Vatican Divestment Campaign heads for collision with Cardinal Pell

As 350.0rg leads a campaign asking Pope Francis to divest Vatican assets from fossil fuels, the Vatican’s newly appointed economic manager Cardinal George Pell is likely resist divestment.

Pope Francis has publicly acknowledged humanity’s role in climate change stating in December 2014 that “the time to find global solutions is running out.”

Pope Francis is planning to release an encyclical on the environment in the coming months. Encyclicals according to Neil Ormerod, Professor of Theology at Australian Catholic University is the most authoritative document a pope can issue.

However, Pope Francis’ acknowledgement of climate change is likely to be opposed within his own ranks, in particular by Cardinal George Pell who was appointed in February 2013 to be the first Cardinal-Prefect of the Vatican’s newly created Secretariat for the Economy. As part of his role Pell is responsible for the Vatican budget and investments.

Cardinal Pell is a well- known climate change sceptic. In October 2011 he delivered a lecture on climate change in which he argued that “the cost of attempts to make global warming go away will be very heavy. They may be levied initially on “the big polluters” but they will eventually trickle down to the end-users. Efforts to offset the effects on the vulnerable are well intentioned but history tells us they can only ever be partially successful. Will the costs and the disruption be justified by the benefits?” Pell then stated that “we must be sure the solutions being proposed are valid, the benefits are real and the end result justifies the impositions on the community.”

Pell’s lecture delved into history, in particularly the Middle Ages when temperatures warmed. But he left no doubt about his views on carbon, stating “as greenhouse operators recognize, plants produce better fruit and flowers when CO2 is increased to 1000ppmv. Californian orange groves are now thirty per cent more productive than 150 years ago and some of this improvement is attributable to the additional CO2 in the air. CO2 is not a pollutant. It is plant food. Animals would not notice a doubling of CO2 and obviously plants would love it. In the other direction, humans would feel no adverse effects unless CO2 concentration rose to at least 5000 ppmv, or almost 13 times today’s concentration, far beyond any likely future atmospheric levels”.

He also condemned climate change activists who he described as “not merely zealous but zealots.”

Pell was no stranger to controversy in Australia but his role as Cardinal-Prefect will give him direct opportunity to influence the investment policies of the Vatican, including its pension investments.

The Vatican is said to have assets of around $4.5 billion through the Vatican bank Istituto per le Opere di Religione, which invests primarily in fixed interest investments and equities.

Whilst restructuring the Vatican’s investments, Pell will also need to heed the Pope’s views on investment. At a conference in 2014 Pope Francis stated ”it is important that ethics once again play its due part in the world of finance and that markets serve the interests of peoples and the common good of humanity. It is increasingly intolerable that financial markets are shaping the destiny of peoples rather than serving their needs, or that the few derive immense wealth from financial speculation while the many are deeply burdened by the consequences.”

Pope Francis’ encyclical on the environment will raise a question as to how the Vatican approaches its own investments. Whilst Cardinal Pell is responsible for the Vatican’s investments it is unlikely that the Vatican will divest from fossil fuels but Pell may come under pressure to invest according to responsible investment practices.

350.Orgs Campaign to Divest the Vatican

One Christian Perspective on Climate Change Cardinal George Pell

Click to access pell-2011_annual_gwpf_lecture_new.pdf

Governments should nudge, not spend

Governments can use ‘nudges’ instead of spending to drive economic growth. An example is using regulation to expand ASX’s trial Equity Research Scheme that provides broker research for a selected number of small cap companies in order to support institutional investment in this market.

We are entering a new global phase where governments will not have the same fiscal power they once had. Governments can use ‘nudges’ to influence economic and social outcomes instead of traditional government spending on programs.

Over the last 100 years governments across the world started making promises they are now struggling to keep.

The first universal age pension promises were made by German chancellor Otto Von Bismark in 1889. The German Government promised to pay pension at the age of 70, dropping to 65 in 1916.

Bismark was a conservative who was the right hand man of Germany’s Kaiser Wilhelm. Bismark’s was motivated, not to address poverty amongst the aged, but to reduce the attractiveness of the emerging socialist party, which he attacked politically, including by passing the Anti-Socialist Law on 19 October 1878.

Bismark’s legacy has grown over the last 120 years as governments have added to their social contracts, establishing universal health schemes.

The problem that governments’ today face is that previous governments never fully funded their pension their promises at the time. Instead of putting away funds to cover future commitments politicians relied on the ability of future generations to fund pensions, age care and health services.

