Brewing a bromance between Burnham and bonds

Speaker A: You're listening to the Global Capital Podcast, proudly sponsored by kfw. Hello and welcome to the Global Capital Podcast. I'm Ralph Sinclair and I'm the Chief Product Officer at Global Capital.

Speaker B: I'm John Hay, Corporates Markets and Sustainability Editor.

Speaker C: I'm um, Frank Jackman, Corporate Debt Editor.

Speaker D: And I'm George Smith, uh, Securitization Editor.

Speaker A: Now this week on the Global Capital Podcast, we'll be discussing the UK's likely new prime Minister's relationship with the bond market. Andy Burnham is seemingly headed straight to 10 Downing street having won a by election to become an MP. About a week ago, uh, he famously or perhaps notoriously said that the country shouldn't be in hock to the bond market, suggesting he wasn't afraid to borrow and spend. Uh, he seems to have rode back from that a bit since. But John, we'll be talking about a piece you've written about two ways which Burnham might change policy that would delight the bond market. Um, we'll also be talking about digital infrastructure investment in Europe with the advent of an asset backed securities backed by fiber optic cable networks. But first, one of the most impressive growth stories in capital markets in recent years, which is the Australian dollar bond market. Uh, Frank, you and Diana Bui, our uh, corporate bond and MTN reporter, have written about the growth of corporate bond issuance in the currency.

Speaker C: Yeah, well the growth I think is maybe an understatement. It's exploded uh, when it comes to corporate bonds. Just for instance, this year we've had just under 9 billion of kangaroo bonds. So these are uh, non Australian denominated companies issuing using a certain type of documentation in the Australian dollar market. So we've had just under 9 billion of those year to date. Last year we had 6 billion. In the entire year. The year before, 5.65 billion. So we're already whatever is 50% up nearly on, on last year and there's still another six months to go. It's, I think it's probably also one of the most active periods of this market in uh, almost a decade. It's pretty, pretty impressive. We're seeing these big European and sometimes American, some from uh, Asia. Asia corporates come to this market and take some pretty attractive size. In the last nine or 10 days we've had some pretty, pretty large deals across formats, across jurisdictions with pretty large order books. Um, from Europe we've had ONI and Telefonica debuting in the market for the first time.

Speaker A: Okay, well let's give a brief history of the Australian dollar bond market. It was many years ago, what we call it global capital, a niche currency bond market where in particular sovereign, uh, supranational and agency issuers would go when they could raise money cheaply there compared to their core currency markets. And gradually over time it's become somewhere where they would do more and more funding. I mean for a number of years now, some of the biggest borrowers in the market have had it as their third or fourth largest currency after dollars and euros. And then they sort of vies with sterling for whether it's third or fourth. But in the last couple of years it's really, really grown, uh, to become something of a more permanent funding market for a lot of these issues. And there's been a lot of bank issuance there too. And I guess, um, this spate of corporate issuance is the next uh, development in this market's growth. What's going on with the investor base in Australian dollars, Frank? What's causing this change?

Speaker C: So there's a couple, um, different factors driving at the moment. So the Australian dollar is primarily, it's the local Australian investor base. So it's accounts and investors that are domiciled in Australia. And one of the big drivers of that uh, is the uh, Australia sort of collectors superannuation fund. So the pension funds, which, uh, one person's telling me is about 4.5 trillion, could hit 6 trillion by 2030, at which point it will be the second largest in the world after the U.S. you know, that's a quite a lot of liquidity, quite a lot of cash that is obviously going to need to be put to work. Obviously not all of that is going to go into the Australian dollar fixed income market. But um, yeah, it's pretty, it's a pretty sizable pool of cash. And obviously these investors, obviously if you're investing in your pension, put some in equities, but obviously you want some in uh, fixed income for the safety. And of course if you take it, if you're an Australian pensioner with, uh, Australian dollar pension, you're probably going to want something denominated in your um, home currency. So this sort of growth in the domestic sort of savings and pensions market has helped drive part of this growth story. But also the um, Australian dollar is, it's a currency that's tapped by investors across the sort of broader Asia Pacific region. I know back when I used to cover the niche currency SSA markets, there was a lot of interest out of Taiwan or Japan or Hong Kong, South Korea. These countries will have interest in the Australian dollar market. And one of the big things people are telling me is there is a large population growth in Asia and Asia is one of the fastest growing population regions in the world and therefore it's one of the fastest growing pools of uh, capital. So a bit similar to the Australian uh, pension story, but there is just, it's a growing region in terms of population and if there's more people, an aging population, there is more funds looking to uh, be put to work in uh, the Australian dollar fixed income market has been a beneficiary of that.

Speaker B: And how much Frank, is the arbitrage effectively for these borrowers changeable? Because obviously a lot of these companies, Telefonica and so on, they don't need Australian dollars themselves. They're going to swap this to uh, another currency. And that's only cost effective, uh, if the swaps work out right. So is the market partly benefiting from some more short term or cyclical changes?

