ALEX BRUMMER: The peril of complex trades

The scene was set for an equity market meltdown in the early hours of Monday, when Saudi Arabia retaliated against Russia after Moscow refused to agree to oil production limits which would prop up the price of energy.

The predictable result was a collapse in Brent crude by as much as one-third from $50 a barrel.

Autocratic nations falling out over a critical commodity can be damaging to us all. The reality is that Opec – the cartel of oil-producing nations – and Russia no longer have exclusivity over how energy prices are set. 

The scene was set for an equity market meltdown in the early hours of Monday, when Saudi Arabia retaliated against Russia after Moscow refused to agree to oil production limits

The surge in fracking in the Permian Basin in the US has totally changed energy economics, creating a global surplus.

The speed with which the spread of Covid-19 has contaminated oil prices and stock markets across the globe is testimony to how little human control there is over commodity and financial trading.

It was once the case that oil moved in lockstep with gold as a safe haven for investors in times of trouble.

As was seen during the financial crisis, the scientists and engineers eagerly employed by trading firms have created products which are so complex no one can be sure how events will play out when market shocks come around. 

The only comfort in the present situation is that post the financial crisis, the banking system has been rendered safer by tougher regulation and capital requirements. 

Risk has been shuffled off elsewhere, to harder-to-police hedge funds and private equity firms.

As noted here last week, the IMF estimates debt-at-risk at £14.6 trillion – that is funds borrowed by firms unable to pay their interest bills.

Fast-trading techniques, outlined by Michael Lewis in his 2014 book Flash Boys, placed AI, telecom speeds and other technology ahead of human intervention.

Stock jobbers in the UK and market makers in the US once acted as a safety valve against the kind of huge swings in prices seen in latest trading. 

By temporarily holding stock, these piggies-in-the-middle were more able to moderate wild swings which can see the value of investments wiped out in a nanosecond.

Using debt to buy shares is as dangerous as ever, as Cineworld chief executive Moshe Greidinger has discovered. When the tide goes out, the borrowers are left stranded.

Coming home

Over the past couple of decades, the goal for many FTSE 100 enterprises has been to increase exposure In Asia.

Tesco is moving in the opposite direction. Chief executive Dave Lewis has abandoned the strategy of predecessor-but-one Terry Leahy, who wanted 50 per cent of revenues overseas. 

Fortuitously for Lewis, the decision to pull back from Thailand and Malaysia, following recent disposals in South Korea and China, looks timely.

Covid-19 has taken the shine off globalisation and the Asian miracle.

What the big disposal worth £8billion does mean is that Lewis has greatly de-risked the Tesco balance sheet. 

The last accounts show a pension fund deficit of £2.3billion and net debts of £2.8billion, down from over £8billion when Lewis took the helm.

His pullback from overseas is counter-intuitive. As a former Unilever executive much of his work was in newly rich economies, so he is more than aware of the opportunities.

Moreover, at a time when the supermarkets are endlessly whingeing about the retail environment – from business rates to competition from Lidl and Aldi – having alternative sources of income in Asia and eastern Europe might look sensible.

When the deal with Thai conglomerate Charoen Pokphand (CP) Group is completed, Tesco proposes to hand up to £5billion back to shareholders. 

That will be small compensation for FTSE 100 investors who are watching their savings being savaged.

A better strategic route for future-proofing Tesco might be to step up IT and digital distribution spend, and to bring forward green goals.

Infection risk

Could there be a worse moment for a big insurance merger? US financial group Aon is splashing £23billion on insurance broker Willis Towers Watson in the world’s biggest insurance deal. 

Aon investors are being asked to swallow a big premium of £3billion at a moment when shares are in freefall and Covid-19 is threatening to land the industry with enormous claims, ranging from cancelled sporting events to business confabs.

And these are the people who are meant to understand risk. Yikes.


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