A few years ago, we did some work around our brand and messaging with the excellent David Butcher of Communications and Content, the outcome of which was the adoption of a Centrus strapline that we’ve used ever since, Finance with Purpose.
One of the reasons I love Finance with Purpose as a core mission statement for our business is that it encapsulates three core aspects of what Centrus believes in:
1. Our People
Our people are our most valued asset and I’m incredibly lucky to be surrounded by such a great team. They bring high levels of energy, talent and engagement to their work, consistently delivering innovative solutions and successful outcomes to our clients. We are absolutely committed to making Centrus a great place for people to learn, thrive and enjoy successful careers, allowing our people to work with a real sense of purpose and commitment.
2. Our Services
We are a financial group committed to sustainability, real assets and essential services. We are fortunate to have built a market leading position across sectors such as affordable housing, education, energy transition, water, infrastructure and transport – all of which deliver useful outcomes and positive impact to society. We are committed to responsible finance as a purposeful and positive force in enabling high quality infrastructure, services and employment while offering stable and reliable long term investment returns to those who need them.
3. Our Business
We have a real passion and belief in business and entrepreneurship as a force for good. As well as generating economic growth, great businesses provide employment, career opportunities and a positive impact on the communities within which they operate. We have had a long held commitment to these values and our recent certification as a B Corporation underlines this belief and sense of purpose in what we do.
So, next time you see us using #FinancewithPurpose, hopefully you will have a better insight as to precisely what we mean!
Another week, another round of interest rate increases. With the Federal Reserve having led the inflation fighting charge on the part of Western Central Banks, its 25bp increase to a 4.5-4.75% target range represents an easing off of the rate of increases. With the Bank of England following on with a 50bps increase, taking its policy rate to 4% – a 14 year high – and the ECB also hiking by 50bps to 2.5%, the squeeze on indebted households and borrowers (including governments) continues.
In the UK and the US, the housing market is already showing signs of stress, unsurprisingly in the US, where the benchmark 30-year mortgage rate has gone from sub 3% to as high as 7% before falling back to north of 6% this is having a negative impact on both new housing orders and house prices, although, the effects seem to vary regionally. In the UK, December house prices fell for the fifth month in a row, the longest decline since the market correction in 2008-09, with mortgage rates in December averaging 3.67%, the highest in a decade. Savills’ latest forecast shows UK house prices falling by an average of 10% during 2023 – when even the estate agents are this bearish, you know the housing market outlook is gloomy.
For the UK, the dark economic outlook continued with the IMF forecasting that the UK would be the only G7 economy to contract in 2023, citing high taxes, increased interest rates, high energy prices and a squeeze on government spending. The IMF forecasts will place further pressure on Jeremy Hunt from his own backbenches to shift back to a more growth-oriented strategy in the forthcoming budget.
Improved sentiment in public & private debt markets in early 2023
Despite the various storm clouds, there were some reasons to be cheerful as the new year commenced. As we know, 2022 was a pretty ferocious year regarding funding markets and volatility across inflation, rates and energy costs. The resulting melee caught many off-guard with the result that public debt and equity markets ground to a virtual standstill at times with volumes massively down on previous years. Although private markets picked up a certain amount of the slack, price discovery becomes increasingly challenging without visibility of reliable public market benchmarks. Being a fickle bunch, investors appear to have rediscovered their nerve over the Christmas break and January saw record levels of issuance in the Euro fixed income market. Although Sterling was less active, there is a clear return of appetite and liquidity as reflected in new issue premia for primary bond issues which are tight to negative, underlining a major shift in investor sentiment.
This is also reflected in buoyant private credit and banking markets at the current time as evidenced by deals that we have in the market for housing, infrastructure, energy and real estate clients. As a result, borrowers are dusting off investment and capex plans which were quietly deferred last year and showing a greater willingness to re-enter funding markets, particularly with all-in rates significantly lower than the levels reached during the UK market spasms of last September. To put this in context, the underlying 5, 10 and 30-year gilt/swap rates are circa 1.5-1.75% down from the highs of last year and credit spreads are 50-100bps lower depending upon the credit rating and sector in question.