Speaker C: A little bit. But um, with the stuff like the arbitrage that because it's now becoming a key part of the funding programs to so many of these corporate borrowers, they may be a little less interested in the arbitrage and thinking actually I don't mind paying a little bit when it can get me some decent investor diversification. I know that um, some of the deals recently have paid up compared to um, where they might have paid in Euros, so obviously a little bit more expensive say to issue in the Aussie dollars. But obviously you're tapping an investor base, the sort of Australian dollar investor base doesn't really play in the Euro market to the, to the same extent as it does at home. But obviously that some of these companies do have funding needs in Australia. I know someone like Angie, which is a French utilities company, does have exposures in Australia that they do, they could use the funds towards. And some of these other companies do have sort of things that they want to finance in Australia. But at the end of the day the arbitrage might not be massive, but the access to a different pool of investors is probably um, well worth paying up a teeny bit for.

Speaker A: I think one of the people you spoke to in the story, uh, Frank said that the degree of investment available in this market now makes it more uh, in his words, structurally sustainable. Now in a classic sort of old fashioned arb market, you know, these, these markets where borrowers come just where the funding is in their favor, they're not so worried about leaving investors with a great feeling about the deal necessarily because they might not be back very, very Regularly. But I think uh, you detected in this market that there is a change of behavior among issuers and that they are pricing deals, uh, so that they will still go on to perform. Which suggests that they're looking at this as a market where there will be repeat issuers.

Speaker C: Yeah, no, definitely. I think people obviously establish the programs and going well we're establishing a uh, kangaroo program. It's not going to be a one off. We're going to keep a regular presence. And obviously the investors have been more than willing to sort of back some of these transactions. Um, I thought it was quite interesting. If you look at say like the order books, someone pointed out that if we go back to there was a sort of spate of kangaroo issuance around 2015, 2016 from big US corporates including Apple, um, which raised two and a quarter billion. But they did so offer three billion book. But now the size of the order books and the demand that people are willing to put to work, it's a lot larger. Last year EDF issued a deal, they broke through 10 billion we had. That record didn't actually stand too long uh, because mtr, the Hong Kong uh, rail network operator got a book of 12 and a half billion last week on G, got a 4.3 billion book with bid to cover ratio slightly higher than uh, what it achieved when it tapped the euro market this week. So sort of investors are willing to put money to work and I think they obviously see that there is performance and that these bonds have been performing and they're sort of willing to, to back this paper. And obviously if you're getting uh, whatever it is, nearly three times color book, you can, you can push the pricing tight but obviously they don't as we say, she said they don't want to push it too tight to um, sort of upset the investors and sort of maintain a pleasant, pleasant feeling for them once the trade has been priced.

Speaker A: Yeah, it shows that uh, not only do they intend to come back in the, maybe not near future, but you know, regularly enough. They're worried about what investors think of them. But it also shows that they're competing against other issuers by sort of trying to look the best, which again speaks to how busy the market is.

Speaker B: I spoke to uh, a banker about this the other day and he said something interesting which was that I asked him what had changed in the market and what was really driving this sort of big wave of issuance. And he said that um, there'd been a change in attitude among the investors in Australia, probably driven partly by you know, the sheer weight of money that Frank was talking about. But he says essentially what they've understood now is that if they price the deals at uh, basically the same spread that the same issuer would issue out in US dollars, then issuers will come to the market. So basically they, you know, they've given up trying to in a way determine the pricing themselves to the same extent. They're happy to accept the pricing is the going rate in US dollars. And as a result they're getting a much higher share of the flow, uh, in the currency. It was interesting as well, Frank, that we gave an award this year, didn't we, for uh, Australian dollar corporate issuance.

Speaker C: Yeah. And the award winner, actually I think they were entering the US and they were stopped by airport security with uh, our awards are a big lump of glass. And it's a big lump of glass, does not show up too well on an airport scanner. And um, yeah, they sort of thought all the security guards coming over and they were taking a look at the award in sort of bit of, bit of unease that the uh, security is taking such an interest in this, in this thing. And uh, he turned around and asked them and they suddenly gave him a round of applause and congratulations. I don't know if the, the airport is considering, uh, an Aussie dollar bond and that that factors into it, but uh, we'll have to wait and see.

Speaker A: Certainly shows though the uh, prestige that a global capital bond award carries that uh, even security in uh, US Airports, um, know when to stand up and pay respect. Okay, Frank. Now there's another interesting aspect to corporate debt issuance in Aussie dollars, and that's the rise of hybrid bond issuance. Hybrids are of course the uh, sort of subordinated form of debt that corporate, some corporate investment grade corporates can issue to protect their investment grade credit ratings. Tell us a bit about what's going on.

