Few predicted the first global pandemic in a century, and certainly not the impact it would have on the global economy and capital markets.
The emergence of Covid-19 saw governments scramble to control the spread of coronavirus, imposing lockdowns and social distancing measures to prevent healthcare systems from becoming overwhelmed.
Capital markets were also impacted with greater levels of volatility as demonstrated by the VIX volatility benchmark. Many asset classes saw steep falls in valuations and rating downgrades as the extent of the pandemic became clear.
However, just as markets sold off, governments and central banks stepped in to provide extraordinary levels of support not seen since the 2008 global financial crisis. Looser monetary policy in the form of quantitative easing (QE), the cutting of interest rates to all-time lows by central banks, and greater fiscal support from governments – estimated at around $11.5trn, according to the IMF – helped prevent the health crisis from becoming a full-blown financial one.
Awash with cash
Capital markets proved their resilience, recovering as more support was promised and liquidity made available. This was evident in the way that higher-rated companies were able to continue to access debt markets last year, even as a vaccine remained on a distant horizon.
Securities trade body SIFMA reported that in 2020 there was $9.9trn in fixed income issuance in the US (through October), up from $8.9trn in 2019, while a further $66bn was raised in initial public offerings on US exchanges.
Whilst the emergence of several viable and effective vaccines has been welcomed, there has been a great deal of hope attached to them in the media. But, following a year in which lockdowns were imposed with just a few hours’ notice, capital market participants might want to temper any optimism with some caution, particularly if the coronavirus situation deteriorates further.
Nevertheless, if the vaccinations are successful – both in reaching large numbers of people and in reducing transmission – then the mood music will be incredibly positive, and should translate into a significant uplift in capital markets activity.
Where to look
Deal uptick
M&A volumes, in particular, should benefit after a more subdued 2020. UNCTAD’s World Investment Report found that cross-border M&A volumes in developed markets had fallen by more than 50% compared with the 2019 monthly average during the first few months of 2020, notwithstanding pre-Covid challenges such as the move towards protectionism and greater trade uncertainty.
Yet, there are still several challenges from last year that have not disappeared entirely, and clients need support now more than ever.
Assets in distress
The emergence of the coronavirus placed greater pressure on companies that were already showing signs of strain before the pandemic began and has acted as a catalyst for something that many in capital markets had been expecting for some time.
The pandemic has shortened the business cycle, pushing embattled companies to the limit. As a result, there was an increased focus on restructurings during 2020 and an increase in covenant breaches, which will likely continue in 2021. Further restructurings this year cannot be ruled out particularly as default rates are likely to rise or fall depending on the success of the vaccine roll-out.
Any change in the willingness of governments, regulators and banks to provide payment holidays or forbearance that were announced early on in the pandemic, coupled with lender dynamics and demands would likely lead to an increase in restructurings.
From a private equity perspective, there could be an opportunity for firms to generate returns from assets that have moved to increasingly attractive valuations during the pandemic. According to data from PwC, the private equity industry had $2.6trn in dry powder waiting to be deployed as of August 2020.
Real Estate
Elsewhere, it may take time for areas such as property, which have been impacted as governments ordered people to work from home wherever possible, to recover. The asset class has tended to act as a bellwether in times of crisis, with investors looking to reduce exposure for more liquidity. This had a significant impact on the market for commercial mortgage-backed securities, according to a Financial Times report.
Brexit & LIBOR
Despite some of the challenges to markets in 2020, participants have continued to work hard to resolve more longstanding issues too. While dealing with the fall-out from the Covid-19 crisis, capital markets have continued to navigate complex operational issues, such as the end of LIBOR and Brexit. While the end-2021 deadline to remove LIBOR dependency is fast approaching, many participants have already made great strides to ensure compliance and issues have been flagged, the Financial Standards Board noted in a recent report.
The uncertainty caused by Brexit negotiations is unlikely to rear its head again this year as an agreement, avoiding a hard BREXIT, was reached with just a week to go before the deadline. This followed months of speculation over whether the UK would exit the EU with a deal or not and how its post-Brexit trading relationship would look. As such, the operational headaches are now likely to be behind many firms who raced to prepare for a ‘hard’ Brexit.
ESG Risks
The events of 2020 heightened the focus on risks of all types, including environmental, social and governance considerations. ESG finally matured, moving from a buzzword to an essential and integrated factor in deploying capital
During 2020, ESG strategies saw greater inflows than other parts of the investment industry as investor appetite has increased, helped by the fact that many of the types of companies they invest in were among those benefiting from lockdown conditions.
Greater awareness and familiarity with such strategies has spurred demand from an institutional investor standpoint and there are an increasing number of signatories to the United Nations’ Principles for Responsible Investment. And while many managers will have seen their P&L statements impacted by the coronavirus, ESG investing could also present an opportunity for managers to generate returns and have a positive impact on the world and wider community.