Life expectancy, which was 72 years when Bismark promised the old age pension at 70 is now 81.9 years at birth for the total population (males 79.48 and females 84.45). The funding requirement for government has expanded from 2 years to 16.9 years.

The ability to finance these commitments had one fundamental flaw. It relied on the structure of society to remain the same, that is, that the numbers of beneficiaries of age pensions and health services would be able to be supported by a larger proportion of the population that was in the workforce.

World War 2 produced demographic distortions that are as pronounced as at any time in human history. The effect was twofold. Firstly 50-70 million people were casualties of the War itself. Secondly following the end of the War soldiers de-mobbed. In Australia almost 600,000 Australians were demobilised in a process that commenced from 1 October 1945. The babies that were born over the next 15 or so years created an unprecedented demographic bulge. For many years this demographic bulge acted in our favour, providing nations with productive workers with an associated appetite to consume and drive economic activity.

The baby boomers are now rapidly approaching retirement. The first are now eligible for the age pension. Over the next 15 years baby boomers will progressively leave the labour force.

Within the decade however a significant proportion will retire. Age pension costs are just one bill governments will pay. Health costs rise with age. Age care costs will also increase significantly, although not as quickly as pension and health costs as the first period of retirement for baby-boomers is a period of relative good health.

None of this is news. Around 250,000 baby boomers turned 65 last year.

It is worth remembering that the first Intergenerational Report in 2002 projected that by 2042 the nation would face an annual budget deficit of $87 billion. One of the report’s central scenarios suggested that spending pressures will begin to rise from around 2017. But indications are that the demographic time bomb is coming early in the form of pressure on the health system.

The pressure on the hospital system is consistent with reports from the National Health and Hospitals Reform Commission who have noted that the two major drivers of demand for health services are an ageing population and higher rates of chronic disease, and that both these demand drivers are expected to accelerate over time, adding pressure across the entire health system.

The last Intergenerational Report in 2010 projected that by 2049-50 net debt would be around 20 per cent of GDP with the Budget in a deficit position of 3¾ per cent of GDP. Deloitte Access Economics has also considered the impacts on State Budgets, which are responsible for most health costs. They model that the State shortfall is almost 2½% of GDP by 2050, meaning that the total shortfall in national fiscal finances by 2050 would be just over 5% of GDP.

The key issue for both Federal and State governments is that no matter who is in power we can expect to see continued Budget pressure due to increases costs associated with the ageing of the population.

The pressure to produce Budgets surpluses is likely to lead to a year by year battle to reduce expenditure and increase revenues in order to pay the mounting pension and health costs. Considered over a medium term period such as 15 years – the period of time in which baby-boomers will transition to retirement – we are likely to see political parties make cuts consistent with their own priorities. This will result in what could be considered a jagged approach to cuts. Coalition Governments will seek to make cuts to welfare expenditure, whereas Labor Governments are likely to seek to pull back wealth concessions including for superannuation.

Overtime fiscal tightening and revenue raising can only go so far.

The question for progressive political parties, both here in Australia and globally is whether there are alternatives to this doom and gloom story. The answer is there is.

The challenge for progressive politics is to firstly understand that the power of governments to spend in order to address social, environment and economics issues will be reduced. Instead of proposing government spending as a solution, progressive politicians need to consider alternatives that produce the same outcomes. This is easier said than done and will require a fundamental change of both policy thinking and structures such as think tanks that can debate alternative approaches.

What may be called ‘Nudge Economics’ represents an alternative way of thinking around stimulating economic activity.

Cass Sunstein and Richard Thaler’s 2008 book Nudge proposed how governments could influence health, wellbeing and happiness through ‘nudges’ that would influence behaviour.

Whilst the book was focused on individuals, it is possible to utilise the nudge framework more widely for governments to ‘nudge’ economic activity.

One example of a ‘nudge’ is that governments could support the development of small cap companies by supporting broker research. Currently the debate on encouraging the development of small business focuses on different incentives that can be provided to entrepreneurs.

One alternative is to support the ability of capital markets to develop small cap listed companies.

There are currently around 2,200 companies that are listed on the ASX. The challenge that Australia’s capital markets face is that there are a large number of companies that are of insufficient size to attract investment from institutional investors. The lack of institutional investment interest in turns means that many companies are not liquid which in turn discourages brokers from providing research as broker research is paid for out of the revenues from share trading.

Academic research has demonstrated that there is a link between broker research and company valuations. Companies with increased valuations find it is easier to raise corporate finance and are likely to have stronger growth prospects.