Speaker C: Yeah, so this kangaroo hybrid bond market is relatively new. I don't even think it's a year old yet. Next, uh, year, I believe, sold the first kangaroo hybrid bond in the summer last year. And we've had deals from the likes of Verizon and most, uh, recently ongee following. Um, it's quite interesting that this issuance is partly driven by, or the interest in this issuance from investors is partly driven by a regulatory change by um, the Australian Prudential Regulation Authority, or apra. So apra, in the sort of wake of the Credit Suisse fallout back in 2023, took a look at what, what 81 or 81 capital bonds do in the foot of Australian bank capital stack. And in late 2024 they basically put out an announcement that said they're going to eventually phase out 81 some sort of bank capitals requirements which meant instead of issuing deeply subordinated perpetual instruments, the sort of major Aussie banks will have to increase the amount of common equity tier one capital in tier two debt that they'll have to issue. But what this is left is a whole of people looking for that really sort of deeply subordinated higher yielding debt from well established companies. So one banker actually said that he estimates there's going to be a sort of 50 billion structural hole in the supply over the next five years as those outstanding 81 maturities roll off and corporate hybrids, both from the domestic market we should say, and from offshore, the kangaroo ones filling some of that, some of that gap. Um, basically this has been cited by many as a tailwind for the market that people are looking to replace the previously strong credit that they got from the Aussie bank majors. Those are sort of very, very high rated banks from the top rated banks in the world and looking to replace what they were getting, those sort of high yielding subordinated instruments with similarly strong and well known credit in the, in the corporate space. So NextEra, Verizon, Oni, all very well established hybrid issuers across a number of currencies. I think they've all done Euros and sterling this year at least, or at least Verizon and ONJI have. So these are issuers ah that are well known and well well versed in tapping hybrid issuance across markets. And obviously people see a sort of a room for them now in the Aussie dollar market.

Speaker A: Yeah and we have seen some international banks fill that gap as well, haven't we? Um, UBS did so last year with an Aussie $81 and in fact got one of our deal of the year awards uh, for doing so, although that does not come with a trophy. So uh, they will be able to uh, travel quite a bit probably through any airport they wish, unencumbered, uh, but yet sadly underappreciated I imagine by airport security.

Speaker C: We might have to bring in a uh, Deal of the Year award for Aussie dollars this year. I don't think we gave one last year in the corporate bond section. So uh, I definitely want to make a note of that.

Speaker A: Excellent.

Speaker C: Given the growth of the market.

Speaker A: All right, good. Well thank you Frank. Um, that story that you and Diana have written is called Offshore Corporate Borrowers Leap into Aussie Dolomart. Now George, uh, turning to you, we keep being told uh, of the need to build digital infrastructure in Europe. In fact sometimes by you, uh, you alluded to that yourself in a recent opinion piece that you wrote. Now data centers are, uh, we've discussed those many times as an asset class within securitization. Uh, but of course the transmission of the data through networks of fiber optic cables is perhaps just as important. And uh, the ABS market is about to play its part, part in Europe in funding those networks, isn't it?

Speaker D: Well we hope so. I think when I was on here a few weeks ago we talked about global abs and that's really where you

Speaker A: mean the conference in Barcelona rather than the uh, asset class itself?

Speaker D: Yes, indeed, indeed. Um, where the European structured finance market kind of gathers each year. And most of that, as I was saying at the time, was about kind of worrying about fraud and that kind of thing. After the collapse of Market Financial Solutions of the founder of which denies any allegations of wrongdoing. But one of the positive points of that um, conference was this excitement about digital infrastructure. And as you say the data center ABS market kind of got going in 2024 and now, I mean lots of people were predicting, asking them to predict when the first fiber deal would come in. Global ABS were saying sort of six months at the, I guess maybe some of the bankers, the more optimistic end of the spectrum, but then other people maybe a bit longer, 18 months. But anyway, I think the point is that there could be a fiber securitization in Europe quite soon. Uh and hopefully the market's kind of ready to get its head around that and underwrite the bonds and take them down.

Speaker A: What's actually being securitized in a fiber securitization?

Speaker D: Yeah, well, uh, that's, I uh, mean there's a lot to say about that. I guess as with all securitization, like the first thing you're securitizing is the receivables themselves. So that is the deal with the end customer, whoever it is, to kind of pay you money in exchange for you providing your fiber data through your fiber uh, cables. So there's fiber to the home, which is the kind of retail one that I'm sure we all subscribe to and we're all using right now to uh, to transmit data back and forth. And then there's like B2B type of fiber businesses where you have contracts with businesses to provide their, their fiber. So at ah, the top level of the securitization, if all goes well, it's, it's those Receivables but that's obviously backed by the entire fiber network um, which is quite a bit more complicated. Like with a data center you have just the building which contains the data center and that's got power and so forth and all the things you need to run a data center. With fiber it's like the cable, the cables themselves and then the various like deals. You have to have the cables in the ground. You don't own the land through which the cables go. You have a kind of a ring and then you have the right to kind of dig up the ground and fix the cables if you need to and that sort of thing. So the cash flows are kind of like ah, as you would have seen in other securitizations, more or less. And um, to an extent there's, there's a caveat to that which I'll come back to. But and then the, the infrastructure itself is, is a very kind of complicated package of, of various different components. I guess the caveat with the cash flow side is that as is the case with the data center securitizations, most of these deals have like tie in periods shorter than the actual length of the securitization or the borrowing that you'd be seeking to do. So in the data center securitizations we often see kind of 15 to 20 year leases and a 30 year legal final maturity on the financing. And the idea is huh, that the data center uh, will be able to be released one way or another to pay down the, the final part of the principle if that happens. And say in this case, I mean people talk about kind of securitization being a 30 year financing uh, on fiber as well or similar. And that's what it has been in the U.S. um, but again your tie ins on your customers are not going to be 30 years. So there's an extent to which you're also thinking about can you release this and will those customers still be around in and over a longer horizon? I guess so.