Although I appear to have missed my invitation, colleagues from our Investor Coverage team had the tough task of departing the UK winter and heading to the US Private Placement Industry Forum in Miami. The positive early 2023 tone was also very much in evidence from the many US institutional investors they met over there with a strong appetite confirmed for strong credits across affordable housing, real estate (secured and unsecured in both cases) and infrastructure. 2022 underlined the need for borrowers to maintain flexibility and access to different sources of capital and given the depth of the US market, this remains an important option for many debt issuers.
Given the gyrations of 2022, we are seeing a renewed focus on risk management across our client base across rates, inflation and power/energy costs. Even though borrowing costs have fallen materially, along with wholesale gas and electricity prices, clients are keen to take risk off the table and to lock down certainty in their business plans wherever possible, even if on balance they expect markets to move further in their favour.
So, in spite of the challenging backdrop, debt markets have very positive sentiment and strong momentum into February, which we hope will set the tone for the rest of 2023.
We wave goodbye to 2022 perhaps with more of a sigh of relief than a tinge of sadness. For it has been a difficult year in which hopes of a “return to normality” after the disruption of the COVID lockdowns were dashed by a confluence of events which have rocked households, businesses, economies and countries to their foundations and demonstrated the fragility of systems which operate without hitch for long periods of settled and benign conditions but which can break apart rapidly under stress.
Variously, 2022 brought us:
War in Ukraine – arguably the first major strategic armed conflict in Europe since WW2. Aside from the obvious and terrible humanitarian toll being inflicted, the knock on effect in geopolitical and economic terms is still unfolding, but will likely be profound. The sanctions imposed by the US and its strategic partners in Europe have fractured the global energy supply system and perhaps signalled the beginning of the end for the dollar-based global monetary system.
Leverage & fragility – in the second half of 2022 the UK experienced a financial convulsion on the back of the Truss/Kwarteng mini-budget. Exploding gilt yields led to a spiralling liquidity crisis for UK pension funds employing LDI investment strategies (basically leveraging assets to drive higher returns in a low interest rate environment) and ultimately forcing the Bank of England to capitulate and re-start its gilts purchase programme temporarily. While many viewed this as a UK specific issue, it was one of a number of rivets popping in an over-leveraged system with rapidly rising bond yields and a rising dollar. Other tell-tale signs were a massive provision of dollar liquidity to the Swiss Central Bank from the Fed, most likely to aid a well-known Swiss bank and the Japanese Central Bank being forced to ditch its 25bps peg on 10 year Japanese Govt bonds in order to prop up the Yen –a supposed safe haven currency whose value had dropped precipitously against the USD.
Inflation at 40-year highs – the energy crisis and broader supply chain issues saw inflation rising to multi decade highs putting further strain on household, business and government finances with the cost of living feeding through to demands for wage increases and widespread industrial action by public sector workers.
Interest rates – with Western Central Banks having long argued that growing inflationary signals were “transitory” in nature, they were forced to throw in the towel in 2022 and to spend much of the year playing catch up by increasing policy rates at an unprecedented pace with bond yields following a similar trajectory. It has become increasingly clear that Central Banks face the unenviable challenge of having to act to control inflation (politically a high priority), whilst minimising the impact on growth with many economies already heading towards a recession. The end of a 40-year bull market in interest rates and the end of an era of easy money experienced since the global financial crisis is likely to have profound effects on asset prices which were driven up by a combination of lower equity return requirements and cheap and easy debt; further impacting consumers sense of a reduction in wealth.
Energy Crisis – UK and Europe (along with other net energy importers) saw dramatic spikes in energy costs, partly as a result of sanctioning one of its major suppliers of oil and natural gas but also in part as a result of poorly thought through energy policies going back many years, including lack of strategic energy security planning and over reliance on intermittent renewable energy without the necessary storage technology to cope with this. This has led to enormous pressure on households and an existential threat to energy intensive industries in the UK and EU. Governments with already high debt to GDP ratios were forced to step in with energy price cap mechanisms –putting further strain on public sector finances.
