Business
Will the UK financial chaos spark a meltdown?
The recent chaos on the UK financial markets has generated waves of stress and selling by investors far beyond the UK.
As the sell-offs collide with high inflation, rising interest rates and the war in Ukraine, they have raised fears the turmoil in the UK could set off a wider crisis.
Many analysts have said they believe the fallout is likely to be limited, especially amid signs that the government is reconsidering some of its plans.
Chancellor Kwasi Kwarteng was sacked on Friday, and the government has dropped parts of the package of tax cuts that initially sparked the market turmoil.
But the episode has highlighted the financial risks of the current moment.
“Markets are fragile. We have seen vulnerability that’s been building over the last decade-plus,” Fabio Natalucci, a deputy director at the International Monetary Fund (IMF), said earlier this week, describing the UK episode as a “warning shot”.
“That fragility makes the financial risk much more elevated.”
How did this start?
Borrowing costs in the UK shot up last month, triggered by Mr Kwarteng’s announcement of £45bn of tax cuts in his mini-budget, which the government said would help reignite economic growth.
But he did not say how he would pay for them, which alarmed investors already worried about the UK’s dim economic prospects. They swiftly sold off their holdings of UK government debt, also called bonds or gilts.
Why does this matter?
The sell-off in UK government bonds prompted a dramatic change in their value.
Prices dropped and investors demanded a higher interest rate for holding a riskier investment, creating major volatility in what is usually considered a stable, safe investment.
That kind of swing can have big ripple effects, as investment firms adjust their holdings to cover losses and the increased risk.
In the UK, some of the first cracks appeared at pension funds, giant investment firms that manage people’s retirement savings and typically put a big chunk towards investments like government debt.
Facing losses that were at risk of spiralling, pension funds pleaded for help from the Bank of England, which agreed to step in and buy government debt as an emergency intervention. In fact, the Bank of England ended up stepping in three times.
The sudden rise in borrowing costs also meant chaos for the UK housing market, where mortgage rates on typical two and five-year fixed deals have jumped to more than 6% for the first time in over a decade.
Analysts expect the rise in mortgage rates to spark a fall in property prices, meaning that another investment often seen as pretty safe is suffering a major, rapid change in value.
How has this affected other countries?
Interest rates on some US and European government debt have also jumped alongside the UK’s.
And as UK firms respond to the changing market, they have dumped some of their riskier assets, creating knock-on effects.
For example, selling of collateralised loan obligations (CLOs), a term for bundles of corporate debt, jumped in the weeks after the UK announcement, the Wall Street Journal reported. That is a part of the market that some already saw as full of financial risks.
“There is a general sense of unease in financial markets because we never know where the landmines are buried,” said economist Barry Eichengreen, professor at the University of California, Berkeley.
“People are worried about which insurance companies and which pension funds and which bond markets are in a delicate state at the moment and we never know for sure.
“When bad things happen anywhere, people pause and global risk aversion rises.”
So will this become a global financial crisis?
IMF officials said last week that global financial instability was now verging on crisis levels, as investors pull back.
“We are certainly at a stressed moment,” said Tobias Adrian, financial counsellor at the IMF warned, noting that indicators of strain, like demand for dollars, have surged. “The only times when things were worse was in times of acute crisis.”
The organisation did not forecast a major financial blow-up, noting that the traditional banking system in major economies like the US and UK has become more resilient in response to regulations imposed after the 2008 financial crisis.
But there are more vulnerabilities in emerging markets, where the Fund estimates that 29% of banks are at risk of financial problems in the event of a sudden, serious downturn.
In the US and UK, officials are also worried about unknown problems in the large “shadow banking” system – where investors develop and trade debt products largely outside the view of regulators.
As central banks around the world raise interest rates, those piles of debt may come under strain.
“When we look at the safety and soundness of the financial system… we should look at not only the banks but also the non-bank lenders,” Ben Bernanke, who led the US central bank during the 2008 financial crisis, warned on Monday.
He was speaking at a press conference that was supposed to be about his winning the Nobel prize in economics, but was dominated by questions about the current economic risks.
For now, the turmoil stemming from the UK appears to be a “bump in the road,” Jamie Dimon, head of US bank colossus JP Morgan said Friday.
But he warned: “There are going to be other surprises”.
Reports /TrainViral/
The prospective new owner of Royal Mail has said he will not walk away from the requirement to deliver letters throughout the UK six days a week, as long as he is running the service.
“As long as I’m alive, I completely exclude this,” Czech billionaire Daniel Kretinsky told the BBC.
Mr Kretinsky has had a £3.6bn offer for Royal Mail accepted by its board.
Shareholders are expected to approve the deal in the coming months, but the government also has a say over whether it goes ahead.
Currently the Universal Service Obligation (USO) requires Royal Mail to deliver letters six days a week throughout the country for the same price. But questions have been raised over whether the service could be reduced in the future.