Speaker B: In a way George, it's quite surprising isn't it that there aren't already securitizations of fiber? Because it's pretty basic infrastructure in a way. After all it's telecom lines using a different sort of wire and they're everywhere across Europe. It shouldn't be beyond the wit of the securitization market to have done this. But I think the fact that there haven't been does tell us something about the way fiber is developed in Europe.

Speaker D: Yeah, I mean so the US I guess is the starting point for a comparison here. That market sort of got going, uh, at the start of this decade and really picked up last year and to a lesser extent in 2023 and 2024. So I mean, it's kind of typical that Europe is about three years behind in terms of developing its capital markets capabilities, I guess, at least as far as securitization goes. So that sort of fits in. I think one of the things there is that the European project finance and bank finance markets in general are quite deep. So if you don't need to raise that much money, you may as well do it in the bank market because it's just significantly easier. And then the other part of it, I suppose, is the rollout of fiber and how that's gone. And what you need for a securitization is like a stabilized network where there's low churn, because as I say, if you're looking 30 years into the future, you need to know what your cash flows are going to be to get the rating agencies and the investors kind of comfortable with, um, that. So in some regions there's been just a lot of, kind of overbuild and competition that's contributed to higher churn. And in some, and there's some consolidation going on in certain markets. And in some markets they just haven't reached the kind of point of stability yet, uh, where they can get comfortable, the rating agencies.

Speaker B: I think it shows that it's a clue to something that is apparent in other ways as well, which is that fiber is a kind of exciting new telecoms technology, but its actual rollout and its financing have not been attended with the same kind of excitement and sort of bullish, uh, investment boom feeling that you've had with, you know, other parts of the telecoms wave like mobile, you know, 20 years ago. And the, you know, we got to the stage with, with mobile where, you know, VOD companies like Vodafone were the, were the sort of top companies in a country or, you know, across Europe. And obviously there's been massive change in the telecom sector with the former darlings, you know, going out of favor and so on and new ones arising. But, but the, you know, a few years ago there was definitely, uh, a lot of enthusiasm among banks. If you talk to them about fiber and you know, they, this is on the loan side, they would be saying, oh, this is a, you know, we expect to be doing a lot of this in the next year. But there've been a lot of credit problems and, and the regulatory issues in in the different jurisdictions can be quite challenging, can't they? And um, and you know some banks have lost money on that.

Speaker D: Yeah, I mean there have been I guess sort of like to varying degrees of kind of um, significance and involvement like balance sheet restructurings or kind of transactions done by fiber operators. Recent ones, um, by Gigaclear and Deutsche Glass Faser which I briefly uh, discussed in the story that they both had as equity injections. So but I think those issues are probably more confined to like certain jurisdictions and particularly to the kind of fiber to the home market which is why I sort of say in the story, I think probably like B2B fiber, which in that case looks a lot more like a kind of data center type receivable structure is probably the better candidate for the first securitizations.

Speaker B: And what are the rating agencies and banks saying about you know, what sort of deals they might be able to bring first?

Speaker D: I think like this has got to look like the US market for further securitization basically because it's going to rely on US Money. Most likely they are, uh, US market is a lot bigger. There's US investors who like generally ah, like the diversification of investing in European collateral. So like giving it a US structure is bigger probably makes sense. That's also what they did in the, in the data center market first. And it's only now that the data center market's probably had four or five deals that people are starting to like think about bringing in some features that more resemble like the European ABS market, be that like a uh, floating rate note or like playing around with the 10 or that kind of thing. And then yeah, I mean the collateral again it was hard to pin down like uh, an exact answer on where it's going to come from. But it seems like with the data centers like you have one or two rated tenants, often like they're the hyperscaler data centers. It may not be exactly the same but like if you have a kind of similar profile, hopefully with kind of rated tenants and things that could make the credit analysis easier or give investors more comfort.

Speaker A: One of the uh, obvious advantages of the US market is that it's one big homogenous place. The European market uh, really isn't. Uh, Even within the EU there are 27 member states, each with their own rules and regulations. What are the prospects for fiber securitization in Europe where they would look to include fiber networks in more than one country?

Speaker D: Yeah, well this is always a problem in European securitization like uh, just purely outside of fiber. Like it's always hard. You know, I think that was a deal, a recent deal which had like Austrian and German collateral and that was like pretty unusual as it was like it's been done in cmbs a little bit. But again it's normally like Belgium, Luxembourg and France or something. They're often quite kind of geographically close together jurisdictions.

Speaker B: So don't forget clos where you know, the portfolios can be you know, continent wide.