Each of these issues in isolation would be a serious and newsworthy event. The fact that they happened concurrently felt rather like living through one of those “perfect storm” scenarios that businesses use as an extreme but highly unlikely set of events designed to test a business plan to breaking point.
In the immortal words of D:Ream and New Labour, surely in 2023, Things Can Only Get Better? We certainly hope so. We found 2022 a tough year to do business and we know that many other businesses are far more exposed to the above issues than those of us working in professional services and finance. Rather like after COVID, we would though caution against any near-term expectations of a “return to normality”.
Sadly, there appear to be few signs of an end to the Russia-Ukraine conflict and with the major powers directly and indirectly involved seemingly entrenched, escalation at this stage seems a more likely eventuality than peace.
While the energy crisis will likely give a long-term boost to the UK and Europe in terms of energy security, supply, clean energy production and energy storage, for the time being, those countries and regions which are self-sufficient in energy resources will be far better placed to ride out the crisis than those reliant on imports. And with government finances being stretched further from an already highly leveraged position, financing of deficits in a world where the natural marginal buyers of government debt (think China, Russia, Middle East & Japan) may no longer have the same appetite for debt issued by Western nations, there may come a point where these countries face an unenviable choice of paying more to borrow, raising taxes or cutting their cloth to reduce deficits into slowing or recessionary conditions.
While many in the financial markets eagerly await the much vaunted “Fed pivot” – i.e. the point at which Chairman Jay Powell throws in the towel on interest rate increases and rides to the rescue of an ailing economy and stock market, he continues to surprise pundits with his clarity of purpose and clear determination to continue on his hawkish path until inflation is brought under control. Perhaps he will eventually pivot, but it may well only be once the Fed has seriously broken something or other be that Main Street, Wall Street or indeed set off a global financial crisis of some shape or form – that political pressure on the Fed might force a change of tack.
Our advice for 2023
So, our cheery advice for 2023 is to hope for the best but prepare for the worst and in doing so, we would recommend the following:
Ensure that your business plans factor in the possibility of sustained and/or higher interest rates, sticky inflation and continued volatility.
Leave higher than normal risk buffers in business plans and credit rating scenarios.
Factor in higher than normal execution risk for any major financing, merger, acquisition or sale process and allow much longer for transactions to complete.
Prepare well in advance and earlier than normal for funding processes and ensure you have fall back options in case of further bouts of market disruption as experienced in 2022 –strategic flexibility will remain key throughout 2023.
Consider the impact of higher cost of debt and equity capital on asset prices – although this hasn’t been clear across all asset classes, it is reasonable to expect an on-going adjustment as buyers and sellers adjust to a new normal.
Be aware of the higher propensity for political interventions as pressure increases on the government to assist under pressure households and businesses and control government finances.
Assume energy costs remain elevated for longer with associated impacts on EBITDA, and plan the energy strategy and narrative around outperforming those assumptions.
As ever, the team at Centrus is here to support our clients in navigating these choppy waters. If you would like to contact a member of our team or want more information on any of the topics mentioned, please email firstname.lastname@example.org
In December 2022, The UK Government is proposing to bring forward legislation for a new levy on UK electricity groups generating more than 100 Gigawatt-hours (GWh) per annum. The idea is to subject “Exceptional Generation Receipts” to a new 45 percent levy which importantly will not be deductible from profits subject to UK corporation tax. The levy will operate between January 2023 and March 2028.
The UK Treasury recently published their proposed calculation of the levy in their technical note. This calculation is as follows:
Less £75m* UK generation in Megawatt-hours (MWh)
Less a Group threshold allowance
Receipts subject to Levy at 45%
Source: UK Treasury Technical Note: “Electricity Generation Levy”
What is the problem?
