December 16, 2022: Global News Roundup
Financial contagion spreads, price caps frustrate insurance and derivatives markets
This post was originally published on IPEwithSBB.org.
The Global News Roundup collects news stories from entirely international (non-US) media sources on variety of pressing global issues and events.
Serious strain was evident across the global financial system this week. In crypto markets, the FTX contagion continued to spread. Binance “temporarily paused” withdrawals of the USDC, a “stablecoin” pegged to the US dollar, following $1.9 billion in customer withdrawals over the preceding 24 hours, which was “the largest daily outflow over a 24-hour period since June 13”. Blockchain data firm Nansen explained that “Binance's withdrawals are increasing due to the growing uncertainty about its reserves report” (this is a similar dynamic to a bank run). Just this morning, third-party accounting firm Mazars stopped work on Binance’s reserves report, prompting speculation about Binance’s solvency. Reserve reports are widely used in the industry to assure customers that the exchanges have sufficient reserves to back customer deposits. FTX owner and former CEO Sam Bankman-Fried was charged by the US Securities and Exchange Commission with defrauding investors on Tuesday, having been arrested by officials in the Bahamas on Monday just before he was supposed to testify before the US House Financial Services Committee.
Rising interest rates also pummeled investors with large real estate exposures, and even the biggest players are experiencing major difficulties. Similar to Binance, global asset management firm Blackstone, which counts some of the world’s largest institutional investors as its clients (including a lot of pension funds), recently limited redemptions following a surge in customer requests: “Blackstone Inc limited withdrawals from its $69 billion unlisted real estate income trust (REIT) [on Dec. 2] after a surge in redemption requests, an unprecedented blow to a franchise that helped it turn into an asset management behemoth. The curbs…fueled investor concerns about the future of the REIT, which makes up about 17% of Blackstone's earnings.” This week, Blackstone delivered more bad news, announcing a delay in the rollout of a new private equity fund: “The asset manager in recent days informed wealthy investors and their financial advisers that it may wait for fundraising conditions and financial markets to improve before launching BXPE [Blackstone Private Equity Strategies Fund].”
As I’ve been describing in my posts for many months now, lying behind this surface-level financial turmoil are hugely consequential structural changes in how the world does business. Recall that I discussed last week how the recent oil price cap imposed by the US and Europe is disrupting maritime insurance markets and generating competition from insurers in China and elsewhere. One of the world’s oldest insurance companies, Lloyd’s of London, described the situation now facing the industry: “Marine service providers in the EU, US and UK are prohibited from providing financing, brokerage, shipping and insurance services to ship Russian oil elsewhere unless the crude was bought at or below a price cap of $60 a barrel…Overlapping sanctions regimes have become increasingly complex in nature and more onerous for industry players to follow.” A prominent London-based law firm connected to the industry remarked this week that “the Russian oil price cap regime is possibly the most ambitious and sophisticated sanctions regime ever contemplated….There are not going to be easy answers to many of the issues raised by the oil price cap.”
News about futures prices further underscored the extent to which the price cap is starting to undermine ‘business as usual’ in financial markets. Physical commodities markets in which prices are fixed or otherwise heavily managed by governments are generally inhospitable to and incompatible with large and liquid futures markets (this is a major takeaway from my 2012 book, Derivatives and Development). To this point, oil traders today are “baffled” by the price cap, because the fixed price established by the cap conflicts with the common practice of using front-month futures prices—which fluctuate constantly—as “benchmarks” for trading in physical markets. As the Ghana Report explained: “Then comes the bigger problem, and that problem is that crude oil is just not traded under fixed prices, which is already causing headaches in the sector. In fact, oil is traded in such a way that it could often be impossible to comply with the cap, even assuming Russia would sell to cap backers” (emphasis added). Historically, when commodity market speculation, manipulation, and/or price volatility increased to a level perceived to be dangerous, many governments opted to regulate the marketplace more heavily and sometimes even banned futures trading altogether. The US Onion Futures Act (below), passed in the 1950s to ban trading in onion futures following an attempt by a couple of traders to corner the market, is a good example. There are lots of similar examples across many countries during the decades following the Great Depression and WWII, a period during which government price stabilization schemes were also more common.