Speaker D: Yeah, well CLOs are kind of their own, like they have their own following and that's kind of like the way a CLOS is done. But like uh, even an auto ABS is, is rarely done um, in a multi jurisdictional manner. So I think it's pretty unlikely that fiber where like the jurisdiction not only on the securitization level but also on the actual regulation of the fiber. Networks like vary so wildly and like you know some, some jurisdictions are probably like unsuitable um, even for like this kind of financing because of their structure means that like throwing together different jurisdictions is probably not a suitable option at least to kind of get the market going. It's interesting because I think, I mean this is the same, the same case with data centers. It may be that that's not such a big problem for, for something like fiber where often the problem for a lender is that they have like 40 million portfolio in Spain, a 40 million portfolio in Italy and a 40 million portfolio in Germany, a 40 million portfolio in the UK and if they could just combine them all, they'd have a big enough portfolio for a securitization. It's unlikely. I think that it's more likely that you'd have sufficient collateral in one jurisdiction if you're operating a fiber network. Uh, just because at uh, a certain point the fiber network needs to be of a certain size and requires a certain amount of investment. So maybe it won't be such a problem. But I really wouldn't think multi jurisdictional deals are likely to be the next step uh, for the market for an

Speaker B: asset class like this which is as you say, you know, perhaps quite fragmented across Europe, quite you know, quite new to securitization. Something that often happens is that they start the first deals are in there asset backed commercial paper market through conduits. Do you know if that's happening at all?

Speaker D: I do not. But I mean I guess there's the bank financing market which is probably like quite a lot of project finance and you know there are banks who are saying, you know, we financed this originator and we want to like arrange Capital markets take out of some form. I don't know kind of whether then what further structuring the banks may have done kind of uh, at uh, the back end, but I think in a similar way to the way the datasets market is being driven is seemingly because in Europe at least, there's a lot of loans on bank balance sheets and they want some options to take them out. There's at least some similar motivation in the market.

Speaker A: And so what of uh, this first deal, uh, what can you tell us about who's going to bring it and when they're going to bring it?

Speaker D: Well, I think, as I said at the start, that, you know, there are predictions probably from about six, six months to about 18 months out in terms of who's going to bring it. I, um, think I probably, uh, stopped short of naming names exactly, because I would like to give them a kind of fair right of reply. But you can look at the, at the sponsors in the US and see who's got, you know, there are big infrastructure sponsors who own fiber portfolio businesses and those are the kind of businesses that you would look, I think to see, um, do the first fiber securitization in Europe.

Speaker A: Well, thank you, George. We'll look forward then to uh, that first deal and all of your coverage of this market between now and then. Um, the story, if anyone wants to read it, is first, European fiber securitization could arrive within 18 months. Okay. Well then, John, once again, the UK is looking at another new Prime Minister. The most likely candidate is Andy Burnham. Uh, he was previously mayor of Manchester. In fact, he had a whole political career before that, uh, and was a previous, um, cabinet minister under a previous Labour government. But he's now, uh, set to replace Keir Starmer as UK Prime Minister. And. Well, over to you I think now, uh, what's Andy Burnham's history with the bond market? I mean, I know I sort of alluded to it at the start of the show, but um, it's a particular interest, isn't it, uh, why the bond market is interested in, um, the new Prime Minister is going to be.

Speaker B: Yeah, I mean you, you did mention in the past that he'd sort of dismissed the bond market a bit or said that we shouldn't be so scared of it. But, but it's been very noticeable in the last few months when his, the sort of campaign to have him installed as the ah, new Prime Minister replacing Keir Starmer has gathered momentum that he very quickly toed the line and you know, obviously the spectre of Liz Truss and what happened in 2022 when she put out a fiscally expansive budget, uh, that the market wasn't prepared for and didn't buy into. Her Prime Ministership ended, you know, I think it lasted in total 49 days or something. And really, you know, it's not an exaggeration to say that the bond market forced her out. Now we've had ah, in fact umpteen prime ministers recently forced out in the uk. Only one, Rishi Sunak, was actually voted out in the general election. Out of the last five or six, you know, so Keir Starmer, he wasn't forced out by the bond market, but the bond market is very much a player in this whole transition. And really I think uh, a key moment was uh, on the 18th of May when Andy Burnham, this was only four days after the by election was called, that was going to be his way back into Parliament. He said that he was going to stick to the fiscal rules of, of the existing labor government and essentially that allayed the concern that had been building up in the market with volatility and the guilt curve and so on about fear that uh, the Labor Prime Minister would change and that you'd get a more left wing one who had borrowed more. And this was really the thing that was uh, worrying the bond market and he's basically put that to rest.

Speaker A: Although equally one of the things that has worried uh, the bond market since this government came to power in was it 2024 I think, um, so much happens, one forgets, uh, but these fiscal rules, I mean some of the opinion has been, well they, they're so restrictive that actually it's very hard then for the UK to grow. So there isn't really a lot of wiggle room in those fiscal rules that Burnham is now wants to stick to.