As is common with hastily considered tax measures, the devil is always in the detail and there are usually unintended consequences. The consequences that we see in this instance are:
1. The Levy was sold in the press as a windfall tax. Unfortunately, it is not – it is a tax on a proportion of revenues not profits.
As a result, the measure risks taxing groups that have properly incurred costs which are subsequently not being offset in the calculation of the levy. By example, those generating electricity to offset usage within their groups need to create formal intercompany contracts rather than selling to the market as a hedge. Failure to do so risks incurring the levy with no offset on the market price paid by another part of the group. As prices rise, this lack of offset becomes punitive, particularly as the levy is not off settable for corporation tax.
2. The Levy risks distorting the market for renewable generating assets with the thresholds being introduced.
Whilst we think the allowances and generation volume thresholds are sensible to avoid bringing too many companies into the levy regime, there is a risk of market distortion as a result. The size, scope and post-tax nature of the levy, together with near term forward prices means that the levy will have a material valuation impact for some but not all current and prospective owners. Those groups with limited current generation will have a significant competitive advantage over the larger generator groups.
What is next?
The proposals are being drafted into law and will be available for view next month (December 2022) ahead of the levy being introduced in January 2023. Whilst we hope that some of the unintended consequences will be ironed out, we think it is unlikely that all of the issues will be addressed given the rushed timeframes.
If you have any questions please contact Geoff Knight, Managing Director – Centrus
As housing associations’ finances come under increasing pressure, how much will unsecured borrowing have a part to play? Gary Grigor of Devonshires and John Tattersall of Centrus Financial Advisors assess the situation
The housing sector has been hit by a number of challenges in recent months. What began as a cost inflation challenge quickly became a more acute operating margin challenge in the face of unspecified caps.
With borrowing costs now far higher than originally forecast, interest cover covenants are coming under increased pressure.
The pan-sector response is still in development, but capex is likely to slow in the short term and efficiency savings will be needed.
Liquidity requirements are likely to fall too, as the temptation to reduce facilities and save carry costs to optimise interest cover performance appeals.
This strategy has risks, though, particularly where it takes time to put new facilities in place should requirements pick up again.
It is in this context that unsecured borrowing may have a strategic part to play.
Unsecured borrowing allows registered providers (RPs) to dispense with providing and maintaining a ring-fenced pool of property security either via a security trust mechanism and/or direct charging to the relevant funder.
Instead, the organisation must maintain a pool of unencumbered assets for the life of the facility. The upside of this is that the time, effort and expense associated with pledging a ring-fenced pool of property security under conventional funding arrangements is dispensed with, paving the way for a quicker and more decisive funding solution.
Unsecured borrowing can also be scaled up and down far quicker than conventional secured funding.
While an unencumbered pool of assets must be preserved at all times, there are not the same rigorous due diligence requirements to be satisfied.
Provided that the unencumbered assets stack up to meet the minimum threshold from a valuation perspective, then that, in itself, will be sufficient.
As a result, the composition of the unencumbered property pool can also dynamically fluctuate over time, facilitating easier asset management and offering protection should asset values fall, as potentially forecast next year.
The Pros and Cons
Speed of execution: With no security charging process, facilities can be executed and available comparatively quickly. They can also be restructured and re-sized with greater ease. Unsecured facilities can offer strategic value where a debt capital markets programme is in train, but the timing is not quite right to launch.
Flexibility: Release and substitution mechanics do not apply, so managing the unencumbered asset pool is generally straightforward – helpful where stock rationalisation is under way.
Sweating the asset pool: Most portfolios have assets that wouldn’t otherwise be acceptable to a funder yet can still generate borrowing capacity via the unencumbered pool.
Cost of carry: Margins and fees tend to be higher for unsecured facilities, albeit the differential to secured facilities has meaningfully narrowed in recent years, particularly on an undrawn basis (as low as five to 10 basis points per annum in some cases).