In an exclusive interview with the BBC, Mr Kretinsky also said he would be willing to share profits with employees, if given the go-ahead to buy the group.
However, he appeared to reject the idea of employees having a stake in Royal Mail, which unions have called for in exchange for their support.
The Royal Mail board agreed a £3.6bn takeover offer from Mr Kretinsky in May for the 500-year-old organisation, which employs more than 150,000 people. Including assumed debts, the offer is worth £5bn.
But because Royal Mail is a nationally important company, the government has the power to scrutinise and potentially block the deal.
As well as keeping the new government on side, Mr Kretinsky also faces the task of convincing postal unions that the proposed deal will benefit employees.
The USO is a potential sticking point for both the government and unions.
Royal Mail is required by law to deliver letters six days a week and parcels five days a week to every address in the UK for a fixed price.
How well this has actually been working in practice is a different matter. Ten years ago, 92% of first class post arrived on time. By the end of last year it was down to 74%, according to the regulator Ofcom.
Last year the regulator fined Royal Mail £5.6m for failing to meet its delivery targets.
Royal Mail has been pushing for this obligation to be watered down. It wants to cut second class letter deliveries to every other weekday, saying this will save £300m, and lead to “fewer than 1,000” voluntary redundancies.
‘Unconditional commitment’
Mr Kretinsky has committed in writing to honouring the USO, but only for five years.
And after that, in theory, the new owners could just walk away from it.
However, Mr Kretinsky told the BBC: “As long as I’m alive, I completely exclude this, and I’m sure that anybody that would be my successor would absolutely understand this.
“I say this as an absolutely clear, unconditional commitment: Royal Mail is going to be the provider of Universal Service Obligation in the UK, I would say forever, as long as the service is going to be needed, and as long as we are going to be around.”
Mr Kretinsky added that the written five-year commitment was “the longest commitment that has ever been offered in a situation like this”.
Another potential stumbling block for the deal, however, is how the company will be structured.
Unions would like to see the company renationalised, but Dave Ward, general secretary of the Communication Workers Union (CWU), told the BBC that would be “difficult in the current political and economic environment”.
Instead, what the CWU is pushing for is “a different model of ownership” – that is, where the employees part-own the business.
To get its support for the takeover, the union wants employees to share ownership of the company, along with other concessions including board representation for workers.
It says profit sharing is “not going to be enough to deliver our support and the support of the workforce”.
If the union doesn’t get what it wants, it won’t rule out industrial action, Mr Ward said. Its members went on strike in 2022 and 2023.
Although Mr Kretinsky said he is “very open” to profit sharing, he is not in favour of shared ownership.
“I don’t think the ownership stake is the right model,” he said. “The logic is: share of profit, yes, [but an] ownership structure creates a lot of complexity.
“For instance, what happens if the employee leaves? He has shares, he is leaving, he is not working for the company, he [still] needs remunerating.”
Mr Kretinsky said he didn’t want to create “some anonymous structure” but instead “remunerate the people who are working for the company, and creating value for the company”.
The union is also concerned about job losses and changes to the terms and conditions of postal workers’ contracts.
Mr Kretinsky has guaranteed no compulsory redundancies or changes in terms and conditions but only until 2025.
“If we are more successful, and we have more parcels to be delivered, we need not less people, but we need more people,” he said. “So really, job cuts are not part of our plan at all.”
He said if the management, union and employees work together, “we will be successful”.
Another concern is the potential break-up of the business.
The profit for Royal Mail’s parent company last year was entirely generated by its German and Canadian logistics and parcels business, GLS. Royal Mail itself made a loss.
Mr Kretinsky has promised not to split off GLS or load the parent company with excessive debt, although borrowings will rise if the deal goes through.
But he has a way to go to convince the CWU.
“I can’t think of any other country in the world that would just just hand over its entire postal service to an overseas equity investor,” Mr Ward of the CWU said.
However, Mr Kretinsky said that the postal unions “do understand that we are on the same ship, and that we need this ship to be successful, and that if we are there, we don’t have any real problems to deal with, because the sky is blue, and it’s blue for everybody.”
The union cannot stop this deal but the government can block it under the National Security and Investment Act.
Business Secretary Jonathan Reynolds has said he will scrutinise the assurances and guarantees given and called on Mr Kretinsky to work constructively with the unions.
Mr Kretinsky may say that he and the unions are ultimately on the same ship but, as things stand, they are not on the same page.
Who is Daniel Kretinsky?
Daniel Kretinsky started his career as a lawyer in his hometown of Brno, before moving to Prague.
He then made serious money in Central and Eastern European energy interests.
This includes Eustream, which transports Russian gas via pipelines that run through Ukraine, the Czech Republic and Slovakia.
He then diversified into other investments, including an almost 10% stake in UK supermarket chain Sainsbury’s and a 27% share in Premier League club West Ham United.
The Czech businessman is worth about £6bn, according to reports.
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