(Image: Public Law 85-839, “An Act to prohibit trading in onion futures on commodity exchanges”. From the US Congress, in the original here.)
In the same vein, the European Commission last month adopted a proposal to cap front-month natural gas prices, i.e., the price of the contract that expires nearest to the present and is often used as a pricing benchmark for trade in physical markets, in a bid to contain the energy crisis. No final decision has been made at this time, owing to internal disagreements among member states, and futures and options industry associations are lobbying specifically against the provision to regulate future prices. The Futures Industry Association (FIA), the International Swaps and Derivatives Association (ISDA), and the Association for Financial Markets in Europe (AFME) wrote a joint statement on Dec. 7 which stated, “[T]he Associations would like to express their deepest concerns regarding the “market correction mechanism” proposal that aims to cap the Dutch TTF front month future contract price as adopted by the Commission on 22 November 2022…A fundamental requirement for exchanges is to provide fair and orderly markets. The proposed “market correction mechanism” is not compatible with this obligation and if implemented, would have profound adverse effect on liquidity, leading to increased volatility, significant risk complications and risk the creation of a disorderly market.”
In addition to taking a bite out of Western insurance and derivatives markets, the oil price cap is also contributing to the growing push for de-dollarization by the BRICS nations. Since Xi’s recent visit to Saudi Arabia, China has been publicly discussing the “petroyuan” as a means of combatting the “weaponization” of the USD. Chinese state media seemed excited about the possibilities: “A discussion of shift to use Chinese yuan in China-Saudi oil settlement is increasingly rising recently amid an ongoing visit of Chinese President Xi Jinping to the country… Saudi Arabia is "in active talks" with Beijing to price some of its oil sales to China in yuan, citing people familiar with the matter.” Related to the discussion above about trouble in dollar-denominated oil futures markets, the Global Times continued: “The Saudis are also considering including yuan-denominated futures contracts, known as the petroyuan, in the pricing model of Saudi Arabian Oil Co, known as Aramco…” (emphasis added). Connecting the petroyuan to the oil price cap imposed by the US and EU, AsiaTimes noted: “If this new oil weapon works and manages to stifle Russia’s profits, there is every possibility that it will be used again, most likely against OPEC members. That is something the group will be seeking to assess closely and react carefully.”
In other news, farmers on the Mekong Delta have been planting a new variety of rice to help manage severe annual flooding. “This is no ordinary rice variety. Known as floating or deep-water rice, as the water level rises, the rice plants outgrow it, reaching up to three meters tall,” reported the Mekong Eye. Local researchers are working to develop a tastier version of the indigenous strain. Vietnamese farmer Bui Bich Tien, pictured below, has been growing floating rice on his 1.5 hectare farm since 1999.
(Image: Farmer Bui Bich Tien, 52, holds a floating rice plant that grows taller than himself in his fields during the floating season in Vinh An hamlet, An Giang province, Vietnam. PHOTO: Thanh Hue. Courtesy of the Mekong Eye, in the original here.)
Things I’m keeping an eye on:
1. US weapons sales and the Ukraine war: Following last week’s news about potential US sales of Patriot missiles to Taiwan, this week the US announced the sale of Patriot missiles to Ukraine.
2. Consequences of the US Federal Reserve’s decision this week: The central bank raised interest rates again on Wednesday by 50 basis points, and traders were surprised by Powell’s “hawkish” outlook on inflation. I’m most concerned about the impact of rising US rates on the debt positions of poorer and smaller economies and governments. Historically, when US interest rates climb like this, sovereign debt crises follow (big chunks of emerging market debt are denominated in dollars). And there have already been a litany of IMF bailouts negotiated over the course of the year.
3. “Christmas surprises”: So-called because of the tendency for global political shocks to happen this time of year. Check this article out for some interesting historical tidbits.
Happy Holidays! I’ll be back in January with the next edition of the Global News Roundup. Sending all of my best wishes to you and yours in the New Year.