Shorter tenor: To further offset the cost difference, most unsecured facilities tend to be structured on a three-year term, if with annual renewal/extension options sometimes available.
Overall asset cover efficiency: Higher asset cover ratios tend to apply in sizing the unencumbered asset pool rather than would otherwise be expected on charged security.
We have advised on £540m of unsecured facilities in the past 12 months, and in several instances, facilities have been scaled up with the additional funding available in less than three weeks from the initial request.
Who should be thinking about it?
Funders will, of course, make decisions on a case-by-case basis, but in our experience, it is likely that an RP with the following would potentially benefit from this financing route:
Reasonable scale: lenders have a strong preference to be one among many lenders, which favours larger treasury portfolios
A strong credit profile – potentially supported by an external rating with a rating agency
A diverse loan portfolio, which is looking to ‘right size’ liquidity, while baking in flexibility and the ability to scale dynamically if needed
A big enough pool of residual unencumbered assets seeking to ‘sweat their assets’ more efficiently
While initially led by some of the newer entrants looking to make a footprint, most commercial funders will now entertain the prospect for the right RP.
In debt capital markets, some institutional investors have also demonstrated their ability and willingness to provide unsecured finance where suitably compensated in the spread, but experience informs us that this tends to be reserved for some of the larger RPs.
If debt capital markets funding is likely to be drawn, the cost differential can also be wider than seen on standby liquidity lines.
This is not to say there isn’t value in unsecured debt capital issuance, particularly where a portfolio contains challenging or quirky assets that would otherwise be challenging to leverage.
The increasingly challenging operating environment may dampen the appetite for unsecured lending among banking institutions, particularly should there be a general reduction in the sector’s credit standing.
However, for the time being we continue to see term sheets offering attractive unsecured funding from a broad range of lenders on a regular basis.
On that basis we consider this a viable solution that deserves due consideration in RP business plans across the country.
Amid the changing financial environment, associations will need a clear focus on quantifying and capping off downside risks, write Jonathan Clarke and Phil Jenkins of Centrus
If any observers of the social housing market thought that the job of the treasurer was an easy one – rolling into one’s home study at 10 am and watching swaps slowly unwind or nudging along some security preparation for next year’s capital markets issue – then apart from being grossly misinformed, they certainly ought not to be thinking that now.
The political and financial turmoil of the past couple of weeks have focused minds; S&P’s awarding on 30 September of a “negative outlook” to the UK’s (AA) rating is in our view a harbinger of negative ratings movements in the medium term. This new path can be navigated, but any hopes that post-COVID we were heading back to the financial world of, say, 2015 have by now been dashed.
The economic and financial markets are the most uncertain they’ve been since the financial crisis, with Credit Suisse’s chief executive being forced to defend the bank’s “strong liquidity position” over the weekend (1-2 October), as soaring credit default swaps suggested market concerns.
In that context, we thought it would be of interest to refresh a piece of analysis we did five or six years ago looking at sector profitability.
A few years into the post-financial crisis period – in the middle of last decade – the macro-economic environment was working out pretty well for housing associations (HAs). Rates were held low and market participants were relaxed about the lack of long-term exit strategy from the various forms of government intervention that sustained that position.
Inflation was positive and low and generally flowing through to rents. Researching for this article, we were reminded of anguished debates over whether Consumer Price Index (CPI) plus one per cent was very slightly worse than Retail Price Index (RPI) plus 0.5 per cent and the ending of rent convergence. (Those were innocent times!)
The broader issues around the lack of affordable housing were very real, but the job of the HA financial risk manager left plenty of strategic space for thinking about development and investment.
The chart above shows the global net surplus for the sector. Pre-financial crisis, the sector net surplus was just a few hundred million pounds. It’s a lot more now, having grown steadily between 2010 and 2018 and peaking at nearly £4bn in 2018, before dropping back to a little below £3bn in 2020 and 2021.