In order to address the lack of broker research of small cap companies the ASX has established an Equity Research Scheme that provides broker research for a number of selected small and medium cap companies. The ASX Equity Research Scheme trial has the potential to be expanded to cover the whole market with in-depth, regular reports.

There are a number of potential ways that the funding for a small cap broker program can be raised.

State Governments may have an interest in paying broker research for small cap companies listed in their home state. It would certainly be cheaper to finance brokerage research than previous schemes where State Governments have competed for a company head office to be located in a particular city.

Alternatively the Federal Government could use regulation to require ASX to establish a broader scheme. The costs of the program could easily be paid for by the top listed companies in the ASX. Whilst it is difficult in a market environment for ASX to require larger companies to pay for the brokerage of smaller companies, since the program would benefit the overall health of the market there is a justification in regulation being used to require listed companies to support the scheme as part of their listing fees.

Having a program that supported brokerage of small cap companies would create an environment that would encourage small cap companies to list in Australia. It would improve the quality and depth of liquidity of small cap companies which in turn would support increased valuations and the growth of smaller companies.

Over the course of 2015 I will write about more potential ‘economic nudges’ that can drive economic activity.


ASX Equity Research Scheme

Carole Comerton-Forde, David R. Gallagher, Joyce Lai and Terry S. Walter, University of Melbourne – Department of Finance , UNSW Business School , University of New South Wales and University of Sydney, Broker Recommendations and Australian Small-Cap Equity

Saudi Oil Prices and ISIS

Global media is focusing on two issues at the moment; the French terrorist attacks and Saudi Arabia’s interventions that have led to a collapse of oil prices. Investors need to spend more time studying global politics to understand that the two events are linked.

The big question facing investors is whether the move by Saudi Arabia to pump out oil is a short or long term move. The answer to this question will have fundamental impacts on the global economy.

Answering this question requires an understanding of the current state of the kingdom of Saudi Arabia.

Saudi Arabia has maintained its kingdom by providing fiscal support for its population and maintaining a strict Islamic culture. The kingdom’s aging monarch King Abdullah is ill, and despite arrangements for succession, the Kingdom is subject to factional power plays with some factions actively interested in disrupting transfer of power. On Saudi Arabia’s borders lies ISIS who is working to achieve an Islamic State in the region. In the last week militants operating from Iraq attacked a Saudi border post killing Brigadier General Awdah al-Balawi who was responsible for Saudi’s northern borders.

Saudi Arabia is facing a budget deficit of around US $39 billion which it will dip into its reserves to fund. Saudi Arabia’s fiscal position is driven by the high proportion of the population that works for the government, which the IMF estimates is around two-thirds of the population. With the emergence of ISIS the Saudi Government cannot afford to reduce spending at this time, as this may in itself lead to civil disruption in the Kingdom.

The question for Saudi is why would they willingly reduce oil prices when the Kingdom needs the revenues for its own budget. The answer is that ISIS represents a greater threat. ISIS was estimated to have been making $3 million a day in August 2014 from captured oil in Syria and Iraq before oil price declines and attacks on ISIS controlled facilities.

The question as to how much of a threat ISIS represents to the Saudi Kingdom is difficult to assess from an outsiders perspective. The killing of Brigadier General Awdah al-Balawi suggests that ISIS may have insider information. What is certain is that with attacks on its senior leaders it is likely that the Saudi royal family is more concerned with ISIS, which would like to replace the Kingdom with a caliphate, than US shale oil producers.

Whether oil prices stay low is likely to be impacted by the success of ISIS. What Saudi cannot afford to do is to give ISIS oil revenues that would enable it to consolidate its power. Low prices are likely to persist so long as ISIS is in control of oil facilities and remains a threat to the Saudi Kingdom. Saudi Arabia has a strong incentive to run its own oil production at full tilt so as to maximise the revenue that it extracts. The US is unlikely to complain as it understands the sensitive situation in the region.

For investors, understanding the future direction of oil prices, will requires an understanding of shifting Middle East sands.

Cyber Cold War increases corporate risk

The Cyber Cold War, which started when the US Government launched the stuxnet digital weapon to attack Iranian enrichment of uranium, represents a growing risk for corporates who are now being targeted by state-sponsored hackers.

On 2 January 2015, President Obama issued an Executive Order placing sanctions on North Korea in relation to what he called the “provocative, destabilizing, and repressive actions and policies of the Government of North Korea, including its destructive, coercive cyber-related actions during November and December 2014.”

The Executive Order directly relates to North Korea’s hacking of Sony but is part of what can be called a Cyber Cold War that started when the US Government launched it stuxnet digital weapon to target Iran’s nuclear program in 2009.