Speaker B: Well, I think yes, and, and this is the, the wider problem for the, for the Labour government has been that it's basically trapped and stuck. It can't really go further left wing because it gets attacked very strongly from the right, the right wing press and so on. And in the middle of that is the bond market. Uh, interest rates are high at the moment. They're higher than they were when Liz Truss was Prime Minister. And that's partly macroeconomic factors. We've also got the war in Iran that started by the US which uh, is, you know, massively pushed up volatility and energy prices and therefore interest rates. So you know, the government's coping with things out of its control but basically there's, it's quite clear that they've got not much room to go left on policy by borrowing more and, and spending more. So, and equally they've been unable to please the left through a number of decisions they've made, you know, trying to sort of be middle of the road. And so the Starmer's government essentially has been unpopular with both sides and that is probably why it's come to an end. Now Burnham's coming in, he's got to try and deal with the same set of circumstances.

Speaker A: Well, speaking of um, Liz Truss and uh, her inglorious 49 days, one of the challenges perhaps Burnham faces is that 49 days from now is um, August 14th. He still might not be in power by now. So if he gets this wrong, uh, he might be the Prime Minister who never was. But luckily John, you've got a couple of uh, prescriptions that uh, he might like to follow that you think would make good government policy and would uh, cheer the bond market. And the first of those is around defence spending.

Speaker B: Yeah, I mean there are clearly one of the big issues uh, in Andy Burnham's inbox is defense spending. And you know, without going into all the details of the uk, uh political decisions, uh, and so on that you know there's basically a review of the government's defense planning and defense spending uh, on a multi year basis that is in the Prime Minister's in tray at the moment. You know, part of it involves a collaboration with NATO of course because you know, there's massive pressure from the US to all NATO members to increase defense spending. So you know this, this is going to be one of the first things that Burnham will have to deal with and that Starmer's government is still dealing with. Two, two defense secretaries in the UK have resigned recently over the issue.

Speaker A: Well one, one secretary, one minister.

Speaker B: Sorry.

Speaker A: Yeah, correct.

Speaker B: Thank you. But, but basically, so he's got to, he's got to make a decision about this. And, and I think it's not easy. No one can pretend it is. You know, it's easy to say, oh, we'll spend more and more and more, but the government doesn't have the money, where is it going to get it? So nevertheless, I think it's critical that Burnham to succeed in, gets on the front foot and has a narrative that is positive, that is, exudes resolution and where he can seem to be defining the story. And you know, so I'm not going to say, you know, exactly what the level of defense spending should be or what we should spend the money on, but he Needs, you know, this is certain to be, uh, a central part of the political scene and debates in the coming years and he needs to get on the front foot with it. And I think that this affects the bond market too, because clearly if there's more spending, it means generally more borrowing and the bond market will need to have an opinion on that. Now my view is that if governments are seen as sort of weakly failing to control spending and therefore borrowing more, the bond market doesn't like that and reacts hard against it. What they can sometimes be persuaded to tolerate is, is a positive plan. And, you know, where the government comes out and says, look, we need to do this, it is an increasing borrowing. But these are the reasons and you know, Germany is a very good example of that. They, they've done that massively under the current Chancellor Friedrich Merz, who made a really 180 degree turn in German, uh, fiscal policy. But the market, you know, although Bund yields have gone up, the market has basically worn it because they believe in the strategy.

Speaker A: I mean, I would say there's a couple of, slight, couple of caveats there. One, um, Mertz is also now incredibly unpopular. It looks like his own party might be trying to get rid of him, um, after not long in power. Such is the way of liberal democracies nowadays. The other reason, I guess Germany was able to make that commitment because it has such better, uh, debt metrics, such better debt to GDP ratios in the UK to begin with. I think you're right though. I mean the defence spending thing seems like a huge opportunity for the uk, both in terms of protecting itself and protecting its economy, which is something that, you know, the markets should like. But also, uh, this isn't just like regular government spending where the money, let's say, you know, goes on whatever civil service pay rises or disappears into a black hole of admin in the NHS or whatever this is. Money is going to end up in the private sector like playing jobs and pushing up tax revenue and things like, things like that. I guess the, the dilemma is that the UK is notoriously bad at uh, defense procurement and wasteful, which is one of the reasons, um, Andy Khan's the defense, uh, minister resigned. So you're absolutely right. It's, it can't just sort of, um, burn Kant's guard and say we're going to meet X percent of gdp, uh, which is the problem at the moment. The John Healey, the Defense Secretary, resigned because the defense investment plan he thought was not enough money. And I guess the Treasury's argument would have Been well, why should we give you all this money when your department wastes so much of it? So um, certainly getting to grips with that uh, dilemma is going to be vital.

Speaker B: Yeah, I do feel for the government and for all governments on this. I mean it's not just the UK that is bad at defense procurement. Probably most countries are. And the reason is it's incredibly difficult because you've got to, you know, modern weapon systems are incredibly expensive. They have to be planned, you know, 10 years in advance at least. And you know, the nature of warfare as we've seen recently changes very fast, especially when there's a major war. You know, the Ukraine conflict has been very different from what military planners would have expected. And so you know, they're constantly trying to, to keep up while having to do things, you know, live with the decisions made 10 years ago. So it is very hard. But I think the government, it's about capturing the narrative. They need to show uh, both voters and the bond market that they're proactive, that they are thinking carefully and that they're on top of the issue.