This reflects these macro factors and the growth in surpluses from sale. We’ve analysed what the net surplus would have been had rates been a more constant five per cent (see dotted line), roughly where the weighted average cost of debt (WAAC) was in, say, 2009, since when it has dropped by about one per cent overall. On that basis, the past couple of years would have been circa £2bn per annum, so still well above pre-financial crisis levels.
On one level, this is a reasonably encouraging picture of health. But focusing just on surplus underplays challenges around higher indebtedness and therefore riskier balance sheets, as well as the emerging investment requirements of existing homes (ie fire safety and decarbonisation spend), which feature in only a limited way in the historic data.
Also, of the circa £3bn FY21 net surplus, surplus from all types of sale was circa £1.5bn. Without that (relatively) risky activity the net surplus with normalised finance costs is not so different from where it was 15 years ago.
Debt per unit and rent policy
In terms of balance sheet profile, the chart below shows the path of indebtedness over the same time period.
Debt per unit growth has significantly outstripped CPI. The early years of this period saw an RPI link and the uplift of rent convergence, but we also have the more recent ‘minus one per cent’ years, and looking to the future the likely five per cent cap. More fundamentally, we are now in an environment where earnings and therefore market rents, to which social rents must in a loose sense be anchored, are not growing in real terms.
In a nutshell, pre-financial crisis the sector made little profit but took little risk. For the past 15 years it has taken risks but been rewarded with much higher profitability, and most forays into development for sale have been successful. But profitability is now back under pressure and cash is being diverted to non-remunerative investments in fire safety and decarbonisation.
Even if these investment concerns are overstated (many associations do not have material fire safety issues, in particular), the underlying model in terms of letting the balance sheet take the strain is in a different place to where it was at the start of this period.
What does it all mean for HA finances?
We draw a couple of key conclusions for HAs’ finances. First, interest rates (and perhaps volatility) are likely to remain at elevated levels compared to the past few years, and perhaps return to being more grounded in the underlying realities of how much private actors require as compensation for delayed consumption (eg meaningfully positive real rates).
Investment decisions will need to reflect this.
Second, while the need for more affordable housing and the investment requirements of existing stock are very real, HAs are at risk again of being seen as cash cows by government. And this is in the context of inflation pressures which may, if rent caps persist for any length of time, create a material inflation mismatch between revenues and costs.
Other sectors and indeed actual people will be feeling the same (or greater) pressures. But if the risk profile of a business has changed, then the approach to corporate finance risk management changes too.
For much of the past decade, financing and hedging decisions for many of our clients have been a relatively relaxing exercise in choosing the best option out of a relatively wide range of acceptable and easily obtained alternatives.
What is needed now is a clear focus on quantifying and capping off downside risks in ‘technical’ areas such as interest rate hedging and access to financing (particularly for weaker credits), but also through ensuring that the financial management of the business as a whole is joined up. This extends to controls over the development programme, integrating financing and asset management decisions, and investing management time in high-quality processes around budget-setting and monitoring.
On the 1st September 2022, the UK High Court dismissed a judicial review, brought by some of the country’s largest defined benefit schemes, over the UK government’s plans, to effectively replace the Retail Prices Index (“RPI”) with the Consumer Prices Index including Housing (“CPIH”).
The ruling makes further legal challenges unlikely and the UK Statistics Authority (“UKSA”) can now legally and practically implement the proposed changes to RPI in February 2030…
This whitepaper asks:
What now for gilts?
What are the implications for other financial instruments using RPI?
As part of their business planning and risk management processes, many of our clients pull together “perfect storm” scenarios in which multiple variables all hit negatively at once in a “what would it take to break our plan” type exercise.
To summarise the perfect storm facing the UK this winter:
CPI Inflation is running at 8.8% with Bank of England forecasting a peak of over 13% in Q4 2022 and more extreme scenarios from other forecasters, as high as 22%
Energy costs are likely to be 3x higher this winter than last year
Base rates have increased from 0.1% in December 2021 to 1.75% today with more increases on the way
Ten-year gilt yields have increased by c.2% over the last 12 months
This changes everything.
