secrets.”

And now (via Bloomberg):

The U.S. State Department is asking colleges and universities to divest from Chinese holdings in their endowments, warning schools in a letter Tuesday to get ahead of potentially more onerous measures on holding the shares.

“Boards of U.S. university endowments would be prudent to divest from People’s Republic of China firms’ stocks in the likely outcome that enhanced listing standards lead to a wholesale de-listing of PRC firms from U.S. exchanges by the end of next year,” Keith Krach, undersecretary for economic growth, energy and the environment, wrote in the letter addressed to the board of directors of American universities and colleges, and viewed by Bloomberg.

As the working group is well aware, it would be relatively easy for the same companies to list on more-permissive exchanges elsewhere in the West, meaning that it would still be straightforward for institutional investors to buy and sell these stocks, although some U.S. retail investors might be discouraged.

The more interesting question, however, for “socially responsible” investors ought to be how they can reconcile holding positions (in funds with any degree of active management) even now in Chinese companies that would fail to qualify for a U.S. listing under the circumstances envisaged by regulators. One of the most popular measures for determining whether a company might constitute a socially responsible investment is how it matches up to certain environmental, social and governance (ESG) criteria.  Normally, “G” (governance) is relatively (and rightly) uncontentious, but, even if we ignore the E and the S (both, I would think, of some relevance when it comes to China), it is hard to see how any investors that pride themselves on paying attention to ESG can invest in companies which deny the necessary access to audit work papers.

— A.S.

Around the Web

Remote working from Barbados….or Estonia?

When it announced its 12-month Welcome Stamp program in mid-July, Barbados became one of the first of several countries, in regions from the Caribbean to Eastern Europe, to create programs for remote workers. The programs employ either special visas or expand existing ones to entice workers to temporarily relocate. Other countries offering similar visas currently include Estonia, Georgia and Bermuda.

A substantial drop in these countries’ tourism numbers is a key reason for the new programs.

Estonia has long been one of my favorite countries to visit, regardless of the time of the year, but for anyone weighing the difference between Tallinn and Bridgetown in December, the choice will be on the binary side.

Not-so-green energy.

At the Democratic National Convention this week, presidential and vice-presidential candidates Joe Biden and Kamala Harris will make the case for spending $2 trillion, or $500 billion per year, to transition the U.S. away from fossil fuels toward renewables like solar and wind.

Biden has said he would not “tinker around the edges” with his plan. “We’re going to make historic investments that will seize the opportunity.

In many respects, the Biden-Harris plan is even more aggressive than California’s. “The plan is very bold,” Leah Stokes of the University of California, Santa Barbara, told the Financial Times. “There is no [US] state right now that has a target this ambitious.””

But California’s big bet on renewables, and shunning of natural gas and nuclear, is directly responsible for the state’s blackouts and high electricity prices.


Down south:

Venezuela’s gold reserves fell by seven tonnes in the first half of the year to reach just 98 tonnes, their lowest level in 50 years, according to data published on Monday by the South American country’s central bank.

The drop comes as Venezuela, whose key oil industry is under U.S. sanctions, sells its gold abroad to obtain foreign currency amid an economic crisis. The central bank maintained reserves above 350 tonnes until 2015, when the increasingly cash-strapped government began to use gold as a collateral for loans.

Random Walk

Today is the first anniversary of the publication by the Business Roundtable of a new Statement on the Purpose of a Corporation, a statement in which the BRT turned away from recognizing the notion “that corporations exist principally to serve shareholders” with something supposedly more “modern” (in fact, if anything, it is a reversion to the pre-modern, but that’s a discussion for another time); namely, that a company should be run for the benefit of its “stakeholders,” of which shareholders are just one category.

The initial statement was signed by 181 CEOs, and many more have added their names since.

Back in 1970, in an essay for The New York Times Magazine (those were the days), Milton Friedman set out why, to quote its title, The Social Responsibility of Business is to Increase its Profits.

He would not have been impressed by those CEOs.

Here’s an extract:

Whether blameworthy or not, the use of the cloak of social responsibility, and the nonsense spoken in its name by influential and prestigious businessmen, does clearly harm the foundations of a free society. I have been impressed time and again by the schizophrenic character of many businessmen. They are capable of being extremely far-sighted and clearheaded in matters that are internal to their businesses. They are incredibly short-sighted and muddle-headed in matters that are outside their businesses but affect the possible survival of business in general…

[S]peeches by businessmen on social responsibility… may gain them kudos in the short run. But it helps to strengthen the already too prevalent view that the pursuit of profits is wicked and immoral and must be curbed and controlled by external forces. Once this view is adopted, the external forces that curb the market will not be the social consciences, however highly developed, of the pontificating executives; it will be the iron fist of Government bureaucrats.

— A.S.

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