Distracted as we were by liquidity events featuring quiz questions
and former Federal Reserve chairmen, we missed this note from Citi
earlier this week on the escalating effects of — one of our favourite
subjects right now — petrodollar liquidity removal from the oil producing sovereign complex.
From Citi (our emphasis):
As Citi notes, in many cases the true nature of the allocation to EM is not disclosed. The disclosed figure, $135-270bn, is certainly large — but it’s not totally scary.
But there are other ways (not mentioned by Citi) that sovereign wealth funds may inadvertently be feeding EM capital markets with liquidity without even knowing it. For example, take “safe-ish” investments in European wealth management products, global bond and equity funds, which allocate capital to the underlying WMP issuers who must then collateralise or guarantee the performance of these products through their own reinvestments/lending to eurobond markets. There are endless ways for these capital flows to be recycled into the EM system.
Not that any of this is new.
A worthwhile read on the history of petrodollar and eurodollar recycling is the following 2014 book “Packing for India” by David Mulford, vice chairman international of Credit Suisse, former US ambassador to India and formally a senior investment advisor to the Saudi Arabian Monetary Agency (H/T to X)
From the book:
In order to stay well below the radar allocations were always kept at below 5 per cent, with SAMA taking great pains to avoid publicity.
Publicly communicated news of its recent redemptions from global fund managers will likely not have been well received for that reason. But it’s important to stress that SAMA is unlikely to be the only such sovereign entity to be redeeming from globally managed funds. Furthermore, there are many reasons for these redemptions, among them servicing domestic liquidity needs but also to make exposures less passive and more active and internally focused.
In that context, should we really be surprised that financial markets are forcing many EM countries with current account deficits to constrain domestic demand? The petrodollar float which provides not just support and lubrication for global risk markets, but access to a continuous liquidity resource to the intermediators of these flows, is being eroded.
With that, arguably, also goes the global shock-absorber effect associated with having a number of extremely wealthy sovereigns reliably and predictably defer their consumption in the global system. Flows aren’t just about to get more aligned, they’re about to get more volatile too, because without a natural buffer in the system there’s no margin for error.
Related links:
Offshore repo, capital charges and petrodollars – FT Alphaville
The greatest sustained EM reserves slump in 20 years – FT Alphaville
With petrodollars also go global reserves – FT Alphaville
Goldman on the commodity/EM financing negative feedback loop – FT Alphaville
Hello world, I’m the petroeuro – FT Alphaville
From Citi (our emphasis):
One topic we have been focused on recently is the pressure coming from the withdrawal of liquidity by Middle Eastern entities. By funding source, 60% of the AUM in the SWF (Sovereign Wealth Fund) community comes from oil/gas economies. In the other 40%, there is also a great deal of commodity content. So, the acute terms-of-trade shock EM economies are now experiencing will probably continue to impact the ability of SWFs to support new investment flows in Emerging Markets bonds and stocks. According to our estimates the AUM at the top 10 SWFs in the world is now at USD 5.4 trillion. EM allocations, in many cases, are not properly disclosed, but the disclosed EM fixed income exposure at these funds is now running at 2.5-5.0% of AUM. That corresponds to USD 135-270bn, a sizeable portion of the current ~USD1 trillion worth of EM debt held by foreign investors.Sovereign wealth funds have a reputation for investing in highly liquid safe assets. The reality, however, is that it’s been a long time since they’ve restricted themselves to such purist strategies because — like the rest of the world — they too have been feeling the effects of a shortage of global safe assets.
As Citi notes, in many cases the true nature of the allocation to EM is not disclosed. The disclosed figure, $135-270bn, is certainly large — but it’s not totally scary.
But there are other ways (not mentioned by Citi) that sovereign wealth funds may inadvertently be feeding EM capital markets with liquidity without even knowing it. For example, take “safe-ish” investments in European wealth management products, global bond and equity funds, which allocate capital to the underlying WMP issuers who must then collateralise or guarantee the performance of these products through their own reinvestments/lending to eurobond markets. There are endless ways for these capital flows to be recycled into the EM system.
Not that any of this is new.
A worthwhile read on the history of petrodollar and eurodollar recycling is the following 2014 book “Packing for India” by David Mulford, vice chairman international of Credit Suisse, former US ambassador to India and formally a senior investment advisor to the Saudi Arabian Monetary Agency (H/T to X)
From the book:
Virtually every week we opened a new flow of credit to a sovereign borrower or to entities designated by the sovereign and enjoying its full faith guarantee. Our earliest deal was a $1 billion, five-year certificate of deposit placement with the Bank of Tokyo, which was the government of Japan’s designated borrower. This was followed by private placements with British designated borrowers, France, Germany, Norway, Sweden, Austria and leading Canadian provinces.He goes on to explain that by 1974, SAMA was already experimenting with equity allocations. By the late ’70s, equity portfolios in all the major markets had been established albeit under extremely strict confidential terms. SAMA, apparently, was extremely sensitive about the management of equity accounts and demanded total discretion and security from the managers, who were required to provide detailed reports on performance and market expectations twice each year.
Most issues were for five years, or sometimes seven, usually for $200- $300 million, and as time went on they were composed of a mix of non-dollar currencies. All placements were documented under English law, and SAMA sought to create at least a theoretical liquidity by insisting that all placements be in the form of securities in $1,000 denominations or some near equivalent in other securities. This policy represented the Saudis desire to have some measure of theoretical liquidity if they should wish to raise cash for their own development needs.
Maintaining adequate liquidity, of course, was a problem the Saudis never faced. New revenue poured into SAMA every month, and the average life of the growing portfolio hardly reached one year. Private placements were a welcome diversification from bank deposits and the relatively small purchases we made of marketable government securities, but private placements took days to negotiate and weeks to close with the appropriate documentation, not all of which were easy to negotiate with borrowers.
In order to stay well below the radar allocations were always kept at below 5 per cent, with SAMA taking great pains to avoid publicity.
Publicly communicated news of its recent redemptions from global fund managers will likely not have been well received for that reason. But it’s important to stress that SAMA is unlikely to be the only such sovereign entity to be redeeming from globally managed funds. Furthermore, there are many reasons for these redemptions, among them servicing domestic liquidity needs but also to make exposures less passive and more active and internally focused.
In that context, should we really be surprised that financial markets are forcing many EM countries with current account deficits to constrain domestic demand? The petrodollar float which provides not just support and lubrication for global risk markets, but access to a continuous liquidity resource to the intermediators of these flows, is being eroded.
With that, arguably, also goes the global shock-absorber effect associated with having a number of extremely wealthy sovereigns reliably and predictably defer their consumption in the global system. Flows aren’t just about to get more aligned, they’re about to get more volatile too, because without a natural buffer in the system there’s no margin for error.
Related links:
Offshore repo, capital charges and petrodollars – FT Alphaville
The greatest sustained EM reserves slump in 20 years – FT Alphaville
With petrodollars also go global reserves – FT Alphaville
Goldman on the commodity/EM financing negative feedback loop – FT Alphaville
Hello world, I’m the petroeuro – FT Alphaville
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