Speaker A: Yeah, but I guess this is why perhaps the UK should consider joining an institution like the Defence Security and Resilience bank, uh, which is expected. The. Oh, it may be that the treaty is signed for that at the NATO summit early next month. And the benefits of that, if the institution works as I believe it's intended to, it's about sort of spreading sort of procurement best practice. It's about extending funding and guarantees to those sort of defense startups, the ones that can produce, well you know, to give an example, companies that can produce drones quickly and cheaply rather than the UK continuing to pour money into 10 year old armored vehicle deals that uh, they are not really fit for people purpose. You know, obviously there's far more, far more detail and nuance to it than that but broadly speaking these are ah, some of the things the UK could perhaps do.

Speaker B: Yes, it's been very sort of surprising and um, no doubt disappointing to many that countries like Britain, France and Germany haven't, you know, strongly backed the DSR bank pushing it. Rob Murray is British and has even been on our podcast. But um, the reason is probably that they don't see that it would, you know, being able to borrow from this multilateral development bank that's being planned would, would benefit their cost of funding because these countries have high credit ratings and fund cheaply anyway. I think they're m, they're missing an opportunity which Canada seems to have seen the benefit and uh, the Point of, by backing it strongly and that is having a dedicated bank financing the private sector, the defense supply chain has got to help, you know, And I mean, I think there are interesting questions about the risk that this MDB will be taking because it's a very, it's going to be specifically concentrated on one industry and that's not what multilateral development banks usually do. And um, an industry where there is high industrial risk, because of what we were talking about, that the projects can fail to be, uh, as valuable, you know, 10 years later as they. As, as you thought. But I do think, uh, you know, he's got to help the defence industry.

Speaker A: Yeah. And I think to your point about borrowing costs for the better rated sovereigns, I mean, you know, the UK and France of course have um, suffered far worse borrowing costs in recent times. But if you consider, let's say, and I don't know who the members of this dsr, uh, bank will be at this stage, but let's say a number of them are East European countries with worse credit ratings than the Western European sovereigns and higher borrowing cost costs. If they can borrow from the bank and do their defense funding more cheaply and that they become more secure countries, then that is of course a benefit to the UK and its security. Its allies are more secure.

Speaker B: Yeah, totally. And it was interesting as well that there was an opinion piece, uh, this week, I think by Mark Carney of Canada and the Luxembourg politician. And Luxembourg course is, I think, AAA rated, you know. So, um, they can see the benefit and are not holding back from it. So. Yeah, I mean, this could be something that Burnham rethinks.

Speaker A: Yeah, absolutely, absolutely. And speaking of those Eastern European countries, the other country other than Canada and Luxembourg that we know will be involved, Romania has come out and said it will be involved in the DSR bank as well. Um, okay, well, let's leave defence there because we probably could talk about that all day. But the other policy area that you're advocating for, uh, is around green policy, um, almost feels somehow quaint, uh, given how it sort of dominated the, um, financial, I guess the discussion for probably like most of the last 10 years until really this discussion about defence, uh, funding picked up in the last year or two. What green policies can Burnham do? Because also this has been part of this UK political debate lately, hasn't it? Because some of the unions which back the Labour Party, have suggested that we should be focusing on jobs rather than net zero. What's your view on what Burnham should do?

Speaker B: Yeah, I mean, it's a Sad state of affairs when the green policy debate has decayed to the extent that, you know, GMB and Unite, two of the biggest unions, have urged Andy Burnham not to appoint Ed Miliband as Chancellor because, uh, as Energy Secretary he pursued Net zero policies strongly. And that included, uh, putting a curb on, uh, oil and gas development in the North Sea. Just wind back five years to the COP21 in Glasgow. And, uh, this was under a Conservative government and the UK was really leading the green agenda at that point, or at least was, uh, you know, one of the leading countries in pursuing an emphatic drive towards net zero. You know, it's perfectly clear climate change hasn't gone away. The thing that has changed is Trump and the politics in the us. But the European countries, and particularly Britain need to recognize that the facts haven't changed. In fact, industry is progressing in a green way and has made great advances in the last few years. And they need to embrace this instead of kind of being afraid and running away from it.

Speaker A: So what do you think the UK could do then and what policies should it pursue specifically that would both improve Britain's environmental fulfillment and also be of cheer to the bond market?

Speaker B: So I think the first thing has to do with the messaging, right? The previous government, although, you know, it came in with some reasonably ambitious climate policies, has rode back on some of them and that just looks like retreat. It looks like being embarrassed about it. And lo and behold, Labour is losing votes on the left to the Green Party and this is part of them lacking m definition and not being clear what they stand for. The government has to come out and say, we back Net zero. That's the most important thing. Net zero itself has come under, under attack and with accusations that it, that it's against the economy or negative for jobs, that narrative has to be overturned. The, uh, it was London Climate Action Week this week and there were a huge number of events, great participation from the finance sector and from industry and so on. And, you know, the appetite is still there in the private sector to go for green growth. There was a speaker from ey, for example, one of the partners there, uh, said that the work that they are doing on green issues with their clients has shifted and from one of risk and reporting to one of opportunity and growth. And this is really the message that is understood in the private sector, but that the government has been afraid to proclaim. So that's the first thing it's messaging. Second thing is what actual policies are needed.

