We thank everyone who attended the Global Ethical Finance Forum (GEFF) in Edinburgh, Scotland last week. One of the audience polls taken during a session at GEFF found that 82% of delegates believed that it was always important for investors to incorporate their morals and values in the financial system. As a company with a long history focusing on the Islamic finance markets, it is heartening to know that so many others from diverse backgrounds share a similar belief about the role of values in finance. The first article this week highlights examples of what we can learn from HRH Emir Muhammad Sanusi II from his time as central bank governor in Nigeria when he was hired to clean up a banking system on the edge of collapse. Look for more wrap-up content relating from GEFF in this space!
I am at peace. When it was time for me to go, I left
What follows is a reflection by Finance Forward inspired by remarks made at the Global Ethical Finance Forum by HRH Muhammadu Sanusi II, Emir of Kano. Finance Forward thinks HRH Sanusi has exhibited leadership that we would all be wise to follow about maintaining humility about the proper role for finance which is to serve the broader economy.
The financial crisis of 2007-2009 acted as a catalyst for much wider action to make financial services reflect and incorporate widely held values. In an interview that was a centerpiece of the Global Ethical Finance Forum held last week in Edinburgh, Scotland, HRH Emir Muhammadu Sanusi II, Emir of Kano described his own experience as the now-former central bank governor of Nigeria. He shared offered the lessons of his experiences in Nigeria which is applicable much more broadly that we have neither learned enough from the global financial crisis nor put enough safeguards in place to keep it from reoccurring, including by punishing those who helped to cause it. To build on these difficult lessons from the financial crisis, HRH Sanusi called on ethical finance to recognize that it is but one part in a worldview that challenges the dominant world view. For ethical finance to fully become a part of this new worldview, it must not only incorporate Islamic finance and other faith groups into its future, it has to build around a proposition that those put in positions of responsibility (within financial institutions, government or otherwise) help others who are not in the same position.
These insights start us down the road towards defining how finance to become reconnected with its ideal role (one that is idealized by regulators and consumers today and which has roots in various faith traditions) as a connection fueling the real economy. Where it has diverged significantly from this role, as it did massively in the run-up to the financial crisis, it stops acting constructively to support the real economy and begins to detract more than it adds.
HRH Sanusi, when he was a central banker, had to take drastic actions to rein in bankers who were not just acting irresponsibly as they did almost everywhere across the world, but were also diverting money from depositors to their own bank accounts. While not all bankers were acting in such a clear-cut way, there was a general shift by the banking system away from its primary role as acting as a custodian for depositors’ money. With close to 90% of any bank’s funding coming from depositors, and much less coming from shareholders, the banks (and their regulators) must be reoriented from a shareholder-driven model towards a banking sector that focuses first and foremost on protecting depositors’ money.
The proposition that ethical finance can bring is to keep a focus on making financial services simple to not allow it to place its own interests ahead of those who entrust their money and the economy to it. Those who want to push forward the cause of ethical finance should recognize that proper regulation is designed around those who depend on the financial sector, not those who profit the most from it.
Summarizing his own experience as Nigeria’s central banker (he was dismissed for pointing out graft in the oil sector after cleaning up the banks), HRH Sanusi explained to GEFF delegates: “I am at peace. If you see graft and don’t speak out against it, you are part of the system that enables it. I was unable to let it continue to happen and weigh on my conscience. When it was time for me to go, I left”. It is an admirably selfless position and one that should inspire us all.
UAE debt capital markets tell more subtle story about future of oil prices and dirhams
UAE capital markets have not escaped the emerging market impact of the Chinese slowdown – the combination of the bleaker economic outlook and the renminbi’s devaluation – triggered the massive sell off in the equity markets (the Dubai index fell over 20% from its high) with the global plunge in commodity markets and heightened volatility in currency markets. As always, identifying a particular cause for the volatility is difficult with so much happening simultaneously: an imminent US Fed rate hike, Euro debt crises, significant fall in oil prices and an appreciating dollar against most other currencies.
Following a major crash on most bourses across the globe, UAE equity markets suffered from the contagion as the DFM General Index fell nearly 25% in just over a month before rebounding. The UAE bond markets have seen much more subtle changes with the volatile backdrop. While some of the volatility in the UAE bond markets was China-led, the continued low oil prices (and fewer expectations of a sustained rebound in the future) have hurt UAE debt markets.
The current market dynamics of the fixed income markets is responding to different impacts. The impact of China is likely to be small despite being one of the UAE’s largest trading partners accounting for $15.8 billion (about 8%) of exports and $39bn (about 17%) of imports. The devalued renminbi and slowing economy may lower oil imports by China, including from the UAE, but the currency changes will make China’s products more competitive in a region whose currencies are tied to the dollar. Since a significant chunk of these imports come from China and are re-exported throughout the region, a rise in Chinese imports will boost the UAE economy.
However, there is more going on than just the shifting trade winds with China. In most emerging market countries today, the currency volatility is making the debt service burden higher the greater the share of the external debt is dollar denominated. For the UAE, however, there is relatively little direct sovereign debt and the private sector debt repayment is insulated at least somewhat from currency volatility by the USD peg. The prospect of a Fed rate hike could strengthen the US dollar furthermore which would increase the pressure on the currency peg.
The impact of this on the bond markets is reflected in the yield spread on Dubai’s 2022 sukuk compared to a 7-year Treasury benchmark which spiked at the beginning of the year before falling back (though it is rising again). A similar move is taking place in CDS for Dubai as well as for Abu Dhabi. The last time before 2015 that either spread was significantly higher than it was in January 2015 was during the ‘taper tantrum’ of 2013 and before that during the Dubai debt crisis in 2010 and European debt crisis in 2011.
Only in the Dubai debt crisis was the rise in CDS spreads accompanied by a rise in the 3 month currency forward rates which can reflect expectations of a change to the currency peg. During 2010, a huge rise in CDS spreads was reflected with a significant move above zero in the AED 3m forwards reflecting the pressure a Dubai or European debt crisis would have on the regional and global economies.
In 2015, despite continued low oil prices, the CDS spreads narrowed again after their January spike but as sentiment about the future direction of oil prices becomes more pessimistic, the currency forward rates are reaching levels higher than either the Dubai or European debt crises. That could reflect fears about the global economy, but it likely also reflects some bet taking that a Fed rate hike could increase the drain on FX reserves enough so the cost of maintaining the peg is no longer outweighed by the benefits. It’s unlikely that the currency peg would be changed soon, but the debt markets and currency forwards market offer a more subtle analysis of what may be to come that the much greater volatility in the equity markets obscures.