Up until now, the main people to focus on the Cyber Cold War have been computer analysts. Whilst the tech world has been full of chatter on the impact of the stuxnet program that targeted centrifuges that Iran was using to enrich uranium to weapon grade, like much that goes on in the world of geopolitics, investors have largely ignored the evolving story.

The story began in 2009 at a time when the U.S was concerned that Iran was on the brink of developing a nuclear weapons. Iran was doing everything it could to hide its enrichment activities, including developing underground facilities. Fearing the consequences if Iran developed weapons – including a possible strike by Israel – the US launched a sophisticated program that spread virally. The purpose of the program was to find certain kinds of industrial computer programs that were controlling the operation of the centrifuges. The stuxnet program was harmless to computers that did not contain certain Siemens software that was used to control industrial machinery. When stuxnet identified a computer running particular Siemens software that was operating centrifuges it would adjust operational settings that would have the impact of destroying the centrifuge.

Stuxnet – and following digital weapons – were successful in achieving their aim. Iran suffered huge problems with its enrichment program with thousands of centrifuges exploding. The US has since been able to use diplomacy to offer a solution that would see Iran uranium enriched by Russia, which would enable Iran to develop nuclear energy without weapons. Talks between parties are continuing.

But for every action there is a reaction.

Once news of the stuxnet program started to creep out on tech blogs, dedicated software analysts dug to the bottom to discover who was behind the program.

Once it was revealed that stuxnet was a digital weapon created by the US, Iran responded in its own way by developing its own cyber warfare capabilities.

According to Cylance’s report, Operation Cleaver, Iran’s cyber program has targeted, attacked and compromised more than 50 victims since 2012.
Iran’s cyber program has been backed up with rhetoric from Ayatollah Ali Khamenei, Iran’s supreme leader, who in February 2014 urged Iranian IT students to prepare for battle, stating “”You are the cyber-war agents and such a war requires Amman-like insight and Malik Ashtar-like resistance. Get yourself ready for such war wholeheartedly.”

According to Bloomberg Businessweek a catastrophic cyberattack on Las Vegas Sands Corp on 10 February 2014 directly targeted the casino’s owner Sheldon Adelson, one of the richest men in the world who had made inflammatory comments about dropping a nuclear bomb in the Iranian desert to send a message to Tehran to stop developing nuclear weapons.

In August 2012, Saudi Arabia’s Saudi Aramco was targeted with a destructive virus called Shamoon that wiped out data on 30,000 machines. It has been speculated that Iran may have been involved in this attack. Whoever was responsible, such attacks are likely to send ripple effects through nation states. The U.S response to North Korea indicates that it will take executive action – even when the target is not critical infrastructure.

The implication of the Cyber Cold War is that the greatest threat to IT systems is no longer from back-room hackers but from state sponsored, sophisticated operations. The Cyber Cold War is becoming a core business risk. The attacks on businesses including Las Vegas Sands, Saudi Aramco and Sony have demonstrated that state sponsored hackers are likely to target hard and soft targets.

What does this mean for investors?

The development of a truly global economy has presented many opportunities for investors, but it also raises the risks of contagion.

At a company level investors should analyse whether a particular company is exposed to attack for any particular reason. It is also important to assess whether a company has adequate risk management practices in place. Questioning a company on their IT security management has not in the past been seen as a material investment risk – but it is now.

It is also important for investors to spend more time reading the political section of newspapers, and not just the business section. Geo-politics – whether it be the impact of Saudi Arabia driving the global oil price down, or cyber hacking by state sponsored hackers – will play an increasing role in the global economy.

In the long term we can expect that governments and tech companies will make investments that will provide better protection of IT systems and will produce a more resilient business environment. Just as defence investments in technology resulted in innovations that were utilised commercially we can also expect that investment cyber defence may result in innovations that have larger commercial applications. But there is no guarantee that this will be the case. Investors have to appreciate the value of IT investments made by companies that reduce risk. The problem of such investments is that they are costly and businesses that are focused on short term profits will have incentives to avoid investment.

We must also hope that global leaders are able to act responsibly to ensure stability. Whether or not a digital attack is an act of war is a question that will be considered by global leaders as they respond to the new environment.


Countdown to Zero Day

Cylance Operation Cleaver Report

Click to access Cylance_Operation_Cleaver_Report.pdf

Iran’s supreme leader tells students to prepare for cyber war

Now at the Sands Casino: An Iranian Hacker in Every Server

Iran hackers may target U.S. energy, defense firms, FBI warns