The Capital Note

Wall Street, Woke Capitalism, and China

(Jason Lee/Reuters)

Welcome to the Capital Note, a newsletter about business, finance and economics. On the menu today: Wall Street and China, Chinese debt and “Lake Woebegone” ratings, Europe’s banks, lawyers seeing green, and Poland flunks an Estonian tax lesson.

Wall Street, Woke Capitalism, and China

Whether it’s from the investment world, big business, Davos, or, these days, no small portion of business-oriented media, we are currently hearing a great deal from prominent figures in the private sector about the need to subordinate shareholder rights to various policy objectives, ranging from climate change to greater boardroom diversity and much more besides.

But when it comes to doing business with China, which, last time I looked, was a corrupt, corporatist oligarchy with communist characteristics, characteristics that have long included concentration camps, slave labor, and, more recently, a revived genocide, with the main target now being Uyghurs, rather than Tibetans, the voices from the business pulpit go quiet.

From today’s Wall Street Journal:

In February 2018, Beijing’s chief trade negotiator was in Washington to try to avert a trade war. Before meeting his U.S. counterparts, he turned to a select group of American business executives—mostly from Wall Street.

“We need your help,” Vice Premier Liu He told guests gathered in a hotel near the White House, according to people with knowledge of the matter. They included BlackRock Chief Executive Larry Fink, David Solomon, then Goldman Sachs Group’s second-in-command, and JPMorgan Chase & Co.’s Jamie Dimon, there as chairman of the Business Roundtable lobbying group.

Yes, that’s the same Larry Fink who has been pressing so hard for more “socially responsible” investing and the same Jamie Dimon who has been calling for more inclusive capitalism, the CEO of a bank which is (too slowly, according to activists) disengaging from businesses of which, on climate grounds, it disapproves. And, yes, that’s the same Goldman Sachs that did this:

As Goldman Sachs Group Inc. moves to increase diversity on corporate boards, the investment bank isn’t extending the initiative to a particularly challenged region: Asia.

Chief Executive Officer David Solomon revealed last week that starting in July the bank won’t handle initial public offerings for companies that lack either a female or diverse director.

But the rule applies only to IPOs in the U.S. and Europe. Asia’s exclusion is striking, given how common all-male boards are in the region. Other bastions of male dominance, including Latin America and the Middle East, also went unmentioned.

Back to the WSJ:

Looking for allies in trade talks with the Trump administration, Mr. Liu dangled a prize, the people say: Beijing offered to give U.S. financial firms a new opportunity to expand in China.

Shortly after the gathering, Mr. Liu presented China’s position to the U.S. side, including the financial opening. Most other U.S. industries were disappointed. The Trump administration rejected the offer as too narrow and sent the Chinese packing.

But Mr. Liu didn’t go home empty-handed. The get-together helped turn Wall Street into one of the biggest cheerleaders for a deal. In the trade agreement that was eventually signed in January, China’s financial opening stood out as a prominent concession.

America’s money men have long held a special place in Beijing’s corridors of power, but until now their firms have had little to show for it. The Trump administration has tried to “decouple” parts of the two economies—a direction that President-elect Joe Biden would have a hard time reversing and may embrace. The broader U.S. business world also has soured on engagement with China.

Wall Street, however, is going all in. Since the signing of the trade deal, JPMorgan will get full control of a futures venture in which it had a minority stake. Goldman Sachs and Morgan Stanley became controlling owners of their Chinese securities ventures. Citigroup Inc., meanwhile, won a custodian license to act as a safe keeper of securities held by funds operating in the country.

Meanwhile the New York Times recently reported that:

Nike and Coca-Cola are among the major companies and business groups lobbying Congress to weaken a bill that would ban imported goods made with forced labor in China’s Xinjiang region, according to congressional staff members and other people familiar with the matter, as well as lobbying records that show vast spending on the legislation . . .

Read the full report and judge for yourself, but one or two of the larger woke corporations do make an appearance.

It’s almost as if double standards were being applied.

But there’s rather more positive news from the Journal:

New legislation that is likely to force some Chinese companies off U.S. exchanges will accelerate a migration under way since last year.

On Wednesday, the U.S. House of Representatives unanimously approved a bill that would ban trading in shares of foreign companies whose audit papers aren’t inspected by U.S. regulators for three consecutive years. The measure passed the Senate in May and is expected to be signed into law by President Trump.

China’s government and financial regulators have long resisted U.S. demands to see the audit papers of Chinese companies whose shares are traded on the New York Stock Exchange or the Nasdaq Stock Market . . .

(We discussed this issue in a Capital Note back in August.)

While “bipartisan” is not always synonymous with good (indeed it can be the opposite), a unanimous vote would indicate that the Biden administration will have difficulty in reversing course, even should it want to. It’s also worth noting that the bill that would prohibit the import of certain goods made by forced Muslim labor in China passed the House in September by a margin of 406 to 3.

Around the Web

Nominal negative interest rates are, in my view, an invitation to disaster, even more so when the borrower is located within a profoundly dysfunctional system, and yes, China is profoundly dysfunctional, at least for those who are not embedded within the system.

Outside lenders and investors, therefore, should only get involved in that market if (1) they are prepared to overlook the concentration camps (and all the rest) and (2) if the returns look exceptionally good.

I’m not convinced that this counts as exceptionally good.

Almost Daily Grant’s:

[O]n Nov. 19, China sold €4 billion in euro-pay sovereign debt including a five-year tranche priced-to-yield minus 0.152%.  That’s the Middle Kingdom’s first foray into the negative-rate club, according to Dealogic. The deal was covered four-and-a-half times over, according to Deutsche Bank head of China capital markets Samuel Fischer, who helped oversee the sale.


However, Grant’s reports that some lenders are losing their taste for Chinese debt:

Bloomberg reports today that corporate dollar-pay bond issuance sank to $9.9 billion in November, down 52% on a sequential basis and the lowest monthly total since April.  That slump comes at a potentially inopportune time. According to data from Debtwire, Chinese state-owned enterprises face more than $3 billion in high-yield dollar bond maturities in the first quarter of next year, by far the busiest quarterly maturity schedule through at least 2023.

One potential explanation for the financing slowdown: A string of recent defaults from those state-owned enterprises across various geographical regions and sectors… Those defaults helped trigger a selloff dealing creditor losses equivalent to RMB 60 billion ($9 billion), a local broker estimated to Caixin on Nov. 24.  Some 10 SoE’s have defaulted so far this year, representing 40% of total such defaults over the past five years.

Suddenly skittish investors have tightened their wallets in response, forcing cash-hungry outfits to pay up, with an unnamed Shanxi-based coal miner reportedly paying 5% coupon for ultra-short-term financing. “This might be a historic credit crisis,” one anonymous investor, who held bonds issued by both Yongcheng and Brilliance, told Caixin.  One senior regulator showed limited sympathy regarding those fears, rhetorically asking in response: “When creditors lent so much money to [now-stricken SoEs], did they conduct their risk control properly?”

I think we know the answer to that.


A key feature of the recent credit scare: A Lake Woebegone-type ratings regime, in which virtually all comers are well above average. More than 98% of outstanding bond issuance in China comes from those rated double-A and above according to Wind Data Services, while some 57% of all onshore corporate debt garnered a triple-A-rating as of mid-October per asset manager Invesco Ltd, up from 38% five years earlier.  Indeed, both Brilliance and Yongcheng had enjoyed pristine triple-A ratings from China’s onshore credit rating agencies.  The recent spate of trouble has done little to change that. According to Wind Data Service, only five Chinese companies out of more than 5,000 have been downgraded below the double-A threshold since the Yongcheng and Brilliance defaults.

“China’s rating agencies are even worse than [those] in the U.S.” Andrew Collier, managing director of Orient Capital Management, groused to the Financial Times. “They’re not only beholden to the customer but also [to] the government.”

Like a home-plate umpire, the Chinese Communist Party is always right.

What could possibly go wrong?

Another reason for thinking that the European Central Bank will be keeping rates low for as long as it can, via the Financial Times:

Europe’s top banking supervisor is writing to the region’s biggest lenders to warn that many of them are failing to do enough to prepare for a likely increase in bad loans due to the fallout from the coronavirus pandemic.

Andrea Enria, president of the European Central Bank’s supervisory board, said the shortfalls in banks’ preparations for a likely rise in bad loans was one factor to be considered in its decision on whether to allow them to resume dividend payments and share buybacks.

Speaking at the Financial Times Global Banking Summit, Mr Enria said some of the 117 banks it oversees were “all over the place” on provisioning for the likely rise in non-performing loans. This was “a concern” for supervisors, he warned.

The ECB ordered eurozone banks to stop all dividends and share buybacks to conserve €30bn of capital in March, shortly after the pandemic arrived in Europe. Since then, the sector has been lobbying hard for stronger banks to be allowed to resume capital distributions early next year.

Mr Enria said “there is genuinely an intensive debate” at the ECB over whether to allow some banks to resume payouts to shareholders. He said the macroeconomic outlook would also be a factor in its decision, which is due to be announced after the ECB publishes its new 2023 forecasts on December 10.

But, to quote the Dallas Fed’s Robert Kaplan (from October):

“Keeping rates at zero can adversely impact savers, encourage excessive risk taking and create distortions in financial markets.”


In November [2019], the Fed warned that a prolonged period of low interest rates could damage the profitability of banks and life insurers and force pension plans to take bigger risks. The result would be to increase “the vulnerability of the financial sector to subsequent shocks,” the Fed said.

The same applies within the EU (where nominal, let alone real, rates are often negative). It’s also worth asking how likely it is that nervous banks will be prepared to boost lending to customers left cash-strapped after the pandemic. The question answers itself and in turn raises questions about the strength of any European recovery.

I don’t know whether there is a green bubble in the markets (my guess would be yes, however bubbles can inflate for a very long time), but one of the reasons that the current sustainability surge is likely to continue for a while is the flourishing ecosystem that both feeds on and nourishes it.

And, yes, the lawyers are on the scene.

Here, via the Financial Times is an example:

Lawyers are paid to find ways to win — whatever the climate. So it should be no surprise that global law firms are scrambling to build out ESG-specific practices to keep pace with the booming demand for regulatory advice and sustainable financial products.

Today, Clifford Chance, one of the four “magic circle” law firms that do the most lucrative City business, announced it had established an ESG task force to be headed by Jeroen Ouwehand.The firm’s ESG efforts will include, for example, advising clients about eligibility of sustainability-linked bonds as European Central Bank collateral, Mr Ouwehand said.

Part of the initiative is commercial — about “monetising our knowledge” as banking clients are moving down the green path as well, said Mr Ouwehand, who is based in Amsterdam and mentioned he became a vegan in 2016. “The last generation of capitalism was really about going global, and I think the next one will be about going sustainable.”

US-based law firms Paul Weiss and Winston & Strawn announced ESG teams this year. In 2019, Freshfields appointed Tim Wilkins as global partner for client sustainability.

“And mentioned he became vegan.”


The climate warriors are coming for your food, but that’s a topic for another time . . .

Random Walk

In contrast to the messy and intrusive U.S. tax system, there is a lot to be learned from how taxation works in Estonia, a country that set out to do things correctly almost immediately after breaking free from the USSR and, to a remarkable extent, succeeded.

But the right lessons must be learned. Via Daniel Bunn of the Tax Foundation, a cautionary tale from Poland:

Poland and Estonia have dramatically different tax systems. While Estonia has earned the top rank in our International Tax Competitiveness Index for seven years running, Poland consistently ranks toward the bottom of the Index. This year Poland ranks 34th out of 36 countries. While consumption and property tax policies are key contributors to this low rank, Poland could also benefit from reforms to business taxes.

Estonia has a cash flow tax on business income. This means that profits are only taxed when they are distributed to shareholders. This is an efficient system that allows businesses to invest and grow their operations and hire without those decisions being influenced by corporate taxes. The Estonian system represents an approach to taxing corporate income in a way that is neutral to business investment decisions and supportive of economic growth.

Poland has taken the Estonian approach to business taxation and decided to implement a reform that, in the end, looks almost nothing like the Estonian system.

This past weekend, the Polish government adopted new tax rules for small businesses that will apply beginning in 2021. Like the Estonian system, the new Polish rules allow businesses to only be taxed on their income when it is distributed to shareholders. However, unlike the Estonian system, the Polish rules only apply to business with revenues below 100 million PLN (US $27 million). This one distinction makes the new Polish rules Estonian in name only.

Limiting the reform only to businesses below the revenue threshold creates a new distortion in the Polish tax system. While some small businesses will likely benefit from the new rules, companies that are close to the revenue threshold will face new uncertainty. In fact, some small businesses will have to plan their tax affairs both under the small business rules and by those that apply for larger companies if their revenue expectations are close to the 100 million PLN cutoff.

The threshold could also drive some businesses to take advantage of the system by misreporting revenues to stay below the threshold.

The new small business regime in Poland joins a suite of other preferential rules that also complicate the corporate tax landscape. The Polish patent box and research and development scheme are just two other examples.

So, while the Estonian tax system is designed with neutrality in mind, Polish tax rules are full of distortions that make the task of complying with corporate taxes more challenging.

The Estonian system provides numerous examples of good tax policy that other countries should follow, but it is important for countries to understand the main lesson of the Estonian approach. That lesson is that taxes should be designed with an overarching approach to maximize neutrality and minimize complexity and distortions.

Instead of simply adopting a preference for small businesses, the Polish government should instead overhaul its corporate tax rules and truly adopt the Estonian approach to taxation.

There’s a lot that the U.S. could learn from Estonia about tax policy, but that, too, is a topic for another time.

— A.S.

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