Take for example a household with a £250k mortgage relating to base rates (there are circa 1.9m of them). If they suffer the full impact of base rate increases, their interest payments will have increased by more than £4k per annum or just under £350 per month. Now, layer this on top of a possible increase of over £200 each month for energy bills, not to mention higher food and petrol prices. A perfect storm indeed.
Now, I use a household for illustrative purposes, but you can apply the same set of issues to pretty much every business in the country, particularly businesses like many of those that we advise which are capital intensive in nature and therefore utilise significant volumes of debt. Since all businesses are energy users and many businesses utilise debt at some level, it is safe to assume that the pain is being felt, or will be soon enough, right across the board. In many instances, you can track this same set of issues right through the product life cycle:
Energy costs, commodity/input prices (including by-products such as fertiliser which requires natural gas) and debt servicing costs will strike at every level of the system on the way through – and right at the end of that chain? The poor consumer, who is already seeing disposable income diverted in order to meet the calls on cash outlined above.
So, what gives?
There isn’t much sugar coating to be done here. The combination of factors at play here is a toxic one which does indeed present a perfect storm for many businesses. In my view we are likely to witness one of those periodic shake-outs of the system which will test the resilience of business models and the nerves of those charged with not only safe navigation but in many instances, survival. It didn’t quite happen post-financial crisis but maybe in due course some of the policy responses to that last ‘big event’ will be seen as a contributing (if not only) factor to the economic story of the 2020s.
Some thoughts on what the coming months and years may hold:
More bailouts – one way or another, UK and European governments face a massive bailout bill to mitigate the societal and economic impacts of what many would consider to be their mismanagement of energy policy over recent years. Some estimates have suggested that just in the UK this may reach as much as twice the cost of the Furlough Scheme at well over £100bn. The incoming Truss Government will have to square this impact on public finances with its desire to stimulate economic growth and investment through tax cuts. Either way, UK and EU countries face huge bills which will worsen national debt and likely maintain Sterling and the Euro under significant pressure against the US Dollar for the foreseeable future.
Political uncertainty – there will continue to be many and varied views on how to run a democracy, but it’s fair to say that in the US and Western Europe the “range of normal” is widening compared to, for example, the post war period through to the Global Financial Crisis (perhaps with the notable exception of the 1970s). One can see obvious tensions in the US, to a lesser extent in the UK and many European countries, and a mixed bag around the rest of world including for example some evidence of tensions emerging within the Chinese polity in response to somewhat faltering growth there. And this piece isn’t about the war in Ukraine but that clearly has triggered some of the factors noted above; it would be wrong not to acknowledge the unfortunate level of uncertainty for people living there and the surrounding countries.
Security & self-sufficiency – regardless of pressure on the public finances, the Government will be under intense political pressure to step up to a wartime footing in respect of greater energy (and food) resilience and self-sufficiency. So, expect to see large investment programmes and policy support in agriculture, fossil fuel exploration/production, gas & battery storage, renewables and nuclear, along with associated grid infrastructure.
Technology – this investment boom, along with increased re-shoring of supply chains (again driven by security of supply, even at higher cost) will drive and accelerate technological advance and adoption as countries with high labour costs and ageing populations seek to compensate with technological advances
National Finances – the urgency of spending commitments outlined above and in terms of increased defence spending will likely trump orthodoxy around control of the national debt and it is interesting that these factors appear to be aligning with an apparent desire on the part of the incoming Government to “de-fang” HM Treasury. Wartime style spending commitments may also require continued “financial repression” in the form of further QE type programmes and ultimately perhaps capital controls, in the event that this feeds through to currency instability (as the Bank of Japan is realising at the moment, you can cap JGB yields when the rest of the world is raising rates, but this feeds through to the currency in the shape of a massive Yen depreciation).
