March 2021

Country Ranking Trends

  • Magni recently updated scores for Accounting. Accounting systems have a material impact on company financial statements. Statements which reflect the performance of company operations accurately enable better investment analysis while reducing investment risks. The update produced no surprises, though many countries received small upgrades or downgrades because of various technical factors.

European Disclosure Requirements Crossing the Atlantic?

  • The European Supervisory Authorities’ Sustainable Finance Disclosure Regulation (SFDR) came into force March 10th and will be rolled out in stages over the next several years. The rules introduce new sustainability-related disclosure requirements on financial services institutions, including US money managers that have investors in the EU. There will be different tiers of product-level disclosure requirements with additional requirements for products carrying sustainable investment objectives. Firms will also need to provide an assessment of any principal adverse impacts (PAI) of investment products. The authorities want to encourage entities to integrate ESG factors into investment decision-making processes and to reorient capital towards more sustainable businesses. The regulations also set out to combat “greenwashing” where unsubstantiated ESG claims are made about an investment opportunity.
  • Implications: The promise of such regulations is that they will improve the quality of ESG disclosures. Complete and accurate disclosure is core to transparency and, hence, part of good governance. Historically, the US has lagged Europe on many ESG matters. The imposition of the requirement on US financial services firms operating in Europe is an interesting jurisdictional issue.

Hong Kong Unbearable Lightness of Freedom

  • An overhaul of Hong Kong’s election rules was passed by China’s parliament, the National People’s Congress, at the end of its annual meeting. The motion passed with 2,895 votes in favor and none against, while one member abstained. The overhaul changes the size and composition of the Legislative Council (LegCo) as well as that of the Election Committee (EC), the body which elects Hong Kong’s chief executive. In addition, a new body was established to vet candidates standing for election. One of Beijing’s top officials in Hong Kong said the changes were needed to ensure that the city is led by “true patriots”. The city is scheduled to pick its chief executive next year: the changes will curb the influence of opposition groups. Hong Kong’s district councilors within the LegCo are the only officials directly elected: in 2019 pro-democracy candidates won more than 80% of the contested seats. The overhaul expanded the LegCo with more reliably pro-Beijing members, candidates selected by the EC, thus diluting the vote of the district councilors. Because of the erosion of Hong Kong’s autonomy, the Heritage Freedom excluded it from its latest Index of Economic Freedom. Hong Kong had long touted its top ranking as a testament to the city’s economic vitality, but the think tank explained its decision saying, Hong Kong’s economic policies are now “ultimately controlled from Beijing.”
  • Implications: Optimists had hoped that the 1997 handover of Hong Kong would help China become more like Hong Kong. Instead, the reverse happened as the process became one of making Hong Kong look more like China. Recent events have accelerated the pace of change. Historically Hong Kong’s governance scored much higher than China’s governance. We expect the quality of governance in Hong Kong to drift down toward China’s relatively low score, though so far China has been careful to avoid touching the parts of governance related to markets.

Will Anyone Like a Pressure-Cooked Turkey?

  • Turkish President Recep Tayyip Erdogan’s removal of Naci Agbal as central bank governor after just four months on the job sent shockwaves through markets. It was the third time since mid-2019 that Erdogan abruptly fired a central bank chief. In the first day of trading following the move the Turkish lira plunged as much as 15% against the dollar to near its all-time low. Agbal’s dismissal was both surprising and disappointing because he had followed an orthodox approach to monetary policy which was well received by market participants. He had raised interest rates repeatedly to fight inflation of nearly 16%, with a cumulative rise of 875 basis points, to bring the rate to 19% over his tenure. The final straw for Erdogan, who holds the unconventional belief that high interest rates cause inflation, appears to have been a recent larger than expected 200 bp hike.
  • Agbal’s successor, Sahap Kavcioglu, is a newspaper columnist and university professor, who has been a critic of the recent interest-rate increases. He is also a former member of parliament from the ruling party, further casting doubt on his independence. He tried to reassure markets after his appointment saying the central bank’s main objective remained achieving a permanent fall in inflation. However, uncertainty created by these repeated sudden policy reversals raises understandable concerns about economic and currency instability. Turkey now risks a balance of payments crisis given its depleted buffer of FX reserves and the reluctance of foreign capital to come in and fund persistent deficits.
  • Implications: In the period following Erdogan winning the presidency, he pursued reforms which improved Turkey’s governance. Even with the improvements, Turkey maintained a relatively low country governance score. The attempted coup in 2016 changed Erdogan. In addition to pursuing those who he thought participated in the coup, including the alleged instigator Fethullah Gulen, Erdogan shifted to economic populism. Reforms to improve governance ended, while economic policies with negative long-term consequences were enacted. The recent acceleration of inflation is one such consequence. In addition to domestic issues, Turkey faces a complex and challenging set of international issues, thus reforms to improve governance are unlikely. Right now, the country needs to restore confidence that the inflation monster can be tamed.

Pisando água is Portuguese for Treading Water…Brazil Style

  • Brazil’s Supreme Court has found that Judge Sergio Moro, who presided over corruption cases against former President Luiz Inacio Lula da Silva (“Lula”), was biased. The ruling annulled Lula’s corruption convictions. He had been convicted in 2017 of accepting a seaside apartment as part of a kickback scheme involving government contracts. Text messages released in 2019 appeared to show coordination between the judge and the top prosecutor during Lula’s trial. Judge Moro’s impartiality was called into question further when he accepted the position of justice minister under President Jair Bolsonaro.
  • Bolsonaro’s election in 2018 had been helped by Lula’s conviction, which barred a top rival from running. Some saw the appointment as payback, though Moro later resigned accusing Bolsonaro of corruption. The recent Supreme Court rulings open the possibility that Lula could run again in next year’s presidential election. The ruling against Moro also tarnishes the Car Wash corruption probe that had brought to light many instances of high-level graft and could call into question other convictions. Lula faces three other corruption cases in Brasília, cases which have not yet reached a verdict. The filing deadline for the upcoming presidential race is August 2022, and given the slow pace of the judicial process, Lula probably will be eligible if he chooses to run. Under Brazilian law any convictions coming after the registration deadline would not bar his candidacy.
  • Implications: Bolsonaro ran on a campaign to stamp out rampant political corruption. Since assuming office, he has pursued populist policies instead of reforms. The quality of Brazil’s governance has not improved in any material way; hence the governance score is stagnant. Should the next election become a Lula versus Bolsonaro contest, the Brazilian population would have a choice of a left-wing populist versus a right-wing populist. Regardless of outcome, Brazil likely will not be on a path to reduce corruption and improve governance.

Pakistan Loses a Wicket, But Survives the Test Match

  • Pakistan’s Prime Minister Imran Khan, a famous former cricketeer, suffered a setback when his finance minister was defeated by an opposition candidate in an election for a seat in the country’s senate. Senators are elected by members of the National Assembly, the lower house of the country’s parliament, and four provincial assemblies. Although Khan’s PTI (Pakistan Justice Party) and its allies control 178 seats in the National Assembly, Finance Minister Abdul Hafeez Shaikh only won 164 votes in an election conducted by secret ballot. Ruling parties usually can count on support for their candidates in the Senate, but in this instance 16 party members voted against their party’s candidate. Khan and his supporters have claimed that some representatives were bribed by the opposition, though no concrete evidence has been brought forward. Following the defeat, Khan called for a confidence vote, which he won, establishing that he still held a majority in the National Assembly, thus avoiding the collapse of his government. The opposition continues to call for Khan’s removal and has announced plans for protests to press their case.
  • Implications: Mr. Kahn has attempted to improve the business climate in Pakistan. That said, the changes have not had material impact on the country’s governance deficiencies and resulting low governance score. Along the way, he has faced many distractions. The current government does not appear to have the strength to enact much-needed reforms.