Speaker A: Right?

Speaker B: So the key thing is about providing policy certainty and A long term approach. Now Adair Turner was speaking uh, uh, at uh, the Climate Action Week as well and he had a very interesting way of breaking down the problem. You can divide the things that need to be done for, you know, to achieve a livable climate into, into three. One is things that the private sector can do alone. Now and with this there's been such progress that uh, renewable energy and electrification and even to some extent uh, electrifying the car transport basically are now efficient. They're cheaper than the alternatives and they're kind of rolling under their own steam. So they don't need a huge amount of financial support from the government. They do need policy support by keeping the regulatory environments stable. And then at the other end of the spectrum you have things, technologies which basically are not economic unless the government changes policy. And he gave the example of iron making. Right. If you produce iron in a green way, it's the same iron as produced using fossil fuels and the product is not itself better. So the only way that that can be made efficient is by the government using a carbon price to require it to be produced in a green way. And in between are uh, things where basically it's about the cost of capital so they can be viable if public sector helps with the cost of capital. And you know, there's a lot of technologies like hydrogen, carbon capture and storage, alternative fuels and so on, which are the next generation of green technologies that the government, you know, they will succeed faster and better if the government thinks about them and plans ahead.

Speaker A: And I guess to tie these two things together, defence and energy, I mean, I guess if the UK is producing more of its own energy from renewables, then that makes you a more resilient, easy to defend economy. So there's, there's you know, perhaps a multiplier effect to be gained from the two.

Speaker B: Yeah, I mean the war, Russia's invasion of Ukraine and in fact the Middle east war have both brought home again the folly of being dependent on imported fossil fuels. And uh, you know we have sun, wind and even tide in the UK and in all other countries or most countries can benefit from those resources and there are ways to tap them that uh, would mean we wouldn't need to import as much energy.

Speaker A: Yeah, I mean I guess the argument that uh, I sometimes hear leveled against um, wind power in particular, but other forms of renewables is that when we produce is the problem with storage is that when we produce it we need to sell it immediately, still have the excess immediately. And the trouble is when it's windy here it's also windy in Germany, for example, and they're also producing a lot of the same time. But I suppose unless you're investing in those areas, you'll never develop the technology to solve that problem of storage.

Speaker B: That's right. And, but battery storage and other forms of, uh, power storage are. There's, there's great technical, technological advance in those sectors. You know, these are the industries of the future. Basically the question for Burnham is does he want to be in the front rank of countries developing these and innovating or left behind? And this is, you know, I think this is the decision for all sensible governments, but in the current political climate, it's not getting the focus it should.

Speaker A: One of the arguments against, uh, what you're advocating for, John, that one often hears, uh, and this is in particular with, I guess, around the debate about whether we should start drilling in the North Sea for oil again, is that North Sea oil will bring jobs and, um, growth now. And yes, emissions might be worse, but the UK's emissions as part of the global total are meaningless. And, um, therefore it doesn't matter. What would you say to that?

Speaker B: Okay, so that's kind of two questions in one. I mean, I admit, I think the question of whether drilling in the North Sea should be allowed is a difficult one. I can see arguments on both sides. You know, I think it's absolutely. There's no doubt that we need to reduce demand for fossil fuels, but whether the UK should also forbid creation of supply that private sector actors are willing to do that is a more difficult question. And there are strong arguments on both sides. However, on the point about UK emissions being, you know, a small percentage of the global total, uh, I mean, it's a fallacy to say that that's an argument against action. It's clearly, emissions are created everywhere. Where there's human life and economic activity, everyone has a responsibility to reduce them. And, you know, it's, it's. The answer is for everyone to do it and we're not going to make things better by saying, oh, well, we're not going to do anything until you do. That's essentially the situation before the world realized it had to act and start collectively getting together to tackle this problem in 1992. So it's obviously incumbent on everyone to do it. And the key point is, well, is that it's economically advantageous. The world as a whole will face far lower costs by making the investments now and sometimes making the sacrifices now to get emissions down than the terrible costs we're going to face. If we let them, uh, continue to rise.

Speaker A: All right. Well, thank you, John. We do have listeners in Manchester. I can see from our statistics and our, you know, the app that shows us all this analysis. I don't know whether Andy Burnham is among them but certainly plenty for him there, uh, to take stock of. And of course he can read for free your opinion piece on this which is called Burnham Needs a Cause Two would please the bond market. And uh, yeah, I would certainly urge him to do so and everyone else who um, wants to know more, uh, that's all we have time for though on this week's episode. So thank you very much for listening and uh, thank you to John, Frank and George for joining me. We'll be back with more from the capital markets next week. Thank you and goodbye.

Speaker B: Thanks very much.

Speaker D: Bye bye.