“Creative Destruction” – What about businesses? Margins will be key to navigating the choppy waters ahead. Businesses operating on wafter thin margins or reliant on ultra-low borrowing costs for their survival are unlikely to last the course – brutal perhaps (and unnerving for business owners, including ourselves…) but on the other hand, a normal part of the capitalist cycle, which was arguably put on hold following the global financial crisis and Covid.
Essential Service Industries – the policy predictions above are likely to present a mixed bag for businesses operating in regulated and/or essential service industries. On the one hand, Government will be keen politically to be seen extracting its pound of flesh through hard-nosed intervention around price settlements to benefit the beleaguered consumer. On the other, large scale and capital-intensive investment programmes will see the Government needing to tap private capital and therefore not wishing to destroy its credibility as an investment partner in key infrastructure. Opportunity beckons for professional tightrope walkers.
Risk Management – some businesses are fortunate enough to be able to pass on their own cost inflation to customers – think scarce commodities, specialist manufacturers or luxury brands. Most however, will see margins squeezed by higher debt, input and energy costs. Larger businesses may have hedging in place to mitigate one or more of these cost increases, even if only for a relatively short period. Hedging and risk management will likely be more widely used by these and other businesses as a result of the recent levels of volatility and the desire to reduce further risk in future.
Credit Ratings – rating agencies will be running the rule over businesses to understand the impact of these changes and risks to their models. Sovereign rating downgrades as the result of deteriorating public finances may trigger corporate and sub sovereign downgrades where there is a clear link through the ratings methodology for essential service sectors.
Higher Debt Costs – in the real assets space, growth in the “Alternatives” asset classes has provided investors with reasonable, low risk, fixed income like returns, during a period of abnormally low interest rates. Bringing some of these asset classes into the investing mainstream has had many positives, in particular, the ability to harness long-term pensions and savings into societally useful asset classes such as infrastructure, PRS, Affordable Housing and Logistics to name but a few. However, the resilience of the case for equity investment in these sectors will be tested as fixed income returns return to levels only marginally below equity cash yields.
Asset Prices – there is little doubt that ultra-low (or even negative) interest rates have distorted pricing mechanisms and inflated prices of many real assets. Ultimately, a sustained higher cost of debt capital will likely feed through to lower asset prices. There is already some evidence of yield expectations rising in commercial real estate for example.
Many of the issues highlighted above point to a recent “reveal” of the fragility of many aspects of the current system, not only in Western Europe and the US but globally. If Central Banks and policy makers were repeatedly “kicking the can down the road” the current crisis certainly has the feel of the impending brick wall. In addition, this lack of resilience is showing itself not only in energy but in housing, health, water, transport and other areas, not only in the UK but beyond.
This is providing a rude wake-up call and forcing governments to at least consider whether the current system is fit for purpose and may herald more fundamental and radical changes. One can’t help but feel that there is a neat (albeit not entirely comforting) confluence of these issues with a re-shuffling of the geopolitical deck and the end of global US and Dollar hegemony. Certainly, the dollar based global financial system is starting to crack and it is likely, that we will, in the not-too-distant future see a co-ordinated monetary re-set at least amongst the US aligned nations a la Bretton Woods, Plaza Accord etc.
On a positive note, many of these changes will force system re-sets, partly market led, partly policy led and will likely herald a new wave of accelerated technological advance to help address current shortcomings across many areas which will bring about new high growth sectors together will employment opportunities, particularly in parts of the UK which are still awaiting the “levelling up” dividend.
This will likely be an unsettling period for both households and businesses and may see some further political turmoil along the way. However, as with most systems, decay gives way to growth and out of the current challenges we face, new opportunities will abound, so sit tight!
The UK Government continues to support the UK’s growing hydrogen market, stating that hydrogen will play a vital role in delivering the UK’s commitment to reach net zero by 2050.
The UK is aiming to develop up to 10GW of low carbon hydrogen generation by 2030, with the intention that at least half of this will be from electrolytic hydrogen, drawing on the scale-up of UK offshore wind, other renewables, and new nuclear.
Here are latest developments in the UK hydrogen space: