Given the unprecedented times we’re living in, we started a new service of sending once a week, a summary of 3-4 articles which reflect the new realities and their potential impact on our lives and assets. Our assessment is that it may take at least 3-4 years until we return to the pre-Covid 19 normalcy. Below are summaries of four intriguing articles with some unique insights.

Our plan is to publish our commentaries on Tuesdays, the summary of the articles on Thursdays, and the weekly summary of market developments on Saturdays. Our clients will continue receiving private emails regarding market developments from our Managing Director.

VoxEU – China’s Overseas Lending and the Looming Developing Country Debt Crisis

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China’s prominent position as an international lender is well-known, but the full extent of its influence is relatively obscure for a number of reasons. This lack of transparency has become an urgent issue as the pandemic has largely paralyzed the global economy.

One of the major contributors to this fuzzy picture of Chinese debt is that many of its loans (about 50%) are insufficiently reported by either the Chinese or indebted nation, or both. In addition, these loans are typically collateral-backed and lent at commercial terms (rather than the concessional or zero-rate loans from other large official entities). Considering the substantial number of countries with more than 5% of their nominal GDP indebted to China, the lack of visibility of these loans creates significant problems for both the public and private sectors. In the case of emergency debt relief, determining repayment burdens and quantifying financial risks requires access to all outstanding debts. Private investors will likely misprice sovereign debt and find that the collateral clauses of Chinese loans entitle Chinese actors to preferential treatment in repayment and default.

These lending phenomena bear many similarities to the boom-bust cycle of the 1970’s and 80’s. A collapse in the price of commodities caused a wave of sovereign defaults from developing nations who had taken short-maturity, low-transparency loans from Western banks. The bust of these loans wiped out nearly a decade of growth as default negotiations stretched on.

Already, international lending (including Chinese lending) has slowed in the midst of the pandemic, and credit ratings have tanked. These circumstances highlight the urgent need for transparency in the midst of the pandemic as creditors seek assurance that their finances are directed towards COVID-19 relief and not Chinese debt repayments. Poor nations deserve better treatment by China rather than risk the loss of their national assets.

Financial Times – CLOs: ground zero for the next stage of the financial crisis?

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Collateralized loan obligations (CLOs), the cousin of collateralized debt obligations who are infamous for their role in the global financial crisis of 2008-09, are beginning to feel the stress from the Covid-19 pandemic. CLOs are packages of risky corporate loans pooled together to form new securities. Though CLO securities struggled in March due to the crisis of confidence in credit markets, they have regained ground. The major concern now is that further corporate downgrades and escalating defaults could bring down the CLO market and, as a result, lead to a deeper sell-off. 

CLO supporters say “shock absorbers” have been built into their structure, however, this does not change the fact that CLOs are complex, made up of low credit quality, and have high exposure to defaults. About a quarter of the loans held by CLOs have already been downgraded and more than 12 percent of loans held by CLOs are now rated triple C – a rating given when a company is on the brink of collapse. As the prospect of CLO companies becoming unable to pay back their investors increases, rating agencies have begun considering downgrading the debt sold by CLO managers. 

Despite the pressures bearing down on the CLO market, central bank support for corporate credit has supported CLO debt prices. Historically, it has been very rare for the debt of CLOs to not be paid back. However, the global economy still remains shut down and we have no concrete idea of when companies will regain the earnings to repay their debt.

New York Times – W.T.O. Chief Quits Suddenly, Adding to Global Turmoil 

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The Director General of the World Trade Organization (WTO), Roberto Azevêdo, recently announced his resignation, effective August 31st. The announcement comes at a time when there is already heightened uncertainty surrounding global trade. The WTO has recently predicted that global trade could fall by one-third as a result of the Covid-19 pandemic. World trade had already been declining prior to the coronavirus crisis due to the escalation of trade disputes.

International trade advances growth, better allocation of resources, improves incomes, increases productivity and overall is an instrument that has assisted nations to improve their standards of living. However, such trade needs to also be fair, promote equity, protect national security interests, and not be a pawn at the hands of manipulative state powers. Mr. Azevêdo, who has been a strong proponent of international cooperation and open trade throughout his career, said in a recent interview: “Either we shape up and begin to talk to each other and find common solutions or we are going to pay a heavy price.” He hopes his decision to resign this year, instead of at the end of his term in 2021, creates the necessary time for important trade negotiations that would otherwise be taken up by a “politically charged process” to pick a new leader.